ImaginativePRO Blog

VC-BACKED STARTUP LIFE EXPECTANCY EXPECTD TO FALL DRAMATICALLY IN 2023 AND 2024

Only one out of every 10 startups survives, said the old adage. But that was far from the case during the boom years of the last cycle when company failure rate was low—very low.

Miguel Luiña, managing director of fund investments at Hamilton Lane said,

"VCs expected a certain percentage of their portfolio not to make it to the next round, but [company survival] has been off the charts."

He added that for certain managers, almost 100% of their companies raised subsequent funding during the capital-rich era that ended last year.
  
The number of VC-backed companies filing for bankruptcy or shutting down has hovered around 1,000 per year since 2016, according to PitchBook data. At the same time, new startup formation has increased, as measured by first VC financing, greatly exceeding startup failures.

Staying alive

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But the years of low startup mortality are coming to an end.

Last week, Wyre, a nearly 10-year-old blockchain-based payments company, reportedly told employees that it is going out of business. A couple of days later, The Wall Street Journal reported that Genesis, a large crypto lender, is considering filing for bankruptcy protection.

While last year's valuation correction has yet to force many companies to close their doors, investors expect the shutdown rate to shoot up dramatically in the second half of 2023 and into 2024.

Micah Rosenbloom, a co-founding partner at Founder Collective said,

"I think loss ratios will be triple—or some big multiple of what they've been." 

The most severe ramifications of the slump are taking a while to manifest for several reasons.

Startups entered the downturn with a decent amount of cash that allowed them to continue operating, and investors did everything possible to help their portfolio companies stay alive by providing bridge financings or helping them secure venture debt.

But most venture capitalists won't be as supportive of their weaker investments this year, as they seek to protect existing capital commitments.

Yash Patel, a general partner at Telstra Ventures said,

"In 2022, [VCs] put money in a lot of companies that probably they shouldn't have." 

Last year, there was still "hope" that many struggling startups could be kept alive, but now it looks like VCs may have been throwing good money after bad, Patel said.

"Investors are going to get very strict about their reserve allocations, saving [funds] for the best winners."

While the number of shutdowns is still low, high-profile closures are on the rise.

So far, the prominent shutdowns have been in the battered crypto space, but investors expect failures in other technology areas.

As to what kind of businesses will go under, VCs are not singling out specific verticals. 

Rosenbloom of Founder Collective said,

"I think it's going to be companies that just either didn't realize how hard this is going to get and could not get control of their burn rates."

COMMENTARY:  At end of Q3 2022, Venture capital activity measured by exits is down against the historic levels achieved in 2021 and Q1 2022 but still well above historical averages. At the same time there has been a uniquely positive aspect of 2022 for the venture industry with US and global “dry powder”—funds available to be invested—standing at a record $572 billion globally and $290 billion in the US.

Today, VC funds are very well stocked to make rounds of new investments at much healthier valuations compared to one year ago.  However, the dramatic valuation gains of the last five years mean established venture investors are typically overexposed within portfolios (“the denominator effect”), pausing on new allocations. At the same time, new institutional venture investors are appearing, especially in family offices, foundations, and endowments (along with their outsourced CIOs), all assessing how to build venture exposure for decades to come.

Lessons From Past History -- Technological Innovations Always Wins

It’s almost over-written that recessionary times bring out the best in exceptional entrepreneurs and young companies. Like an ice bath to a strong athlete, the shock from rapid change in the environment forces rapid adaptability and resilience while narrowing operating focus and creativity. 

During recessions the strongest startup companies are quicker and more adaptive to:

• Cost efficiency needs.
• Customer acquisition gets cheaper.  
• Hiring gets easier to compete in.

(Competitor layoffs and reduced stock option values in bigger corporations mean the opportunity cost of quitting to join a startup you’ve had your eye on for some time is lower.) In addition, the most talented entrepreneurs and companies enjoy competing to secure new capital rounds in an environment where investors get much more selective.  

There are secular factors to bear in mind as a driver of venture capital investments, over and above the capital market cycle. Accel Founder Arthur Patterson, whose lifetime of venture experience spans multiple market cycles, shared with me the observation that the supply of innovative new companies is the real determinant of overall longer-term returns, created primarily by technological innovation but with social behavior trends also a factor in enabling new company supply.

These secular factors in the formation of new companies are independent of VCs or IPOs. Consider how the year 2008 was not only the lowest point in the business cycle but also a pivotal year in the development of mobile (iPhone 2 released ex-US and with 3G) and cloud computing technologies (DropBox first software release, 2008, with iPhone app 2009). Facebook and Twitter would not have gone viral in the same way in the early 2000s on desktop web browsers as they did on smartphones from 2008-10.

Mar Hershenson, Managing Partner, Pear Venture Capital provides a view of the future.  

“We will see more real companies and better investors. Less money in the system means companies need to have better operational excellence (do more with less money). Investors are also going back to basics. Diligence is back, along with appreciation for companies that are building real value, not relying only on future value.  Less founders. Less investors. More opportunities. When it is harder, the tourists leave.”

Startups are going to have a tough year in 2023. While many have gotten their burn rates way down, most startups still are losing money and will eventually need to raise capital in 2023. Because most startups avoided raising in 2022, there will be a glut of startup companies in the market for capital this year and while there is plenty of venture capital sitting on the sidelines waiting to be deployed, VCs will be much more selective, instead of funding everything that moves as we’ve done over the last few years.

Good businesses with product market fit, positive unit economics, and strong leadership teams will raise capital although it will be at the new normal in terms of valuation. I believe that “new normal” is more or less where we were in 2015:

• Seed rounds were done around $10mm.
• A rounds were done around $15mm to $25mm.
• B rounds were done around $25mm to $50mm.
• Growth rounds had a cap at 10x revenues.

This new normal will lead to many:

• Flat Rounds - A flat round cis when the valuation remains the same from the previous round of funding.  
• Down Rounds - A down round refers to a scenario where the value of a business at a time of investment is below the value of the same business during a previous period or financing round.  Normally during a down round, investors purchase equity in the business at a lower price, in comparison to previous investors.
• Inside Rounds - An inside round is additional investment that is made by a company's existing investors. From outside a company, it is difficult to know why it was done or whether a company is doing well or not.
• Structured Rounds - Highly structured rounds are almost debt that sits on top of the existing equity capitalization structure. 

None of that is good, but the worst of those options is rounds with a lot of structure.  I believe founders and CEO's and Boards should take the pain of a new valuation (flat, down, whatever) over structure.

But there is a huge number of startups out there that have not really found product market fit, have not created positive unit economics, and have unresolved issues in their founding teams and leadership teams. These startups will struggle to raise capital at any price and most of them will fail. This has already started to happen but because so much capital was raised in 2021 and the early part of 2022, it has taken longer for these companies to fail. I think we will see a lot of startups in this category go under or taken out in fire sales in the first half of 2023.

Venture Capital Slowdown Is In Full Swing

Global venture funding reached $74.5B in Q3’22, hitting a 9-quarter low. This represented a 34% drop quarter-over-quarter (QoQ) — the largest quarterly percentage drop in a decade — and a 58% decline from the investment peak reached in Q4’21.

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The number of deals fell to 7,936 total, marking a 10% quarterly drop.

US-based companies accounted for just under half (49%) of global funding in Q3’22, collectively raising $36.7B across 2,866 deals. Some of the largest rounds in the US went to TerraPower, EnergyX, and Xpansiv.

As noted previously, VC firms have huge amounts of a capital available for startups, but are adopting the "new normal" when deciding on seed to late stage rounds, and limiting funding in 2023 to startups with my "Big Four Must Haves": 

• Proven Market Fit.
• Sustainable Business Model.
• Experienced Management Team.
• Competitive Advantages.    

As a management consultant, I strongly recommend that startup CEO's and founders concentrate on innovation, indentifying their best customers, understanding the customer journey start-to-finish, rapid and precise execution to gain traction and market share and developing competitive advantages.  This is why an experienced management team is so important and essential in executing the "Big Four Must Haves."         

Deal Count and Value Declines in Q3 and Q4 2022 

The deal count in 2022 for the full year was 15,852, down 14% from 18,521 in 2021. And deal value was $238.3 billion, down 30% from $344.7 billion a year earlier, according to a report by Pitchbook and the National Venture Capital Association (NVCA).

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U.S. VC exit activity was 1,208 deals valued at $71.4 billion, down dramatically from 1,925 deals valued at $753.2 billion a year earlier

With each quarter the deal activity declined and that could foreshadow a slide in 2023, the report said.

On an annual basis, angel- and seed-stage deal activity remained relatively resilient in 2022, with $21.0 billion invested across an estimated 7,261 deals. However, the four consecutive quarters of declining deal counts could foreshadow a continued slide in 2023. Seed-stage deal sizes and pre-money valuations demonstrated notable growth over the 2021 figures due in part to a large number of actively investing micro-funds as well as the participation of nontraditional and crossover investors.

Exit Value and Exit Count Continue To Decline 

Nontraditional investors are slowing their capital deployment to VC amid less attractive risk/return profiles. Relative to 2021, the upside potential for the VC asset class declined significantly in 2022, which turned many investors away from the space. As such, just $24.1 billion in deal value involved nontraditional investors in Q4— the lowest quarterly value in three years. Not only are we seeing lower deal value, but we are also seeing fewer nontraditional participants within the venture ecosystem.

Exit activity continued its steep descent in 2022, with just $71.4 billion in total exit value generated—the first time this figure has dipped below $100 billion since 2016. Public exits of VC-backed companies have slowed to almost nonexistent levels, with just 14 public listings occurring in Q4, demonstrating how drastically institutional-investor appetite has been affected by rising interest rates and volatile macroeconomic factors.

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Acquisition activity has also declined significantly; Q4 posted roughly $763 million in total acquisition deal value, the first time we have seen this quarterly total fall below $1 billion in more than a decade.

How Many Startups Fail?

Approximately nine startups out of ten fail. 20% of the startups fail to complete even one year in the market.  In the following section, you will come across facts and figures related to the failure rates of startups. 

• 90% of the startups fail and are shut down. 
• Within the first year of establishment, 10% of startups fail. 
• Companies with 11 to 50 employees are at greater risk of failure. 
• 70% of startups fail within two to five years of their establishment. 

The following table breakdowns the startup failure rates after various years of establishment. 

Until The End of The Year	Failure Rate
1st year	20%
2nd year	30%
5th year	50%
10th year	70%

• Only 6% of the startups that went over Shark Tank have shut down.
• 75% of venture-backed companies rarely return the cash to the investors.  
• In 30 to 40% of cases of startup failure,  investors lose their initial investment. 
• Only 0.05% of the startups receive VC funding. 
• 43% of entrepreneurs are concerned about the failure of their startups. 
• 80% of e-commerce startups fail. The rest 20% succeed significantly.
• In the USA, 80% of startups fail.

Courtesy of an article dated December 22, 2022 appearing in Forbes, an article dated January 1, 2023 appearing in AVC, an article dated October 11, 2022 appearing in CBInsights, an article dated January 5, 2023 appearing in Venture Beat and an article dated  January 11, 2023 appearing in Pitchbook

WHERE STARTUP FUNDING REALLY COMES FROM (INFOGRAPHIC)

Prominent VCs and angel investors may dominate the headlines with their big sticker investments, but personal loans and credit – along with investments from friends and family – make up the lion's share of funding for startups in the U.S.

According to data compiled by Fundable, only 0.91 percent of startups are funded by angel investors, while a measly 0.05 percent are funded by VCs.  In contrast, 57 percent of startups are funded by personal loans and credit, while 38 percent receive funding from family and friends.  

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COMMENTARY:   Financing a startup is not a simple process.  Below we break down every step of the process and how it impacts your ownership. The first thing to understand about startup funding is that is not done all at once. There are multiple rounds of funding that occur as the business grows.

In the beginning stages, funding will typically come from your savings, loans, and family members. You should create a pitch deck, demonstrate an understanding of the market, and use this as an opportunity to show you have the skills necessary to run a business. 

After you have solidified your pitch, you should consider bringing on a startup co-founder. This person can be someone to bounce your ideas off, or even someone that compliments your skillset. Keep in mind that startups with two co-founders raise 30% more than startups with only one. 

