Twitter: Great Story or Not, TWTR Stock Has a Valuation Problem

by James Brumley | January 2, 2014 9:35 am

Twitter: Great Story or Not, TWTR Stock Has a Valuation Problem

The last few days have been, shall we say, less than great for Twitter (TWTR[1]) shareholders. TWTR stock remains down 13% from last Thursday’s peak of $74.73, even with Tuesday’s 6% bounce … and worse, there’s still room for TWTR to keep falling.

Twitter185 Twitter: Great Story or Not, TWTR Stock Has a Valuation ProblemTwitter fans will be quick to point out that the value of TWTR stock had nearly tripled from its IPO price, setting up the inevitable — and obviously temporary — slide that shares have just experienced. After all, the company’s revenue is poised to see wildly hot growth over the next couple years, and it’s only a matter of time before the rest of the market recognizes this once-in-a-lifetime opportunity.

There’s just one problem with that optimistic assumption: There’s no possible way Twitter could ever even justify its current price around $60, let alone last Thursday’s peak of more than $74. Indeed, it would be tough for anyone to justify TWTR stock being valued at even half of its current price.

Offended? That’s fine. But before you grab your pitchfork and prepare the tar and feathers, at least hear the argument.

The Tail Is Wagging the Dog

Most of the time, a company’s underlying fundamentals drive the value of that company’s stock. It’s a loose, elastic connection, but a discernable connection all the same. In some cases, however, the story of a company is much bigger than its actual results. In those cases, the buzz surrounding stock itself dictates how that company’s fundamentals are perceived (or outright ignored).

TWTR stock falls in the latter category. That’s how Twitter shares managed to run from an intraday low of $38.80 in late November to a high of $74.73 in late December.

There’s just one problem with those buzz-born rallies, though: Once the buzz stops, it’s anyone’s guess as to when, or if, the bullish buzz will get going again.

The risk of that silence is clear, too. TWTR stock lost more than 20% of its value in just a two-day span before the buyers stepped back up to the plate again Tuesday. Just for the record, though, there’s no assurance that Twitter-mania will keep the rebound in motion. See, during that two-day rough spot, traders were forced to at least consider the possibility that the newest sensation on the social media landscape might not be all it’s been touted to be.

In other words, the honeymoon is over. From here on out, Twitter is going to have to keep its stock pumped up based on results. That’s where things get tricky, as Twitter isn’t even close to creating results worth touting.

The Twitter Numbers Still Don’t Make Sense

If you’re reading this, odds are you’re already aware of the forecasts for Twitter’s top line through 2015. Still, it never hurts to have a refresher.

Among the six investment banks that underwrote the Twitter IPO — presumably the organizations most familiar with Twitter’s inner workings — on average they’re expecting revenue of $968 million in 2014, and revenue of $1.29 billion for 2015[2].

For perspective, Twitter’s current market cap is $35 billion. That’s a price-to-sales ratio (and a projected one, at that) of 27.3, which is more than 10 times the market’s norm of around 2.5.

As for earnings — real, operational earnings — well, that’s not even part of the average investor’s equation at this point. The sheer premise of TWTR stock is enough to keep some folks on the hook. To the extent it matters, though, many of the same brains that expect Twitter to generate revenue of $1.28 billion in 2015 expect a profit of 18 cents per share[3] for the same year. Compare that to the stock’s current price of $63.65, and what you’ve got is a forward-looking P/E ratio of 353 — about 23 times greater than the market-average P/E of 15.1.

But Twitter is going to trounce those estimates, you say? OK, fine — just for the sake of argument, let’s say Twitter can surpass its current expectations[4]. By how much can the company leave the outlooks in the dust? Even if revenues roll in twice as strong as 2015′s expected figure, shares are still valued at 13.6 times the market normal price/sales ratio. And even if profits reach 36 cents per share in 2015 vs. the projected 18 cents, TWTR stock’s value is still 176 times its future income, or still more than 11 times the market’s typical price/earnings ratio.

Point being, there’s still not any room for more justifiable value.

So the final question to consider here is this: When is the music going to stop?

Well, once the market realizes there’s a serious lack of value here, the “right-pricing” pressure[5] could make the last few days look like child’s play.

As of this writing, James Brumley did not hold a position in any of the aforementioned securities.

Endnotes:
  1. TWTR: http://studio-5.financialcontent.com/investplace/quote?Symbol=TWTR
  2. revenue of $1.29 billion for 2015: http://blogs.wsj.com/moneybeat/2013/11/06/twitter-ipo-wall-streets-revenue-forecasts/
  3. profit of 18 cents per share: http://www.nasdaq.com/article/twitter-an-early-look-at-earnings-estimates-cm296758
  4. let’s say Twitter can surpass its current expectations: http://investorplace.com/2013/11/twtr-stock-can-twitter-raise-profitability-new-ad-idea/
  5. the “right-pricing” pressure: http://investorplace.com/ipo-playbook/twitter-stock-twtr/#.UsTzxbS1XS0

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