The bungled initial public offering (IPO) for Facebook (Nasdaq: FB) was a real eye-opener for any company looking to go public.
Facebook's shares famously plunged soon after they started trading, in large part because the $16 billion offering was so large that it created a great deal of investor confusion as share allocations were misdirected.
Lesson learned. Twitter’s (NYSE: TWTR) IPO valued the company at just $1.8 billion. Sure, that's far higher than the initial $1 billion planned offering, but still a much smaller fish for the markets to digest. In a sure sign that investors must own this company, shares were initially set to be priced at around $20, the deal was eventually bumped to around $26, and opened at an eye-popping $45.10 a share. At that price, Twitter is now valued at more than $25 billion.
Most of the company is still in private hands. Look for Twitter to slowly offer more shares in various secondary offerings, but the initial scarcity factor is going to make huge instant profits for some investors.
But if you missed out on this morning’s offering, then you should wait. Twitter is now valued at more than 30 times projected 2014 sales, a multiple that is truly in nosebleed territory. The relatively few shares available means that shares have become wildly overvalued. Sure they can rise higher still, but you’d be owning shares simply on faith, and not in the context of any fundamental valuation.
By The Numbers
Of course the $16 billion Facebook IPO and the $1 billion Twitter offering don't reflect their true size. Facebook sports a $119 billion market value and is likely to generate roughly $7.5 billion in revenue this year. Twitter's debut value of more than $25 billion is up from an estimated $9 billion valuation in 2012.
More to the point, Twitter is likely to have less than $600 million in revenue this year, which means Facebook is more than 10 times larger. In a moment, we'll take a closer look to see if Twitter has the potential to ever become a major revenue generator. But first, let's look at the company's recent numbers.
Twitter's Impressive Growth
Source: Twitter's S-1 filing
Twitter's recent financial results are as you'd expect: strong revenue growth, rising gross margins, yet stubbornly high operating losses. A remarkable number of tech/social media IPOs in recent years have decided to go public when year-over-year revenue growth starts to decelerate below 100%. That will likely happen in the third and fourth quarter, as Twitter had especially robust growth rates in the second half of 2012 and the comps are starting to get tougher.
Though we have yet to see any financial projections from most analysts, Cantor Fitzgerald’s Youseff Squali has just issued a report (as his firm didn’t participate in the IPO). His report had a bullish tone, noting that “Twitter is a high-velocity and efficient communication platform that is highly complementary to traditional media outlets (especially TV), and as such, fulfills an important unmet need.” Yet shares have already surged far beyond his $32 price target.
My greatest concern: Twitter is most likely to keep losing money at least through 2014. (In contrast, Facebook was already profitable for several years before its 2012 IPO).
Growth And Valuations
The key questions around Twitter: What kind of growth is it capable of, and what kind of value can it sustain?
There have already been some minor grumblings that Twitter's revenue streams (from products such as promoted tweets and promoted accounts) are a little lighter than many had expected. Analysts at Wedbush Morgan, for example, had been anticipating $310 million in revenue for the first half of 2013, but Twitter had just $254 million in revenue.
Twitter faces the same conundrum as Facebook. A large installed base of customers, many of which have used the service for free, will need to be "monetized." To its credit, Facebook delivered a multi-point plan of attack that is now bearing fruit. Facebook boosted revenue 37% in 2012 and is expected to grow even faster 45% rate this year.
Make no mistake: Twitter's installed base of 215 million monthly active users is a powerful advantage. And gone are the days when Twitter was simply used by self-interested navel gazers. These days, Twitter serves as a vital source for information, commentary and breaking news.
Here's the challenge: Twitter must build an even deeper platform that keeps users engaged, enhances the amount of time spent on the site, and generates meaningful revenue per user. To help in that effort, Twitter hired Jennifer Price in August. She was the former head of media sales at Google (Nasdaq: GOOG) and is expected to help extend the appeal of the platform to TV advertisers and video game users.
As noted earlier, Twitter's shares are already in the stratosphere. Let's plug in some numbers and see how they compare with other hot dot-com stocks.
Simply looking at likely 2013 results for Twitter, this stock would be even more richly valued than the market's current most expensive group of dot-com stocks. To be fair, all of these companies are likely to post excellent sales growth in 2014 and 2015, but as I noted recently, it's unclear if these companies will ever deliver the bottom-line results to justify their current valuations.
What To Look For
As Twitter is quite likely to do several additional stock offerings over the next year or two, the investment banks are going to be sure that their analysts have very nice things to say once the research reports start to flow.
Yet there's a very good chance that Twitter is not going to be able to live up to the analysts' very lofty expectations, and as we saw with Facebook, the IPO could quickly lose steam as the days and weeks pass by. Extending the Facebook analogy further, shares of Twitter are likely to be much more appealing once the story has lost its IPO glow.
Risks to Consider: As an upside risk, analysts may develop extremely high target prices just so they can garner a great deal of buzz for their firm's future banking efforts with Twitter.
Action to Take --> You'll be hearing a lot of analogies between Facebook and Twitter in coming weeks, but you should ignore them. Facebook has steadied itself and cultivated a clear and far-reaching growth strategy. At this point, Twitter just needs to find a way to get to break-even. The company will need to come up with a range of new revenue streams from its current platform before it can become hugely profitable.
Editor's note: This article was originally published Oct. 16, 2013.