The next stage is known as pre-seed funding. This is when you present your fine-tuned pitch to family and friends, and potential angel investors. Keep your expectations in check, startup funding for this round typically doesn’t exceed a million dollars. However, this money will be critical to the success of your company, allowing you to hire your first employees or even secure an office to work out of. Another option at this stage is to secure a business loan. You’ll have to pay back the loan with interest, but you also won’t be giving up equity.

The next stage is called the seed round. $1.7 million is the typical amount raised during this phase. This is the stage where venture capitalist funds and accelerators start to show interest in your company. However, depending on the source of funding, you may give up 10-25% of equity during this stage. 

The Series A round is the funding round that switches the focus from your company’s potential to its traction in the marketplace. Positive market reception increased revenue, and savvy use of previous investments will all play a role in this round of funding. Venture capitalists, hedge funds, and private equity firms will all be interested during this stage. Series A investments average around $10.5 million and may cost anywhere from 15 to 50% of the equity in exchange. Some businesses elect to try equity crowdfunding at this stage if they don’t attract a lot of interest from large investors. 

The Series B  round funding is traditionally used to scale your business to keep up with increased demand amid strong signs of growth and success.  In this round, you can expect around $25 million in funds in exchange for 15-30% of equity. Series B funding will also draw more scrutiny from potential investors, so make sure the business is fully fleshed out and ready to operate on a much larger scale. 

The Series C round is typically the last funding round before a potential initial public offering (IPO). Investment banks and private equity firms will be targets during this stage. If you make it to this round, your company will not be seen as a risky investment and more attractive to more conservative investors. Money raised during this round could be used to acquire competitors, increase the company’s global footprint, or increase the valuation before an IPO. 

During all the startup funding rounds described above, the shares of the company are privately held, and can’t be offered to the public. Through an IPO, the previously private shares can now be sold to the public. This allows investors to liquidate their shares if they choose and allows the company to raise even more money. Once a company goes public, the value of the company switches from an investor’s valuation to the trust and judgment of the public at large. 

Courtesy of an article dated November 20, 2013 appearing in Entrepreneur.com and an article dated October 26, 2019 appearing in My Startup Land

SNAP'S Q1 2017 EARNINGS UNDERWHELM INVESTORS, REVS $150 MIL, BELOW WALL ST EST, USER GROWTH SLOWS, STOCK TANKS

 

Snap reported quarterly financial results for its first time as a public company on Wednesday, posting revenue that missed estimates and slower-than-expected user growth.

Shares plummeted more than 20 percent on Thursday. The company spent $2 billion on stock-based compensation expenses after its initial public offering, widening net losses for the quarter to $2.2 billion.

CEO Evan Spiegel got a $750 million bonus for taking Snap public. He told analysts on a conference call that the company was focused on improving quality for users during the first quarter, especially for those with Android mobile phones.

Despite the steep loss during the quarter, Snap is "still in investment mode," the company's chief financial officer, Drew Vollero, said on a conference call with analysts.

The Numbers

• Revenue: $150 million reported vs. $158 million expected by a Thomson Reuters consensus estimate.
• Global DAUs: 166 million reported vs. 167.3 million expected by StreetAccount.
• ARPU: 90 cents reported vs. 90 cents per share expected by StreetAccount.
• Loss of $2.31 a share including compensation expenses.
• Analysts at Thomson Reuters estimate an adjusted loss of 20 cents per share, wider than the 19 cents expected.

That's compared with revenue of $38.8 million in the year-ago period.

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Amid trouble at Facebook and Google, unprofitable underdog Snapchat aims for engagement

As the company behind the viral ephemeral messaging app and Spectacles glasses, Snap's IPO was the biggest technology offering since Alibaba.

And it's growing at an extraordinary rate: Revenue rose 286 percent year over year in the first quarter. Daily active users rose 36 percent from the year-ago period, and average revenue per user grew 181 percent.

More than 3 billion Snaps were made daily in the first quarter, the company said, up from 2.5 billion in the third quarter of 2016. Users spent an average of 30 minutes a day on Snapchat, the company's chief strategist, Imran Khan, said on the conference call, and cited Nielsen data showing that many Snap users could not be reached by traditional TV channels.

Khan told CNBC.  

"We made good progress this quarter improving the performance and quality of our Snapchat application, especially on Android, which has helped result in increased net user adds and engagement.  We still have a lot of work to do, and are excited about the potential from continued performance improvements."

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But since its IPO in early March, Snap has faced an uphill battle to convince Wall Street it can make money with advertising, even with Facebook and Google dominating the market.

Spiegel said that automation will help the company make more money for advertisers.

Khan said.  

"People are going to copy your product if you build great stuff.  Just because Yahoo has a search box doesn't make it Google."

Facebook, in particular, has pushed aggressively into Snap's turf. Boss Mark Zuckerberg told analysts that Instagram Stories has 200 million daily active users, and WhatsApp Status has more than 175 million daily active users.

As a whole, Facebook has 1.28 billion daily active users, nearly eight times as many as Snapchat.

Other revenue sources, like Spectacles, have hardly made a dent in the company's business. Analysts surveyed by Thomson Reuters expect Snap to post a per-share loss through the end of 2018.

Snap has not made great gains in the markets, trading mostly below the high of $29.44 in its first week of trading. Indeed, the stock fell as low as $17.07 after hours, just 7 cents above its IPO price, as shares changed hands in heavy volume.

When Facebook, Yelp, Twitter and LinkedIn reported their first quarterly results as public companies, the stocks fell by an average 14.1 percent the next day, according to Jim Strugger, derivatives strategist at MKM Partners.

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Snap should have set its expectations lower, Art Hogan, chief market strategist at Wunderlich Securities, told CNBC's "Closing Bell" on Wednesday. He explained that a company's first earnings report as a public company is "really dependent" on executives giving realistic guidance. But that's just part of the growing pains of becoming a public company, Hogan said.

COMMENTARY:   I won't lie to you,  I am not a fan of startups with unproven or unsustainable business models and no evidence of profitability.  In my opinion, Snap Inc has many similarities to Twitter:  1) user growth slowing down at time of IPO filing, 2) lack of profitability and 3) small market focus (primarily Millennials).  Snaps has positioned itself as a "camera app" that allows Millennials, its core user demographics, to share photos that automatically disappear.  

In a blog post dated October 10, 2016, I commented on Snap Inc's proposed $25 billion IPO.  Like Twitter before it, I had a lot of reservations about the Snap IPO, because there were already strong signs that user growth was slowing down, and many analysts like myself, felt that Snap's business model, which depended almost entirely on advertising, was unsustainable. Furthermore, Snap derived the majority of its ad revenue from the U.S., so in order to sustain growth, this required expanding its user base internationally.   

Snap is very slow in providing advertisers with the tools they need to target potential customers, and this is the same thing that plagued Twitter's ad revenue growth.  On May 4, 2017, Snap announced a suite of tools to help advertisers market to its users more effectively.  If you ask me, they should've done this much sooner.

For those of you who like reading the minutes of Snap Inc's Q1 2017 earnings conference call with investors, you will find it all below:

Snap Q1 2017 Earnings Conference Call Notes from Tommy Toy

Snapchat is opening itself up to advertisers of all sizes with new buying tools

According to an announcement on May 4, 2017, starting this June, Snap is going a step further by flinging wide its gates to advertisers of all sizes and budgets with a new suite of self-service tools. The move could help considerably grow Snap's fledgling ad business, which is expected to reach $1 billion in revenue this year.

Releasing a self-service ads manager is intended to erase any friction that may be keeping advertisers off Snapchat, a company spokesperson told Business Insider. Snap expects larger buyers to still go through one of its auction partners, which offer more custom targeting like timing ads to run alongside TV campaigns or during specific weather conditions.

Snapchat's new ads manager will let any advertiser buy, manage, and view reporting for their campaigns. All ad formats, including app install ads, sponsored geofilters, and fullscreen video, are available alongside existing targeting capabilities like goal-based bidding. The manager is free to use and requires no minimum ad spend.

A new mobile dashboard will also allow marketers to see their ads like a normal user, view analytics, and get notification updates about their campaigns directly from the Snapchat app. Over 20 brands are testing these new tools now as part of a private beta, and Snap plans to make them available to everyone in June.

Below is the Snap Inc Q1 2017 Earnings Report Press Release: 

Snap Q1 2017 earnings report from Tommy Toy

Courtesy of an article dated March 13, 2017 appearing in MedaPost MoBlog, an article dated May 10, 2017 appearing in MediaPost Social Media & Marketing Daily, an article dated May 11, 2017 appearing in CNBC and an article dated May 4, 2017 appearing in Business Insider

SNAPCHAT PREPARES FOR A $25 BILLION IPO, BUT THIS COULD BE TOO EARLY AND THE BUSINESS MODEL MAY NOT BE SUSTAINABLE

 

Snap, Inc. is reportedly preparing an IPO that will value the company formerly known as Snapchat at around $25 billion.

The social darling is shooting for a March offering, The Wall Street Journal reports, citing sources. A company representative declined to comment on the report, on Thursday. 

Standing in stark contrast to struggling social networks like Twitter, Snapchat is presently making more money than it can count.

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Indeed, despite direct competition from Facebook and other tech giants, the company is positioned for “explosive” growth in ad revenue over the next few years, according to a recent forecast from eMarketer.

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The research predicts that the playful messaging app will generate $366.69 million in ad revenues this year.

That figure is expected to jump to $935.46 million, next year.

Cathy Boyle, principal analyst at eMarketer, recently said Snapchat’s bright outlook has everything to do with its young user base.  Boyl notes in a report.

“Advertisers are attracted to Snapchat for its broad reach among young Millennials and those in Generation Z, which are valuable demographic groups for many businesses.” 

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To its credit, Snapchat has also tailored its ad strategy specifically for this easy-to-alienate demographic.

According to Boyle.  

“To engage those often hard-to-reach consumers, Snapchat has expanded its advertising portfolio over the past year to include a wider array of video ads and more sponsored geo-filters and sponsored lenses.”

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Stateside, Snapchat’s Discover feature generates 43% of ad revenue, which is its largest single share, according to eMarketer.

Next year, however, the research firm expects Stories to overtakes Discover as the dominant ad revenue source -- by generating 37.8% of the company’s domestic ad revenue.

Having launched its ad platform in mid-2015, Snapchat still only captures 2.3% of social-networking dollars, eMarketer estimates. That’s despite the fact that it now commands 36% of the market in terms of domestic users. 

Approaching its would-be IPO, Snapchat continues to experiment with new categories.

Bounding into hardware and physical fashion, the company recently unveiled Spectacles -- stylish video-recording sunglasses that are expected to retail for $130.

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Set to hit shelves later this fall, the shades can record 10-second video snippets, which are designed to approximate one’s natural field of vision. That's thanks to a 115-degree lens, which records circular video. If Spectacles are well received, Snapchat would become the first company to convince consumers to wear connected gadgets on their face.

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Google notoriously spent millions of dollars in development and marketing dollars, before giving up on its Glass initiative. Yet Snapchat -- which just rebranded itself as Snap, Inc. -- seems to have learned a few things from Google's failure.

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Spectacles’ $130 price tag is far more reasonable than the $1,500 that Google tried to charge people for Glass. Snapchat’s glasses are also being sold as a single-purpose device, which is historically much easier to market.

like Google, Snapchat currently enjoys a strong bond with young consumers -- the ideal demographic for starting trends and popularizing products.

Although bold, Snapchat’s move into hardware should not come as a complete surprise to industry watchers. The social darling recently joined the industry group that runs the Bluetooth wireless standard, which followed several hires and smallish acquisitions in the arena of consumer electronics.

COMMENTARY:  I have to confess that I have not followed or even taken the time to use and evaluate Snapchat because I am most definitely not in their demographics.  The idea of posting photos that dematerialize is something that just does not interest me.  I ask the question:  Why do I need this? I could not bring myself to come to a practical answer.  On the other hand, I wasn't in Facebook's demographics either, but now everybody seems to be using the social giant site to connect and engage with users throughout the world.  

