How Twitter could earn its $1 billion valuation

Last week I wrote that Twitter was raising $50 million in new funding that would value the messaging service at $1 billion. Now it looks like that was a bit off -- Twitter is actually raising $100 million, although the implied value is still $1 billion.

One of the interesting things that happened since last week is that a mutual fund has decided to put some of its investor's money into Twitter. The fund, T. Rowe Price (TROW), will join Spark Capital and Institutional Venture Partners in this $100 million round -- which, when closed, will bring Twitter's total capital raised to $150 million.

One way to start thinking about Twitter's $1 billion valuation is to look at it in the context of the number of users. The San Jose Mercury News estimates that Twitter has 40 million to 50 million users. This is one-sixth Facebook, which has 300 million users and was valued at $10 billion on 2009 estimated revenues of $500 million, mostly from advertising.

Unlike Facebook, Twitter has no revenues. But comparing the two on a value-per-user basis suggests that Twitter's value -- $20 per user (assuming it has 50 million users) -- is less than Facebook's $33.33 per user. Based on Facebook's revenue per user of $1.67, Twitter could justify a $1 billion valuation if it could generate $83.5 million in revenue.

There are at least two possible ways Twitter could generate advertising revenues: targeting Twitter users or Twitter search ads. Based on these 10 Rules for Advertising on Facebook and my limited knowledge of Twitter user profiles, it looks plausible that Twitter could charge for advertising targeted by users' location, sex, and/or biography. (I should note that Twitter has said it has no plans to begin running ads in 2009.)

Alternatively, or additionally, Twitter could try the Google (GOOG) approach -- placing unobtrusive text advertisements next to Twitter Search results.

I am pretty confident that Twitter will be able to figure this out in the next year. And that will make T. Rowe Price shareholders happy, along with all the others who get to invest in Twitter before its likely 2010 IPO.

Peter Cohan is amanagement consultant, Babson professor and author of eight books including, You Can't Order Change. Follow him on Twitter. He has no financial interest in the securities mentioned.

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