Last week I said I was interested in Twitter Inc. based on my assessment of the opportunity facing the company and the proposed IPO price. What none of us really knew, at the time, is what would happen to Twitter shares in their first day of trading.
So what did happen? The company priced its IPO at $26 (U.S.), slightly higher than the $25 I used for the analysis in my last column. But the stock shot up beyond $40 immediately. My analysis never even had a chance at applying to those of us who couldn’t get an allocation of IPO shares.
In case you’re unfamiliar with how initial public offerings work, there is only a limited pool of stock for sale. In Twitter’s case, that’s about 70 million shares plus what pros call a “greenshoe,” which typically gives the underwriters the ability to sell 15 per cent more shares. Given the strength of the offering, I’m assuming Twitter’s bankers exercised the greenshoe, thereby selling over 80 million shares and raising about $2-billion for the newly public social media giant. That sure sounds like a lot of cash, but it’s really a drop in the bucket. For every $1 raised in the Twitter IPO, there is about $7,500 invested in companies within the S&P 500 index, which has a combined market value of more than $15-trillion.
Social media, video and search is fascinating to me because advertisers are likely to rebalance where they invest in ad campaigns over the next decade. Online ads, and in particular mobile ads, should see immense growth. Twitter, in my mind, is likely to be the No. 3 online ad platform behind Facebook Inc. and Google Inc. I felt reasonably comfortable at $25, but I’m not as comfortable above $40. Twitter is now worth almost $30-billion, or about $129 per active user. I realize Twitter has significant growth potential in its user base, and I believe it should ultimately be able to monetize that user base as well as Facebook can. But with Facebook we’re currently paying $97 per user.
To be sure, both companies still have plenty of growth left. The world is becoming more and more mobile, and there are still billions of people on the planet that don’t use smartphones yet. Yesterday’s dominance by cheap Nokia phones is transitioning into tomorrow’s dominance by cheap Android-powered phones.
I could be making a mistake by avoiding Twitter at this price. I could be underestimating the potential to turn users into cash. But looking at the post-IPO stock price, I’ve concluded that I’d rather own Facebook. Don’t get me wrong. I’m still very bullish on Twitter’s business, but I think it has more execution risk than Facebook, which has already build a fairly popular ad platform and already generates admirable profit.
Facebook’s non-GAAP operating margin was a whopping 49 per cent last quarter, up from 42 per cent a year ago. They’ve proven they can monetize mobile users, with 49 per cent of ad revenue coming from smartphones and tablets. They delivered earnings per share of 25 cents for the quarter. If we annualize that to $1 for the year, it still puts the price-to-earnings multiple at 47. That’s not cheap. But let’s take a longer term view. I expect Facebook can deliver 25 per cent earnings growth for the next five years, resulting in annual per-share earnings of over $3. Even if the price-to-earnings ratio drops to 30 by then, I expect my investment to approximately double over that time period.
To take a reasonable position in the stock, I need to raise a bit of cash. So my Strategy Lab model portfolio will sell off only 10 shares of Netflix, leaving me with 80 shares. This, combined with the portfolio’s existing cash balance, will allow me to purchase 125 shares of Facebook.
My portfolio already owns Google, which I’m still bullish on. But I’ve come to the conclusion that Facebook is a much stronger growth platform than I gave it credit for at the time of its IPO. As advertising dollars flow into the mobile device space, I’d rather have more exposure to this trend. I’d rather add Facebook than Twitter at today’s prices. Should Twitter experience some strong volatility to the downside, I’ll likely add it to my portfolio too.