Lots of Chatter About Twitter

 | Apr 23, 2014 | 10:00 AM EDT
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Twitter (TWTR) is scheduled to announce earnings next week, which is looming large in the minds of investors. In January, Twitter held its first conference call as a public company. Its stock was riding high; it entered the earnings report at a closing price of $65 per share. When the numbers first crossed the wires, the stock immediately jumped to over $70 per share. They quickly came back to earth though.

By the end of the next trading day, Twitter's shares had fallen from $65 to $50 – more than a 20% drop. And, amid the tumult of March, they have moved down to the mid-$40s. So, going into next week's earnings, the company is facing a skeptical Wall Street.

On the positive side, Twitter has a much lower valuation today than it did in January. It also has the tailwinds behind it as an increasing number of advertisers want to spend more money on social media than they ever have before. If you're a big brand or agency, and you're going to earmark money toward social media, you're certainly going to spend money on Facebook (FB) and you're probably also going to spend money on Twitter.

Twitter also continues to dream up new ways for those brands to spend money. A few months ago, the company bought MoPub to beef up its presence in the mobile ad space. Management recently reannounced to the world that they had MoPub and its whole third-party mobile ad network for brands to sell through to.

The idea with the MoPub acquisition is that Twitter wants a big brand to be able to come to Twitter and spend money on mobile ads. The hope is that they will then be surprised to find that, through spending money on MoPub, they can find their mobile ad is being seen by as many mobile users (if not more) as they could get on Facebook. MoPub's network added to Twitter's provides that extra reach.

The risk to Twitter, though, in the short term is its valuation and its lack of user base growth. Although there were some fears at the time of the Twitter IPO that growth had stalled, the January earnings report underlined that issue. If we see another quarter of flat-lined growth, people will start to question the underlying valuation of Twitter.

At the moment, the stock trades at a trailing price-to-sales ratio of 39x. That compares to Facebook's similar ratio of 20x and continued high-flier Zillow's (Z) of 21x. LinkedIn's (LNKD) is 14x. Yelp's (YELP) is 21x.

Is Twitter really deserving of that extra valuation premium relative to these others? I think high 20x is probably reasonable, but that's still lower than current levels. To me, it suggests that Twitter has further to drop before it goes back up.

Fears about user growth in the short-term could trump excitement over possibilities of monetizing the Twitter user base in the intermediate term.

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