I earned several eye rolls and smirks when I tell colleagues I purchased shares of Twitter (NYSE:TWTR) yesterday. I think they felt I was yet another victim of the latest tech bubble. How could I buy stock in what is now a $25 billion company that does not (and likely will not) earn money? They lost $65 million last quarter and yet the stock is currently trading around 22x 2014E sales, which is almost double that of LinkedIn (NYSE:LNKD) and Facebook (NASDAQ:FB). What a joke.
And I would agree with them - if I thought Twitter was going to follow the same business plan as Either LinkedIn or Facebook.
Consider the following:
- Twitter management didn't "need" the cash to survive. They had plenty of funding available without the necessary headache of adding investor relations and overhead departments.
- Twitter's founders didn't exactly cash out. The company only monetized a small percentage of the firm via the IPO: an expected 70 million shares at the anticipated $26 share price, or $1.8 billion in proceeds was only 12.9% of the implied enterprise value (per the S-1 filing). It isn't to say they didn't make themselves rich. But if they wanted to be greedy and get out at the top, they could have done better for themselves.
Most importantly, while its technology is leading edge and has effectively displaced the evening news, management realizes they will not always be ahead of the curve. They will either need to partner with the "next best thing," innovate (build or buy) or die. This industry is a pioneer's dreamland and the future is too wide of an open canvas to take one deep investment bet and hope it's the right path. Twitter did that once and perhaps management realizes lightning might not strike twice.
As investors, we all try and capitalize on new trends and technology. We do not simply buy one stock, we develop a thoughtful portfolio. Twitter's management has deep expertise in the social media space, but even there, it makes sense to diversify out its investments in R&D. And given the tech bubble, which I agree totally exists, that will cost a lot of money.
Here is where I differ on my investment thesis: I believe that overnight, Twitter created a new currency: Twenty-five billion "dollars" of Twitter stock. The company just raised what I will call the first vintage of Twitter Venture Capital Funds. They are free to invest, test, partner and succeed in several new startups and technologies in their fields of expertise. They never could have afforded to stay on top without some currency or means to invest. Now they have one.
So what is this new tech venture capital fund worth? We have a benchmark right in front of us. Google (NASDAQ:GOOG) is a venture capital company disguised as a search engine. Google is in the rare position of having a cash flow stream and equity, enough to make the investments that have now brought them so much success (Note: Google says Google Ventures and Google Capital are arms-length firms but they are both funded by Google's balance sheet in their entireties). Calm down - I am not saying Twitter is the new Google. Just remember that Google didn't always have the clamor of its success. The fact is, several search engine companies have failed (or are not doing well). Google had to become more than that - and did. I am suggesting that Twitter, right now, has that same chance.
So let's look at some numbers. As of today, GOOG's market capitalization is around $340 billion. That is around 28x 2013E free cash flow. Twitter probably won't earn free cash flow from years to come, so a financial analogy is baseless. My question is: putting current revenue and business model aside, can I put a multiple of return on Twitter's new $25 billion of "venture capital investment money" and then multiply that by some probability of venture capital success?
Let's compare Google's comparative advantages and investment value propositions with Twitter's sets of expertise. The Google venture investors come from entrepreneurial, engineering and physician backgrounds. Check. They have access to industry experts, a huge human capital network and leading edge research and technology. Check. They have financial partners who know what they are doing. Check. And now they both have currency to fund the next new thing.
This is not to say Twitter management will make the RIGHT investments. I will grow and change my investment in TWTR as I watch what paths of investment they choose (multiple of return). There is a lot of risk in an unproven investment management team (probability of return). I do think they have superb access to start ups and technology and they will gain assistance with their financial backers (unless they cash out, which would be another red flag).
As with all startups, getting in early is the only way to get the best long-run return.
Disclosure: I am long TWTR. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: I always put my money where my mouth is.