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Twitter IPO: 5 red flags

(MoneyWatch) Now that Twitter has filed for its initial public offering, attention is shifting to the social networking firm's financial performance and prospects as a public company. But as Facebook's (FB) ballyhooed -- and disappointing -- IPO showed, it is easy for average investors to get swept up in the hype and lose money.

The hubbub around Twitter's hotly anticipated IPO, in which the company hopes to raise $1 billion, is already going on overdrive. For retail investors, the question is what surprises might lie in store. Here are five red flags visible in Twitter's IPO filing.

Losing money

This is the most obvious issue when looking at Twitter's financials for the past few years. Unlike Facebook, the company has never made money. Twitter lost $67 million in 2010, $164 million in 2011 and $79 million in 2012. In the first six months of 2013, the company lost $69 million, up from the $49 million it lost in the first half of last year. If the increased losses keep pace the rest of the year, Twitter could be talking about losing more than $110 million in 2013. That's not as bad as 2011, but that year included an almost $36 million dividend payment; the loss without the dividend was $128 million.

Another way of assessing these losses -- the size of the loss compared with revenue -- might offer hope that Twitter could see enough future revenue growth to eventually turn the corner. In 2010, the company's losses were about 2.4 times its revenue. In 2011, the figure was 1.5 times as large, while in 2012 the loss was only 25 percent of revenue. The number edged up to 27 percent in the first six months of 2013, a big improvement from the 40 percent of revenue Twitter notched in the first six months of 2012. If revenue can keep growing fast enough, it could outpace larger losses and bring profitability. There's just one problem....

Slowing growth

Revenue growth at Twitter has slowed significantly. In 2011, revenue was 3.8 times what it was the previous year. In 2012, it was just under triple the 2011 number. Comparing the first six months of 2013 and 2012, revenue this year was 2.1 times bigger than 2012.

To increase revenue growth, Twitter needs some new ways to make money. It's trying new things, but some of its standby strategies don't necessarily work with the way the business is going.

Incompatibility of revenue mechanisms and mobile

The burgeoning mobile arena is vital to Twitter. Indeed, the sector is the "primary driver" of the business, with 75 percent of the site's monthly average users having accessed the service from a mobile device. More than 65 percent of its ad revenue comes from mobile devices. Whatever Twitter does to increase revenue has to work in the mobile space.

For now, "substantially all" of Twitter's revenue comes from its promoted tweets, promoted accounts and promoted trends, the company said in its IPO registration statement. All three are ways that advertisers pay to get more attention from the service. Unfortunately for Twitter, promoted trends and promoted accounts "receive less prominence" on the mobile applications than the desktop ones, and that has reduced the revenue they can get and may receive in the future. In other words, Twitter greatly depends on mobile and greatly depends on three types of advertising sales, two of which don't do so well in mobile. As the trend toward mobile only grows, that could limit revenue.

Confusing metrics

As often happens with high-tech companies, Twitter has defined some new types of business metrics that can be confusing. For example, it looks at "timeline views," which are when people look at or refresh the list of tweets or view search results. Then Twitter calculates timeline views per monthly average user and ad revenue per thousand timeline views. Investors will need to be careful and translate these numbers to more broadly used metrics, like revenue per user, to compare Twitter with its competitors.

For example, in the second calendar quarter of this year, Twitter generated revenue of 80 cents per thousand timeline views across all its global users. The average user registered 601 timeline views per month, meaning that quarterly revenue per monthly average user was just over 55 cents. That is extremely low compared to Facebook, Yahoo (YHOO) and Google (GOOG).

Too much U.S. dependence

As has been true with Facebook, Twitter is heavily dependent on U.S. users for revenue. The revenue per thousand timeline views in the U.S. during the second quarter of 2013 was $2.17. For the rest of the world it was only 30 cents. In addition, U.S. Twitter users averaged 825 timeline views per month, versus 652 views overseas. That means average revenue per user in the U.S. for the quarter was $1.79, while it was 20 cents for Twitter users abroad. Meanwhile, timeline views per monthly average user in the U.S., as well as the total number of timeline views, are flattening.

If that continues, Twitter will have to explain to potential investors how it can keep fueling the revenue growth it needs to eventually become profitable.

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