Readers will need no reminding of the maelstrom of criticism that befell Facebook (NASDAQ:FB) and Morgan Stanley in the wake of the social media giant's IPO last year. On September 12, Twitter announced it had confidentially filed an S-1 with the SEC. Within hours, the media world was alight with speculation as to the structure of the IPO, and whether it would suffer the same plights as Facebook. This article aims to compare the two. The differences, the similarities and why it might be better to ignore the IPO - at least for now.
The investment world's immediate comparisons of the upcoming IPO with that of Facebook is no surprise. Both companies operate in the social media industry, both have experienced rapid user base growth in a short period, and both generate the vast majority of revenues from advertising.
The first, and arguably most important, similarity is the inevitable hype the IPO will generate. When Facebook went public last year, its users were desperate to buy its shares. Rarely does a company's IPO generate so much retail interest from those outside the investment world. Individuals wanted to buy Facebook stock not because of any potential returns, but to be a part of something they see as an integral part of their daily lives. This led to a disregard of the fundamentals of the company, and a mass acceptance of what -- looking back--proved to be an overpriced offering. Twitter will no doubt generate the same sort of mass general public attention and, as a result, a large proportion of its retail buyers will put non-return based motives ahead of others.
Another slightly less obvious similarity between the two is rooted in speculation, but from two different angles. Facebook stock experienced large gains over the past two months on the back of a positive financial statement. The crux of the positivity was Facebook's successful monetization of its mobile user base, and the resulting revenue growth. At the time of its IPO however, Facebook was struggling to monetize this user base. Before the company took the in-feed ad route, mobile screen size was limiting its potential for revenue generation. Looking back, it seems an obvious route to take. It also seems ridiculous to imagine that Facebook wouldn't find a way to monetize its 469M monthly active mobile user base, but at the time, how and when was unclear. Investors who took part in the IPO did so based on speculation that it would do these things, and do them right.
The speculation aspect of the Twitter IPO comes as a result of the JOBS act. The terms of the act enabled Twitter to file its IPO S-1 confidentially, and not reveal any financial data right up until three weeks before the IPO. This means that a large proportion of the time between the September 12 announcement and the expected Q4 2013 offering will be spent guessing as to the company's financials. Figures are already established - $500M, $583M, $650M - and when the company's financials are officially released investors' opinions as to the future of the company will likely be based around actual versus expected, rather than just actual. To analogize, consider an important data release in the currency markets, US GDP growth rate for example. If GDP growth rate is forecast to be 3%, and it comes out as 2%, even though the economy is expanding, the US dollar will likely see a decrease in value. This is because the economy is not expanding as much as expected. Twitter's masked IPO is similar. Investors will form expectations and base their response on these expectations. If revenues are revealed to be $700M, this will likely exceed most analysts' expectations, and create inflated demand for its stock. The same is true in reverse for $300M. Either way, demand for Twitter's stock is likely to be distorted.
The main difference in the two IPOs is rooted in growth potential. Twitter currently has an estimated 100M monthly active users. Facebook currently has over 1.1B monthly active users. While the two services have their differences, they are similar enough to say that Twitter still has plenty of room for growth, without requiring any significant changes to its business strategy. With user base growth should come revenue growth, and in turn share price increase. Conversely, when Facebook went public last year, the social media platform attracted approximately 950M users. The rapid user base growth the company experienced between 2005-2011 limited any potential for further growth. This means user base growth as a driver of revenue growth was a limited option for Facebook when its IPO took place. To drive any substantial revenue growth the company needed to refocus its strategy.
Another difference lies in Twitter's treatment of its privately held shares. As soon as the company announced it had filed the S-1, it froze trading in this secondary market. Facebook did the same, but just four weeks before its IPO, leaving just short of 15 weeks' worth of secondary market speculation that served to artificially inflate the company's valuation. A lack of private market speculation coupled with Goldman Sachs' likelihood to avoid a replay of Morgan Stanley's Facebook overvaluation debacle will likely lead to a much more accurate offer price.
A Valuation Consideration
Both Facebook and Twitter derive the majority of their revenues from online advertising. One of the driving factors behind both companies' recent valuations is their adoption of a rapid expanding subset of online advertising: native advertising.
Native advertising is the placing of ads that match the look and feel of the platform on which they appear. On Facebook, native ads are placed in the news feed. On Twitter, they come in the form of promoted tweets. While many analysts expect native advertising to be behind the majority of any future growth in both companies' revenue, there will come a point at which diversification will be necessary. Social media ad networks are increasingly diverting ad revenue from social media companies. They provide third party marketplaces through which advertisers and social media publishers can transact without the host platform's input. Consider IZEA. IZEA's platforms are home to a database of social media publishers that are willing to promote goods and services via their personal social media channels. IZEA runs a number of these marketplaces, and the number of advertisers using them to arrange native ad publishing is rising. Analysts expect spend on this form of advertising to reach $160M by 2014. $160M that would otherwise be contributing to the earnings of, among others, Facebook and Twitter.
In the same way as display ad placement, native ad placement on social media sites will likely be increasingly arranged by a third party in the future. With this in mind, investors looking to place valuations on social media sites such as Facebook and Twitter should do so with the consideration that alternative revenue streams might be required in the medium to long term to sustain growth.
There will be countless words written comparing the Twitter and the Facebook IPOs. So far the majority of said comparisons conclude that Twitter's will be much improved, but in light of the debacle that was Facebook's this does not necessarily mean it is worth investors' consideration.
Only when the details of its offering are made public can an accurate call be made as to the company's current position and, in turn, its prospects. The smart investor will recognize this, and act accordingly.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.