Many investors are salivating at the prospect of getting a piece of Twitter’s much-hyped initial public offering, hoping to ride the social network’s coattails all the way to the bank.
The exuberance over Twitter, which is set to go public this week, has some recalling the dotcom mania that surrounded intriguing yet unprofitable and unproven tech names some 15 years ago.
“Twitter looks like a bubble-era IPO,” said James Gellert, CEO of analytical and independent ratings firm Rapid Ratings. “They’ve obviously got a really intriguing business but that doesn’t mean they can monetize it.”
Gellert said analysis by his firm of Twitter’s financials reveals the micro-blogging company’s risk profile is eerily similar -- 92% to be exact -- to the financial metrics of bubble-era IPOs.
By comparison, professional network LinkedIn (LNKD) matched just 46% of these unfavorable metrics at the time of its very successful IPO and more-mature Facebook (FB) mirrored only 33% when it went public last year.
So while the potential may be there for Twitter to turn into the next great tech star, investors should realize that the micro-blogging company is still just a toddler with a far more dangerous risk profile than more mature tech IPOs.
“Retail investors will need to be very conscientious about following up on the developments of the company. This is not one you just tuck away and assume it’s going to do great,” Gellert said.
But just because Twitter has a high risk profile that doesn’t mean its IPO will be a dud or that its future is bleak.
“Twitter has only just begun to turn on its monetization engine for more than 230 million monthly active users,” Rick Summer, senior stock analyst at Morningstar, wrote in a bullish research note published on Friday.
Still, Twitter has yet to generate a profit and its losses are actually accelerating, widening to $64.6 million in the third quarter from $21.6 million the year before, according to regulatory filings.
Party Like It’s 1999
The dotcom bubble, which occurred between 1997 and 2000, allowed companies like Pets.com that had no profits, little revenue and unproven business models to raise huge sums of cash.
According to Rapid Ratings, Twitter’s profile more closely matches the IPOs of the 1997-2000 period than any IPO since. Twitter matched 36 of the 39 ratios of the profile characteristics of bubble-era IPOs, compared with 18 matches for LinkedIn and 13 for Facebook.
Yet investor demand for Twitter's IPO is very strong. In fact, Reuters reported Twitter plans to close the books on its IPO on Tuesday, a day earlier than expected, due to the strong demand.
This is not one you just tuck away and assume it’s going to do great."
- James Gellert of Rapid Ratings
“There is exuberance in the market and there’s a novelty value in Twitter,” said Gellert. “It’s not to say Twitter’s stock and IPO won’t do well. But anyone who buys it must understand it is a very different entity than Facebook, which has a much more mature profile.”
Twitter must be tired of the comparisons with Facebook, the last big tech and social-media company to go public.
Mark Zuckerberg’s company was at a very different growth stage when it went public, generating regular profits and displaying a more developed, albeit still imperfect, monetization strategy.
IPO Valuation Could Be 'Stretched'
Facebook generated an annual profit of $1 billion on sales of $3.7 billion in the year before it went public, compared with a loss of $79.4 million on revenue of $316.9 million for Twitter last year.
“Facebook historically has a track record of raising capital, using it to generate more sales and generating more profitability in a correlated fashion. That’s something Twitter has never been able to do,” Gellert said.
Even an analyst from one of the big banks bringing Twitter public believes the company may not turn a profit anytime soon. According to reports, Bank of America Merrill Lynch (BAC) Internet analyst Justin Post recently warned investors that Twitter could be mired in red ink through at least 2015 amid slowing revenue growth.
Scott Kessler, equity analyst at S&P Capital IQ, believes Twitter should be valued at $11.3 billion to $13.7 billion. After raising the price range on Monday, Twitter's IPO would actually value the company at $13.6 billion and the price tag is even higher when all of the company's outstanding shares are included.
“We see considerable growth and opportunities and considerable uncertainties and risks, and believe the public valuation for Twitter could be stretched from the start,” Kessler wrote in a research note.
He pointed to risks such as “confusion about Twitter’s offerings and their appeal,” the number of well-positioned competitors in this space, signs of “decelerating” user and engagement growth and “somewhat lacking corporate governance.”
Bumpy Ride Ahead?
The willingness to overlook the relative financial immaturity of Twitter highlights a recent shift among investors to support tech IPOs of less proven companies. This shift can largely be attributed to the fascination with social-networking companies and their inspiring potential.
Just because some of Twitter’s financial metrics may mirror those of bubble-era IPOs doesn’t mean the micro-blogging company will fail. After all, Amazon.com (AMZN) went public in 1997 just as the bubble began inflating and today it is one of the most powerful forces in the e-commerce world.
IPO companies today are “worlds removed from what passed as dotcom companies in the late 90s,” said Brian Wieser, an analyst at Pivotal Research Group who recently slapped a “buy” rating on Twitter.
“These are big companies. They have raised massive rounds of capital. That doesn’t assure success but these are much closer to real businesses. They are integral parts of marketers’ plans while the pipe dreams of the 90s” were not, he said.
Twitter has been faster than Facebook at monetizing its mobile business, generating 70% of its ad sales from mobile, compared with 49% for the larger social network.
Wieser said his favorable view on Twitter’s management team, which is led by CEO Dick Costolo, is a key part of his bullish stance.
Morningstar’s Summer pegs Twitter’s fair value at $26 a share, which is 8% above the midpoint of the IPO range. His bullish case is $50 a share, 108% above the IPO range.
But even bullish analysts are warning investors to buckle up for a wild ride given how young the company is.
“Investors who are seeking growth and are willing to withstand the likely volatility in business results and stock prices should consider an investment,” Summer said.