“The Muppets must be fed!” I say to myself.
Sorry let me start at the beginning.
I was so excited! When Twitter, Inc. filed their preliminary prospectus with the SEC I downloaded it immediately. I love this stuff. The intimate details. Who will run the company? How many shares will they have? Who is on the board? How much were the executives paid when the company was private? And most importantly, who will be worth what when the IPO is all said and done. Call it financial porn.
So I have been fingering through this massive document, as I have done with hundreds of others, trying to get a sense of the company. I restlessly pick up the document multiple times over the last week only to slam it back on the table feeling unsatisfied. This document is slowly getting dog-eared and marked up. Something is wrong here. The feel is wrong. I couldn’t put my finger on it until the latest issue of my New Yorker was found in my mailbox a week ago.
I know what you’re thinking, what does the New Yorker, a literary magazine with poetry, have to do with the prospectus and IPO of Twitter, Inc.?
Well in the October 14th issue is an article by Nathan Heller called “Bay Watched.” Subtitled “How San Francisco’s new entrepreneurial culture is changing the country”. (Unfortunately The New Yorker magazine hides behind a paywall so I cannot link this article but if you’re an technology investor this article is a must read.) There is a lot in this article, but I found a few sentences that targeted my problem with Twitter, Inc.:
“A record number of late-phase companies… are lingering in venture portfolios, instead of going public or being acquired. … by the time a startup goes public, much of the tech community has put its money in and reaped its benefits.”
“ ‘By the time the company goes public, there’s no money to be made, in my eyes,’ Juda Gomila, an avid startup entrepreneur and investor who co-founded the mobile-gaming platform Heyzap, says” the article continues.
And then for the knockout punch the article introduces you to Ms. Diane Mulcahy.
“Not long ago, Diane Mulcachy, who manages the private-equity portfolio at the Ewing Marion Kaufman Foundation, led a quantitative study of venture capital over the past two decades, showing that recently the average V.C. fund has barely broken even.”
The article continues,
Mulcahy discovered that it was a bad deal for investors. Her foundation scaled back its V.C. investments, and so did a lot of others.
Wow, so much for the Wall Street Journal, and the other business rages. A literary magazine tells it the way it is, in and around the tech scene on the streets of San Francisco and suddenly one can clearly see what is going on here.
The game is up. V.C.’s are getting squeezed because clients want better returns. How do you get better returns? Higher valuation exits as investments are sold from the V.C.’s portfolios – if and when they can exit (sell) their positions. Twitter, Inc. has name recognition with the general public and its revenues are growing but still not profitable. Why not wait for profitability before the IPO? Simple, will Twitter ever be profitable?
But wait. Doesn’t this happen all the time? Twitter, Inc. is no different than any other high tech IPO or otherwise, isn’t it?
Yes, I agree this is done all the time. But Twitter seems different, a little bit like a “scorched earth policy” in terms of valuation. Usually IPO’s, high tech or otherwise, leave something on the table for the general public. For the last guys (and gals) in the line, the company and the underwriters leave a little something. Not too much mind you, but a little. In this deal, it seems to me, they’re leaving nothing – not a crumb for anybody.
Back of the Envelope Model Price Calculations
So this is where I have fun. I dig out my pencil and calculator and push around some numbers. Now keep in mind this is early days and the prospectus is filled will holes (blanks) where the numbers should be. However I calculate on a pro forma basis after the IPO, Twitter, Inc. will have a calculated Economic Book Value or EBV (Green Line) of $1.59. (Again this is my estimate based on a limited financial disclosure. I will fine-tune these numbers as time goes on and more information and common stock pricing is made available.)
Rumour has it Goldman Sachs, Twitter, Inc.’s lead underwriters, wants to price the company’s IPO at $25. This would mean Twitter’s valuation would be between EBV+8 and EBV+9! Keep in mind Facebook’s IPO valuation initially came at EBV+7 and promptly dropped to EBV+5 over a period of several months post its’ IPO. Also Facebook, the company, was making money! Twitter, Inc. has never made money and just recently reported a higher loss than the previous quarter even though revenues were higher.
But hold on, back on October 7th, Robert Peck of SunTrust Robinson Humphrey place a $50 price target on the company. Really! If Twitter came to market at $25 and climbed to $50 a share this would make Twitter, Inc. one of the most expensive stocks in our Model Price database. A valuation level almost reaching EBV+10!
This IPO process and Twitter, Inc.’s first day of trading will be fun to watch. Since Goldman is the lead underwriter I couldn’t resist poking fun at what disgruntled employee Greg Smith said in his resignation letter to Goldman that was published in the New York Times recalling five different managing directors referring to their own clients as “Muppets”.
On second thought it is a good thing the Twitter, Inc.’s corporate logo is a bird. In my opinion, sooner or later the stock price will need a set of wings to help it with its’ valuation of the company if the company’s fundamentals – earnings – don’t materialize soon.