Latepost Twitter Announces Ipo: The Valuation
Influenza A virus subtype H5N1 lilliputian to a greater extent than than a calendar week ago, I posted my kickoff accept on Twitter too argued that fifty-fifty inwards the absence of fiscal information from the society (since the prospectus had non been filed yet), you lot could cost the company. Based on prior transactions inwards the society (VC infusions too acquisitions) too the multiples of revenues/users for other companies inwards the infinite (the social media medley, every bit I called it), I argued that Twitter would hold upwards priced at most $12 billion past times the bankers.
I also argued that every bit a long term investor, focused on value, you lot could non purchase the stock, at whatsoever price, unless you lot gauged its value first, too promised to provide to the society too value it, i time the filings were made. Twitter did file its S-1 (the pre offering filing) tardily inwards the twenty-four hours on Oct 3 too I am going to give it my best shot. Since I volition reference this filing through my valuation, you lot should download the filing too exercise it to non entirely follow my estimates but to modify those that you lot don't concord with. As alongside all of my valuations, I would hasten to add together that this is my valuation too piece it informs my conclusion on whether to purchase or sell the stock, you lot should brand your ain best judgments most the company. (I know that this resembles the boilerplate disclosure that you lot meet inwards every electronic mail that you lot acquire from your broker but I actually hateful this too I am non maxim it to avoid getting sued.)
The state of the society
Before I embark on the ambitious undertaking of forecasting the future, I volition get down past times looking at the society every bit it stands now. The fiscal filings pigment the moving painting of a immature society alongside lilliputian inwards terms of conventional earnings or cash flows to dorsum it up, but plenty of hope (a unsafe word). Let’s start alongside the income statement. In the tabular array below, I listing the company’s fundamental income disputation numbers from 2010 to 2012, alongside the 2013 information inwards the concluding 3 columns.
The numbers pigment a moving painting that should non hold upwards surprising. The company’s revenues have got grown rapidly, alongside the revenues inwards the kickoff 6 months of 2013 jumping to a greater extent than than 100% from the revenues inwards the kickoff 6 months of 2012. Notwithstanding the jump, though, the revenues over the twelve months ending June 30, 2013, were entirely $448 meg (which is good below the rumored $583 meg that I used inwards my pricing post). The society has reported operating losses through its entire life, though to hold upwards fair, R&D expenses draw organization human relationship for a chunk of the operating expenses. The society does study an adjusted EBITDA, too piece the tendency is positive, I cannot read much significance into a number that is based on the fiction that employee expenses tin hold upwards added dorsum because they are non-cash. Allowing for the fact that R&D is actually misclassified working capital missive of the alphabet expenditures (by accountants) too assuming a 3-year amortizable life for R&D does improve the operating income somewhat, every bit does the capitalization of operating lease expenses (moved to debt). Even alongside this improved operating income, Twitter’s pre-tax operating margin is barely positive (0.96%).
Looking at the ease sail only adds to the narrative of Twitter every bit a young, early-in-the-lifecycle company, every bit tin hold upwards seen inwards the next table:
These numbers illustrate how completely useless accounting ease sheets are at immature firms, particularly inwards technology. In fact, the entirely number inwards this ease sail that has whatsoever relevance is the cash balance, alongside the intangible property item mensuration none of the truthful intangibles too goodwill playing its commons (and useless) purpose every bit plug variable. I capitalized their past times R&D expenses too am showing it every bit an asset. The volume value of equity is negative but every bit an investor, that tells me nothing, too the shift to a positive volume value of equity inwards the pro forma disputation matters fifty-fifty less. The society has lilliputian debt (a working capital missive of the alphabet lease) too a serial of convertible, preferred percentage offerings, reflecting its multiple VC working capital missive of the alphabet infusions, which volition acquire converted to equity on the world offering (removing a major headache inwards the valuation). Comparing Twitter’s financials to Facebook’s at the fourth dimension of its world offering (see my valuation of Facebook on the twenty-four hours before its offering) should brand it clear that Twitter is much before inwards its growth path than Facebook.
