Twitter – The Biotech Alternative

twitter-bird2The launch of the Twitter (TWTR) IPO is still a month away but already bulls and bears are out in full force. It’s rare for me to comment on new issues but I’m making an exception believing this is truly a unique property. Before you start sending the hate Tweets and emails that make me wish I had secret service protection, just hear me out.

Like other professional money managers I’m often approached by retail investors asking me whether they should buy the next hot IPO or a stock they heard about at a cocktail party. I try to avoid it as best I can because no matter how my recommendation works out, I’m a loser. If I tell them to buy it and it goes up, it will be their idea and if it tanks, I’m the moron who talked them into buying it.

Ok, now that I’ve given you my reservations about speaking out, let me tell you why I’m a bull on the name. First, Twitter (TWTR) is a unique company that is rapidly becoming a must use business tool. I use it. (@davidnelsoncfa) Fortune 500 companies use it and you probably do too.

Business gets it and they are doing everything they can to make sure they don’t get left behind when the social media train leaves the station. Recruiters tell me that one of the most important skills they look at when recommending a Chief Information Officer is their social media IQ. Some firms have dedicated a position and employ a Chief Social Media Officer.

The Tie-Breaker

The producers at Fox Business asked me to join Gerri Willis on The Willis Report to discuss the Twitter (TWTR) IPO. Even with the knowledge that Twitter has 218 million users and revenue growth in mid double digits, I was still waffling on my position as bull or bear. Then suddenly, while looking up at my news feed there it was. The tie-breaker I had been looking for.

On Wednesday, Comcast (CMCSA), NBC Universal and Twitter announced a strategic partnership to connect millions of Twitter users with television viewing. By integrating the Twitter experience into their programing they can enhance the viewing experience and hopefully boost ratings. This couldn’t come at a better time for the broadcast community as millions of subscribers are cutting the cord and using cable just as an internet feed. This is very popular with the twenty something crowd and if they are anything like those in my office, they are big Twitter users as well.

One of the first steps by Comcast is a new feature called “See It” that gives millions of Xfinity TV customers the ability to instantly access a TV show right from a Tweet. Millions of Twitter users are Tweeting about their favorite shows and sporting events. Why not find a way to monetize it.

I think this is just the tip of the iceberg and if I let my imagination run, I believe thousands of companies will figure out ways to use Twitter to help generate business or increase customer traffic. Once analysts start to discount this potential new revenue and potential earnings, valuation models for the out years will have to be raised.

What the Street Thinks of Twitter

While there isn’t a lot of street research out on Twitter prior to the IPO, some brave souls have ventured into the battlefield. Robert Peck from SunTrust has an initial target of 51. This implies a $24 to $27 Billion market cap depending on the share count used in the analysis. (Current shares outstanding vs. fully diluted)

Hillside Partner’s Rory Maher is more tempered and is out with a note pegging valuation at somewhere between $13 and $17 Billion. He goes on to say “Twitter is likely not going to reach size of Facebook, but incremental streams should drive strong growth.” After the launch we will be flooded with initiations of coverage. I expect targets to be all over the map.

Think of it like a Biotech

The truth is it’s very difficult to come up with an accurate valuation on a rapidly emerging growth story like Twitter. It’s hard enough valuing stocks like Exxon (XOM) that have revenue, earnings and a dividend history. I prefer to think of company in the same light as a Biotech that has had great Phase I and Phase II trials and is now entering Phase III. If Phase III hits the money starts to roll in.  In the end, an asset is worth what the next incremental buyer is willing to spend.

Current talk has the pricing somewhere around a $15 Billion market cap. (I hope) At $15 Billion I think it’s a buy. At $20 Billion it probably trades sideways. At $30 Billion watch out and wait for an opportunity.

Corporate Governance

Twitter is the first Silicon Valley Company I can remember in a long time that is not issuing dual class stock. This is a practice where founders and insiders end up with shares that have super voting rights giving them the ability to control the company long after they’ve sold a big portion of their stake. Google (GOOG) founders Page and Brin wanted to sell shares but were concerned that options dilution might put them at risk of losing control of their baby. Solution: just create Super Voting shares for yourself and you never lose control.

Many companies still choose this route and I think it is more than a black eye for Wall Street and corporate America. I’ve talked about this in previous posts and still believe it is; “The Rape of the American Shareholder.” Twitter has chosen not to go down this path and I applaud them. Bravo!

The Offering

A lot of reference will be made to the Facebook (FB) IPO disaster and the potential for a repeat performance. Goldman Sachs (GS) as lead banker is not going to make the same mistakes as Morgan Stanley (MS) who continued hype the stock and raise the IPO pricing. When it finally hit a level where institutional interest disappeared, they dumped it on their retail customers. The rest is history. The stock tanked and their investors were left holding the bag. I’m sure many Morgan Stanley clients were shocked when their brokers called and told them they got every share they asked for. I started my career on the sell-side as a broker and I can assure you that when your sales manager comes to you and says your clients got a full allocation, you are about to have a very bad day.

Other Thoughts

If you decide to participate in Twitter, either now or 6 months from now just remember this falls into the speculative basket of your portfolio. Don’t invest the same dollars in Twitter that you would in Boeing (BA) or General Electric (GE).

– David Nelson, CFA

Funds managed by David Nelson currently have long positions in Facebook (FB), Google (GOOG) and Boeing (BA)