Twitter valuation of $8 billion hints of a bubble

The whole world knows how Twitter and Facebook gave power to the people and overthrew dictators.  

Events in Tunisia and Egypt did more to advertise the power of these social networks than multimillion-dollar campaigns.

Still it was a surprise to read recently in the Wall Street Journal that some investment analysts were putting a market valuation of $8 billion on Twitter. In an informal poll on the Journal‘s website, 80% of the readers said Twitter was not worth that much.

Where do valuations come from

In the days when dinosaurs ruled the earth, a newspaper company would often be valued at 2.5 times sales. Those standards have gone out the window. Facebook is now valued at 25 times sales, and Huffington Post at 10 times sales, based on the price that AOL recently paid.

 By this same yardstick, Twitter is being valued at 200 times sales, a stratospheric number even compared to Facebook, which has three times the registered users of Twitter.

Alan Mutter, The Newsosaur, produced an excellent graphic on his blog (reproduced here) that shows the relationships between old and new media valuations.

Notably, newspaper companies like McClatchy, New York Times and Gannett all have market valuations of less than than 1 times sales. 

To quote Mutter:

Recent deals like the Facebook financing, the Demand Media IPO and the Huffington Post sale show that investors put far more value on companies aggregating cheap or free content than on dedicating generous resources to original, high-quality journalism.

In other words, investors like the fact that these new companies have none of the high costs of producing and distributing content (journalists, printing presses, delivery trucks). Even advertising sales are automated on the web so there are no sales commissions, which can take 15% off the top.

Earnings matter less in short term

Another old standard for valuing a newspaper company was 10 times earnings. In the case of Huffington Post, earnings were negligible and Twitter reportedly is losing money. So they would have zero value by that yardstick. Obviously there is a new logic at work. The valuations are based on the hopes for rapid growth and earnings to go with it.

There was a time when the valuations placed on Google seemed ridiculous. But after several years of looking like a risky investment, it is now immensely profitable.