Here's What Twitter Needs to Do to Make the Stock a Buy

As the microblogging giant prepares to come to market, tweets speculating about the value of Twitter stock abound...

On Sept. 12, the online social networker announced it filed confidential S-1 papers to the Securities and Exchange Commission for an initial public offering (IPO). No doubt that Twitter hoped filing confidentially might help it avoid the rampant and sometimes damaging speculation suffered by some of its Internet-based IPO brethren, like Groupon Inc. (Nasdaq: GRPN) and Facebook Inc. (Nasdaq: FB), both of which lost over half their value within six months of listing.

Facebook's IPO was priced at 107 times trailing 12-month earnings, making it pricier than 99% of all companies in the S&P 500 at that time.

Already the rumors are swirling. Reportedly, Twitter will list on the New York Stock Exchange (NYSE), perhaps to steer clear of Facebook's fate on Nasdaq, or in reaction to Nasdaq's recent three-hour trading freeze.

The main question for investors who will consider investing in Twitter stock is this: How will Twitter make money? The answer - and execution - will make or break Twitter stock.

What to Consider Before Investing in Twitter Stock

Twitter has 554,750,000 active registered users, but unless those users pay - or advertisers pay to be in front of those users - popularity won't translate to profits.

"You've got to convert eyeballs to money," said Money Morning's Chief Investment Strategist Keith Fitz-Gerald. "Just because someone uses social media to keep in touch, doesn't mean it will convert to advertising. We've seen on Facebook and others, ads don't lead to revenue. And if it doesn't convert, it doesn't matter."

Money Morning E-commerce Director Bret Holmes said that in order for Twitter stock to take off, the company will have to change how it's currently trying to make money.

Currently, Twitter's cost-per-acquisitions are seven times higher than that of Facebook, making many potential advertisers hedge the platform due to poor returns on investment.

That's why Holmes sees Twitter eventually opening its site to third-party remarketing and retargeting agencies - much like Facebook is doing now.

"If Twitter fixes that, the closer they'll get to the kind of profitability that has fueled Facebook's rise over the last four months," Holmes noted. The Facebook stock price has doubled in two months. [Wednesday we explained the secret behind FB's price surge - go here if you missed it.]

IF the company fails to adjust its ad model, it's a guarantee that Twitter stock will go the way of other popular IPO bombs, like Groupon.

The company already has been testing out new advertising methods. After some limited testing in May, in late August Twitter announced it will open up Lead Generation Cards to all businesses.

These will allow businesses to register customers and their respective emails for memberships directly within a tweet. For instance, a customer/user can click to expand a tweet, and then he or she will see an option to sign up for membership. The customer/user can then easily sign up using the email address connected to his or her Twitter account.

Twitter released a Cards case study on its blog that indicated decent results. The study showed outdoor apparel company Rock/Creek attaining a 4.6% engagement rate and more than 1,700 new email contacts in one week via a Card within a Promoted Tweet. Customers were enticed to share their email addresses by being entered into a drawing for a free pair of Chaco sandals.

Twitter is clearly testing the advertising waters, but investors should keep in mind that even if Twitter does manage to find a sustainable advertising model, investors aren't guaranteed a reward.

"When it comes to Twitter, here we go again," Fitz-Gerald said. "I am unaware of a single social media company that has paid off over the long term for anyone other than the investment bankers, early angel investors, and company officers."

As far as Fitz-Gerald is concerned, the idea that an average investor can make a fortune on a social media IPO like Twitter is all but an illusion because they are the absolute last ones in the value chain.

If you are a serious investor, do not be surprised if you can't make Twitter stock work in your favor.

Twitter Do you think Twitter is a good investment? Yes, it's too popular to disappoint. No, social media IPOs have little value to the average investor.
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