Now comes the news that Snapchat is coming out with Spectacles, their first foray into cnsumer electronics.  Didn't Snapchat's founders realize how intrusive taking someone else's picture without their permission can be?  Google found this out when they introduced Google Glass, their augmented reality glasses.  The cost for a pair of Google Glass was also prohibitively expensive.  Maybe Snapchat will have better luck.  Millennials are pretty impulsive, and love trying the latest in consumer electronics devices. They make the lions share of early adopters.  The price is just right for Millennials, who are strapped for cash and carry a lot of debt, mostly from student loans.  The glasses look "retro cool," but they don't rock my world from a designer standpoint.  On the other hand, Spectacles differentiate the company from Instagram and Twitter's Vine and Periscope which also allow users to exchange video content via mobile devices.  However, it still comes down to a sustainable business model, and Snapchat only began running ads in mid-2015.  In my opinion, this is not a very long time to prove the sustainability of their business model.  

The big news of the day is that Snapchat is planning a $25 billion IPO.  I smell another Twitter IPO in the making.  A startup that just began making money from ads in md-2015 is not reliable proof of a sustainable business model.  Snapchat relies exclusively on Millennials, and that market although large, and soon to be the largest demographic segment in the US, is not broad or mainstream like Twitter or Facebook.  Another question:  How profitable is Snapchat?  If they are anything like Twitter at this stage of their development, they are probably not profitable.  Both Twitter and LinkedIn (recently acquired by Microsoft) were never profitable, so I would be very cautious about investing in a startup with such a narrow demographic focus.

I am dying to review Snapchat's S-1 filing.  It should help answer a lot of investor concerns, and validate my own suspicions and doubts.      

Courtesy of an article dated October 6, 2016 appearing in Social Media Marketing Daily, and an article dated June 6, 2016 appearing in AdvertisingAge, and an article dated September 6, 2016 appearing in AdWeek, and an article dated September 24, 2016 appearing in The Verge, and an article dated October 10, 2016 appearing in Profit Confidential

TWITTER'S REPORTS Q1 2016 EARNINGS, BUT WEAK REVS, STAGNANT USER GROWTH, POOR AD TARGETING, MAKE THE STOCK VALUELESS

 

Twitter reported its Q1 earnings today, and they’re not great. On the back of 310 monthly active users, the company posted revenues of $595 million, with Q1 GAAP diluted earnings per share of ($0.12) and non-GAAP diluted EPS of $0.15. This is a big miss on revenues but a beat on EPS.

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On top of this, the company issued very weak guidance for Q2, and currently Twitter’s stock is trading more than 13% down in the immediate aftermath of the results coming out. We’ll update this as it moves.

Twitter (NYSE:TWTR) shares declined 16.2% between the close of trading on April 26 (the day it announced its Q1 2016 earnings the price was $17.71 per share) and April 27 ($14.86 price end of trading)  (Click Image To Enlarge)

Analysts’ expectations for non-GAAP EPS averaged out at $0.10, while the average estimate for revenues was $608 million. The company remains unprofitable with the net loss it reported this quarter coming in at negative $79.7 million. GAAP EPS was expected at negative $0.17. Twitter itself provided revenue guidance of $595 million to $610 million.

The company also issued new guidance on Q2 that spells bad news for the quarter ahead (or at least much lowered expectations). Twitter expects revenues between $590 million and $610 million, but this is a huge step down from $678 million, which is what analysts had estimated before today’s release. Ebitda is also taking a big hit: with Twitter estimating between $145 and $155 for Q2, while analysts had expected $173 million.

Twitter’s 310 million MAUs is not great user growth, although it is up a bit. But this graphic with nearly-identically sized bars, from Twitter itself, sort of says it all when it comes to the topic of stagnating growth.

Monthly Active Users (MAU's) Comparison Twitter vs Facebook, Instagram and Snapchat (Click Image To Enlarge)

As a recap, last quarter (Q4), Twitter disappointed on revenues of $710 million and adjusted EPS of $0.16 per share, with monthly active users 305 million, essentially flat on a year ago and notably a decline from the previous quarter. And a year ago, the company’s stock dropped 18% on poor revenue and user growth.

A year ago, monthly active users were 302 million, with 80 percent of them using Twitter on mobile.

The thing about Twitter is that it is growing in some of the key areas where it hopes to as a business, but just not enough, at least not right now. The company said that advertising revenues were up 37% over a year ago, representing sales of $530 million. But that number was down by quite some way on last quarter, when ads brought in $640 million in revenues.

Part of this is because Twitter is still not pulling in as many big ad dollars as they expected or hoped to. The company noted.  

“Year-over-year revenue growth from large brand advertisers was softer than expected,although brand advertising remains our largest overall contributor to revenue.”

The company in the last quarter has made some waves to try to extend out its position as a media engagement platform, such as its deal to stream NFL games earlier this month, tapping both into its ambition to do more in video as well as sports content. Its early move with Periscope, however, is now facing competition from the likes of Facebook with its new Live product, and potentially Google, which reportedly is also building a live video service.

The company said in its report.

“As we outlined last quarter, we’re focused on what Twitter does best: live. Twitter is live: live commentary, live connections, live conversations. Whether it’s breaking news, entertainment, sports, or everyday topics, hearing about and watching a live event unfold is the fastest way to understand the power of Twitter. Twitter has always been the place to see what’s happening now and our continued investment in live will strengthen this position. By doing so, we believe we can build the planet’s best daily connected audience. A connected audience is one that watches together, and can talk with one another in real time.”

Earlier in the quarter, there was a lot of commotion around the company’s move to play around with the algorithm that serves Tweets to surface them non-chronologically, although we’re hearing a lot less about this more recently both from Twitter and users.

Internationally, it’s made some moves to potentially monetise its audiences outside the U.S. a bit better. In the UK, Germany and Japan (and soon France), Twitter is now working with Yelp to power location services (similar to the deal it has with Foursquare in the U.S.), although a recently appointed a new head of China has been spotted with controversy.

COMMENTARY:   It's become increasingly apparent that Twitter (NYSE:TWTR) is in trouble. Its user base is stagnant, its management is leaving in droves and its financials, as compounded by the company's most recent release, continue to miss the mark. Twitter's current market capitalization is a little over $10.2 billion - 60% down on its 2013 IPO cap.  A number of analyses have addressed each of these points individually, but none have as yet put forward the real issue.  That is, Twitter is essentially valueless.  This conclusion may come as a shock, but it shouldn't be.  Twitter's HQ is on fire, and key members of its management team, have bailed out.  That is the most important evidence.  Why Twitter is valueless will be discussed in more detail shortly, but first, let's note some of the arguments put forward by proponents of the company and its long shareholder base.

1. Perhaps the foremost argument for Twitter's bright future is the vast swathes of user data it holds, and - perhaps more importantly - the real-time data its platform generates.  As we will discuss, these are two very different things, and their value (especially in the case of the former) is overrated.
2. Twitter's large user base is often used to justify its multibillion-dollar market capitalization. A base of more than 300 million monthly active users is nothing to be ashamed of, and while growth is modest, any company should be able to effectively monetize such a large base of users. Twitter is failing to do so - again we will get to why shortly.
3. Twitter's utility as a news broadcasting platform. As stated by CEO Jack Dorsey:  "Twitter is the most powerful communications tool of our time.  It shows everything the world is saying...10 to 15 minutes before anything else."

There are more arguments in support of Twitter, but these seem to be the primary reasons behind an investment in Twitter as things stand - aside from the fact that optimists might regard its current price (78% cheaper than its 2013 highs) as a discount entry.  We hope, however, that the debasing of the three mentioned support points will, by proxy, debase this latter fourth.

We can debunk the above three arguments why Twitter is a worthwhile investment below:

Data - We will look at the data Twitter holds on its users as individuals first, as this is far more relevant to its ability to generate revenues (as things stand).  This is the data Twitter uses to target its advertisements - its sales pitch to potential ad clients, if you will.  Fake profile data aside, it also knows how old we are, where we live and - in many cases - what we do for a living. Aggregate this data and any company worth its salt should be able to offer up a pretty targeted campaign for a client. Not Twitter, apparently. We know this through two primary pieces of information. The first, through a statement made by the company's head of U.S. ad sales back in February. In an interview with Digiday, Twitter's Matt Derella discussed the company's new strategy of serving advertisements to users that aren't logged into the platform. To quickly explain this, in previous incarnations, Twitter would only display advertisements to a user that was logged in. If a non registered, or non-logged in user, was browsing the Twitter feeds of other users, it would be an ad free experience.  

It's reasonable to assume that Twitter should be able to serve far more effective advertisements to users that are logged in than it can to users that aren't (read: anonymous browsers). Not so. Here's what Derella said:

"We can provide the same level of deliverable results that we can with logged-in users."

This means that the data Twitter holds on its users doesn't actually translate to any deliverable benefit to its advertisers. How this can be the case is anyone's guess. The most logical assumption, however, is that Twitter's advertising is equally ineffective for both logged in users and for anonymous browsers, and that the former simply aren't responding to the ads being served across the platform. The second piece of information relates to a shift of ad clients away from Twitter, and is something we'll address in the second part of this piece - the part that relates to Twitter's ability to monetize its userbase.

Let's move on now to the real time data. Back in October,  Twitter's said that the hashtag, and the text-based communication, made for far easier aggregation than, say, Instagram or Snapchat's images. At the time, Twitter had just closed deals with IBM and Bloomberg - deals that looked to mark a shift in focus toward the data side of the business that, for so long, analysts had been screaming at Twitter to take advantage of.  Fast forward to the present day, however, and neither of these supposedly pivotal deals look to have progressed into anything game changing and if latest management-investor communications are to be believed, the company has once again shifted towards trying to redesign its ad offerings (vertical video load, DoubleClick integration, etc.) rather than package and sell its data. The latest news in this arena is that Twitter is targeting Japan as a data customer. There are only 35 million MAUs in Japan (about half the US equivalent figure). If the company struggles to sell its data to US businesses to the extent that advertising still accounts for the vast majority of its revenues, chances are it won't do a whole lot better in Japan. Another example, in this author's opinion, of a Hail Mary from Twitter. To put it another way, another example of the company talking big, but when it comes down to it, not being able to deliver. 

Large User Base - let us now address the second argument in favor of a bullish twitter thesis - the company's user base and its monetization. 310 million MAUs, as mentioned, is a good number. When compared to Facebook (1.59 billion MAUs), it obviously falls considerably short, but to say that a company should be able to effectively monetize 310 million active individuals is not being too hard on Twitter. For some reason, however, it hasn't been able to. Most reading will already be aware that the company generated $595 million revenues during the first quarter of 2016.  Of this number, $530 million came from advertising. Although now we are hearing that the big-ticket advertisers are shifting away from Twitter and toward fresher alternatives such as Snapchat. This isn't a surprise. Twitter has far surpassed the point where it can be considered an experimental advertising platform for the big-name brands.

It's now at the point where advertising agencies and their clients have data on the efficacy of a Twitter campaign and are able to weigh this up against reallocating their dollars toward expanding campaigns on the other established platforms or initiating experimental campaigns on platforms that are at the stage Twitter was half a decade ago. In other words, Twitter has attempted to monetize its user base and to some extent has done so. But as advertisers shift from the platform, chances are we will look back and see the current circa $600 million - or around two dollars per monthly active user - as a peak.

Utility As Advertising Platform - Following on from Dorsey's quote above, and this time with reference not just to Twitter's fast paced, information breaking nature but also its shift into live streaming with Periscope, here's another quote (from the latest report):

"As we outlined last quarter, we're focused on what Twitter does best: live. Twitter is live: live commentary, live connections, live conversations. Whether it's breaking news, entertainment, sports, or everyday topics, hearing about and watching a live event unfold is the fastest way to understand the power of Twitter. Twitter has always been the place to see what's happening now and our continued investment in live will strengthen this position. By doing so, we believe we can build the planet's best daily connected audience. A connected audience is one that watches together, and can talk with one another in real time."

