Twitter Inc. (TWTR) shares took a massive plunge during Friday's low volume holiday trading session, dropping 13.0% for the day to $63.75, and are now trading 14.7% below Thursday's intra-day high of $74.73. Like many other 'rational' investors, we are enthusiastic about Twitter as company, believe in its story, and want to own its shares for the long term, but at the same time cannot justify paying the premium valuation at which its shares are currently trading. Ever since its IPO last month, the stock has been hijacked by speculators, bidding shares up almost two-fold, from its low of $38.80 five weeks ago to Thursday's intra-day high of $74.73, amounting to a market-capitalization of $41.5 billion at its peak, while FY 2013 revenue is estimated at only $639.1 million.
There is very little in the line of standard fundamentals metrics that can support such a high valuation. Profitability is one year out, as analysts project its first profit of 1 cent per share for 4Q/2014, with shares trading at almost 500x FY 2015 annual earnings projection of 13 cents per share, even after Friday's massive drop. For FY 2013, Twitter is expected to generate $53.6 million. in EBITDA, so that it trades at a current EV/ EBITDA ratio of almost 700, and at a still high 107.5 based on FY 2015 EBITDA analyst projections of $328.0 million. Also, shares trade at an astronomical 66.2x trailing-twelve-month (TTM) sales and at 48.8x book value. Twitter's growth, however, is expected to be phenomenal, with revenues projected to rise 77% from $639 million in FY 2013 to $1.13 billion in FY 2014, and 57% to $1.77 billion in FY 2015.
While stratospheric valuations are not altogether new for high-growth technology market leaders, especially in Social Media, Twitter shares seem to be establishing an altogether new standard, at least in recent times. We don't recall seeing such premium valuations since the 'bubble' stock valuations at the turn of the century, just before many of them plunged, including the ones that later went on to become market leaders in their category. The table below compares the valuation of Twitter shares to three other leading stocks in Social Media at three different points in their life cycle, including current metrics, metrics when they traded at their peak, and metrics at the earliest point available when projected growth was highest so as to be most comparable to Twitter.
As can be seen from the table, Twitter's valuation metrics, whether peak or at lower prices after Friday's plunge, are out of bounds compared to its peers. Of the three peers, online professional social network provider LinkedIn Corp. (LNKD) comes the closest in terms of its projected growth to Twitter, at 112% projected two-year revenue growth as estimated by analysts in Dec. 2011 vs. 177% for Twitter currently. Even then, LinkedIn shares traded at the time at far more reasonable valuations, given its growth, at 79.0x projected earnings for 2013 vs. 490.4 for Twitter currently or 574.8 at its intra-day peak on Thursday. Also in Dec. 2011, based on two-year projections, LinkedIn shares traded at a more reasonable 23.4x EV/ EBITDA (Enterprise Value / EBITDA) when compared to Twitter's metrics in the 107.5-126.1 range, and at 6.4x projected sales two years out vs. 20.0-23.4 in the case of Twitter. At its peak two months ago, LinkedIn shares still traded at 80.0 P/E, 35.0x EV/ EBITDA and 10.6x PSR, much more reasonable than comparable ratios for Twitter shares at their intra-day peak on Thursday.
Comparing it to Groupon Inc. (GRPN), a provider of discount deals from local retailers, Twitter's metrics seem even less reasonable. For example, at its peak in Oct. 2011, Groupon shares traded at 22.1x EV/ EBITDA and 7.3x PSR (price to sales ratio) vs. comparable ratios of 107.5-126.1 and 20.0-23.4 in the case of Twitter shares, while projected two-year revenue growth for Groupon was in the 87% range vs. 177% for Twitter. In the case of leading social network platform Facebook Inc. (FB), its shares traded at 39.6 P/E, 18.4x EV/EBITDA and 8.7x PSR at their peak last week, while two-year revenue growth projections are at 64% vs. 177% for Twitter.
Assuming Twitter's revenue growth moderates to the 100% range in the next two years, by 2015 year-end, a reasonable assumption given the already observed decelerating revenue growth year-over-year from 172% in the Dec. 2012 quarter to 105% in the latest Sept. 2013 quarter, Twitter shares at current prices would still be trading at the top end of valuation ranges compared to the valuation of its peers at their peaks. So, assuming FY 2017 revenue in the $3.5 billion range, about twice current analyst projections of $1.77 billion for FY 2015, at $75, Twitter shares would still be trading at almost 12.0 PSR, a premium to all three peers listed above, that traded at PSR's in the 7.3-10.6 range at their peaks. Slicing the data another way, even if we assume that Twitter shares can trade at year-end 2015 at 10.0 times peak sales projections two years out (i.e., FY 2017 sales), and assuming that a reasonable investor would need at least a 15% required rate of return to hold Twitter shares over that period, due to the high risk of uncertainty, it would put the current valuation of Twitter shares in the $48 range, far below even Friday's closing price of $63.75.
Our $48 target price for Twitter shares, which we believe is quite generous, is not that far off from the price targets put on its shares by many brokers. Macquarie, for instance, downgraded shares to Underperform on Friday, while maintaining their price target of $46. Also, Morgan Stanley, Deutsche Bank, Goldman Sachs, and many others, all have price targets in the $40 to $55 range, many issued in just the last month. Macquarie's statement in its note on Friday, "We continue to believe that Twitter as a company has a bright future and many opportunities ahead" probably reflects the sentiments of a vast majority of 'rational' investors. As a company, there is a lot to like. Its strength and potential in mobile advertising, particularly as ad spend is shifting to mobile, is particularly noteworthy. Its re-tweet feature is particularly attractive, especially when compared to Facebook's relatively closed model, as it has the potential to turn every follower into a brand ambassador, widening the reach for advertisers. And management has executed well in improving user engagement and evolving their business model, particularly as it relates to advertising. All-in-all, a great stock story and an ideal candidate for a long-term buy, but just not at today's elevated prices.
Our bearishness and low price target on Twitter notwithstanding, we would not sell short Twitter shares right now after Friday's steep decline. Rather, we would wait for prices to rise back towards Thursday's intra-day high, even pierce it higher by a bit. We believe this is especially likely in Twitter's case as the stock has been recently dominated by speculators, and it is unlikely that they will give up on the upside without at least once trying to mount a rally back to Thursday's intra-day highs.