As the massively under-priced IPO of Royal Mail showed last month, pricing of shares in newly floated businesses is an enormously difficult business.
So it is easy to agree with Tomas Freyman of BDO that tomorrow’s flotation of Twitter is priced at what looks like “bubble territory”. It is, after all, a loss making company whose flotation values it at $17bn, according to the Evening Standard – more than 20 times current revenues. Freyman, having “looked under the bonnet” of the company, feels the company has a maximum valuation of $10bn – and even then only if it made significant strides in its business model.
BusinessWeek offers an equally damning verdict: compared with its 2012 revenues, the valuation is an astonishing 43 times revenues, it claims, and the $25 a share represents a P/E ratio of -171.
But the discrepancy between these two figures indicates the huge problem that traditional valuation methods face. Twitter, as the BBC points out, has seen astonishing growth. Some analysts expect the business to grow revenues 100% this year; third quarter figures support that (wouldn’t that be great for media headhunters? Surely there will be a few hires in that?). Another year of that kind of growth, and the price starts to look more reasonable – at least to the kind of investors who are still buying Google shares at P/E ratios of 29.38, or Facebook shares at 102.68 P/E. Just to be clear, that means that at the current rate of profit, it would take you 103 years to recoup your investment in Facebook, or a mere 30 years in Google. Of course, nobody expects to have to wait that long: most people who participate in an IPO are looking for quick returns. Recent history indicates that a little patience can be well rewarded.
Facebook famously saw its share price collapse after an apparently over-valued IPO back in May last year. But, if you bought shares back then for $38, you could sell now at $49. Not a spectacular result – but a 30% return on your investment in eighteen months, and double your return on the FTSE 100 in the same period.
Impossible as it now also seems, Google was also in trouble at flotation, cutting its price to $85 per share in 2004. Less than a decade later, those shares are trading at $1,022 each – an increase of 1200% plus.
Of course, an IPO is always a punt – anyone who lived through the dotcom bubble burst of 2001 knows how it feels to get it wrong. I would never buy shares at such a massive multiple (I am far too bearish), but I would not be surprised if in six years’ time I was not kicking myself. And perhaps Mr Freyman will be too.
DISCLAIMER: This should on no account be taken as investment advice. Anyone who has examined my track record of investments would recognise that my instincts are hopeless. As my daughter would have it: “I’m just saying, that’s all.”