The top US securities regulator has warned that technology companies with lots of users will not always translate them into large profits, in comments that appeared to be timed to coincide with the eve of Twitter’s flotation.
Mary Jo White, the chairwoman of the Securities and Exchange Commission, questioned whether investors could understand a company's prospects when they were bamboozled by the "sheer magnitude" of user numbers that might bear no relation to profitability.
Although she did not name Twitter, the speech at a gathering of securities lawyers in New York comes at a crucial time for the unprofitable company, which goes public today.
The microblogging platform does not charge for its service, but relies on advertisers who want to reach its audience of 230 million monthly active users.
She said that in recent years many technology companies had relied on “unique financial or operational metrics” to demonstrate their size or growth prospects, including their user numbers or the number of people who “like” their company. “In the absence of a clear description, it can be hard not to think that these big numbers will inevitably translate into big profits for the company. But the connection may not necessarily be there,” Ms White said.
"What if only a fraction of those users are paying customers? What does that mean for future financial results? What if the bulk of the growth in the number of users is in an area where the company has not yet figured out how to turn those users into paying customers? What does that then say about the meaning of user growth rates?"
Metrics questioned
The SEC has questioned the metrics used by tech companies in recent years to support growth projections. Groupon, the online voucher site, and Facebook faced questioning from the regulator in the run-up to their flotations.
In 2011, Groupon was forced to abandon a measure it called “adjusted consolidated segment operating income” which the SEC said was “potentially misleading to readers”. Groupon argued that it was the appropriate measure to demonstrate its financial health, but it excluded significant expenses such as large marketing costs when reporting operating income.
As Facebook prepared for its IPO last year, the SEC examined the social network's mobile growth forecasts, and asked it to clarify the risks associated with users migrating to mobile. Facebook said it could lower ad revenue. The company still increased its IPO price range and the size of its offering but its stock fell on the first day of trading and did not recover for more than a year.
Secret changes
In approaching its fundraising, Twitter made use of a new act that enables a company with revenues under $1 billion to keep its discussions with the SEC secret. But when the San Francisco-based company published all the drafts of its filings in October, it showed the changes it had made in secret.
It showed advertising rates would decline in the near term and profitability would be affected by its share handouts. Whether Twitter added these disclosures itself or under pressure from the SEC will not be known until after the IPO.
– (Copyright The Financial Times Limited 2013)
