Twitter’s IPO and what it reveals about the sublime and ridiculous nature of our capital markets

Twitter’s IPO brings to mind Julius Caesar’s alleged description of his campaign in Britain: ‘veni, vidi, vici’, or ‘I came, I saw, I conquered’. Following the management’s successful road show targeting targeted institutional investors, demand was such that shares were 30 times oversubscribed prior to trading on the New York Stock Exchange. With the first trading day done, let us examine the IPO and what the future looks like for Twitter’s investors.

The initial price range was set between US$17 and US$20 per share, which translated into a very fair valuation given the current outlook. Three days before the IPO date the price range was raised to US$23 to US$25, before being raised again to a final price of US$26 thanks to continuing demand.

It has since emerged that Twitter insisted that the share price did not exceed USD 26 to avoid a situation similar to the Facebook IPO when the price was inflated considerably. The management insisted on a low proportion of retail investors in favour of more long-term institutional investors. From what we have heard, a group of large institutional investors have bought almost 50 percent of the issued shares which is beneficial for Twitter as a broad and long-term investor base is ideal for a public company.

It took 80 minutes for the NYSE to match the order book ahead of the first trade. The share price opened at US$45.10 which was significantly higher than the IPO price of US$26 and oscillated heavily for the first couple of minutes before the wall of buy orders finally reached tipping point, pushing the share price to a high of US$50.09.

However, the enthusiasm was very short-lived and the share price quickly dropped to its opening price of US$45 before it flirted for a few seconds with US$44. At this point the lead underwriter, Goldman Sachs, most probably began being more aggressive in putting a floor under the price to make the first day of trading a success. As the session progressed the share price rose steadily to around US$48.50 before declining back to US$45 in a complete replay of Facebook’s first day of trading, which also ended the day at exactly the opening price.

If the Facebook deja vu continues, Twitter may very likely see renewed pressure on the share price. Facebook lost 11% on the second trading day.

Based on the opening price of US$45 per share, Twitter is valued at EV/Sales of 21.7 (with sales being the 12-month estimate). This is twice the valuation of Facebook which is already priced aggressively (see the table below). The key message to investors is that this forward valuation means that the downside risk is significant in the case that Twitter does not meet expectations at the next earnings release.

If Facebook’s life as a publicly traded company is any guidance, Twitter will find it difficult to satisfy investors’ expectations in its first year as a public company. Every detail will be scrutinised at the next earnings release and investors will likely be very critical of performance given the high forward valuation.

The combination of restricted shares coming to market next year, outstanding preferred shares and numerous stock options means that the supply pressure will likely exceed the demand side of the equation, and as a result the share price is likely to be weak over the coming year.

That said, the share price and the company’s fundamentals can often live in two different worlds. So while the share price can be under pressure for a year, the underlying fundamentals of the company can easily strengthen, which was obviously the case for Facebook since its IPO last year.