Trading Twitter IPO - Highly lucrative or highly risky?

19/11/2013 By: City Index

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The eyes of the financial markets are fixated on Twitter this week as the social networking giant prepares to launch its Initial Public Offering (IPO) on Thursday 7th November.

Investors and traders alike will be asking themselves should they go long or short on Twitter shares when they become publicly traded - via the New York Stock Exchange - on Thursday?

So, here’s my view…

Forget about Royal Mail; Twitter is a different kettle of fish

First and foremost, FORGET ROYAL MAIL. It would be extremely lazy and equally dangerous to assume that, following Royal Mail’s IPO, all IPO’s are priced to succeed. They’re not. No matter how much the underwriters want them to be. If everything worked out that way, we’d all have extra pocket money every week.

Royal Mail shares were significantly undervalued and everyone knew it. Twitter is not Royal Mail. The Royal Mail IPO was a once in a decade event. IPO’s are - by and large - highly volatile, potentially highly lucrative and equally highly risky. So approach trading Twitter with care, dedication and your eyes open.

Where will Twitter shares trade: $17, $20, $25 or more?

Twitter had originally been expected to launch its IPO at a price between $17 and $20. Yet on Monday, according to a regulatory filing, this price range had been increased to $23 to $25, which would give the social media firm a market valuation of around $13.6bn. Twitter intends to sell at least 70m shares, which would mean the IPO could raise as much as $1.75bn in the public offering. 

And what’s more, Twitter is expected to close its books on the IPO a day earlier than expected. So we have two very indicative pieces of evidence that suggest Twitter’s market debut is likely to be a positive one: a hiked price range and over-subscription.

But we’ve been here before haven’t we? Remember Facebook? Facebook’s listed price was hiked in the days before its debut on the markets in what the underwriters described as hugely over-subscribed. Yet Facebook shares rallied to as high as $45 before plummeting back to $38 on day one, and as low as $33 on day two. Over-subscription and price boosts are not a shoe-in for a strong market debut, despite the signals they send.

A successful float at the top end of this prospective price range ($25), would mean Twitter would be trading at a valuation of 11.8 times its estimated sales for next year (i.e. forward 12 months earnings). Compare that to Facebook, who currently trade at 11.5 times earnings and LinkedIn’s 12.2 times earnings, and this places Twitter broadly in line with its peer group.

Some analysts have already called for a pricing of $26 a share (Morningstar), $29 a share (Pivotal) and even as high as $50 (SunTrust). 

It must be remembered that IPO pricing works to optimise demand and net the firm listing maximum profits for its share sale. It’s about finding the right balance between price and demand: no easy task. IPOs are traditionally valued to provide some minor discount to buyers to attract their thirst to acquire shares.

What can we learn from Facebook’s IPO?

Twitter is, of course, a much less cluttered market listing than Facebook. Facebook’s IPO has multiple classifications of shares and also listed on Nasdaq (the traditional tech exchange of choice). However, technical difficulties exacerbated the problems endured for Facebook on day one, forcing nervous traders to reduce their risk. 

We can also talk about the learning curve from Facebook’s IPO failure. Underwriters may have had to become more conservative as a consequence. Are they likely to repeat the same mistakes? And what’s more, this is a much smaller market sale than Facebook. Twitter is a smaller company, has less aggressive expectations and a much simpler business model.

Twitter is about to enter into a new realms of multi-functional TV advertising. Companies that buy TV ads around specific TV shows will soon be able to advertise on Twitter when user groups are talking about those same TV shows or topics. That’s a completely new era of advertising dynamics that Twitter can capitalise on.

$28 plus market debut is possible but beware of volatility

There is every chance we could see Twitter shares trading as high as $28 and even $30 a share on the immediate days following its launch given the demand, simplicity and earnings ratio compared to its peers but traders must be careful of the initial two to three weeks and of the heightened volatility the IPO will inevitably bring. IPO’s can be extremely dangerous to trade around with wide daily price swings making trading them not for the faint hearted. Even stop losses you may have on positions that seem far away can come into consideration within a matter of hours.

So trade carefully, with a clear mind and a distinct exit strategy.

Historical tech IPO’s

As mentioned before, Facebook endured an extremely rocky IPO launch. It took shareholders 15 months before shares started to trade back above the list price. LinkedIn, on the other hand, saw its share price double on its first day of trading only to then lose a third of its value in the subsequent month before prices recovered. Google’s shares price doubled within two months of listing.

The key lesson here: market volatility. If you can stomach double digit daily price swings, then maybe tech IPO’s are up your street. If you can’t, stay away as the risk is large.

Twitter vital statistics

  • Founded in April 2007
  • 230m monthly active users
  • 500m tweets sent per day
  • 76% of active users are on mobile
  • 77% of accounts reside outside of the US
  • Twitter has never made an annual profit
  • Last quarter, Twitter doubled revenues to $168.6m
  • Last quarter, net losses widened to $64.6m from $21.6m a year ago