Unless you've been living on Mars for the past few days, you've probably heard the news that Twitter has filed to go public. This is big news as I have been looking forward to this IPO. Mainly because I view it as a significant catalyst for Sina (SINA) shares, but also because Twitter is a company whose model I am particularly fond of. The platform is like a breaking news network, gossip site, virtual publicist, financial rumor mill, and celebrity fan club all rolled into one. I've always seen it as a potential data goldmine, and have consistently felt that it was the best opportunity in social investing because of its lagging monetization initiatives relative to its social platform presence. The stock has always had an OTC value that looked dirt cheap to me. But outside of negotiating a multi million dollar stake in a private transaction, (something I tried but failed to convince a former employer to do at a $3 billion valuation) there are limited practical ways to get exposure to the company. It is for this reason as well as factors such as mobile engagement in China, relative valuation, and liquidity that I have spent so much time focusing on Sina. But now that the cat is out of the bag, it's time to take a closer look at what Twitter is worth.
"I would think that given the whole momentum behind them….[they will price in the] low-to-mid 20's… giving them an overall valuation between $10.5 billion to $11 billion" Santosh Rao, Greencrest Capital
Valuing Twitter's IPO
Suffice to say there is a lot of confusion out there surrounding this name, and based on my experience with Weibo this is not a big surprise. The big microblog platforms scaled rapidly, but they have been very slow to get going on monetization. This has created a good deal of market confusion as enthusiasm around exploding user growth gave way to skepticism regarding monetization. For example, as of 2009 Twitter didn't even generate revenue. And up until about 12 months ago, you could say the same thing about Weibo. Both platforms had huge users bases, but unlike LinkedIn (LNKD) and Facebook (FB), didn't seem to know how to make money off of them.
See, the microblog platforms are all about mobile, and for the most part smartphone ubiquity is really a phenomena of the last 18-24 months. Thus, the market has had little to go on revenue potential wise, and until recently had become increasingly skeptical of mobile ad/fee leveraged models. (I personally shared some of that skepticism with respect to platforms/models that I don't believe port too well onto mobile, however, that never got in the way of my optimism regarding the microblogs.) This has all started to change over the past few months, but as you can see from the above articles there is still a good deal of confusion out there. And since I didn't come across a single article or sell-side report that I think did a good job of nailing this down, I have decided to weigh in on the matter.
Date of IPO
Shares Offered as % of total Outstanding
Market Value At IPO Pricing ($ billions)
Value end of 1stDay
TTM Rev at IPO ($ billions)
Market Cap to TTM Revenue after 1stDay of Trading
May 18, 2012
May 19, 2011
(Note outstanding shares include deep in the money stock options on listing that don't make it into the official outstanding count in the S-1)
I put together this table because I think figuring out Twitter's 'fair' initial price to sales (as far as valuation, revenue multiples is about the only way to go with these names for now) multiple isn't that difficult. I am going to go on record that the stock will trade at a minimum multiple of 40x ttm revenue on day one. I am now very confident of this floor. What I can't predict is just how far above this floor the initial ceiling ends up being.
So, why 40x you may ask?
Well, the best way to answer this question is by focusing on the differences between the previous two major social IPOs, and figuring out where Twitter falls on the spectrum. The factors that matter are overall market sentiment, scarcity of the offering, and timing of the IPO relative to where the company is in their revenue growth curve.
1) Market Sentiment- LinkedIn's IPO coincided with a much more troubled equity market as Eurozone issues had just started to really gain steam. Facebook's timing was much better, but it still was more of a standalone IPO, as market demand for IPO's remained weak. Twitter will be listing in a very strong equity market environment as well as a heating up IPO market for tech. So, overall the advantage multiple wise falls to twitter.
2) Pricing- LinkedIn was priced to create future demand. They sold 8% of their shares in their IPO versus 18% for Facebook. They then over the next two years sold another 11% at an average 3.5x their initial offering price. Facebook went a different route and chose to take advantage of huge hype and maximize their exit on IPO day. The consequences of such a decisions are measured in subsequent performance, but the rationale is usually quite clear. If you are early in your revenue growth curve, the LinkedIn approach makes sense because your ability to leverage an abnormal phase growth multiple is significant. However, if you are already on a multi-billion revenue run rate, maximizing your exit opportunity based on past growth rates matters more than ensuring secondary market interest remains strong. Twitter clearly falls into the LinkedIn category as it will be going public at well below the $1 billion revenue level. This means that what is effectively a staggered IPO is more likely. Though I wouldn't rule out the possibility that a strong market, investor IPO enthusiasm, and Twitter mania won't tempt them to consider a one-time shot. Overall, my expectation here is that Twitter's underwriters aim for a 25x-30x price to sales multiple for pricing, and bank on the market to deliver something north of 40x on the open. This would translate into a 30-50% pop on day one.
3) Growth Curve- The main driver behind my floor is that Twitter is going public very early in its growth curve. To put this in perspective, Facebook filed its IPO with $4 billion TTM revenue and over 900 million users. Go back three years and the company had slightly less than 200 million users and TTM revenue of less than $500 million. Twitter as a growth company is a lot closer to the Facebook of Q1 2009 than the FB of Q1 2012, which is why LinkedIn is the better comparable here. LinkedIn has delivered a good portion of its abnormal revenue growth sweet spot as a public company. By the end of this year, LinkedIn will have gone from its $290 IPO ttm revenue to an annual rate of $1.5 billion. That's a five fold increase in revenue over 2.5 years which has largely been driven by flipping on the monetization switch and not exponential user growth. (LNKD has gone from 100mln MAU to 180mln over this time period) Now considering the fact that advertisers favor Twitter over every other social platform, the platform has a good shot at even exceeding LinkedIn's performance.
