Don’t Be Fooled by Twitter IPO Hype

With Facebook (Nasdaq: FB) and LinkedIn (NYSE: LNKD) shares soaring this year, there is considerable hype surrounding social media stocks.
Twitter – one of the earliest and best-known social media platforms – now plans to go public before the end of the year. That will allow the company’s founders, employees, and early investors to cash in on a ripe market for overpriced social media stocks.
There is no doubt that Twitter is a huge force on the Internet. After Facebook, it’s the largest U.S. social network site, with 200 million active monthly users.  Not surprisingly, the Twitter IPO is already attracting considerable attention from the media, as bankers and company insiders hype the Silicon Valley success story.
But that isn’t enough reason to justify buying this upcoming IPO. . .
Earlier this month, Twitter filed its IPO documents with the Securities and Exchange Commission, giving potential investors some insight into the company’s business and finances.
The 164-page S-1 registration statement is full of legalese and background on the company. But as a value investor, the only part that I care about is the financials. Here is a summary of Twitter’s financial performance for the last three and a half years:

Twitter Historical Financial Results

The positive news is that Twitter is growing quickly. Its revenues grew by 200% in 2012, and were up 107% in the first half of this year.
A big reason for that rapid growth is that the seven-year-old company is still in its infancy. While Twitter was founded in 2006, it didn’t begin generating meaningful revenue until 2011. And a small revenue base has made it much easier for the company show impressive revenue growth.
But the flip side is that because the company only recently began generating revenue, the losses are huge. Even last year – when revenue tripled – the company lost $79 million. This year the company is trending toward an even bigger loss.
When Twitter’s two largest social media peers – Facebook and LinkedIn – went public, they were profitable companies.  They had already experienced their most rapid phase of growth and had developed proven and profitable business models.
And that’s one of my biggest concerns about the Twitter IPO. . .the company is still ironing out its business model.  That certainly creates opportunities to innovate and grow. It also opens up the company – and its investors – to many unknown risks along the way.
Consider Twitter’s sales per user, for example.  In the most recent quarter, the company generated revenues per user of just $0.64.  That’s 60% below the revenue per user at Facebook. And it’s a sign that the company is still figuring out how to monetize its users.
The Twitter IPO is likely to happen in November, with shares trading on the New York Stock Exchange under the symbol TWTR. The investor roadshow starts next week, which should shed a bit more light on the company.  While we know more about Twitter now than we did a few weeks ago, we’re still missing a few key pieces of information.
The company hasn’t decided how many shares it will sell, or the price per share.  As a result, we don’t know what the value of the company will be when the Twitter IPO occurs.
Based on private market transactions in August, Twitter estimates that it’s valued at $9.7 billion.  I’ve also seen more recent reports saying that hedge funds were trying to buy shares privately at a $14 billion valuation.  TheStreet reported that Twitter plans to raise $1.4 – $1.7 billion at a $15 – $16 billion valuation.
If TheStreet’s report is accurate, Twitter would go public at 26-times this year’s estimated revenues of $600 million.  Since the company won’t earn a profit in 2013, it’s impossible to value the company on a P/E basis.
A valuation of 26-times revenue would be a premium to Twitter’s peers.  Facebook and LinkedIn currently trade at around 18-times earnings, and they offer investors the bonus of being profitable.
Thanks to soaring social media stock prices, investors should expect Twitter execs and their bankers including Goldman, Morgan Stanley, and J.P. Morgan to put a premium value on the stock.
Once we know more about the Twitter offering price and valuation, I’ll share my full analysis.  In the meantime, I offer up my words of caution.  If the valuation is too high, Twitter shares will flop just like the Facebook IPO. Buyers beware…