To offer up some credit, this statement is partially correct. Twitter's allure (for some) is that it offers a resource through which individuals looking for access to the latest breaking information can see what's happening.  Twitter offers users a list of "what's trending" on a geographgic basis.  There are a number of issues with this, however.  First and foremost, credibility. There have been numerous studies undertaken (here are three examples, but a quick search reveals plenty more) that totally debase the credibility of Twitter users' response to any crisis or breaking news event. Yes, factual information will generally publish through Twitter before mainstream media channels publish it, but there is a reason for the delay in the latter, and the reason is credibility. With some exceptions, reputable media channels fact check, cite sources and hold accountability for what they publish. The average Twitter user does not, and this unreliability undermines Twitter as a go to news source altogether. How can a user determine what is fact and what is fiction? Further, even if individuals did go to Twitter to glean the latest information before it breaks anywhere else, the chances of Twitter being able to serve them effective advertisements in the sort of environment that requires instant and first look access to a crisis or breaking news event are minimal.

It's important to note that this is not some sort of bias-driven rant intended to discredit Twitter as an investment opportunity. The platform has its uses. I also have an admittedly small, personal and professional following, with whom I'm able to share my blog posts via my Twitter account: @turk5555 Twitter broke the recent Prince passing and I happened to see it there first as I was (likely) performing one of the two already mentioned Twitter related activities.  Others no doubt, will have similar experiences with the platform. Some will use it far more.

When all is said and done, Twitter's advertising model has failed to generate an ROI for investors. Twitter has shown it is unable to deliver any (it has failed to generate a profit since it was founed in nearly 10 years ago) ROI, and any turnaround looks highly unlikely given current conditions.

As a mainstream information sharing platform, or as a forum through which individuals are able to keep tabs on the people that pique their interest, Twitter will probably be around for years to come. It's just not an investment opportunity, and it's not going to be long before even the most ardent Twitter bulls are forced to come to this realization and unload.

When Jack Dorsey returned to the helm as CEO in August 2015, he promised big changes would come, but with the exception of its Moments app, I have not seen any game-changing changes that would spark a turnaround in the number of monthly active users (MAUs) or advertising revenues.   Revenues are up year-to-year, but the increase in video ads has come at the expense of promoted tweets. Advertisers have merely shifted ad dollars from promoted tweets to video ads.    

The biggest problem that I see with Twitter is that it has become a "one trick pony" in the sense that people view it as a place to post your tweets and not much else.  In my opinin, Jack Dorsey must make a huge pivot to redesign Twitter into a social network with features that existing users will fall in love with to increase engagement and new user signups.  I have not seen evidence of either.  

Twitter's failure to provide advertisers, especially large brands, with ad targeting tools based on demographic and online behavior attributes, has created an endless parade of promoted tweets and video ads that are irrelevant to users.  I hope that the recent hiring of a full-time head of marketing, will correct this huge weakness and bring back big ad spenders.

Courtesy of an article dated April 26, 2016 appearing in TechCrunch, an article dated April 26, 2016 appearing in CNBC and an article dated April 26, 2016 appearing in SeekingAlpha

SQUARE'S IPO POPS BY 45%, BUT ITS A LOSER, 25.7 MIL SHARES SOLD AT $9.00, SHARES CLOSE AT $13.07, THE WINNERS AND LOSERS

The most anticipated technology initial public offering of 2015 is in the books and Square finished its first day of trading on the New York Stock Exchange up more than 45% from its $9 per share IPO price. In the aftermath, there will be plenty of talk of unicorns, ratchets and the disparity between public and private valuations. But who actually came out on top and who was hurt in the San Francisco-based company’s IPO? FORBES assesses the winners and losers from Square’s big day.

 

Winners

Jack Dorsey turned 39 on Thursday,  the day of the IPO, and now holds the unique position of being CEO at two multibillion-dollar public companies. While most wouldn’t envy his task,  Dorsey seems to relish the fishbowl-like scrutiny that comes with running both consumer-facing tech firms, Square and Twitter.  Yes, his net worth fell $730 million because Square went public below its last private valuation, but Dorsey has never been in it solely for the money.  He has returned shares to his companies in the past, most recently handing one-third of his Twitter stake back to the social media firm in October. In the Square IPO prospectus, Dorsey committed to give 40 million shares, or about 10% of the company, to a foundation. He’s also not struggling at the moment with a net worth of more than $1.4 billion. It remains to be seen if he can manage the dual-CEO roles, but Dorsey has established himself as one of the leading entrepreneurs of his generation and he’s not even 40.

Square CEO Jack Dorsey receives kiss from his mother, Marcia Dorsey, outside the NYSE (Click Image To Enlarge)

Square CEO Jack Dorsey poses for photo outside NYSE (Click Image To Enlarge)

Square CEO Jack Dorsey with co-founder Jim McKelvey (Click Image To Enlarge)

With Square pricing its offering well below its expected range at $9 per share, Square merchants, some of whom were able to buy in at the IPO price, benefited greatly. Through a special program, certain merchants who use Square products were able to purchase some of the 1.35 million shares that were donated by Dorsey.  Dorsey told FORBES on Thursday.  

“Sellers want to own Square and be investors in our success.”  

It was also a win for retail investors, who were in a frenzy as the stock shot up in its first hour of trading. More than 47 million shares exchanged hands on the first day of trading, according to FactSet data, and those who bought early and held on through Thursday were able to feel the full extent of the stock’s pop. Among those investors was Tod Wilson, a pie maker whose company was used as an example of a successful Square business in IPO filings and on the company’s roadshow video. Wilson “missed the program” that allowed him to buy shares at the IPO price, but bought in on Thursday and is still holding that stock.

As an investor in the company’s late-stage Series E round, Goldman Sachs and other participants in that financing were protected by a provision known as a “ratchet.” While those investors bought shares at a price of $15.46, the company guaranteed them at least a 20% return on that investment. In order to make that happen when it priced its shares at $9 each, Square was required to issue an estimated 10.3 million shares–valued at nearly $93 million at the IPO price–to those investors. Those shares were worth a collective $135 million when the market closed on Thursday.

Losers

Goldman Sachs saw gains on Thursday as an investor, but as underwriters along with Morgan Stanley MS -3.03% and JP Morgan overseeing the IPO process, it certainly left money on the table for its client, Square. This of course opens up a debate as to what constitutes a “good IPO” with companies weighing the benefits of a first-day stock pop to drive investor interest versus taking in as much cash as possible. Publicly bankers often say pricing an IPO is more an art than a science, with the general understanding that a 15%-20% first-day trading pop is optimal in terms of maximizing proceeds and allowing buyers to feel like they got a deal. Had the underwriters priced Square’s shares at $12–in the middle of its suggested $11 to $13 range–the company could have taken home an additional $77 million in cash. Some argued that because of Goldman’s role as a Series E investor and its ratchet preference, the bank may have had an incentive to price the IPO as low as possible.

While investors with ratchets benefited from the provision, Square’s employees did not. Because the company was obligated to issue more stock to those Series E investors, the entire share pool was diluted. At a Silicon Valley tech firm, where employees are often attracted to companies based on the type of equity packages they receive, that won’t sit well with a mid-level engineer or designer who may have given up a cushy job at Google GOOGL +2.32% for Square and its equity. Come the expiration of the lockup period, which prevents investors and those inside the company from selling, employees may find themselves in a tougher market if they want to offload their shares.

Perhaps one of the more curious things on Square’s IPO prospectus was the disclosure of two unnamed investors who bought $30 million worth of Series E shares last month. The company said those backers included one existing investor and one new investor, though a Square spokesperson declined to say who they were. Whoever they were, they bought a total of 1.9 million shares at a price of $15.46 each and waived their right to maintain a ratchet. With shares closing at $13.07 apiece today, that holding is still underwater to the tune of about $4.5 million.

COMMENTARY:   Square, known for its small, white readers that plug into smartphones and tablets, now has a market value of about $3 billion compared to the $5 billion value implied in its fundraising a year ago.

The steep markdown could foreshadow trouble ahead for venture capitalists and other investors who have been pouring billions of dollars into technology startups in recent years.

The IPO discount also leaves Square with less money to draw upon as it strives to turn a profit for the first time in its six-year history. Before paying its investment bankers and other fees, Square raised $231 million in the IPO, instead of the $282 million to $346 million that the San Francisco company had been seeking.

According to Square's S-1 filing, which I described in detail in a blog post dated October 16, 2015, a total of 185,361,631 class B shares are held by outside investors, insiders and directors.   The percentage of total class B shares held by major shareholders include Jack Dorsey (24.4%), Khosla Ventures (17.3%) and Director James McKelvey (9.4%).

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Square had to discount its IPO shares at the $9 per share late Wednesday, below a target of $11 to $13 that Square set the week before.  The price is 42 percent below the $15.46-per-share price that Square fetched a year ago when it raised $180 million while it was still a privately held company.  In my opinion, this was just a strategy by the IPO underwriters Goldman Sachs, JP Morgan and Morgan Stanley to line their pockets at the expense of Square.  Shame on Jack Dorsey for letting them get away with this.  Don't let Jack Dorsey ever give you advice on bluffing while playing poker. He left a lot of money on the table    

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The initial public offering of Square was supposed to be a sign of doom for unicorns (startups with pre-IPO market values of $1 billion or more), a proof that you can't make money investing in pre-IPO tech companies any more. On the other hand, here is how much money Square's investors have actually made, by funding round: 

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Those are paper profits, based on Square's $9 per share initial public offering price, and on a $13.50 per share trading price as of about 11 a.m. Here they are in table form:

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If you invested in Square at any point, from its Series A round in 2009 through its IPO last night, you've made at least a 20 percent return on your money as of this morning, or about a 7 percent compound annual growth rate. And if you got in early enough, or late enough, your returns were way better. In aggregate, Square's investors have tripled their money; its pre-IPO venture capital investors have almost quadrupled theirs. Everyone can breathe easy now! Unicorns are fine again.

Obviously there were some bumps along the way. Thursday's IPO priced below the Series D round, leaving the Series D investors with a paper loss. It priced even farther below the Series E round, but the Series E investors had negotiated for themselves a "ratchet," in which Square essentially guaranteed them a 20 percent return in the IPO. Their shares were worth only about $87 million at the IPO price, so Square had to give them another 10.3 million shares -- worth another $93 million -- to make up for it.  

WHAT TO MAKE OUT OF SQUARE'S IPO

The stock market guru Ravi Bala of Seeking Alpha really know how to sense out of the Square IPO. Ravi took the time to compare the financials for Square Inc and Twitter, and I agree with his conclusions. Seeking Alpha says.

"Square (NYSE:SQ), like most IPOs, runs on stories. How an unprofitable company got into the market is beyond me. There are parallels between Dorsey's new company and his older one, Twitter (NYSE:TWTR), that makes me believe that Square is on track to cause major headaches to investors who will focus on the future and not pay attention to current results.

Square was founded in 2009 and just went public. It is approximately six years in business and is unprofitable. Twitter was founded in 2006 and went public in 2013. Interestingly, both went public in November in their respective years. Both companies are very young. Just as Twitter has shown, I would say that Square needed to stay private for a bit longer until it showed signs of profitability before entering the public markets.

Take a look at the two financials below. The first table is Square and the second is Twitter. Notice the general similarities. Net income and cash flows are negative despite increasing revenues. What struck me as interesting is that both companies had increasing revenues and increasing negative free cash flow in their respective years as they finished their IPOs. Everyone in the investment world touts the philosophy of Warren Buffett, but no one seems to apply his sage wisdom. You just do not invest in companies that have not proven themselves out. Like Twitter, Square is still trying to prove its concept out. There is no moat established. For GARP investors, what did Peter Lynch say? He said that you need to see a tendency in growing earnings. Square shows the complete opposite.

Square Inc Financials

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Twitter Financials

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Here is where things get much more interesting. Below I extend the table and show you how worse off Twitter has been since it went public. Revenues have been increasing, but it has become very obvious that the net income and free cash flow numbers are accelerating in the wrong direction. I do not want to draw any conclusions but based on the youth of Square and the fact that it may be losing one of its biggest customers, Starbucks, I think Twitter's performance foreshadows Square's future.

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I took a look at both companies' S-1 filings to see if there were any similarities. Four of the banks who underwrote Twitter's IPO underwrote Square's. I'm very curious to know why these banks would want Square to go public given that its financials going into the IPO were much worse off than Twitter's. It may not mean much to some people, but I would not trust their judgment this time for their poor judgment last time."

