7 Reasons the Twitter IPO Will End Badly

Twitter itself is an innovative company, but it's a shaky investment

     

Much has been written about Twitter (TWTR) in the past few months as this social media darling approaches its IPO.

But the most important question to investors going forward is whether it’s worth buying the Twitter IPO — either in the immediate days following the event (expected Thursday), or anytime in the next few weeks before we learn anything new about the company.

The question of whether Twitter stock is a buy as it hits Wall Street has two answers.

Firstly, if you are a “retail investor,” then you probably shouldn’t buy any IPO, let alone the Twitter IPO, on the day of its debut because you simply are not able to participate in the process the same way as major investors do. It’s challenging enough to find a good buy among established companies let alone a new issue that has little history, no valuation context and a steep information gap between small-time investors and the institutional traders who are in the know.

And secondly, if you do chose to roll the dice on an IPO, then you should steer clear of Twitter and instead find an investment that isn’t quite so frothy or quite so fraught with systemic risks.

Here are seven reasons I don’t like Twitter as an investment around its IPO:

#1: Tech IPOs Feel Bubbly

For starters, let’s admit that the broader market has plenty of froth right now after a 23% year-to-date run, and the tech IPO market is even bubblier … meaning the initial public offering of a fashionable social media stock like Twitter is tailor-made for an overhyped debut.

The tech IPO market has shades of a dot-com bubble in the works. Market research firm Dealogic estimates that 2013 technology IPOs have generated 39% returns on average in their first month of trading, the highest since — you guessed it — 1999 and 2000.

Of course, back then the returns were an astounding 142% in 1999 tech issues, then an average return of 71% for tech IPOs in 2000 right before the bubble burst … but if you think 39% returns is sustainable, you’re fooling yourself. Especially when you consider that’s the average; Marketo (MKTO), for instance, popped 77% in its first day of trading back in May.

And let’s not forget about that late bloomer Facebook (FB), which has sprinted ahead by about 80% since June.

Twitter could open 50% to 100% above its offer price and run up for a few weeks or even months, but if and when the bubble bursts, the correction could be severe.

#2: Growth Concerns

Beyond the idea of broadly overhyped tech IPOs, there’s the more pressing issue of overhyped potential in TWTR itself. Because according to Twitter’s S-1 filing about a month ago, Twitter’s user growth is slowing to a crawl.

  • 185 million monthly active users as of Q4 2012, up 10.7% from Q3
  • 204 million monthly active users as of Q1 2013, up 10.2% from Q4
  • 218 million monthly active users as of Q2 2013, up 6.8% from Q1

Sure, revenue is growing faster than users are growing. But the idea of buying Twitter stock after the IPO simply on the hopes of better monetization amid anemic user growth is hardly the story that is being pitched by investors who have bought into the limitless potential of social media.

Furthermore, that’s not the pace of growth investors demand from a company that is sure to debut at a nosebleed earnings multiple — and it won’t take many slow-growth reports to rattle TWTR investors.

#3: Geography Concerns

Even if growth continues (and even accelerates), Twitter’s geographic breakdown complicates the growth mission. The reality is that all Internet users are not equal, and a user base skewed toward the West is the most valuable to advertisers.

To the point, Twitter’s S-1 filing stated that 25% of revenue in the second three months of 2013 came from international sources. However, 169.1 million of its 218 million users in total were located overseas — or a massive 77%.

I recently pointed out the geographic risk posed to Facebook, and though the companies aren’t completely analogous, the representative dropoff in margins when comparing the U.S. and Europe with the rest of the world is instructive for how Twitter likely breaks down. For Facebook, for instance, U.S. users generate almost six times the revenue of Asia users.

#4: Valuation Concerns

Back to the aforementioned nosebleed earnings multiple.

The Twitter IPO will result in roughly 545 million shares outstanding, and if rumors are true that Twitter is projecting a meager $40 million in 2013 earnings and just $80 million in profits for 2014, that backs out to EPS forecasts of a bit more than 7 cents this year and just short of 15 cents in 2014 earnings per share.

For those of you who are bad at math, that means a forward price-to-earnings ratio of 100 if Twitter trades for just $15 a share … which is far below where it’s offering at.

 
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Article printed from InvestorPlace Media, http://investorplace.com/ipo-playbook/7-reasons-twitter-ipo-will-end-badly/.

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