Twitter's First-Day Gains Destroy Its Long-Term Prospects

Twitter's First-Day Gains Destroy Its Long-Term Prospects

Although we don't believe in timing the market or panicking over daily movements, we do like to keep an eye on market changes -- just in case they're material to our investing thesis.

Stocks fell today, with the S&P 500 and the narrower, price-weighted Dow Jones Industrial Average up 1.3% and 1%.

What looked inevitable did indeed come to pass: Shares of Twitter began trading today and the issue was received with a frantic clamor as it hit the secondary market. The shares, which were priced at $26 in the primary market, opened at $45.10, for an immediate 73% gain and they finished the day with roughly the same gain, at $44.90 (the peak price was $50.09).

You could almost see the flow of funds out of other social networking/Web 2.0 stocks into Twitter, as the former group wilted in the soaring heat of Twitter's debut:

Daily Return









Source: Yahoo! Finance

But while Twitter's first day success may have been (near) inevitable, the odds of its success as a long-term investment look badly -- perhaps irretrievably -- harmed after today's surge in the stock price. Twitter now commands nearly the same market capitalization as LinkedIn ($24.5 billion against $25.2 billion), despite having less than two-fifths of its revenue - and no profits! The comparison is even more damning when one observes that LinkedIn's stock itself looks far from cheap, sporting a price-to-forward earnings multiple of 108 (based on estimated earnings per share for the next 12 months.)

For more evidence of Twitter's overvalution, the Financial Times' esteemed Lex column describes two scenarios for the stock's value in five years' time based on a comparison with Facebook's operating history. Here's what their less optimistic scenario - which still corresponds to what they call a "deliriously good five years" for the company -- looks like:

So let's call it a 50 per cent growth for five years. Keep the [operating] margin and tax rates fixed [at 38% and 30%, respectively], but cut the p/e ratio to a still-meaty 25, given the slower growth. In this 2018, Twitter has still just had a deliriously good five years. But its shares are worth $36. Discounted at 10 per cent a year, their 2013 value is $22.

Is it impossible for Twitter to turn into a great long-term investment from its current price? No, that prospect is conceivable (with great effort and imagination), but the question reminds me of the Vegas bookie who, in describing his activity, asked whether it is possible that the lamb at the slaughterhouse will rise up and strike down the butcher. His answer: Yes, it's possible, but we like to bet on the butcher.

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Fool contributor Alex Dumortier, CFA has no position in any stocks mentioned. The Motley Fool recommends and owns shares of Facebook and LinkedIn. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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