The recent Twitter IPO (TWTR) was a huge success, but likely not for you. It was priced at $26 and the closed the day at $45. If you had the chance to buy the shares at the IPO price, you would have made 75% in a day. Chances are slim that you did. If you bought on the first day of trading, you are already down 12% and will lose more in the coming weeks.
The whole episode reminds me of an old Wall Street adage: two out of three ain’t bad. This refers to the firm and the broker making money…the client, well he doesn’t really matter in this game.
So here’s the truth about the Twitter sale…
The underwriters for the IPO – those whose job it is to “sell” the shares and allocate the stock to various brokerage firms and investment banks, know going in whether there is demand for the stock or not. They price the shares lower than they know the shares will “open” at to ensure that their biggest clients, the other banks, will make money. Why? Because they need these same clients in the future to fund other deals, some that may not be as profitable. It’s like a well-orchestrated dance with money changing hands with the full knowledge that a good chunk of the profits will be reinvested in future deals. It sounds as if there are no losers, right?
Wrong! The loser is the retail customer, the guy who has to log in with a username and password. He’s the buyer in the after market, buying the shares from the flippers, the guys who got the IPO shares. The transfer of wealth is staggering, over a billion dollars on the first day of trading. The flippers know full well that the shares will ultimately trade lower, causing the retail investor to sell for the most part, since that is what retail investors do – they buy high and sell low. After a certain point is reached, the dance begins all over again and the stock, after trading down substantially, makes a nice recovery. It’s at that point that the retail investors have fled, leaving the real money on the table.
If you want to see an example of how this has worked in the past, look no further that the recent Facebook (FB) IPO. The shares came public at around $38, plunged over the next few months to $18 and are now trading at close to $50. If you know any initial IPO investors who made money, drop me a line. Few retail investors have the fortitude to withstand a drop from $38 to $18 and still hang on to their shares. For Facebook the carnage was actually worse since most investors who wanted in to the IPO received an allocation of shares from their broker.
Twitter may be a good company; it’s certainly cash rich. But, whether it is a good investment is another story altogether. Based on its current valuation, the company, which earns no profits now, is valued at $24 billion. It is expected to have around $600 million in revenues for 2013 and no profits. When it does finally make profits, sometime in 2015, it is expected to earn around 30 cents per share. If Apple (APPL) were similarly valued, it would be worth more than the GDP of Germany. But, at least Apple makes money.
Twitter is a brand name, but what it does, allowing users to message their activities immediately, is not something that can’t be replicated. In fact, it’s something that may face obsolescence if new social media trends emerge. Remember Myspace? It was bought by Rupert Murdoch for close to $600 million, only to be sold a couple of years later for $35 million, thanks to the adoption of a new social media platform, Facebook. The question for Twitter investors is whether the company is so unique, like Facebook, or just a fad, like Myspace. Based on the price they paid, they better be praying it is the former, not the latter.
To your wealth,
Banker X.