But for now let's simply assume that on IPO day Twitter looks a lot more like LinkedIn than Facebook, and hence should be able to pull off a trailing sales multiple at least equal to what LinkedIn delivered. Performance from then on will really depend on how much above and beyond that multiple Twitter ends up trading. And if you are wondering what FB-esque priced for perfection looks like, consider that based on LNKD's growth the stock could have arguably supported twice its actual IPO valuation on its 1st day.
Putting all three of these factors together, I conclude Twitter will end up commanding the highest 'social big three' revenue multiple out of the gate. And for those looking for other premium factors, I'd also add in the intangibles here of Twitter's recently acquired video app Vine being in the midst of its user growth sweet spot and the mobile advertising market suddenly being en vogue.
Cracking The Revenue Mystery
Now that we have a multiple, we need a revenue estimate to get at a valuation. I personally don't believe in using forward estimates for any IPO exercise as I bake growth expectations into the trailing multiple. But as Twitter is in emerging stealth company disclosure mode, we don't have actual revenue numbers yet. Not exactly a big deal as I am guessing we get these numbers within a month, but this is still an obstacle for the purpose of this analysis. Anyway, eMarketer's estimates on the name are pretty well known by now with the firm predicting roughly $600 million in 2013 revenue and $1 billion plus for 2014. I chose to ignore these estimates and go right to some reliable sources for the actual data. What I discovered is that Twitter 2012 revenue was at least $300 million, and that current ttm is at least $450 million. So, applying my minimum 40x trailing multiple to $450 million produces an $18 billion valuation. That being said I think the actual number will be closer to $500 million so expect Twitter to trade in the $20 billion plus range on day one. (I'm estimating $25 billion as the market cap)
Sina Is Still the Best Way to Play This
It still is the best way to play this IPO, and the only social web platform play worth buying in this crazy environment. My logic behind this is that either Twitter ends up selling such a small slice that getting an allocation will be either very difficult or relatively pointless as far as potential return on deployable capital goes. And if that doesn't happen, you will most likely be stuck with what will be a priced to perfection IPO which as Facebook investors can now tell you is a not a pleasant experience. Sina on the other hand allows microblog/Twitter bulls to maximize the Twitter IPO upside in what remains a relatively mispriced asset. This is because Wall Street (several sell-side analysts) has been valuing Weibo based on a 50-60% discount to Twitter's current value, and they have generally been pretty conservative by using Twitter valuations based on its last capital raise.
That is going to have to change. If your Sina price target is based on a SOTP using a $8-$10 billion Twitter valuation, well, a $20-$25 billion market cap will require a significant revision. Not that the analysts are right in going this route, but either way 'value' estimates will be going up. And remember that this market is still somewhat Facebook shell shocked, and has forgotten just how CRAZY things can get when the herd gets behind something. For those with a short memory, I need only to remind you of Renren's (RENN) IPO. The stock priced $7.2 billion, opened over $10 billion, traded as high as $12 billion, and closed at $9 billion. This was for a company with ttm revenue of $70 million. So, Renren's price to sales multiple range on ipo day was between 100x and 175x. This turned out to be a top and the stock really blew up fast as there was no real traction behind the platform, but it still serves as a good reminder of what can happen when things get stupid. Anyway, assuming a mean $22.5 billion market cap for Twitter, Weibo is worth between $9- $11 billion at a 50-60% discount. That works out to about double Sina's current market cap. So, whether you're bullish or not, you don't need to stretch to make a 'cheap' stock argument here.
Really, the only headache you have with Weibo is the on again off again concerns regarding government crackdowns on the microblogs. This is something that I think is overstated as China has already embraced these platforms, and has no way of turning back. That is not to say they won't work hard at controlling them, but this is cost of investing in Chinese Internet companies.
Don't Chase the GSV Capital Trap
It's been a while since I wrote anything about GSV Capital (GSVC), but what I had to say then still holds true today. You want to avoid these closed end pre-IPO funds because they typically do nothing more than enrich the people running them. This is going to be difficult for most retail investors to do because 14% of GSVC portfolio is made up of Twitter shares, but it's the right move. Since going public in April of 2011, GSVC has seen its NAV decline for every single quarter except the most recent one. Furthermore, stocks like these tend to trade at a persistent discount to NAV because of the portfolio mix. See, the problem with this model is that the upside in portfolio is nowhere near what it should be to offset the downside. Late stage pre-IPO investing means you are buying premium valued private companies with near term liquidity event expectations. The upside relatively speaking is not what it should be as a best-case scenario like Twitter usually translates into doubling your money. Meanwhile the downside tends to be a complete total write-off. Yet, you are paying the manager what amounts to 4% simply to hold the positions, and another 20% if they ever make money. Do you want to pay these fees for a passive strategy of simply buying what the VCs have made hot? The complete lack of dynamism makes this model very unappealing, and it is one that has a long market track record (going back 100 years) of epic failure. When the IPO window dries up, companies like this are no different than a real estate flipper sitting on a portfolio of off plan units at the peak of a market.
Anyway, despite my Twitter infatuation, I am personally very wary of the growth complex now as the amount of new supply coming to market (IPOs and Secondaries) and irrational pricing in existing listed names is hitting extremes. It is at times like these that you need to be very picky with your 'growth' related longs as the smarter big picture move is now shift to a solid and sustainable short bias in this complex.