Learning From The Facebook IPO Debacle To Invest In Twitter

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Review of dynamics surrounding Facebook IPO.

Review of dynamics surrounding Twitter IPO.

Implications from Facebook IPO if attempting to in invest in Twitter.

Two years after its Initial Public Offering [IPO], any investor that participated in the Facebook (NASDAQ:FB) IPO is sitting on a nice profit.

Since debuting at $42.00 on May 18th, 2012, it has been a wild ride for investors in the issue. After closing at $38.23 that day, it went into a tailspin that did not end until it bottomed on September 4, 2012, at $17.55.

Twitter (NYSE:TWTR) shares have taken a much different course. Let's examine the details of both IPOs to determine if TWTR is worth taking a look at as a potential investment.

First of all, FB got a raw deal from Wall Street as well as the Nasdaq market system. After years of resisting buyouts and going public, Mark Zuckerberg finally relented. In 2006, FB was courted by Viacom (NYSE:VIA) and Yahoo (NASDAQ:YHOO). One year later, Microsoft (NASDAQ:MSFT) outbid Google (NASDAQ:GOOG), (NASDAQ:GOOGL) to purchase a 1.6 percent stake for $240 million. In 2009, Digital Sky Technologies received a better deal than Microsoft when it purchased nearly a 2 percent stake for $200 million.

Where Wall Street failed the company was by overestimating its initial valuation. While the company was aiming for a $28 to $35 IPO price, the street suggested a higher price. Because of strong demand (primarily from retail investors), it was too tempting for the underwriters not to take advantage of.

On May 14th, at Wall Street's urging, the target price was raised from $34 to $38, with some ultra greedy investment bankers suggesting a $40 valuation. If not for a dip in the stock market the day before the IPO, this scenario may have come to fruition.

Also, on May 16th, due to high demand, FB announced it would see 25% more shares than originally planned. This meant the stock would IPO with a gargantuan 421 million shares.

The underwriters finally settled on a $38.00 valuation, which was exceeded by four points upon its chaotic opening. Since the Nasdaq system was ill-equipped for the onslaught of orders, many investors did not receive confirmation of their entry price for days.

At $38.00 or $104 billion, FB became the largest valuation to date for a new publicly-traded company. To put this into proper perspective, when FB closed one week later at $26.81, it still had a mind boggling price/earnings ratio of 85, a lofty valuation considering it had just posted a decline in both earnings and revenue in the first quarter of 2012.

With too many shares becoming available at too high of a price, the outcome was inevitable. As a result of the instant losses confronting both large and small investors, they raced for the exits and cut the price by over 50 percent over the next four months.

Patient investors that waited for FB to come into the lower range of its original valuation still took some heat, but much less than those that "liked" the issue on its first day of trading.

On September 15th, TWTR announced that it had filed papers with the SEC for its IPO. One month later, the company declared that it would debut on the New York Stock Exchange with a much smaller float of 70 million shares. Many viewed its debut on the NYSE as a direct response to the fiasco that occurred on the Nasdaq system during FB's IPO.

As a result of the much lower float, TWTR shares skyrocketed, trading at a huge premium to its original valuation ($45.00 vs. $26.00). This time around, investors planned to be more patient and wait for it to drift down closer to its original valuation.

After the brief dip under $40.00 that was short-lived, those investors waiting for the FB scenario to unfold began to doubt their strategy. And once TWTR breached the $50.00 level, the buying frenzy was on in full force. Investors were determined not to miss out on the next Google or Apple (NASDAQ:AAPL).

Throw in a couple of Wall Street initiations of coverage, and shorts scrambling for cover, and TWTR nearly doubled in the month of December from its $38.80 low to its $74.73 high.

Keep in mind, all of this was taking place before the company disclosed earnings as a public company. Once that information became available, it was all downhill, erasing all of its gains and much more.

And with the lock-up period expiring last week, TWTR blasted through its all time low ($38.80) and did not find support for over $9.00 lower until it bottomed at $29.51. Since making the low, TWTR has rebounded to $34.10, before falling back to its current level.

Obviously, a combination of savvy long-term investors and shorts looking to book profits created a support level well ahead of the all important $26.00 IPO level. Also, with very little stock being available to short last week (and what was available, at exorbitant rates), the bounce should not have come as a huge surprise.

So is TWTR a good investment at its current level? According to Barrons it is. In their opinion, the 57 percent sell-off has put in a floor for the issue. Although the issue still appears to be overvalued based on its current profit and revenue figures and unknown P/E, it may be appealing as a takeover candidate.

Keep in mind, in February FB agreed to purchase WhatsApp for $19 billion, another instant messaging system with no discernible profit pattern. At $32.00, TWTR is now valued at $23 billion with an enterprise value (market cap less cash) of $21 billion. And there are certainly a few tech giants flush with cash that may be willing to make the investment.

In addition to Barrons, Wall Street has been warming up to the issue. During the past week, SunTrust Robinson has upgraded it from Neutral to Buy. Also, Bank of America has upgraded the issue from Underperform to Neutral and maintains its $36.00 price target. Morgan Stanley, which revived GW Pharmaceuticals' (NASDAQ:GWPH) shares, upgraded TWTR from Underweight to Equal-Weight rating last Thursday.

So how may an investor participate in any potential upside while trying to limit downside exposure?

If an investor believes the bottom is already in, they can attempt to purchase the issue at its current level and be prepared to exit if it takes out its all time low.

Also, one can sit tight and wait for TWTR to visit its original valuation ($26.00) and be prepared to start nibbling ahead of that price, $28.00 for example, and perhaps add more shares if it does reach $26.00 or even lower.

Finally, an investor can purchase options or longer-term options (Leaps) on TWTR. That way, investors can cap their downside exposure, but will be relying on the timing of a deal or an improvement on the earnings front to profit.

In closing, with 255 million active daily users, 500 million tweets per day using thirty-five plus languages, one would think that TWTR will eventually figure out a way to profit from all that traffic.

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.

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