The IPO prepare
Valuing a company, only ahead of a world offering, is tricky for multiple reasons. The kickoff is that at that topographic point is a feedback number from the offering itself, since the cash retained from the offering augments the value from the theatre (if the founders don’t cash out). The minute is that the percentage count is a fundamental too shifting number, alongside conversions of other types of securities (preferred inwards this case) too shares used inwards employee compensation (restricted stock units (RSUs) too options) overhanging per percentage values.
- Magnitude of the initial offering: While this may hold upwards putting the cart before the horse, the kickoff number that you lot demand to guess is the dollar value that the society hopes to heighten inwards the initial offerings. In most IPOs, entirely a pocket-sized fraction of the society is offered too Twitter seems to hold upwards no exception. This tidings story suggests (and I tend to believe it) that Twitter plans to heighten most $ 1 billion inwards the offering, at a stock cost of roughly $20/share. Note that I am non suggesting that this is the correct value for the percentage too it volition actually non touching on my valuation.
- Use of the offering: On page sixteen of the S-1, Twitter specifies that it plans to retain the proceeds from the offering inwards the society too exercise it to encompass investment needs (acquisitions, working capital missive of the alphabet expenditures too working capital). That effectively agency that the twenty-four hours of the offering Twitter’s cash ease volition growth past times roughly $1 billion, if that is the offering amount. (In some IPOs, the founders of the society cash out a portion of their ownership too accept the offering cash out of the company. In that case, it would non augment the cash balance).
- Post-offering shares outstanding: As I noted inwards the concluding section, Twitter has a whole serial of convertible preferred offerings. On page 17, the society notes that all of the convertible preferred shares volition hold upwards converted into mutual shares, removing i potential entanglement. On the same page, the society specifies that it expects to have got 472.613 meg shares outstanding afterwards the offering, but too so proceeds to say that this number excludes 44.157 meg employee options (potentially convertible to shares), 86.915 meg shares of restricted stock units (also granted to employees), 0.117 meg shares issuable on a warrant too 14.791 meg shares to hold upwards issued to MoPub stockholders every bit payment for the acquisition. There is absolutely no valuation solid set down for excluding these shares and the full number of shares that I volition exercise inwards my per percentage value is 574.44 meg (472.613+86.915+0.117+14.791). The options also correspond a claim on equity value, but I volition bargain alongside them separately.
The value of Twitter lies inwards what it tin do alongside its 215 meg users (the guess inwards the S-1) rather than what it has done inwards the past. This is the department where I am certain that nosotros volition have got to concord to disagree but the next sections summarize my assumptions.
A. Cash Flows/Earnings
1. Revenue Growth: The kickoff leg of value creation for Twitter is for it to hold upwards able to grow its revenues out, from the $448 meg inwards the most recent twelve months. To acquire some perspective on what the potential for revenue growth is inwards this sector, I started past times looking at the latest assessments of the size of the online advertising market. While the estimates vary across sources, this i (from eMarketer.com) looks similar it is roughly reality (with the percentage marketplace shares too dollar revenues inwards billions):
There are ii factors to maintain inwards mind. The kickoff is that the online portion of the advertising marketplace is continuing to capture a larger percentage of overall advertising revenues (as attested to past times the woes of impress too traditional media companies); applying a 5% growth charge per unit of measurement to 2013 online advertising revenues yields a value of $190 billion for the overall marketplace inwards 2023. The minute is that at that topographic point is a large segment of the marketplace currently that is splintered amid thousands of other companies, some conventional press media too many real small. Thus, the expert tidings for Twitter is that at that topographic point is a large potential market, but the bad tidings is that at that topographic point volition hold upwards plenty of contest from both the existing players too novel entrants. In fact, i interesting too disquieting aspect of the inflation of marketplace values of many of the companies on this listing is that the marketplace does non seem to hold upwards factoring inwards the finite size of the overall market. Thus, Google's electrical current marketplace cap implies that marketplace expects its revenues volition growth to $75 billion past times 2023 too Facebook's marketplace cap implies a revenue of $60 billion for that company; if the marketplace is right, those ii companies lone would draw organization human relationship for 60-70% of the overall marketplace inwards 2023. I do recollect that Twitter starts alongside some advantages. While it does non have got Facebook's user base of operations (or expansive interface) too Google's slowly reach, it does have got a much-used too unique platform too an active user base. I volition assume that Twitter's revenues volition attain $11.5 billion inwards 2023. That volition hold upwards to a greater extent than than a xx plication growth inwards revenues too interpret into a revenue growth charge per unit of measurement of 55% for the side past times side five years, scaling downward to stable growth (of 2.7%) inwards twelvemonth 11.
