By Brian Hamilton, Chairman of Sageworks
Twitter is significantly overpriced despite what Wall Street says
It doesn't take 140 characters to describe Twitter's IPO: Use some common sense and look at the numbers.
Some on Wall Street are commending Twitter (TWTR) for its "conservative" valuation, but this IPO is actually a profound example of another company with a serious overvaluation challenge.
No IPO should get a pass on fundamental things like earnings and quality of revenue, and if you examine how Twitter shares will be priced relative to these basic financial measures, Twitter will be very expensive, especially for retail investors just now joining the financing 'party,'
Using the high end of the updated share price range released on November 4th ($25), Twitter shares are expected to be valued at about 43x last year's revenue. By this metric, their relative value is significantly higher than Facebook's (FB) shares at IPO, when the company was valued at about 22x sales. Even looking at this year's financials so far, Twitter would be valued at roughly 24x sales.*
Contrast that with Microsoft (MSFT), which had an IPO price that valued the company at less than 4x sales and Apple (AAPL), which had a sales multiple of 10 at its IPO, based on the 12 months of results immediately preceding their IPO.
One might suggest that these Microsoft and Apple IPO valuations were cautious and dated; products of a different era. However, look at current valuations of these proven and profitable tech companies: Based on their most recent annual revenues, Google (GOOG) is valued by the market at less than 7x sales, Apple at just over 3x sales and Microsoft is valued at just under 4x sales.
Twitter lost $80 million last year and is still losing money -- $133.9 million in the first nine months of 2013. It defies basic economics that a company losing more than $100 million is worth $13.6 billion. Facebook, Microsoft and Apple were all profitable when they went public, generating positive net margins ranging from about 10 percent to 27 percent.
So while Twitter shares are likely to be priced on a valuation equivalent to a negative 171x profit, Facebook's IPO price was 81x profit, Apple's was 102x and Microsoft's was 22x profit. Remember these relative valuations the next time someone tries to talk about how "conservative" Twitter's valuation is. You cannot look at the value of a company without comparing it with fair, if imperfect, benchmarks such as revenue and profits. This is like judging a basketball player's free throws by looking at how many he or she makes without regard for how many were taken.
Twitter fans talk about the company's financial potential, but most companies that go public have potential. And as a famous football coach once said, "Potential means you ain't done it yet." In fact, a report out last week said an analyst with one of the firms underwriting Twitter's IPO expects the company to lose money through at least 2015. Why is it that tech companies continue to get a pass in the basic things that matter in valuing any company: things like revenues, cash flow and profits. I have some reservations about a company going public without cash flow and profit; I have a much greater problem when they do so and expect a high valuation. Buzz and hype should only get you so far. Ultimately, companies must be evaluated on their fundamental performance and financial strength.
Will Twitter shares increase on the first day of trading? They may; the buzz surrounding the IPO and its "conservative" pricing may cause deal-seeking retail investors to hop in early on. But it's dangerous to assume that this IPO or any other is inherently a good investment opportunity simply because people on Wall Street are excited. Over many years, Wall Street's excitement isn't a great predictor of stock performance. In fact, as we have seen many times, the collective financial memory of investors is short, and buying a company when it is priced highly may work sometimes but is a bad bet in the majority of cases. Just ask first day investors in Groupon (GRPN), another recent "hot" (and unprofitable) tech IPO. Remember that the investment bankers hired to buy and re-sell shares to other investors before the IPO will get paid whether the stock soars or tanks on opening day. Incentives are never so clearly unaligned as they are between buyers and sellers in a hyped stock. And often, by the time the opening bell rings on IPO day, most of the investing public has missed any "deal," because the earlier investors who bought at low prices have already locked in their returns.
This is not to say that Twitter is a bad company. They have a large, influential user base. But it's half the size of Facebook's, and Twitter's revenue predictability isn't rock solid in a social media world that changes dramatically and quickly. In any case, this IPO is another situation where the stock will be overpriced when mom and pop retailers get a chance to buy shares. My advice: Tweet all you want, but don't buy the stock.
*Looking at their average monthly revenue YTD through September 2013 multiplied by 12.
Brian Hamilton is the chairman and co-founder of Sageworks. He is the original architect of the company's artificial intelligence technology, FIND, the leading financial analysis technology for analyzing private companies.
Hamilton is an expert on the financial performance of privately held U.S. companies and is regularly interviewed on the economic performance and sentiment of private companies.