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Twitter's Lack of Diversification Looms as a Key IPO Risk

Tickers in this article: FB GS

NEW YORK ( TheStreet) -- The power of Twitter's platform and its value to users may be unimpeachable; the company's business model isn't.

As Twitter braces for an initial public offering of its stock, the company has built an impressive and fast-growing stable of users on the micro-blogging site. However, Twitter's highly concentrated advertising-based earnings loom as the crucial risk for investors to weigh.

Meanwhile, investors might want to consider the fast growth that Twitter reported in its Thursday S-1 filing with the Securities and Exchange Commission as more of a risk than a positive for the company. Much of Twitter's business model and earnings streams remain unproven, even as revenue at the company is set to exceed $500 million this year.

Investors should think carefully about whether Twitter will be able to generate sustainable earnings from its near-quarter billion member social network as the company's stock listing looms.

Virtually all of Twitter's revenue comes from advertisers and in the form of three sources: Promoted Tweets, Promoted Accounts and Promoted Trends. If those forms of advertising prove ineffective or are overtaken by competitors, Twitter may find itself at a loss to maintain or grow its business.

Worse yet, the company has few long-term revenue streams to cushion itself from an economic downturn or changes to the online advertising market.

"As is common in the industry, our advertisers do not have long-term advertising commitments with us," Twitter said in its IPO filing.

"If we experience a decline in the number of users or a decline in user engagement, including as a result of the loss of world leaders, government officials, celebrities, athletes, journalists, sports teams, media outlets and brands who generate content on Twitter, advertisers may not view our products and services as attractive for their marketing expenditures, and may reduce their spending with us which would harm our business and operating results," the company added.

To maintain or grow its ad dollars, Twitter may also have to prove the relevance of its advertising product. Are firms getting their bang for the buck by spending their ad budgets on Promoted Tweets? How will Twitter explain firms' return on investment as a means of locking up long-term business? Those issues remain open.

Consider Twitter's accelerating revenue growth. On one hand, that may signal to potential investors in Twitter that the company will soon be able to scale its business profitably. Taken another way, however, may raise new question marks.

Twitter's revenue was a mere $28 million in 2010 and it was just over $100 million in 2011. Last year revenue tripled to over $300 million, and those sales are poised to double in 2013.

Most of Twitter's revenue growth has come from the launch of its advertising products.