SQUARE IS A LOSER IN SHEEPS CLOTHING

I don't think that Ravi Bala is not too far off in his assessment of the Square IPO.  I don't think we will have to wait more than a year or two to realize that the Square IPO never should've happened.  There is just too much shit going on right now that is likely to affect stock prices in the immediate future, not including rising interest rates, ISIS terrorism, Square's unproven and unprofitable business model, geo/political problems like a possible confrontations with China, North Korea and Iran.  When you add the weakness in the IPO market, the underwriters rushing (more like RUNNING) to get this IPO in the books before the end of the year before stocks lost their luster, it would not surprise me if there is a shareholders revolt somewhere along the way, when this thing collapses due to some or all of the above.  

I keep reading that Jack Dorsey was the only logical choice that Twitter had, so they kept him to serve as permament CEO.  It's quite a challenge to fix the problems of a bad and underperforming company, let alone two simultaneously.  If you ask me, I think Twitter's board of directors should've hired Snoop Dogg.  He offered to serve as CEO, and I think they should take him up on it.           

In my blog post (see above) about Square's IPO filing, I made the following comments about Square's IPO which you should note.

"I am always concerned when a startup that has never generated a profit since it began operations, that startup competes in a mature and highly competitive industry (credit card payments) and that industry is dominated by larger and more established players, and that startup is led by a CEO (Jack Dorsey) who splits time between two troubled companies (Twitter and Square), and then that CEO thinks its time for an intial public offering when stock market indicators say otherwise, then it makes me wonder about the wisdom of that CEO.  This is the case with Square, Inc. and CEO Jack Dorsey.

Jack Dorsey has his work cut out for him, not only with Square, but especially with Twitter, a social network which has never generated a profit, has lost numerous executives since the start of this year, whose monthly active users has stalled, and advertisers are questioning Twitter's viability as an advertising platform.  

Dorsey recently announced that Twitter would layoff about 10% of its workforce or about 336 employees, mostly from its engineering staff.  This will cost the company about $20 million in severance payments and other separation entitlements.  Even after you factor the savings from in wages, payroll taxes and employee benefits due to these layoffs, this will not make a substantial dent in their operating losses to date.  This makes you wonder if Square will require some staff pruning after the IPO.   

Even if you adjust Square's earnings for the money that it is losing from the Starbucks deal, the company is still losing a substantial amount of money.  Unfortunately, Square will continue to lose money off the Starbucks deal until October 2016."   

Courtesy of an article dated November 19, 2015 appearing in Forbes, an article dated November 20, 2015 appearing in Bloomberg, an article dated November 19, 2015 appearing in Forbes, an article dated November 19, 2015 appearing in Seattle Times, an article dated November 19, 2015 appearing in The Wall Street Journal, an article dated November 19, 2015 appearing in QZ.com, an article dated November 19, 2015 appearing in Newsweek, and an article dated November 19, 2015 appeariong in ABC News

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TWITTER REPORTS DISAPPOINTING Q3 2015 EARNINGS AND USER GROWTH, STOCK DIVES 10%, IS IT TIME FOR RADICAL CHANGES?

Twitter shares are crashing in after-hours trading after the company reported another quarter of disappointing user growth and a weak revenue forecast for the last three months of the year.

Here are the key Q3 numbers:

• Monthly active users: 320 million, versus the 324 million expected by analysts, and compared to 316 million users in the second quarter.
• Monthly active users, excluding SMS followers: 307 million users, compared to 304 million users in the second quarter.
• Revenue: $569 million, up 58% year-on-year, compared to the $559.6 million expected by analysts. Twitter had already pre-announced that revenue will be at or above the top end of its forecast range of $545 million to $560 million.
• Adjusted EPS: $0.10 versus the $0.05 expected by analysts.
• Net loss:  Another huge loss of $132 million, compared to a net loss of $175 million in the year-ago period.
• Q4 Revenue Guidance: $695 million to $710 million, versus analyst expectations of $739.7 million.

Twitter shares plunged roughly 13%, or $4.04, to $27.30 in after-hours trading Tuesday.

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It's not a great debut for Jack Dorsey, who was appointed CEO earlier this month. He previously served as interim CEO, and will be hosting his first earnings conference call with investors as the company's new chief later Tuesday. Wall Street will be looking for answers about how Dorsey intends to revitalize the company's flagging user growth and reverse the growing impression that Twitter could become a social-networking also-ran.

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To put Twitter's stalled user growth in perspective, the company added a total of 4 million new users this quarter. Facebook, more than four times the size of Twitter, added 49 million new monthly users during its second quarter.

Twitter also appears to have suffered a steep and sudden drop in the prices that it charges marketers to run ads on its service. Twitter revealed that its "cost per ad engagement" fell 39% year-over-year.

Dorsey said in prepared remarks that the company has simplified its "road map" and organization around a few big bets across Twitter, Periscope. and Vine that it believes represent the largest opportunities for growth.

Busy Period

It's been a busy few months for Twitter. In addition to appointing a new CEO, the company launched the new Moments feature, which tries to make it easier for new users of the service to follow live events, such as sports and presidential debates. And the money-losing company recently slashed 8% of its workforce.

While Twitter eliminated some of the uncertainty about its management by completing its CEO search, the appointment of Dorsey to the role creates more questions. The 38-year-old Twitter cofounder also serves as the full-time CEO of digital-payments company Square, which is in the process of preparing for an IPO.

Twitter's stock has plunged 41% from its 52-week high of $53.49, though it has rebounded from recent lows when shares were trading below the company's IPO price.

Twitter warned investors last quarter that they should not expect any meaningful user growth for a "considerable" amount of time. The question now is whether Dorsey has a plan to change that.

You can also view Twitter's press release regarding their Q3 2015 earnings report by clicking HERE

COMMENTARY:    Twitter's third quarter 2015 earnings failed to meet investor expectations on user growth and guidance for the fourth quarter 2015, driving down its stock price.  More specifically, Twitter continues to struggle in attracting and retaining new users to its platform, and its advertising business is facing challenges with respect to direct-response advertising.  

In addition, while ad engagement and videos have recently snowballed on the platform, the average cost per ad engagement continues to decline substantially. Notwithstanding these challenges, we think it’s too early to expect results from the new leadership. Product changes have recently accelerated on the platform (for both users and advertisers), and if successful, these initiatives could meaningfully drive growth over the coming quarters.

Key Takeaways From Twitter’s Third Quarter Earnings

User Growth Failed To Impress: Twitter’s total average monthly active user base was 320 million in Q3 2015, as compared to 316 million in the prior quarter. Excluding SMS fast followers, the MAU base was recorded at 307 million, which represented a sequential rise of 3 million users. These metrics failed to match expectations, as other social networks such as Facebook FB +0.00% and Instagram have seen much stronger growth. We believe the recent product innovations undertaken at Twitter should start to yield results (in terms of user base growth) going forward.

Guidance Came In Below Expectations: Twitter’s management guided for revenues of $695 million to $710 million for the fourth quarter of 2015. This came in significantly below average analyst estimates of $739.7 million. We believe this weak outlook indicates continued challenges in the company’s advertising business (most prominently in its direct response ad units).

Revenue Growth Driven By Rise In Ad Engagements: Twitter’s overall revenues rose by 58% annually to $569 million during Q3 2015. Advertising revenue increased by 60% in dollar terms and by 67% in FX-neutral terms. This was primarily driven by a 165% annual increase in the number of ad engagements, due to growth in both auto-play video ads and off-network advertising business. Off-network advertising revenue (which includes advertising through TellApart, TapCommerce and MoPub Network) contributed about 13% of overall ad revenue during the quarter. The average cost per ad engagement dropped by 39% annually, due to a shift towards lower-cost auto-play video ads. Going forward, we believe growth in overall ad engagements will continue to drive the company’s advertising business, as there is still significant potential to increase ad load levels on the micro-blogging platform.

Video Usage Has Gone Up Significantly On Twitter: Video consumption has been growing tremendously on Twitter of late with the launch of auto-play videos. Native video views have risen by up to 150 times across the Twitter, Periscope and Vine platforms over the past six months. As a result, video ads have gained much more prominence on Twitter over the past few months. Moreover, the company plans to pilot Promoted Moments (video-focused ads) across the U.S. during Q4 2015.

Innovation Has Accelerated On The Platform: One positive that we have noted of late is that product changes have accelerated under the leadership of Jack Dorsey. With new features such as Highlights on Android, Polls, and recently launched Moments, the company aims to step up engagement levels on the platform. Additionally, changes have also been made on the Vine and Periscope platforms, such as introducing music on Vine. While it’s too early to measure the precise impact of these changes, we believe these recent initiatives could drive growth in the coming quarters. Twitter’s efforts to simplify its service will be central to its long-term goal of drastically expanding its audience base, and we will be keeping an eye on its progress in meeting these goals.

Conclusion

I don't know about you, but I don't see Jack Dorsey turning around Twitter anytime soon.  The fact that Twitter will fail to exceed Q4 2015 guidance should give you a good hint.  All these wonderful things that Jack has implemented since he took over the helm as CEO (I actually consider him part-time CEO since he splits duties with Square) will do very little to increase new users, monthly active users, revenues and profitability.  

Twitter is very troubled company whose original business model has become outdated and has lost its luster.  It is no longer an exciting and fast growing social network when Dick Costolo came on board as its CEO in June 2010.  Since the beginning of 2013, Twitter quarterly MAUs have been growing at single digit rates, and have remained this way ever since.  Year-to-year growth rates have also been on a steady decline when Dick Costolo took over.  The following charts make this point very clearly. 

 

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I find it unforgiveable that Twitter's stock was rewarded with a nice "bump" (opened at $28 and ended the day at $48) when it went public in November 2013.  MAU quarterly growth rates were in single digits and the company has never generated a profit since it was founded in 2006.  Fast forward to today, and nothing really has changed.  MAU growth remains stagnant and another huge loss.  

Twitter really needs to make radical changes and this does not leave out the possibility of making a huge pivot in its business model.  When I say radical, I men possibly rebranding. This might include a name change, getting rid of the blue bird logo, and getting rid of "tweets."  

Twitter also needs to consider transitioning from a pure online microblogging site to a true social network.  This means giving Twitter a completely new look that's modern, slick, and cool, and offers more functionality and customization.    

I would also consider eliminating the ad-based revenue model, and going to a subscription based model for larger users.  I would not mind paying $4.95 to $9.95 per year depending on the number of followers and tweets and retweets I post.  If these changes are too radical for you, then I would recommend a mix of subscriptions and advertising.

Bottomline, Jack Dorsey needs to make Twitter easy and fun to use.  This is the only way to increase usage and engagement.  Increasing the length of tweets doesn't do it.  You need RADICAL changes to Twitter.  Sleep on that.  Comments gladly encouraged.     

Courtesy of an article dated October 27, 2015 appearing in Business Insider, an article dated October 29, 2015 appearing in Forbes, an article dated October 27, 2015 appearing in Marketing Land, an article dated October 27, 2015 appearing in Fortune, and an article dated October 27, 2015 appearing in Seeking Alpha

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CREDIT CARD PAYMENTS STARTUP SQUARE FILES FOR AN IPO, BUT THE IPO MARKET IS SHAKY, AND HUGE CHALLENGES REMAIN AHEAD

Square's IPO filing comes as market for IPOs remains shaky

Payments startup Square Inc. filed to go public Wednesday, even as it grapples with mounting financial losses and an unusual corporate structure that requires its founder to spend part of his day leading a larger technology company.

Square, known for its credit-card readers that attach to mobile devices, is run by Twitter Inc. co-founder and Chief Executive Jack Dorsey.

Square card swiper attaches to any mobile device allowing anyone to accept credit card payments (Click Image To Enlarge)

Square said in Wednesday’s regulatory filing that it would offer up to $275 million in stock, a figure that could change leading up to the IPO.

The offering is seen as a harbinger for tech companies valued at $1 billion or more—Square was valued by investors last fall at about $6 billion.

Most of these highly valued companies have stayed away from the IPO market with ample private capital available—in fact, there have been just 22 tech IPOs through the third quarter this year, compared with 53 through the third quarter of 2014, according to Dealogic.

