Can Twitter Rake in the Ads to Justify $1 Billion Valuation?

The question about Twitter used to be, "Is it a business?" Now, the question becomes "How big can it be?"

And the answer is: It better be big. CEO Evan Williams confirmed last week that the microblogging service had finalized its new funding, reported to be $100 million, giving Twitter -- which now has no monetization program in place -- a whopping $1 billion valuation. Prior investors Spark Capital, Benchmark Capital and Institutional Venture Partners doubled down, and late-stage investors T. Rowe Price and Insight Venture Partners joined up.

With the funding, Silicon Valley and the venture community are once again setting their sites on the marketing budgets of American business to support another free "cloud" web service, in this case 140-word bursts of text. Indeed, they're counting on the exponential growth of advertising revenue in a flat market for a company that -- while certainly useful to marketers -- has yet to earn its first dollar.

"I think they can build some kind of ad business, but the more relevant question is can they build an ad business worth a billion plus dollars," said Warren Lee, VC at Canaan Partners. "That would require tremendous volumes of impressions and reasonable conversions. Lots of execution will be needed. Not impossible but unlikely."

The cash infusion (on top of $55 million already raised and the estimated $25 million Twitter has left in the tank), puts the pressure on Twitter to earn its first $100 million within the next year or two, and sparked cries of "bubble!" from the cheap seats, but that was true of AOL, Netscape, Google and Facebook.

'No precedent'
Yet Twitter is quite different. "It's the first one that's not a destination -- it's a distributed service," said Seth Goldstein, CEO of SocialMedia and investor in early Twitter backer Union Square Ventures. "There is no precedent for how to monetize it. "

Like Facebook, businesses already use Twitter to communicate with their fans and don't need to pay Twitter a thing to build followers or communicate with them. "What we see is a move away from brands using broadcast media to more engagement media," said Zephrin Lasker, CEO of sales-lead exchange Pontiflex. "If you have engagement on a one-to-one basis, extremely scalable, that's valuable."

Valuable to marketers, but is it valuable to Twitter? With the money comes an expectation of corresponding revenue, and while verified accounts, corporate services and analytics are interesting, advertising is the business that scales. While co-founder Biz Stone said there are no plans to start an ad business this year, it seems inevitable Twitter will be going toe-to-toe with Facebook in the ad market.

"What is interesting from an advertising perspective is the same thing that is interesting about Facebook: It is one of the only platforms of scale that has two-way messaging potential," said Michael Lazerow, CEO of Buddy Media, which sells ads on Facebook widgets. "But are they a $50 mil or a $1 bil business?"

Twitter could turn on revenue immediately, but appears to be in no rush to do so. Observers have, for example, long wondered why Twitter didn't start running contextual or keyword ads next to tweets, like Google. Twitter could run the ads based on the content of tweets combined with what Twitter knows about the user from their profile and registration details.

Outside factors
The problem with that is that more and more users access Twitter from third-party apps like TweetDeck or Tweetie not owned by Twitter, and those services, too, need a business model and may also incorporate advertising.

Mr. Stone said that ads won't come before 2010 and Twitter's early-stage venture backers have told Ad Age the ad business, narrowly defined, isn't that interesting to them. On its site, Twitter touts marketing success stories from Pepsi, Jetblue and Dell, which consist of the brands using the service to connect with fans.

The cash could allow Twitter to make some acquisitions; perhaps one of the URL shorteners like Bit.ly, one or more of the Twitter applications, or one of the many, many firms now making dashboards to manage Twitter for corporate clients.

With a valuation of $1 billion, Twitter's investors believe one or more of the following outcomes are likely: an IPO or an acquisition at a healthy price. Already Twitter has reportedly turned down bids from Facebook, Google and Microsoft.