Twitter's New Ad Plan Just Might Justify a $1.4 Billion Valuation

Twitter's Biz Stone
Twitter's Biz Stone

Twitter, the 140-character messaging service, has announced a way to make money off its millions of users. Co-founder Biz Stone (pictured) says Twitter is going to sell search advertising to companies. It sounds similar to what Google (GOOG) does, and along the lines I wrote about last September. Moreover, I think Twitter's new business model could justify the $1.4 billion valuation it now has on the SharePost index (a valuation index for private companies).

Twitter's proposed business model centers on what the company calls Promoted Tweets. They appear when users search for keywords that advertisers have paid for in exchange for showing their ads. Twitter will show its users the Promoted Tweets based on those tweets' relevance to each Twitter user.

The way Twitter measures that relevance will be its special sauce. Twitter plans to introduce what it calls "resonance" -- a nine-factor scoring tool that considers such things as how many people saw the post, how many people replied to it or forwarded it to their followers, and the number of people who clicked the links in the Tweet.

Using Facebook as a Comparison

Stone's announcement of a business model raises the question of whether it will generate enough revenue to justify a $1.4 billion valuation. By my calculations, it would take between $146 million and $241 million in annual revenue to justify that valuation.

I made this estimate by assuming that Facebook is a comparable company for valuation purposes. Facebook has a "value/sales ratio" of between 5.8 and 9.6. This range is based on Facebook's estimated $11.5 billion valuation in March 2010 on the SharePost index and revenues that could range from $1.2 billion to $2 billion in 2010, according to a March 2010 TechCrunch report. I calculated the sales range for Twitter by dividing its valuation by the Facebook value/sales ratios above.

How realistic is it for Twitter to generate that much revenue? Computerworld reported that the service had 75 million users in January 2010. So generating between $146 million and $241 million in revenue would imply revenues per user between $1.95 and $3.21. This is about a third less than Facebook's revenue per user of between $3 and $5.

In the Ballpark

So Twitter's model could justify its valuation if enough advertisers bid for those text words. The New York Times reports that a movie studio could use Twitter's service to track negative reactions and link to a positive review soon after that negative sentiment appeared. Given the importance that advertisers place on entering the conversation about their product, these revenue figures could be in the ballpark.

It remains to be seen how well Twitter can pull off its ad plan, but Biz Stone's biz model could well be worth that $1.4 billion valuation.