Recent sharp stock-market swings have deterred some firms from pursuing public offerings. The Square filing came as two of the year’s biggest IPOs ran into trouble. Supermarket operator Albertsons Companies Inc. delayed its IPO plan, according to people familiar with the offering, while payment-processing company First Data Corp. priced its IPO below expectations.

San Francisco-based Square, meanwhile, is hewing closely to a script followed by other Silicon Valley technology firms: swelling losses despite growing revenue.

Square said sales rose 54% last year to $850.2 million and are on a pace to exceed $1 billion this year.

But Square’s net loss in 2014 grew at nearly the same rate, widening to $154.1 million from $104.5 million the year before.

Square also will have to assuage investor concerns about Mr. Dorsey. Earlier this month, the 38-year-old was appointed permanent chief of social-media company Twitter, of which he was also a founder and helped guide to an IPO in 2013.

The company said in its securities filing on Wednesday. 

“This may at times adversely affect his ability to devote time, attention and effort to Square.”

It isn’t clear how much of any given day Mr. Dorsey spends at Square or Twitter offices, nor how his time on the IPO roadshow may affect Twitter’s operations.

Twitter and Square CEO Jack Dorsey (Click Image To Enlarge)

More than being the face of the company, Mr. Dorsey is the largest shareholder, holding nearly one-quarter of Square’s stock.

Mr. Dorsey also profited by selling $1.2 million in marketing consulting services to Square through West Studios LLC, a private firm in which he holds a stake. West Studios also purchased 375,000 shares.

Including Mr. Dorsey’s stake, venture-capital firm Khosla Ventures’s 17.3% stake and smaller shares held by board members and executives, about two-thirds of Square is held by insiders.

A few company insiders—including co-founder James McKelvey,General Counsel Dana Wanger and director Larry Summers—cashed out of some of their shares in January 2014 at $13.53, according to the filing.

According to Square's S-1 filing, a total of 185,361,631 class B shares are held by outside investors, insiders and directors.   The percentage of total class B shares held by major shareholders include Jack Dorsey (24.4%), Khosla Ventures (17.3%) and Director James McKelvey (9.4%).    

Square Inc Class-B Shares Beneficially Owned Before the IPO Filing (Click Image To Enlarge)

Perhaps underscoring the risks Square’s investors see in the company, the company raised about $150 million last September and October in a round that came with potentially onerous restrictions.

Investors including J.P. Morgan Chase & Co. and Rizvi Traverse paid $15.46 a share and required that the IPO must price at $18.56 a share or higher, otherwise they are entitled to receive additional common shares, the filing shows.

Those firms will also get their money back before any other investor in the case of a company sale.

An $18.56 IPO price would suggest a pre-IPO valuation of $7.4 billion including stock awards, or $5.6 billion excluding them.

Square’s IPO, if successful, would cap a tumultuous six years for the payments company. As recently as last year, Square discussed with Alphabet Inc., then Google, a possible acquisition as its losses rose to around $100 million, people familiar with the matter told The Wall Street Journal at the time.

The company also backed off its e-commerce marketplace and mobile wallet, products it had touted as meaningful advances from its core card-swiping business.

The company typically charges merchants 2.75% to swipe credit cards through its reader, according to the company’s website.

The bulk of that money is spent on fees to payment networks, other financial intermediaries and fraud costs. And it faces competition from PayPal Holdings Inc., newly separated from eBay Inc., among other payment companies.

Square reported it was bilked by a single seller, costing it $5.7 million in this year’s first quarter, raising questions about its fraud-prevention systems.

Investors, too, may wonder how Square will replace lost revenue when its deal With Starbucks  Corp. to process credit- and debit-card transactions in most of its stores concludes in next year’s third quarter.

That deal, while unprofitable, brought in $123 million in sales last year, or 14.5% of revenue.

Square said in its filing that it expected Starbucks to seek another payment processor and had given the Seattle company leeway to do so starting this month.

More recently the company has been focusing on peer-to-peer payments and small business lending to help boost its results. Square said it had originated $225 million in loans since May 2014.

COMMENTARY:    Square has never generated a profit since it was founded.  For the year ending December 31, 2014, Square had a net loss of $154 million.  For the six months ending June 30, 2015, Square had a net loss of $77.6 million, so it appears to be on course to lose about as much money in the year 2015 as it did in 2014.    

Gross Payment Volume (GPV)

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• Processed $23.8 billion in payments in 2014, and on course to do $35-36 billion in 2015. 
• Square processed 446 million individual payments from 144 million cards.
• Retail businesses make up 21% of Square’s merchants, followed by services at 17%, and food businesses at 15%.
• The tiniest sellers (processing less than $125,000 in payments per year) represented 92% of its merchants in the second quarter of 2011, compared with 63% in the same quarter this year— meaning that its stable of large customers has grown, relatively speaking
• Square’s deal to handle payments for Starbucks is a money loser. Square lost $28 million from the partnership in 2014, and $14.3 million in the first six months of 2015 (luckily for Square, the relationship will end by October 2016, if not earlier)

Square is a relative small fry when you compare the firms Gross Payment Volume (GPV) with the $4.9 trillion in total purchases paid by credit card as of 2013.     

By comparison, Paypal, the gross payment volume (GPV) leader, processed $65.94 billion in credit card payments in the Q2 2015 alone and $248.23 billion in GPV during the 12 months up to and including Q2 2015.  Paypal also generated net income of $419 million for the year ending December 31, 2014.  When you compare Square's numbers, it's no contest.  

Consolidated Statement of Operations 

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Quarterly Results of Operations 

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Consolidated Balance Sheets

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Pending Litigation

Square has a pending patent infringement litigation with Robert E, Morley and a related entity and has yet to be settled.  This should be of concern to potential IPO investors because it has serious consequences if the court rules against Square.  Facebook was faced with three major lawsuits prior to its IPO, but these were all settled before the IPO date.  The most famous lawsuit was filed by Cameron and Tyler Winklevoss, classmates of Mark Zuckerberg at Harvard.  The Winklevoss twins claimed that Mark Zuckerberg had stolen the idea for Facebook from a social network that Zuckerberg had contracted to write the software for.  This lawsuit was settled for a reported $100 million.  

Here's what the IPO filing says about the Morley lawsuit on page 39.

"We are currently in litigation with Robert E. Morley and a related entity regarding the inventorship of certain patents related to our intellectual property (Morley Litigation). If one or more claims in the Morley Litigation were determined adversely to us, or if the Morley Litigation were settled on unfavorable terms, this could affect our ability to use certain intellectual property and could also result in substantial monetary liabilities. In addition, Mr. Morley filed a subsequent lawsuit containing allegations that the formation of Square and the development of our card reader and decoding technologies constituted, among other things, breach of an alleged oral joint venture, fraud, negligent misrepresentation, civil conspiracy, unjust enrichment, and misappropriation of trade secrets, as well as other related claims. Mr. Morley contends that he was an equal partner with Jack Dorsey and Jim McKelvey in the business enterprise that ultimately evolved into Square, and that Mr. Dorsey and Mr. McKelvey breached their alleged oral joint venture agreement with Mr. Morley by excluding him from ownership in Square. Mr. Morley is seeking a judgment and order that Square, Mr. Dorsey, and Mr. McKelvey hold ownership of Square in constructive trust for Mr. Morley, as well as a variety of damages, injunctive relief, royalties, and correction of inventorship of certain of our patents."

Square SEC Form S-1 (IPO Filing)

Below is the complete Square Inc SEC Form S-1 (IPO Filing). 

Square, Inc SEC Form S-1 - IPO Filing from Tommy Toy

I am always concerned when a startup that has never generated a profit since it began operations, that startup competes in a mature and highly competitive industry (credit card payments) and that industry is dominated by larger and more established players, and that startup is led by a CEO (Jack Dorsey) who splits time between two troubled companies (Twitter and Square), and then that CEO thinks its time for an intial public offering when stock market indicators say otherwise, then it makes me wonder about the wisdom of that CEO.  This is the case with Square, Inc. and CEO Jack Dorsey.

Jack Dorsey has his work cut out for him, not only with Square, but especially with Twitter, a social network which has never generated a profit, has lost numerous executives since the start of this year, whose monthly active users has stalled, and advertisers are questioning Twitter's viability as an advertising platform.  

Dorsey recently announced that Twitter would layoff about 10% of its workforce or about 336 employees, mostly from its engineering staff.  This will cost the company about $20 million in severance payments and other separation entitlements.  Even after you factor the savings from in wages, payroll taxes and employee benefits due to these layoffs, this will not make a substantial dent in their operating losses to date.  This makes you wonder if Square will require some staff pruning after the IPO.   

Even if you adjust Square's earnings for the money that it is losing from the Starbucks deal, the company is still losing a substantial amount of money.  Unfortunately, Square will continue to lose money off the Starbucks deal until October 2016.   

Lise Buyer, an IPO consultant with Class V Group in Silicon Valley who also helped guide Google Inc's IPO, said so eloquently, and dead on.  

"Management and management focus are the single most determining factor of the success or lack thereof of a company pursuing an IPO.  Were I a (Square) investor, I would want to be compensated for the cost of a part-time CEO who already had a full plate. And by compensated I mean I would expect a lower valuation."

David Erickson, a longtime banker and venture capitalist who teaches at the University of Pennsylvania Wharton School of Business, has real concerns about Jack Dorsey's ability to run two troubled companies simultaneously.

"Investors would have to get comfortable with how he would do both jobs well.  What would also, I think, make this particular situation more challenging is the turnaround currently going on at Twitter, and the time I assume it would require."

Lisa Buyer, of Class V Group, echos similar concerns about turning round two companies simultaneously.

"There is so much uncertainty and so much attention needed at Twitter that it certainly should not inspire confidence in potential investors about Square.”

Let's come to some agreement here.  Nothing significant is going to change at either Twitter or Square by the end of this year, or even within the next year.  Twitter may never grow much beyond 300 million active users or increase engagement significantly without a major increase in new users. I am already juggling too much time between Facebook, Twitter and LinkedIn.  I think most users are not going to abandon Facebook so they can tweet all day long.  They simply have to much invested in Facebook and other social networks.  

In conclusion, after reviewing Square's achievements and numbers, I am of the opinion that the Square IPO is just too high risk.  There is none of the hype that existed when Facebook had their IPO. Facebook shares were selling in the secondary markets for over a year before their IPO, setting the market price, and raising expectations to intolerable levels. Square would need to add a dozen major accounts with the volume of a Starbucks, and those accounts would have to be profitable, between now and the actual IPO date to create investor excitement and hopes of a successful IPO.   I don't see any evidence that Square is raising expectations and creating excitement among potential investors.  In fact, the reverse is true -- there are a lot of doubts about the Square IPO.  

In short, the Square IPO is DOA.  It was a bad idea from the beginning, and only going to benefit early investors and a few of the employees.  In fact, most of the early VC's have clauses that in the event of an IPO, they get their money first.  Isn't capitalism great?!!  Yippee Kiyeaa!!    

Courtesy of an article dated October 14, 2015 appearing in The Wall Street Journal, an article dated October 15, 2015 appearing in MediaPost Mobile Marketing Daily, an article dated October 14, 2015 appearing in Fortune Magazine and the SEC Form S-1 Registration Statement filed by Square, Inc. 0n October 14, 2015

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A LOOK BACK AT FACEBOOK'S OFFER TO BUY TWITTER, WHAT REALLY HAPPENED, THE TWITTER IPO, AND TWITTER TODAY

Facebook depicted as the enemy is pecked to death by an armada of Twitter "Blue Birds" (Click Image To Enlarge)  

In the early days of Twitter, founder Biz Stone says he turned down a huge offer from Mark Zuckerberg. It is now worth $23bn.

Twitter founder Biz Stone has told how he turned down a $500m (£290m) offer from Facebook to buy the firm – and watched as its value later soared to billions.

He told Sky News Digital View that on October 11, 2011 he and co-founder Evan Williams travelled to a meeting with Facebook boss Mark Zuckerberg several years ago.

Twitter Co-Founders (Left-To-Right):  Evan Williams, Jack Dorsey and Biz Stone (Click Image To Enlarge)

Neither really wanted to sell the company, he said, so they decided to come up with a number "so big", that "no-one would ever say yes to it".

