Twitter: Highly Overpriced Post-IPO

Twitter (NYSE: TWTR  ) is currently trading around $40. Strong market sentiment has pushed the stock from the already-expensive IPO price of $26, gaining over 50%. Is Twitter's price justified by its business potential?

At Amigobulls, believe that Twitter is overpriced based on comparisons of key business parameters with those of Facebook. The companies are comparable entities with similar business models, and we've examined revenue growth rates, revenue per user, and current valuation multiples, plus considered the impending dilution due to stock options and other events, which will happen through 2016, impacting the value per share.

Revenue growth
Twitter had remarkable growth in the years leading up to its IPO. The company has maintained an annual growth rate above 100% each year for the last three. However, the growth rate has slowed as the revenue base has grown. Facebook, on the other hand, has seen a push in revenue growth in 2013, mainly due to better monetization of its huge mobile user base. While Twitter's growth has been phenomenal, the company must find new products to generate the huge growth rate currently factored into its price. How long can Twitter maintain the impressive growth rates it has so far managed? The chart below shows annual revenue growth for the last three years for Facebook and Twitter, and it is clear that revenue growth at Twitter has been slowing down dramatically.

Twitter v/s Facebook revenue growth based on latest SEC filings

Revenue per user
Revenue per user is an important metric for any online business. Twitter's revenue per user has increased over the years as the company has achieved better monetization through products aimed at online advertising and data licensing services. However, Twitter's current revenue per user is far lower than Facebook's. In its IPO year, Facebook had annual revenue per user in excess of $5, against Twitter's current year revenue per user of $2.88.

Twitter will continue to see better monetization as it realizes the benefits of current investment in research and development and sales and marketing. As a result, the company will register higher revenue per user. However, we believe the inherent nature and variety of Facebook is something Twitter lacks, so Twitter to achieving a revenue per user rate on par with Facebook will be challenging.

Twitter and Facebook annual revenue per average monthly user numbers based on latest SEC filings

Twitter v/s Facebook growth in revenue per user based on latest SEC filings

It's interesting to examine the growth rate in revenue per user of the two companies. Twitter's revenue per user growth rate has been on a downward trend for the last three years, while Facebook's revenue per user growth has been put back on track after a dip in 2012. The lower revenue per user in 2012 was largely due to Facebook's inability to optimally monetize its mobile user base. However, Facebook seems to have found a solution in Q2 2013, putting the 2013 numbers back on track. We believe Facebook will continue to grow its revenue per user in the coming years due to better monetization of its user base. However, Twitter's revenue per user growth rate will slow down unless the company comes out with new products to better monetize its user base. The table below shows the annual revenue per user growth rate of Twitter and Facebook for the last three years.

The valuations
We also examined the current valuation multiples of the two companies. Since Twitter has yet to report profit on a GAAP basis, we examined price-to-sales multiples of the two companies. Facebook currently has a Last Twelve Months, or LTM, P/S multiple of 16 times, against Twitter's 41 times.

Current valuation multiples for Twitter and Facebook

Taking into account Facebook's higher per-user revenue potential, Facebook should enjoy a higher valuation multiple. To simplify our calculations, assume that Twitter will be as promising as Facebook in two years in terms of growth rate and revenue per user. We value Twitter based on estimated 2015 numbers and using Facebook's 2013 P/S multiple of 15 times. The table below shows Twitter's last three-year numbers along with our estimates of Twitter's future revenue and monthly active users over the next two years. We assumed a user base growth of 70 million every year going forward against last year's addition of 68 million users. We also assumed Twitter can grow revenue per user by $1 every year through 2015, though the incremental increase in 2012 was $0.83. Based on these optimistic assumptions, Twitter will generate revenue of $1.78 billion in 2015. Using the P/S multiple of 15, Twitter is valued at $26.7 billion by the end of 2015.

Twitter future revenue and user estimates assuming linear growth

ESOPs and other dilutions lead to lower value per share
Calculating Twitter's expected value per share in 2015, we examined dilution in the shareholding, which is likely to happen within the next three years. Current outstanding shares of Twitter are 544.7 million, and the likely number of outstanding shares by the end of 2016 will be 775.5 million after adjusting for warrants, restricted stock units, stock options and stock incentives. We assumed that the conversion and exercise of options will happen at a linear rate over the three years, leaving 698 million outstanding shares at the end of 2015. The table below lists dilution through 2016 via conversion and fresh issue of options and shares.

Twitter share dilution based on company's SEC filing

Adjusting for the increased share count, Twitter's 2015 value per share is $38.35.  Discounting it by 10%, which is the minimum required rate of return (considering the current risk associated with Twitter as an investment), the present value per share is $31.70, 21% below the Nov. 26th closing price of $40.18.

Twitter intrinsic value at optimistic estimates

Conclusion
Twitter is significantly overvalued, even assuming a P/S multiple comparable to Facebook. Even under best case scenarios, there is a 21% underside risk from current price levels. Twitter's $26 IPO was overpriced, and alongside the impending dilution it's a risky buy. Only a miraculous increase in Twitter's revenue or future profits will justify its current price. 

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