You might have heard: Twitter had an IPO today. It achieved a market capitalization of $25 billion to $26 billion, even though the company has yet to hit $1 billion in revenue and has not earned a dime of profit. But clearly, people were excited.
Not for Your Average Joe
The company, now listed on the New York Stock Exchange (NYSE), sold 70 million shares at an IPO price of $26 per share, raising $1.8 billion in capital for the company.
But that doesn't mean the average Joe was able to buy Twitter at $26. As soon as the stock started trading, it opened above $40. It hit a high of $50 before falling back slightly. It was recently trading at $46.
The only people who could get shares at $26 were those with an investment banking relationship who were able to receive an "allocation." Some of these were traders who were able to flip the shares into the market at a quick profit.
This means there was more demand for the shares than was priced into the IPO offering. Pricing an IPO is always a delicate game for the bankers who set the price. If they price shares too high, the price falls when the stock hits the market.
An oft-cited example of this was the Facebook IPO. You remember ... the share price plunged after the IPO. Not only that, but the Facebook IPO was plagued with technical problems. The Twitter IPO went much smoother.
In the case of Twitter's IPO, the market gave the shares an immediate $20 premium, meaning, they "left money on the table." That's because with such high demand, the company could have sold shares at a higher price before it traded publicly. The Twitter bankers left about $1.5 billion on the table by pricing it at $26 (70 million shares times a $20 share premium on the open market).
But they might be okay with that because it made the market "feel good," and they got plenty of money.
Goldman Sachs was the leader underwriter on the deal — of course. Co-underwriters included other big names such as JPMorgan Chase and Morgan Stanley. Bloomberg expects Goldman and the other bankers will make about $60 million in fees off the IPO.
A quick recap of the basics:
- IPO Shares sold: 70 million at $26, raising $1.8 billion for the company
- Lead Underwriter: Goldman Sachs
- Market cap: $25 billion to $26 billion
- Founders take: Co-founder Ev Williams owns 70 million shares, worth about $2.7 billion. Co-Founder Jack Dorsey clocks in at 23 million shares and $1 billion.
Is Twitter Worth It?
Whether Twitter is worth its valuation is anyone's guess. There is no conventional answer, because this is not a conventional situation. Typically investors analyze a company's value based on the potential profitability of the company and how fast it will earn back invested capital.
But by achieving at least a $25 billion valuation without ever having achieved a profit, Twitter has no track record on profits. It has achieved a valuation among the most successful companies on earth before it has returned any capital at all. This is incredibly rare. The last time something happened like that was in 1999. Does that make you feel better?
Since Twitter's inception, the company has burned through an accumulated deficit of $418 million, according to SEC filings. From the company's S-1 statement with the SEC:
Although our revenue has grown rapidly, increasing from $28.3 million in 2010 to $316.9 million in 2012, we expect that our revenue growth rate will slow in the future as a result of a variety of factors, including the gradual slow down in the growth rate of our user base. We believe that our future revenue growth will depend on, among other factors, our ability to attract new users, increase user engagement and ad engagement, increase our brand awareness, compete effectively, maximize our sales efforts, demonstrate a positive return on investment for advertisers, successfully develop new products and services and expand internationally. Accordingly, you should not rely on the revenue growth of any prior quarterly or annual period as an indication of our future performance."
In other words, many expectations are already built it. Twitter will either meet and exceed these expectations and become one of the largest technology companies on earth, or it will become just another run-of-the-mill technology company with a middling valuation, of which there are hundreds. Pick one scenario, investors have a chance of making money. Pick another, and they don't.
One great example: Yahoo was once an investor's darling. Yahoo's peak market capitalization during the tech bubble in 2000 was about $140 billion. It's down ticked about $100 billion since then.
But that doesn't mean that Yahoo is a terrible company. It makes about $1.3 billion a year in profit, so it's a money-maker. And recently shares have been rising again. This is just an example how market works: It's not a real time reflection of how good a business is, it's a real time reflection of investors' expectations of what the business will eventually become.
Investors Expect a Lot of Twitter
There are typical metrics you can use to value a technology company, but many of them should be thrown out the window with Twitter. The most basic is the price/earnings ratio. This is the share price divided by earnings per share. Twitter is not expected to have earnings per share, so the P/E is infinity. Can't use that.
- Twitter: 37
- Yelp: 22
- Facebook: 22
- Yahoo: 7
- Google: 6
Now, this number should be seen in the context of the company's growth potential. Companies will get a richer valuation for perceived growth potential. Generally, as a company "matures" and its growth slows, the ratio on the stock valuation on a P/S and P/E basis will shrink. You can see that in the companies above.
It's All Relative
Investing is always a relative game. If one were to decide whether Twitter was a good investment, you would have to evaluate it against the competition and its current valuation.
If you think Twitter will someday be as big a company as Google, which has a market cap of $338 billion, $58 billion in revenue, and about $12 billion in annual profit, then go ahead and buy it. It would be an excellent investment. If Twitter got that big you would make nearly 10 times on your investment.
Facebook is a more modest example. Facebook currently has a valuation of $117 billion on $7 billion in revenue and about $1 billion in profits. In the next year, it's expected to have $1.5 billion in profit.
Will Twitter be as big as Facebook? If it achieves that kind of growth in the next several years, investors buying at the market price today will double or triple their money.
So, as you can see, that's the big question: Does Twitter have the products, growth capabilities, and management chops to catch up to Facebook? Investors today appear to think it has a very good chance.