Twitter (NYSE:TWTR), one of the most anticipated social media IPO's since Facebook (NASDAQ:FB) has been a dream come true for many. Unlike FB, or its competitor Linked in (NYSE:LNKD), TWTR exploded higher and hadn't started looking back until very recently. Some have called it a mini bubble that is bursting. The so called burst began last week (Dec 27) and continues into this week. It shouldn't surprise anyone, as since it went public in November, shares had appreciated over 150%. Those who are surprised were the same that believed a triple bagger was approaching. I argue that the bubble has not burst. Rather, it is only deflating. Alas, the air began deflating from the bubble on Friday when shares fell nearly $10, or 14%. This was the largest one-day fall for the company thus far in its history that is being still measured in weeks. What started it all?
A Seemingly Benign Downgrade, But Look To History
A Macquarie analyst came out with a downgrade on Friday, following a string of negative sentiment. The downgrade was simply from neutral to underperform on yet the $46 price target was held. Just about everyone I have spoken to regarding TWTR have said that the valuation is completely unjustified. That the company has not a drop of earnings to speak of, and there is simply no fundamental reason the stock should be this high. I tend to agree. However, I was on the opposite side of the Amazon (NASDAQ:AMZN) trade for several hundred points while it too ran up. Competitor LNKD has some earnings to speak of, but always traded at a disgusting premium.
Rich Valuation Triggering A Selloff, But Is The Company's Future Bright?
Since the IPO, the insane levels of jubilation and euphoria for this stock have been unparalleled. I got in at $40, and out at $50, and have since watched the madness play out. This action is pure momentum. But why the momentum and why has it come crashing down? I mentioned that there are no earnings to speak of.
Growth In Revenues Guides The Stock Action
What this stock is trading on, much like the AMZN craze, is a growth in revenues. TWTR revenues are up over 110% in 2013. Still, it doesn't make money. And true, it produces nothing, unlike the AMZN comparison. Despite its lack of tangible goods, it follows in the footsteps of FB and LNKD with having over 225 million users worldwide. This number could double by this time next year. With revenue and a user base growing, earnings are not far off. Monetizing is the key. That said, TWTR is building the tools it needs to monetize properly. TWTR is now tracking user demographics, Tweets and user activity for use by advertisers aims to integrate music and video into the TWTR experience (watch out FB!).
Twitter Wins 2013...
What's amazing is that before this selloff, TWTR was outpacing FB and LNKD for 2013 performance as TWTR was up over 150% while FB had doubled 2013 and LNKD was up 90%. Here is why I think the selloff is justified. TWTR was trading at over 30 times projected 2014 revenues of $1.0-$1.2 billion. Wow. This is more than double the ratio of trading price to estimated revenues for FB and LNKD for 2014. Therefore, unlike the AMZN story, the bubble is not so much bursting for TWTR, but is certainly deflating. I don't blame the investor that sets their shares ablaze and sells away. But for those on the sidelines with risk tolerance, opportunity is knocking. A risk tolerant investor can leverage this selloff to initiate a position, but there is no immediate rush. My hypothesis is that given the volumes of investors who missed the first run up, they will be sure to pour into round two.
My Sentiment, An Upcoming Catalyst, And Understanding Momentum
My sentiment? There are high hopes for this stock. It is trading at too rich a valuation. Shares came to far, too fast. But that doesn't mean the bubble has burst. It has only deflated. With a growing user base, proper moves to monetize, and the benefit of having the successes and failures of competitors to draw from, I believe TWTR is simply taking a break. Given the action thus far in the stock, I will reinitiate a position should the stock fall to below $48, and add further to the position on dips. One major fundamental catalyst approaches. TWTR will report quarterly earnings at some in early 2014. When that happens, if the company's operational performance and outlook do not satisfy investor expectations, the stock price could dip down to where I may place a second order (depending on the outlook of course). At the same time, if the company's performance exceeds expectations, shareholders could be justified for holding the richly valued shares and new investors could be drawn in. That would serve to support the stock further. That's the great thing about these types of stocks. They can trade wildly, which for the risk averse investor, means successful trades can be made.
A Twitter Investment?
While I made a profitable trade in the name, I believe that TWTR can indeed follow the AMZN investment approach. I think it can burn the shorts left and right. Currently about 5% of the shares are short. After today's action you can bet that number has grown. Once the short covering begins, it may be time to get back in. The smart shorts will start bailing at $60, $55 and $50. The greedy may hold longer and get burned. Don't be that guy. Instead, if you do short, take the gain, because it can turn around in an instant. With the intense growth in users and revenues, it should only be a matter of time before earnings are indeed reported for the company, instead of operating losses.
The Key Question That You Must Ask Before Investing
The question is, will the company continue to trade at a premium relative to FB and LNKD when it comes to the ratio of trading price to projected 2014 revenues? I am inclined to answer yes, with the belief that should growth continue, the TWTR price to sales ratio will better align with 2015 and 2016 projections for FB and LNKD.
Disclosure: I am long AMZN. 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 may initiate another position in TWTR in the next 72 hours