Twitter Sold Some Stock
A little-known 1 provision of the Financial Blogger Code of Conduct says that I have to give you my opinion on what Twitter is worth, but it doesn't say when, so I figured I'd wait until it had traded for a bit. It's worth $45.25! Or whatever, I don't know, that was a while ago, that number changes rapidly, look at a screen, there's your number, you're welcome.
Of course, I could have gone other ways. I could have done some sort of DCF-y valuation; FT's Lex column produced a delightful tool to do just that and you might want to play with it. 2 The problem is that a discounted cash flow model takes future cash flows, monkeys with them, and spits out a price, so you have to know the future cash flows to make it work, and you don't. A DCF on Twitter is just a way to dress up guesswork in pseudoscience. Guessing the price directly is no sillier than guessing the next 10 years of revenue growth and operating margins. 3 Ten years ago I was on Friendster.
If you're not going to do a DCF, and you shouldn't, your valuation options get dicey fast. One approach is "this valuation is hard to justify on the fundamentals, and by fundamentals I mean comparable-company price to sales ratios," which, I mean, that is not fundamentals in my book, that's just some numbers, but there you go. 4
"One day Twitter will make money," said Anup Srivastava, an assistant professor of accounting at Northwestern University's Kellogg School of Management. "But it's not clear why anyone should pay this much for it today."
Okay, but Anup. If it were clear today why people should pay $45 for Twitter, then it would be worth much more than $45. The market is a tool for reducing uncertain future states into a number in the present. You can't just be like "I'm gonna wait to buy Twitter until it's clearly making tons of money, and then I'll make a killing, suckas."
Or you could just find a counterintuitive dodge, but that has its own risks. Felix Salmon's valuation is: "Twitter's worth cannot be expressed in money, so just go tweet for 100 hours." Trust me that there is a bear case there too.
But while the blogger bylaws require us all to write something, they're also very clear that we don't have to be right, or even wrong. Twitter's underwriters do not have the same luxury. Actually, they're in a pretty rough spot: The value of Twitter is truly, wildly uncertain, so they will probably get it wrong, just like everyone else.
But they will be evaluated, harshly, on whether the market agrees with them today. Too high a price and it's a disastrous rerun of Facebook; too low a price and someone will complain about how Twitter left money on the table. This evaluation is sort of only fair: They've been talking about it with the market for the last two weeks, they should have some insight. But still. The norm is that volatile post-IPO performance is bad in itself, and when you underwrite a stock that is by its nature going to be volatile you are just in for trouble.
Here, the deal priced at $26 opened at $45.10, and in early trading seems like a "left money on the table" sort of problem, which is a much better problem than "disappointed everyone and blew up widows and orphans," though there's plenty of time for that. Generally, you'd have to give them a pretty good score: That initial 73 percent gain is a little rich, but it's within the realm of plausible tech-company IPO pop. No one at Twitter will be too disappointed, and obviously anyone allocated shares in the IPO will be thrilled.
The transition from "private company valued essentially by bankers' appraisals and insiders' hopes" to "public company valued by a ruthless and shifting stock market" is a necessarily harsh one, and the underwriters' role is to smooth that transition as best they can. The Epicurean Dealmaker wrote a fantastic post a while back explaining how that works in practice, and I will endorse but not repeat his entirely correct explanation of why IPOs are supposed to price at a discount; just go read it.
One obvious move that the underwriters can make to smooth that transition is to allocate a lot of shares in the IPO to a smallish number of large, long-only, "real money" investors who believe in Twitter's story and want to be long-term investors. You know: Like the pre-IPO investors. The rumor is that that's what happened, with hedge funds looking for a quick flip getting few or no shares, and with a few large long-only investors getting big allocations.
Remember that Twitter's bankers stopped taking orders for the IPO at noon on Tuesday, but didn't price until Wednesday evening. What did they do Tuesday afternoon and all day Wednesday? Goldman's people have gotten pretty chill recently, but I doubt they were at the bar. They weren't taking orders, and they weren't pushing on price -- by Tuesday they had telegraphed that the deal would price above the $23 to $25 revised range, and it came at a relatively predictable $26. That leaves fighting over allocations. More specifically, it leaves them with a long time to sit with each investor who'd put in an order, stare deeply into their eyes, and say, "You're not going to sell your shares, right? Right? Seriously, look at me, you're not going to sell?" The ones who were convincing presumably got big allocations.
But that does increase the odds of a big pop. For one thing, those long-term dedicated investors tend to be more price-sensitive than the quick-flip ones (I mean, they've done DCFs or whatever). For another, if in fact a lot of shares are locked up with big investors who are not looking to sell (and might be looking to add), then all the hedge funds and dentists and grandmothers looking to buy shares in the aftermarket are chasing a much smaller supply of stock than the 70 million shares that were technically floated.
So, sure, the price went up. And so Twitter's new group of long-term shareholders were rewarded for their belief and will be more likely to support the company in the future. Or I guess so the underwriters hope, and will tell their client, who actually knows; maybe the long-term guys dumped all their stock when they saw it trading at $45, that temptation might have been too much for them.
We'll find out eventually. That's the nice thing about the Twitter IPO: It happened. All the speculation about what it would be worth was wiped out by the fact of what it trades for. Now we know.
Who am I kidding, incredibly well-known, if there's one thing that anyone knows about financial bloggers it's that they're required to have an opinion on Twitter's IPO valuation.
Aswath Damodaran, the internet's best writer about valuation, built his own calculator and got a price of $17.84. Oops, sort of.
On the other hand, Lex's calculator is great for taking the market price and backing out what the market expects Twitter's revenue growth, etc., to be. Though you can't take that too seriously.
Is this a minority view? When I see the words "fundamentals" and "multiple of revenues" in the same sentence, I stop reading, but then I'm a terrible investor, so.
To contact the author on this story:
Matthew S Levine at email@example.com