What's Wrong With Twitter's IPO?

11/08/2013 12:00 pm EST


This week, it seems like there is nothing to even discuss besides this company's new IPO. Of course there is, however, Alex Dumortier of The Motley Fool UK, feels just a bit more discussion, along with a brief look back, is a good way to avoid making the same mistakes of the past, or some brand new ones.

Twitter (TWTR) has priced its shares at $26 each, more than the $23-$25 range initially announced, due to high demand, making it the biggest market debut for a technology firm since Facebook (FB).

If you want any evidence that Facebook's botched May 2012 initial public offering was a traumatic event, just look at the following headlines regarding the most anticipated IPO since the Facebook fiasco, which I culled from Yahoo! Finance's homepage:

  • Challenges abound for Twitter heading into the IPO (Associated Press)

  • Success of Twitter's Business Model Questioned Ahead of IPO (Breakout/Yahoo! Finance)

  • As Twitter IPO prices, poll says it's not worth hype (CNBC.com)

  • Good News for Twitter IPO: Small Investors Are Skipping It (The Exchange/Yahoo! Finance)

But who, exactly, was traumatized? Investors or financial journalists? One headline tells a different story from those I just cited-one of enthusiasm, rather than skepticism:

  • Twitter boosts IPO range amid strong investor demand (Reuters)

Although they maintained the size of the offering at 70 million shares, Twitter and its underwriters first raised the previous $17 to $20 pricing range for the stock to $20 to $25, before Thursday's $26 news. If the underwriters exercise the overallotment option for an additional ten million shares, Twitter will end up raising more than $2 billion at the top end of that range.

The truth is that this is a fantastic time for Twitter to go public: the stock market has had a great run this year, and growth-stock IPOs have been making eye-popping debuts (in the US, witness the shares of sandwich chain Potbelly (PBPB), which more than doubled on their first day of trading, and we all know the score with Royal Mail (LSS:RMG) by now). Finally, the most highly visible social networking stocks—Twitter's peer group—have outpaced the market, as the following performance graph of Facebook and LinkedIn (LNKD) illustrates:

Click to Enlarge

With those precedents in mind, should investors ignore the skeptical articles regarding Twitter and plow into the stock? My answer: no.

Where Facebook and LinkedIn are solidly profitable, Twitter isn't. In that regard, it's closer to local-business review site Yelp (YELP), which has yet to turn a quarterly profit (although that hasn't stopped the stock from gaining 241% this year.) Twitter is a fascinating platform, and it has already made a massive impact on business and popular culture, but as a business model, it's still finding its feet. Several ad buyers at major advertising firms recently told the Financial Times that the funds they allocate to Twitter come out of their experimental budgets.

I think the odds are excellent that Twitter's stock will post muscular gains once the shares begin trading, but whether it will prove an excellent long-term investment looks much more uncertain. Investors who are interested in buying the shares should first ask themselves what they expect to achieve, over what timeframe...and how much they are prepared to lose in an adverse scenario.

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