He said they came up with $500m, and "laughed so hard at that".

But despite Mr Zuckerberg saying it was a "big number", an offer was drawn-up later that day.

The pair turned it down, saying they felt like they were "just getting started" with the business.

He added that he did not get on with the Facebook founder.   He told Sky's Ian King.

"I like him, and I respect him, it's just that we didn't click.  I'm a jokey guy and he's a very serious guy so every joke I made – it was a tough crowd."

He also commented on the use of Twitter by extremists in Iraq and beyond, saying he still believed the social network was a tool for good rather than evil.

"When you create a large-scale platform where hundreds of millions of people have freedom of expression, you have to take the good with the bad.  If you're going to tout the fact you're encouraging free speech then you can't curate it. As soon as you do that you lose the trust."

He also said the growth of Twitter into a $23bn (£13.5bn) company feels "strange".  He said.

"I've come to terms with it but I wouldn’t call it surprised - it feels strange in a good way to go to the shopping mall and see the little bird I drew.  It doesn't seem that long ago that we were just a rag tag group of guys."

COMMENTARY:     

Facebook Tried To Acquire Twitter Twice

According to a report from a new book by New York Times writer Nick Bilton called "Hatching Twitter: A True Story of Money, Power, Friendship and Betrayal", Facebook CEO Mark Zuckerberg tried to acquire Twitter on two separate occasions according to TechCrunch.

The book alleges that Zuckerberg first went through "official channels" before approaching Twitter CEO and founder Jack Dorsey with a $500 million deal. (The price was Twitter's, not Zuckerberg's.)

Apparently, Dorsey took a meeting with Zuckerberg and suggested to the board that the deal would be great for Twitter.   The board disagreed and later Dorsey was pushed out of his chief executive position to a largely symbolic role. It was then that the other founders, Evan Williams and Biz Stone, had a meeting with Zuckerberg, too.

This was in October 2011, just before Twitter was a household name, so saying no to $500 million took some chutzpah -- or arrogance, but the board believed it was a "billion-dollar company." However, the rumor was that Zuckerberg told the Twitter founders that they needed to sell to Facebook or deal with a "clone" that his company would create and strangle Twitter in its crib.

The Road To Twitter's IPO

On October 3, 2013, San Francisco-based Twitter filed its S-1 prospectus for an initial public offering seeking to raise $1 billion. Twitter pegged the fair value of its common stock at $20.62 a share in August.  According to an unnamed source familiar with the IPO filing, this gave Twitter an implied book value of $12.8 billion based on the 620 million shares outstanding.   The share price was 28.6 times Twitter's annual revenues compared to Facebook's 26 times revenues and LinkedIn's 14.5 times annual revenues during their IPO's.

The following infographic tells everything you need to know about Twitter at the time they filed for their IPO with the SEC:  

Twitter -- The Road To The IPO (Click Image To Enlarge)

Twitter's IPO

On November 7, 2013, Twitter's had its IPO.  Shortly after the opening of trading, Twitter Inc. (NYSE:TWTR) shares rose 73 percent in a frenzied trading debut that drove the seven-year-old company's value to $25 billion and evoked the heady days of the dot-com bubble.

The stock closed its first trading day at $44.90 a share from the initial public offering price of $26 set late on Wednesday, falling back from a near-doubling in price at a session high of $50.

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Investor enthusiasm for the microblogging company defied traditional valuation analyses. The shares traded at about 22 times forecast 2014 sales, nearly double the multiple at social media rivals Facebook Inc and LinkedIn Corp, even though Twitter is far from turning a profit and posted a loss of almost $70 million for its most recent quarter.

Yet fans believed that Twitter, which boasted it had 230 million users globally and had revenues of $253.6 million for the first six months of 2013, and $316.9 billion for the year ending December 31, 2012, had established itself as an indispensable Internet utility, alongside Google Inc and Facebook, and that it has only scratched the surface of its potential as a global advertising medium.

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Mark Mahaney, an analyst at RBC Capital Markets, said.  

"When people use Twitter they are following certain people, they're searching for specific information.  There are powerful marketing signals that are almost Google-esque, something that Facebook doesn't really have."

The IPO was shadowed for months by Facebook's troubled 2012 debut, in which the shares quickly fell below their offering price amid trading glitches and subjected the company and its lead banker, Morgan Stanley, to accusations that they had been greedy in pricing the deal.

Twitter's opening appeared to go off without a hitch, prompting Anthony Noto, the Goldman Sachs banker who led the IPO, to write a simple Tweet: "Phew."

Still, Twitter found itself subject to the opposite criticism, that it had priced the shares too low and left more than a billion dollars on the table.

Ken Polcari, director of the NYSE floor division at O'Neil Securities, said.  

"In my mind they certainly could've raised the price on this thing and gone into the low 30s. From an outsider looking in I would say they were overly cautious because they didn't want a disaster on their hands ... I'm sure the company didn't want a Facebook debacle,  I get that, but I think they were overly cautious and it cost them some money."

Heavy demand for the IPO shares was apparent before the final pricing.  Market sources said investors had asked for 30 times the 70 million shares on offer in the IPO, representing about 13 percent of Twitter's outstanding common shares.

Twitter could've raised $2.1 billion if an underwriters' over-allotment had been exercised making it the second largest Internet offering in the United States behind Facebook Inc's $16 billion IPO in 2012 and ahead of Google Inc's 2004 IPO, according to Thomson Reuters data.

The NYSE, which snatched the listing away from its tech-focused rival, Nasdaq, marked the occasion with an enormous banner with Twitter's bird logo along its Broad Street facade.

Twitter executives including Chief Executive Dick Costolo and the three co-founders - Evan Williams, Biz Stone and Jack Dorsey - appeared on a packed exchange floor to witness the debut.

Twitter CEO Dick Costolo (far right), and co-founders Jack Dorsey, Evan Williams and Biz Stone (l-to-r) cheer as trading begings on the floor of the NYSE. (Click Image To Enlarge)

At current valuations, the stakes owned by Williams and Dorsey would be worth around $2.7 billion and $1.1 billion, respectively. Costolo, who invested $25,000 in the fledgling company in 2007, holds a 1.4 percent stake worth about $360 million.

They hefty valuations were cause for celebration for some insiders but they sounded alarm bells for some investors who cautioned that the froth was unwarranted.

Pivotal Research's Brian Wieser wrote in a note cutting his rating on the stock to "sell" from "buy". 

"With a price that pushes into the high 30s and beyond, Twitter is simply too expensive.  One way to justify a $45 price in our model would involve presuming that Twitter could generate more than $6bn in annual revenue by 2018. However, we think that would seem overly optimistic."

British actor Patrick Stewart, of Star Trek fame, rang the opening bell at Big Board together with nine-year-old Vivienne Harr, who started a charity to end childhood slavery using the microblogging site.

Stewart said, adding that he had only been tweeting for about a year.

"I guess I represent the poster boy for Twitter." 

In San Francisco

At Twitter's headquarters in San Francisco, offices opened early and hundreds of employees flocked to the 9th floor cafeteria to watch the festivities on TV while eating "cronuts," a croissant-donut hybrid, made by Twitter's resident chef, Lance Holton.

The public debut was the latest milestone for a service that was born out of a nearly-defunct startup in 2006 and was derided by many in its early years as a silly fad dominated by people talking about what they had for breakfast.

But Twitter quickly began to penetrate popular culture in unexpected ways, with its open design and broadcasting format attracting celebrities, athletes, politicians and anybody who wanted to share short, punchy thoughts with a digital audience.

Its business potential developed more slowly, and the company appeared to be floundering as recently as three years prior to the IP, when it was riven by management turmoil and frequently crippled by service outages.

Under Costolo, who took over as CEO in October 2010, the company rapidly ramped up its money-making engine by selling "promoted tweets," messages from marketers that are distribute to a wide-ranging but targeted group of users.  In the third quarter 2013, Twitter made $168 million in revenue, it said, more than double the third quarter 2012.

The company said in its investor prospectus that more than three-quarters of its users were outside the United States.  Despite its early reputation as a hangout for Silicon Valley early adopters and tech geeks, some of its most active markets now include Japan, Indonesia, Brazil and Saudi Arabia.

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The three most-followed accounts belonged to a trio of pop stars: Katy Perry @katyperry, Justin Bieber @justinbieber and Lady Gaga @ladygaga. (U.S. President Barack Obama @barackobama came in fourth.)

P.J. Crowley, the former U.S. State Department spokesman, said. 

"Twitter has, when coupled with the increasing distribution of smart phones and reach of the Internet, an impact on global connectivity and transparency.  It has definitely contributed to the acceleration of the news process and helped to expand the availability of information sources to a wide range of people."

The 140-character messages have spawned an Internet culture of its own. The "hashtag," a pound symbol devised by early Twitter users to denote the topic of a conversation, has became ubiquitous, with the word even becoming an ironic expression parodied by the likes of "Saturday Night Live."

Sell Rating

As Twitter's stock soared after the opening, the company's market value, including restricted share units and other securities that could be exercised in the coming months, was over $28 billion.

Fund managers who got small allocations at the IPO were hopeful the stock would trade down after Thursday's pop.

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Mark Hawtin, portfolio manager of the GAM Star Technology Strategy, said.

"We have a target of $40 and we won't buy more as long as it is trading above that."

Jerry Jordan, manager of the $48.6 million Jordan Opportunity Fund, who got a small allocation, said he would buy more of Twitter if it trades down around $30-$35.  

Jordan said.

"A lot of these sexy IPOs have a big pop on the first day and then they grind sideways." 

Twitter's successful debut is likely to stoke interest in other up-and-coming consumer Internet companies such as Uber, Pinterest, Airbnb and Square, all of which boast private-market valuations well north of a billion dollars and could go public in the coming years.

Still, two early social media success stories, Groupon Inc and Zynga Inc, have suffered major reversals since going public last year. Groupon, despite big gains in its shares this year, still trades at less than half its 2011 IPO price. Zynga is worth about a third of its 2012 IPO price.

And first-generation social media firms such as MySpace have all but vanished as fickle users moved on to the next big thing.

Twitter Today

On April 29, 2014, Twitter released its first quarter financial performance, reporting revenues of $250 million for the quarter, a net loss of -$132.4 million, and earnings per share of $0.00 on a non-GAAP basis.  The street had expected Twitter to report revenue of $241.5 million, and a three cent per-share loss.

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That non-GAAP $0.00 EPS is slightly occlusive — the company in fact had non-GAAP net income of $183,000 in the period, or about the cost of one engineer’s yearly cost to a tech company. However, when you stretch $183,000 across more than half a billion shares, it doesn’t go far.

Twitter’s revenue is up 119% year-over-year. On a GAAP basis, Twitter lost a stunning $132 million in the period. That amounts to a GAAP net loss of $0.23 per share.

Twitter Net Losses Pile-up

Twitter has yet to generate a net profit in any quarter since it began operations.  For the years ending December 31, 2013, December 31, 2012 and December 31, 2011, Twitter reported net losses of -$645.3 million, -$79.4 million and -$164.1 million respectively.  Twitter also reported a net loss of  -$132.4 million for the 1st Quarter ending March 31, 2014.   All together, Twitter is carrying cumulative net operating losses of $1.127 billion since it began operations in 2006.  

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Twitter Operating Expenses

Twitter operating expenses during the 4th Quarter 2013 were a record $752.4 millon -- exceeding the combined total of $548.4 million spent during first three quarters of 2013.  Most of this went into research and development (R&D) and sales and marketing expenses.    These two constitute the majority of Twitter’s operating expenses and stood at a combined 62.5% of revenue in 2013. 

Twitter’s R&D expenses as a percentage of revenue has come down from a massive 91.7% in 2010 to about 32.2% in 2013.  However, the figure stood way above Facebook’s 9.6% which suggests that the company has a long way to go in terms of improving monetization and reducing the cost burden. 

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Twitter’s sales and marketing expenses as a percentage of revenue increased from 21.4% in 2010 to about 30.3% in 2013 as it ramped up its sales force to sell ad inventory slots and acquire customers. In comparison, the figure for Facebook stood at around 10.5% during the same year.