2. Target Operating Margin: Twitter's losses may hold upwards getting smaller too capitalizing R&D too lease expenses does brand their operating margin for the concluding twelve months slightly positive (0.96%), but it is clear that Twitter's value every bit a society volition eventually hold upwards determined past times how much profits they tin generate inwards the future. To brand an guess of the pre-tax operating margin that Twitter volition hold upwards able to generate, i time it gets through its growth pains, I took a human face at a mix of firms that I would class every bit the social media medley:
It is hard to compare margins across these companies, since some (like Netflix) derive all their revenues from subscription revenues, some (like Pandora) have got a mix of advertising too subscription revenues too some (like Google & Yahoo) are search engines. The society that is closest to Twitter inwards its advertising revenue model is Facebook too the society delivers an impressive 30% pre-tax operating margin, but Facebook's margin has shrunk every bit its revenues have got grown. Will Twitter hold upwards every bit profitable every bit Facebook? There are tidings stories that advise that Twitter gets less revenues from advertising per user than Facebook, but those may hold upwards reflective of where Twitter is inwards its growth phase. Twitter, alongside its 140 grapheme limit, has a to a greater extent than constrained format for advertising delivery but may operate meliorate inwards mobile advertising (which is the cutting border of online advertising) than Facebook. Overall, though, I would anticipate Twitter to have got a slightly lower operating margin (25%) than Facebook does right away (30%), particularly since Facebook's margins volition also compress over time.
3. Reinvestment to deliver growth: Growth is never easy, nor is it always free. With high growth companies, the tool I exercise to guess reinvestment is the ratio of sales to invested working capital missive of the alphabet (with higher numbers translating to to a greater extent than productive growth). To acquire a feel of what this number volition human face similar for Twitter inwards the future, I took a human face at Twitter's express past times too at Facebook's numbers:
Note that for Twitter, I have got computed the ratio of incremental sales to reinvestment each twelvemonth from 2010 to 2012, too that my reinvestment number includes acquisitions, modify inwards working working capital missive of the alphabet capitalized R&D too is internet of depreciation. I have got also computed the full sales to invested working capital missive of the alphabet for Twitter, Facebook too the sector inwards 2013. While Twitter's incremental sales to reinvested working capital missive of the alphabet ratio has risen over time, it is withal below the manufacture average. Put inwards intuitive terms, Twitter is spending large amounts (on R&D too acquisitions) to deliver its revenue growth too you lot have got to hope for improvement every bit the society gets larger; Twitter specifically forecasts most $225-275 meg inwards acquisitions for 2013 (S-1, Page 51). Based on these data, I assume that for every $1.50 growth inwards time to come revenues, Twitter volition have got to invest a dollar inwards capital; this allows me to guess the reinvestment (including internet cap ex, modify inwards working capital, R&D too acquisitions) each year.
B. Risk/Cost of capital
Is Twitter a risky company? Of course, but to guess the charge per unit of measurement of provide that I would demand to encompass its risk, I looked at 3 components:
- Business mix: While the volume of Twitter's revenues come upwards from too volition maintain to come upwards from advertising, Twitter does have got a information trove of past times tweets that may hold upwards mined for commercial or inquiry reasons. In the kickoff 6 months of 2013, Twitter generated 12.6% of its revenues from its information services too this proportion volition in all likelihood pass upwards inwards the future. Using a draw organization mix of 90% advertising too 10% from information services yields a beta of 1.40 for the company. (Beta for Twitter = (0.90) (Beta for advertising) + 0.10 (Beta for information services) = 0.9(1.44)+0.1(1.05) = 1.40)
- Geographic mix: While Twitter generated real lilliputian of its revenues from exterior the USA inwards 2011 too 2012, most 25% of its revenues came from the the ease of the the world inwards 2013. Using an equity hazard premium for the USA of 5.75% too a GDP-weighted average equity hazard premium of 7.23% for the ease of the world, alongside the electrical current weights of 75% too 25% for each, yields a value of 6.15% for Twitter. Given that Twitter right away has far to a greater extent than followers exterior the USA than inwards the USA (S-1, Page 67), the proportions too equity hazard premium may shift inwards the future.
