Spark Capital investor on Twitter: "Depending on what day it is, they’re profitable"

On April 13, Todd Dagres of Spark Capital came to speak at our New Enterprises class. Todd is a former instructor of the class, and an established venture capitalist -- his VC bio lists Akamai and a host of investments in other networking companies dating back to the 1990s. He is also one of the much-lauded early investors in Twitter, and after his presentation, he fielded questions from the class. I raised my hand, and popped two questions that I thought were relevant to the discussion about building a profitable enterprise (our assignment that week was a go-to-market strategy for our own business ideas): I asked Todd how the Twitter team sold him on the costs and the revenue potential, and whether or not the company was profitable.

Todd responded:

“The second question I can’t answer. I can say that ... let’s put it this way: Depending on what day it is, they’re profitable. So they’re generating lots of revenue (see, that’s the revenue right there). And depending on how much comes in that day, they can be profitable. So they are monetizing, put it that way.

As far as, did they have a plan? Absolutely. They had a plan that said, 'we're going to grow subscribers, we're going to monetize subscribers.' So they had a plausible plan. By the time we invested, they had decent momentum. They had under ... (trails off)

When we invested, by the way, you’ve got to understand. It’s not like it is now. Back then when we invested, Facebook was a fraction of what it is now. Zuckerberg had yet to be on the cover of a magazine, and Twitter, had, probably when we invested, 600,000 subscribers. Which if you look at it , 600,000 subscribers, that’s a lot. 'Why did you wait until they had 600,000 subscribers?' Back then, it wasn’t as obvious as it is now that you can monetize the subscribers.

When we made the Twitter investment, there were articles in the press that outnumbered the other articles in the press, relative to social networking. And basically what the articles said on the negative side, is 'social networking advertising CPMs suck.' And I even saw one table that said, 'here is the CPM hierarchy.' And down at the bottom, along with the nastiest stuff you can imagine, was social networking advertising CPMs. And the reason given was, 'you have no idea what people care about on social networks. But if they go to a car site, ho ho ho!’

So cars, financial services, things like that had the highest, high tech blogs and magazines and things like that had the highest CPMs, and way down at the bottom was social networking because no one could understand why advertisers would advertise against social networking, ‘you never know what you are going to get.’ Someone talks about what they did last night, 'who cares, who would ever care about that?' But as we know now, Facebook knows a lot about you, and they can target ads against you, better than probably Google can. All of a sudden, social networking CPMs have gone way up, and it’s pretty obvious. ... (trails off)"

I wasn't able to ask a follow-up question, but there are problems with some of the arguments he used to defend Twitter and its revenue potential:

1. Facebook may know a lot about its users, but Twitter does not. Real names and other demographic data are not required for registration. Many people on Twitter deliberately obscure their identities.
2. Facebook CPMs may be higher, but not by much, and surely not approaching the levels that I see Federated Media charging vendors to post display advertising in its network of online publishers (food blogs currently command $5-$12 CPMs, and Business Insider gets >$20 for display advertising). In my own small advertising tests using Facebook's self-serve advertising platforms, I paid for $0.14 CPMs in February 2010 and $0.20 CPMs in April 2011.
3. If it wasn't obvious back in 2006 or 2007 that it was possible to monetize Twitter's subscribers, why invest in the company?
4. Regarding the claim that "depending on how much comes in that day, they can be profitable": Such a defense would never be accepted by the current instructors for New Enterprises (Bill Aulet and Howard Anderson) for our class projects. It's also the sort of thinking that got lots of people in trouble in the late 1990s. Private market trading has valued Twitter at close to $8 billion, not based on real earnings or a plausible business model, but rather the premise that the people behind Twitter will somehow figure out a way to make it work. They haven't so far.

The unsaid argument for investing in Twitter was never mentioned by Todd, and indeed is seldom mentioned in the classes we have on building innovative businesses: A VC's primary responsibility -- or, should I say, fiduciary duty -- is to produce returns for their funds. If the exit is tied to actual revenue or profitability of their portfolio companies, that's great. But if not, who cares, as long as the exit is for a comfortable multiple of the initial investment?

As we have seen many times throughout history with everything from tulip bulbs to dot-coms selling bags of dog food, if enough people think that a popular product or service will be The Next Big Thing, a bevy of dreamers, flippers, and suckers will surely come a-running. Of course, the problem with the sale of unprofitable companies at logic-defying valuations is someone will end up getting burned. While the party is still going, however, no one wants to hear the sour notes. In Twitter's case, its status as a game-changing platform creates value on a different dimension for partners in the ecosystem. But this value does not easily translate to revenue, which once again takes us back to the question of Twitter's long-term value to investors.

More blog posts about my MIT experience:

• Infinite Corridor Walthrough
• A curriculum for learning computer programming in WoW
• My MIT center of gravity shifts to digital media
• The challenges of creating a mobile educational app based on Linked Data
• MIT Sloan Fellows program: Soft vs Hard
• Goodbye, Vietnam
• First day of the spring semester ...
• Linked Data revisited: What I learned, what we created, and what's next
• Social TV poster #1: PeoplePixPlaces
• MIT Sloan Fellows: One semester down, two to go