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Twitter reported that it had 255 million monthly active users. In the sequentially preceding quarter, Twitter had reported 241 million monthly active users. That’s growth of 14 million in the three-month period, or around 5.8%.

Twitter Monthly Active Users

While sharing its financial results for its first quarter 2014, Twitter announced a number of new milestones that showed the service’s user growth has slowed while its mobile advertising share has grown.  The social network has now passed 255 million monthly active users, 198 million of which were monthly active mobile users as well.

The company’s monthly active user count has only grown 25% in the past year. Monthly mobile active users have grown by 31% in the past year.  However, this growth remains modest.  78% of Twitter’s users access the site from a mobile device.  Investors appeared concerned that despite quickly expanding revenue, Twitter’s days of massive user growth were over.  That meant lower future top and bottom line growth.

Twitter Share Prices

When Facebook went public in May 2012, the company's shares were priced at $38. On the first day of trading, the stock price didn't jump as anticipated and would likely have fallen below the IPO price of $38, if the IPO's underwriters hadn't stepped in to support it. In subsequent weeks though, the share price quickly fell below $30 and continued to slide for months. It took the stock more than a year to return to its IPO price, clearly indicating that the IPO had been priced too high by Facebook's underwriters.

18 months later, Twitter, having witnessed first hand how hard Facebook's reputation had been hit by its disappointing IPO, was desperate to avoid making the same mistake as its big rival. The company's IPO was priced at $26, which was above its initial price range, but still modest according to many experts who anticipated massive demand for Twitter's shares. When Twitter finally made its trading debut on November 7, the share price jumped more than 70 percent, creating a lot of positive press for the company. The fact that Twitter's shares have continuously traded above $40 since the IPO and are currently approaching $50 indicates that conversely to Facebook's IPO, Twitter's IPO was significantly underpriced.

In the end it seems that Twitter avoided Facebook's IPO mistake, overpricing, by making another mistake, underpricing. To figure out which is worse, one needs to remember what the goal of an initial public offering is. Normally, a company goes public in order to raise money that can be invested in the company's growth. By pricing its IPO very high, Facebook squeezed every dime out of the investors waiting eagerly to get in on the hottest IPO of all times. The company ended up raising more than 16 billion dollars in return for lot of bad publicity and some disgruntled investors. Twitter chose the opposite route. Selling 80 million shares at $26 a piece, the company raised $2.1 billion when it easily could have raised more. Assuming a possible IPO price of $40, Twitter left more than a billion in investment capital on the table or rather in the accounts of its early investors. Twitter sacrificed that money in return for a lot of goodwill, but filling the pockets of banks and investors has never been the purpose of an IPO. So in the end, by avoiding Facebook's mistake, Twitter may have made an even bigger one: losing out on a billion dollars worth of additional capital.

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Twitter's share price has been on a steady decline since the start of 2014.  Twitter shares peaked $73.31 on December 26, 2013 and ended the year 2013 at $63.65 per share.  Twitter shares hit a low of $30.66 on May 7, 2014.  Twitter's share price has rebounded some since its low, and ended at $37.84 at the end of trading on July 10, 2014.

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Twitter Revenue Forecasts for Q2 2014 and Full-Year 2014

Twitter expects its second quarter revenue to come in between $270 and $280 million. Full year 2014 top line should be between $1.20 and $1.25 billion, coming in on the low end of expectations.

That aside, Twitter’s $2.2 billion in cash and equivalents is right where it was before the quarter started, meaning that the company has plenty of runway to execute on whatever its plans may be.

Conclusions and Ending Comments

I am really disappointed in Twitter.  From the size of its R&D and sales and marketing expenses, I see a public company that is still trying to develop a predictable and successful business model. This is a company went to public much too soon, but in hindsight chose the IPO route to take advantage of the recent popularity of social networks going public, and the success of Facebook in monetizing mobile and rising share price.

Facebook was able to successfully monetize desktop users, then quickly switched its platform to successfully monetize its rising mobile users.  Facebook was able to do this, and it did this quickly, with much success, and has been rewarded by Wall Street and Main Street investors with a stable share price.  

I am not too sure that Twitter will be able to repeat the success of Facebook, and prop up its share price to its high of $73.31 in late 2013.   For one thing, Twitter users were already predominantly mobile, and it has monetized them with its line of "promoted" advertising products.  However, how much more can it squeeze out of those mobile users.  

User participation is also a huge issue with Twitter.  Less than 5% of Twitter users actually tweet on a regular basis (once a day).  So what if they have 255 million monthly active users. Only 5% of them are active on a regular basis.  The recent Twitter redesign may help increase user participation, but not without giving users an incentive or sense of urgency to tweet.  The limit of 140 characters per tweet really limits user participation.  Facebook places no such limit on user timeline posts, and this is a huge competitive advantage.  It is no wonder that average revenues per user are one-fifth of Facebook.                

Courtesy of an article dated June 10, 2014 appearing in Sky News, an article dated October 4, 2013 appearing in Bloomberg, an article dated November 5,  2013 appearing in NBC Bay Area, an article dated November 7, 2013 appearing in Reuters, an article dated April 29, 2014 appearing in TechCrunch, an article dated March 13, 2014 appearing in Forbes, an article dated April 29, 2014 appearing in the TNW Blog, and an article dated December 10, 2013 appearing in Statista

 

ECOMMERCE SITE ALIBABA FILES FOR AN IPO, AND WHAT YOU SHOULD KNOW ABOUT THIS YEAR'S MOST-HYPED IPO

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Alibaba filed paperwork on Tuesday, May 6, 2014 for a $1 billion public offering. It is expected to increase significantly and could become the largest tech IPO of all time.

If your first thought reading that is "What the heck is Alibaba?", you're probably not alone.

Alibaba is a household name in China and well-known among certain tech industry watchers and investors abroad, but it doesn't exactly have mainstream recognition among consumers in the United States. That might change after its IPO.

To help you get a head start learning about this fast-growing tech company, we've put together a primer on what Alibaba does, how it got so big and what impact it might have on other U.S. businesses.

What exactly is Alibaba?

The Alibaba Group is the largest ecommerce company in China and, according to some reports, the largest in the world. It primarily consists of two big shopping websites: Taobao, which launched in 2003 to compete with eBay in China, and Taobao Mall (or Tmall), an online shopping marketplace.

So basically it's just China's version of Amazon?

Not quite. Unlike Amazon, Alibaba doesn't actually handle any of the logistics — like fulfillment centers — for online shopping. It just creates the platform and user experience for consumers to shop from various brands.

Even that user experience is notably different.  Kelland Willis, an analyst with Forrester Research says.  

"When you are buying something on Amazon, you are engaging with Amazon.  When you buy on Tmall, you are engaging with the brand."

Alibaba's investments also extend well beyond traditional ecommerce. It has invested in a Chinese department store operator, mobile messaging app Tango and Weibo, China's version of Twitter which recently went public. It is also reportedly in talks to get back a stake in Alipay, a payment service like PayPal.

Screenshot of Alibana's Taobao Mall ecommerce site (Click Image To Enlarge)

Just how big is it?

Alibaba generated more than $3 billion in revenue for the fourth quarter of 2013, an increase of 66% from the same quarter a year earlier. Its gross profits for the quarter shot up by an even higher percentage to just under $2.4 billion.

The Wall Street Journal reports hearing from sources that the combined sales volume on Taobao and Tmall hit $240 billion in 2013. On Single's Day, which is essentially China's version of Cyber Monday, Taobao and Tmall topped $5.75 billion in sales. That's more than double the sales of all online retailers on Cyber Monday.

Alibaba is expected to go public with a market cap of around $165 billion, though some analysts think it may top $200 billion.

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How does someone even build up a company that big?

Alibaba was founded in 1999 by Jack Ma, an eccentric English teacher-turned-entrepreneur who became interested in building Internet companies after going online for the first time in 1995 while on a trip to Seattle.

Alibaba Group CEO Jack Ma (Click Image To Enlarge)

The secret to Alibaba's success, according to Forrester's Willis, is a combination of launching when the ecommerce market was still small in China and going out of its way to build trust with consumers in the country.

Willis says.

"What Taobao did from the beginning was they created a set of regulations that absolutely ensured consumers get the product they ordered.  It builds trust with the brand. As a result, consumers thought of Alibaba Group as a whole as one they could trust to interact with."

One example of that is the option to pay cash upon delivery, after the shopper has had a chance to inspect the item in person. 

China's ecommerce market has also ballooned in recent years and is expected to be larger than that of the United States in the not-too-distant future.

Why is one of the largest companies in China doing a public offering in the U.S.?

Initially, Alibaba reportedly wanted to go public on the Hong Kong stock exchange, but decided otherwise because regulators in the country would not greenlight its proposed governance structure. But Alibaba stands to gain other benefits from listing in the U.S. as well.

R.J. Hottovy, senior analyst with Morningstar says.  

"By listing in the U.S. you open up the doors to a lot more potential investors.  There are some question marks about accounting and security rules outside the U.S. and European markets. The U.S. listing will add a layer of creditability."

Alibaba Group's headquarters in Hangzhou, China (Click Image To Enlarge)

Will the Alibaba IPO have any impact on U.S. tech companies?

The Alibaba IPO is coming at a time when investor sentiment for the tech sector has weakened thanks in part to sky high valuations. That could change if Alibaba proves to be a strong IPO.

Hottovy says.  

"If it was successful and did well and was priced with a premium valuation, I think that could have a halo effect on the broader tech space.  It could spur some renewed interest in the space."

At the very least, it will have a notable impact on Yahoo, which as a 24% stake in Alibaba and stands to net as much as $10 billion from the Alibaba IPO, depending on how it prices. That could give Yahoo and CEO Marissa Mayer the additional resources needed to make some big acquisitions.

COMMENTARY:   Among the biggest shareholders set to profit from the IPO is Yahoo, which holds a 22.6 per cent stake, and SoftBank, the Japanese telecoms group which has 34.4 per cent. While SoftBank executives have said it plans to retain the stake, Yahoo will sell part of its holding and its current director on the Alibaba board will step down.

Other known investors include Singaporean sovereign wealth fund Temasek and US fund Silver Lake. Mr Ma himself holds 8.9 per cent of the company.

Corporate governance activists, however, have questioned the board structure that Alibaba is proposing. Under the terms, a 28-member management partnership of senior executives from Alibaba and affiliates has the “exclusive right” to appoint a majority of the board.

With that level of control kept by the partnership, “it really all comes down to what is the quality of those independent board members,” said Gary Hewitt, head of research for GMI Ratings, a governance analysis group.

The company named only three members of a board that will have nine people: Mr Ma, Joe Tsai, the executive vice-chairman, and Softbank’s Masayoshi Son.

The company’s Chinese retail platforms had 231m buyers last year, just shy of one-fifth of China’s total population, and nearly 40 per cent of the number of Chinese who use the internet. Its ambitions are expanding, however, both across other sectors of China’s internet and outside its borders.

Its many operations include a small business loans division, a group buying site, cloud computing business and an online advertising exchange. It is affiliated with China’s largest online payments processing network, Alipay, although that business was spun off in 2011 to a separate vehicle and is not part of the listing. 

Alibaba has also embarked on an ambitious, multibillion-dollar string of deals to broaden its reach beyond ecommerce. So far this year, it has taken stakes in companies ranging from China’s largest video hosting site, Youku Tudou, to the US start-up Lyft, a car ride-sharing service.

Jixun Foo, a partner at venture capital group GGV Capital, which had been an early investor in Alibaba said. 

“You should think of them beyond an ecommerce player, just as Amazon is going beyond ecommerce to compete with Netflix, for example, in the so-called online video space.  They are testing the water on many fronts.”

Most of its revenue comes from online marketing, commissions on transactions and fees for its services. In the nine months to December 31, it generated revenue of $6.5bn and net income of $2.8bn, according to the filing.

Alibaba is being advised by Credit Suisse, Deutsche Bank, Goldman Sachs, JPMorgan Chase, Morgan Stanley and Citigroup.

Courtesy of an article dated May 6, 2014 appearing in Mashable and an article dated May 6, 2014 appearing in the Financial Times Tech Hub