The much-anticipated IPO is being priced at $26 a share, but that doesn't necessarily mean it's worth $26 a share. Given the hype surrounding the social network's imminent arrival on Wall Street, price could easily get confused with value - a distinction that's especially important in Twitter's case because its financial prospects are so sketchy. Anant Sundaram, a finance professor at Dartmouth's Tuck School of Business, explains the difference (via MoneyBeat)
People conflate the two all the time. Value refers to the intrinsic worth of the business based on forecasts of cash flows and cost of capital. Price, on the other hand, is also driven by factors such as sentiment, momentum, demand relative to supply, and so forth, which can make the price deviate from intrinsic value. In an efficient market, there should be no distinction between value and and price, but we know that markets are not always efficient, and certainly not in every asset. On an intrinsic value basis, even allowing for generous assumptions regarding growth, margins, etc., I believe Twitter is overvalued. For example, to get to even a valuation of $8 billion, Twitter will need to grow its revenues at a compounded growth rate of nearly 30% per year for the next ten years. Even then, 70% of the price that people would be willing to pay for it today lies in cash flow forecasts from year 2024 to forever.
I think investors are overestimating the ability of Twitter -- and others like it -- to be able to monetize non-US and mobile users. The former because there are less advertising-intensive markets than ours is, and the latter because the business model of mobile advertising -- especially in a world in which the user pays for cellular data -- is still in its infancy, with all sorts of twists and turns ahead.
As Twitter begins trading on Thursday, the obvious question is whether there will be a "pop" - that is, will the stock immediately shoot up? Pops can be very profitable for the Wall Street investors lucky enough to be let in at the offering price, but not so much for the companies themselves. From NPR's Steve Henn:
HENN: Neil Stewart [research director for Investor Relations magazine], says Facebook sold so many shares at such a high price, it glutted the market for its stock.
STEWART: It was a shambles in the end. It took a year to climb back to its IPO price. It disappointed a lot of people. It was probably pretty hard within Facebook to keep their heads down working away when all that was going along.
HENN: Recently, Mark Zuckerberg was asked if he had any advice for Twitter on the eve of its IPO.
MARK ZUCKERBERG: See, that's funny on its surface, because I'm kind of the least - the person you would want to ask last how to make a smooth IPO.
HENN: Zuckerberg jokes about it now, but it's might not be fair to call Facebook's IPO a complete failure. The company raised billions of dollars on great terms. And today, its investors - assuming they held onto their stock - are doing great. In fact, there's a school of thought - especially on the West Coast, and especially among entrepreneurs - which believes that a big old-school pop on the opening day of an IPO is actually really bad thing.
BILL HAMBRECHT: When I try to think when did I first start questioning the system, to be honest, the first time really - someone brought it home to me, was in the initial pricing of Apple Computer in 1981.
HENN: Bill Hambrecht is an investment banker based in San Francisco. He's been helping tech companies go public for years, including Apple, Amazon, Genetech and Google. He says a pop doesn't benefit tech firms. It benefits Wall Street.
HAMBRECHT: Steve Jobs figured out very quickly how Wall Street worked. And he really questioned: Hey, why do you price it at 18 when you know it's going to sell at 28? And why do you charge me a 7 percent commission? And, you know, who gets that stock at 18? I mean, you know, why not my friends? Why your friends? I mean, he questioned the whole process.