Twitter's Correction Isn't Over #BrokenIPO

Momentum has reversed, but Twitter's correction hasn't run its course.

May 6, 2014 at 7:00PM
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U.S. stocks closed lower on Monday, with the benchmark S&P 500 losing 0.9%. Meanwhile, the narrower Dow Jones Industrial Average (DJINDICES:^DJI) fell 0.2%, while the technology-heavy Nasdaq Composite Index (NASDAQINDEX:^IXIC) was down 1.4%. In company-specific news, shares of Twitter (NYSE:TWTR) were decimated today, losing 18% in the wake of a massive "lock-up" expiration that saw roughly 480 million shares -- approximately 84% of all shares outstanding -- become eligible for sale. While some bottom-fishers may see today's decline as a buying opportunity, I think that'd be jumping the gun for investors with any concern for intrinsic value.

Images

Source: Twitter.

It's not entirely clear why Twitter's shares sank this afternoon. Sure, the headlines finger the lockup expiration as the cause, but as Bloomberg pointed out yesterday, "some of Twitter's biggest stock owners who in total have at least 205 million shares -- including venture capital firm Benchmark and co-founder Evan Williams -- have declared they're not letting go of their equity."

So, which investors were selling their shares today? Those who are now able to do so or those that are anticipating heavy selling from the first group? It appears that a significant proportion of the former group are committed to holding the stock (although that still leaves a huge number of shares that could potentially be sold), while the latter group could presumably have sold their shares before the day of the expiration (a date that is well publicized). No wonder Bloomberg's Jonathan Weil titled his column "I have no idea why Twitter's stock crashed."

Here's what we do know, however:

  • The number of Twitter shares that changed hands today was more than 10 times the average daily volume over the past 12 months.
  • The stock closed at $31.85, a new all-time low and a stunning 56% decline from its all-time high, which it hit on Dec. 26.
  • Even after today's drop, the shares are valued at 127 times estimated earnings-per-share for 2015!

Those three observations suggest to me one thing: Twitter's stock price has been and continues to be driven by momentum traders and other short-term-oriented "investors."

And here's something that investors ought to have known before today that is undoubtedly a factor in today's drubbing: Twitter shares became extraordinarily overvalued in the wake of their Nov. 7 IPO and were, therefore, almost certain to suffer a brutal correction. I'm not saying this simply with the benefit of hindsight, either: On Jan. 6, with the shares at $66.29, I wrote: "Twitter shares finished 2013 massively overvalued. I don't see the business fundamentals catching up with the valuation this year -- expect Twitter shares to struggle."

The sentiment regarding the stock has clearly reversed – dramatically so. As such, today's milestone was as good a catalyst as any for a sell-off (last week, it was disappointing user growth numbers). I see no reason for the correction not to continue now that it is firmly under way -- the stock's current valuation doesn't provide a floor on the stock (see my third bullet point, above) and once sentiment turns (near) unanimously negative, stock prices tend to undershoot fair value, anyway. At this stage, I think the odds are excellent that Twitter's stock will ultimately suffer the indignity of becoming a "busted IPO" -- i.e., it will trade below its $26 offer price. Look out below!

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Alex Dumortier, CFA, has no position in any stocks mentioned. The Motley Fool recommends Amazon.com and Twitter and owns shares of Amazon.com. Try any of our Foolish newsletter services free for 30 days. We Fools don't 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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