A Warning for Wannabe Twitter IPO Investors
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The Fiscal Times
November 5, 2013

As the clock ticks down to Twitter-Day, otherwise known as Thursday, the amount of hype and speculation is growing at an even faster pace than Twitter’s revenues. Fuel has been added to the fire by news that Twitter’s underwriters, led by Goldman Sachs, raised the target price range for the IPO from $17 to $20 a share to between $23 and $25 a share.

If we assume, conservatively, that the deal actually prices at the midpoint of that range and underwriters forge ahead with the plan to sell 70 million of Twitter’s 555.2 million shares outstanding, that would give the deal a value of $1.68 billion and Twitter a market capitalization of $13.32 billion.

For a company that was valued at $10 billion by one of its inside investors as recent as May, that’s quite an accomplishment. Still, amidst the pre-IPO exuberance, there are plenty of people around who are able (and in some cases, very eager) to find a way to justify those figures. The more reasonable from among their ranks acknowledge that their calculations aren’t based on today’s reality but on the company’s future prospects. That’s completely logical: After all, the market bases its view of a company’s valuation on what lies ahead, not on history. But there are others for whom even $18 a share still looks pricey.

History is full of examples of IPO bets that have paid off very well indeed for investors. When Amazon (NASDAQ: AMZN) went public in 1997, it was valued at $441 million; today, its market capitalization is $164.34 billion. eBay (NASDAQ: EBAY) was another member of that first-generation of Internet IPOs: Like Amazon, its business model simply wouldn’t have been possible without the web. When it went public in 1998, further into the dotcom boom, it was valued at $2 billion; today’s market capitalization is $51 billion.

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But that’s for investors who bought and held – and how many of us are psychologically capable of doing so in the midst of some of the big market downturns that we’ve witnessed in the years since the tech IPO boom kicked off? Back in January 2000, Amazon’s market cap stood at $28.8 billion; after the 9/11 terrorist attacks in 2001, it was only a tenth of that. By early 2004, it was north of $20 billion once more. About two years later, Amazon’s market value had been cut in half. By January 2008 it was $40 billion – then cut in half again after the financial crisis decimated stocks. That’s a brutal roller coaster ride.

Facebook (NASDAQ: FB) – the largest technology IPO in history – is another example of just how volatile these businesses can be. The social networking company’s market capitalization had plunged from more than $70 billion at the time of its IPO 18 months ago to only $39 billion by the end of August 2012; it wasn’t until this July that it finally broke decisively above the IPO valuation.

A SMOOTHER PROCESS

To the extent that Twitter is a radically different deal from Facebook, it has at least as much to do with the way the deal is being structured and run by underwriters as it does the company’s business model. After all, both businesses are in roughly the same industry, relying on their status as key ways for us to connect to each other and thus generating lots of data calculated to appeal to advertisers. For both, a lot hinges on their ability to monetize that data in a way that doesn’t alienate their users.

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But Twitter’s underwriters and the company itself seem to have learned a lesson from Facebook’s troubled market debut. Twitter is coming to market earlier in its life, enabling underwriters to hint that there has been more upside potential left on the table for the first round of public market investors. Twitter picked a different set of underwriters – led by Goldman Sachs rather than that bank’s archrival, Morgan Stanley (NYSE: MS) – and a different exchange, the New York Stock Exchange rather than Nasdaq.

Above all, the process – aside from the debate over the gender makeup of the board and an opportunistic lawsuit from disgruntled wannabe investors – is moving along far more smoothly than did those of either Facebook or Groupon (NASDAQ: GRPN).

Make no mistake, however: That’s not necessarily because Twitter is a far better company. It’s all about the underwriters – expert salesmen – trying to ensure that the sale they’ve been charged with handling goes through as profitably as possible. Take the initial valuation range of $17 to $20, which some market participants hailed approvingly. That was clearly designed to ensure that investors didn’t balk at a price that it could be argued reflected as much hype as reality. It’s always easier to boost the range later, and that’s just what Twitter’s underwriters have now down.

Meanwhile, Twitter will have chosen the best possible moment to go public. Bankers push for any IPO candidate to pick a moment when earnings, cash flow or revenue are likely to be particularly impressive to go public. But that can leave a post-IPO company with an earnings hangover down the line, and cause a selloff if there’s a disappointment six to nine months from the time of the IPO. That’s particularly true of high-growth technology companies that are teetering on the brink of becoming mature. The law of large numbers dictates that they can’t grow to infinity and beyond at a double- or triple-digit rate. And for a high-expectations stock like Facebook or Twitter, an earnings disappointment will be particularly significant.

Today, Twitter’s newly-upsized deal is dressed to impress, in hopes of coaxing the maximum number of investors to put in a bid for some of the relatively few shares being offered. But as those shut out of those IPO allocations battle for shares when trading begins on Thursday, you may want to remember that the days of truly massive “pops” in technology IPOs were largely a phenomenon of the dot.com era and that if the shares price at $25 and rapidly double, you’ll be looking at a company that isn’t just priced for perfection but for utopia.

Business journalist Suzanne McGee spent more than 13 years at The Wall Street Journal before turning to freelance writing. Author of the book Chasing Goldman Sachs, she has written for Barron’s, The Financial Times, and Institutional Investor.