November 15, 2014

The Challenge with Twitter

Yesterday, Twitter's bonds have been classified as "junk" and a "speculative" BB-, three levels below investment grade. Why is this important? Credit ratings normally tell us about the capacity of the issuer to service its debt. Capacity to service debt is dependent on several things but is obviously heavily reliant on earnings.

It's always a challenge to monetize an idea. This is especially true for social network Twitter. Unlike Facebook, Twitter has yet to crack this problem of how to generate substantial revenue from its huge user base. 

Twitter is free to use for consumers and its revenue is generated mainly through advertising. The advertising model it uses is quite simple. It offers advertisers the opportunity to become a "promoted" account or have a promoted "post" that will be shown to the advertisers targeted users.  It's very similar to the Facebook advertising model. However, one key difference is the way the newsfeed works on both sites. Facebook has an algorithm that allows it to filter the posts shown to its users showing users the most relevant posts. Twitter works simply using a chronological algorithm showing users the most recent posts. 

This difference actually helped drive Twitter's popularity. Users mainly use Twitter as a real-time news channel. It's a modern day newsroom for people around the world. However, it gives advertisers little incentive to advertise. Facebook in a way forces advertisers to promote posts because not everyone will see it. For Twitter, this is not the case. 

The main draw for advertisers is that it can promote to gain more "followers". However, advertisers are moving more and more away from the model of "buying" followers and fans and have started focusing on gaining followers and fans organically using engaging content. And the reason for this is quite intuitive. Customers normally will follow and become fans of brands on their own, even without possibly having advertising push demand for it. And who wants a fan base that is purely bought anyway? 

Unfortunately, shareholders are probably getting impatient. Twitter's stock price has tumbled in recent weeks. A quick look at the performance over the past month will show this apparent decline.

Screen shot taken from Yahoo Finance
So what's next for Twitter? I'm not sure actually. They still have a huge base of users and they provide a service that is quite unique in the market. Getting junk bond status is not uncommon for up and coming companies that are projected to grow but haven't quite figured out yet how to make money. For Twitter, the challenge really is how to create a regular revenue stream while at the same time look for continued growth prospects using it's excess cash. Hopefully, they crack this challenge soon enough.

Link here to the original article from BBC