Twitter's valuation is interesting with the number of active users doubling every year and expected to touch 1 billion by 2015, which Facebook had when it went public in 2012
With the New York Stock Exchange running a test drive to brace itself for the much-awaited Twitter Initial Public Offering (IPO), it is worthwhile examining some of the characteristics of Twitter to guesstimate the value of the IPO.
Twitter, intends to sell 70 million shares at between $17 and $20 each, and will be holding the biggest Internet IPO since Facebook, raising about $1.6 billion with a total valuation pegged at about $11 billion. Twitter shares are expected to be traded from November 7. However, this valuation is much less than that of Facebook that opened its IPO last year at $38 per share at a market value of $104 billion.
Twitter, much like Facebook, is a Group Forming Network (GFN), consisting of groups of users who are connected to each other, tweeting and re-tweeting the 140-character feeds over the internet. Much like any other network such as telecom, Twitter has direct network externality effect that increases value both for the network owner as well as users connected to the network, as the number of users in the network increases. The billion dollar question is: is the value of the network (i.e. Twitter) proportional to n (the number of Twitter users), or square/exponential in n. A number of researchers looked at this problem in detail: (i) Sarnoffs Law is more conservative in estimating value that varies linearly with n and found to be true in the case of television and cable broadcasting networks; (ii) Robert Metcalf, the inventor of Ethernet, is widely-credited with Metcalfs Law that states that value is proportional to square the number of users, i.e., n2; (iii) Reed however proposed that in a GFN, the value could be exponential as many sub-networks can be created as in the case of Facebook and Twitter; (iv) and finally, a conservative estimate by Odlyzko and Tilly who argued that not all connections between users and sub-groups are equally important, and hence, the value is much less. For those technically inclined, they proved that it is in the order of nlog(n). In other words, increasing the number of users from 10 to 20, the value of the network only doubles, i.e., 10 to 20, as per Sarnoff; quadruples, i.e., 100 to 400,