- Financing mix: Twitter has working capital missive of the alphabet leases of $71 meg too the capitalized value of operating leases is $127 million. Collectively, debt accounts for 1.69% of working capital missive of the alphabet too Twitter's cost of capital, given these assumptions, is 11.22%.
Getting from the value of the operating assets to the value of equity per percentage inwards Twitter requires us to acquire over a serial of speed bumps:
- NOL & Taxes: The company's operating losses have got resulted inwards a internet operating loss of $468 meg (S-1, page 217) which I exercise to shelter the company's income, when it does start making money, from taxes. As a result, I do non human face the society to pay taxes until twelvemonth 5. Once it starts paying taxes, I assume that it volition human face upwards an effective taxation charge per unit of measurement of 30%, which over fourth dimension volition motion to the marginal taxation charge per unit of measurement of 35.50% (S-1, page 211) afterwards twelvemonth 10.
- Cash & IPO Proceeds: I add together upwards the cash too curt term investments of the society (see page 173) to brand it at a cash balance, which is added to the value of the operating assets. Since I have got assumed that the IPO proceeds volition hold upwards $1 billion too that they volition hold upwards retained past times the firm, I add together that value to the cash.
- Capital & Operating leases: As mentioned inwards the hazard section, I did convert the operating lease commitments of the society (page 214) to debt too added it to the working capital missive of the alphabet leases to brand it at a full value of debt of $299 million.
- Survival Risk: While immature companies alongside operating losses are susceptible to failure, I volition assume that Twitter's deep pocketed equity investors volition select inwards capital, if the society gets into trouble, rather than exit value on the table. I have got assumed that at that topographic point is a 100% guide a opportunity of the society surviving.
- Option overhang: The society has 44.16 meg options outstanding, alongside a strike cost of $1.82 (S1- page 207). Halving the remaining life on these options, to reverberate the empirical reality that employee options acquire exercised most halfway through their lives, gives me a life of 3.47 years too inwards conjunction alongside an estimated criterion divergence from the society of 53.6% (see page 207) yields a value of $805 meg for these options (net of taxation benefits inwards the future).
- Classes of shares: The best tidings I meet inwards this filing is that at that topographic point is no advert of ii classes of shares (with dissimilar voting rights) or special corporate condition (which I did meet inwards the Facebook filing). While that may modify inwards time to come revisions, that does brand my undertaking easier inwards terms of estimating value of equity per share.
If you lot do non similar my assumptions, delight modify them too come upwards up alongside your ain guess of value. If you lot are so inclined, delight do move into your numbers inwards the Google shared spreadsheet that I have got created.
Decision Time
Having learned from the Facebook fiasco, I expect the bankers too the society to brand the Twitter IPO a smoother offering. That procedure volition of course of educational activity start alongside the route show, where they volition bundle the society similar a shiny novel present, too disclose their “offering” price. I am certain that artner=yahoofinance">Goldman’s bankers, working on this deal, are a capable lot too volition cost the stock well, alongside only plenty bounce to brand those who have a percentage of the initial offering experience special. As I sentinel the frenzy, I have got to remind myself of ii realities. The kickoff is that at that topographic point volition hold upwards lots of distractions (like this one) during the IPO, most designed to accept my oculus of the ball. The minute is that the bankers have got their ain agenda, too I cannot brand the error of assuming that it matches mine. Watching out for my interests, hither is how I meet Twitter: at a $6 billion marketplace cap ($10/share), I recollect it is a real expert deal, at $10 billion ($17.5/share), I am indifferent to it, too at $20 billion ($35/share), it is a satelite shot. Could I hold upwards wrong? Of course, but I would rather hold upwards transparently incorrect (hence the long weblog post detailing every supposition that I made) than opaquely right. I welcome disagreement (though I would much appreciate your phrasing it agreeably).
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