Twitter: Is the Fix in for Earnings?
It's time to take a fresh look at earnings expectations for Twitter.
Think about it.
Twitter is the biggest, brightest shining star in the red-hot social media sector, which, of course, itself sits in one heck of a tech bull market.
The Global X Social Media Index ETF (NASDAQ:SOCL) was up a whopping 64% in 2013, while the Nasdaq Composite (INDEXNASDAQ:.IXIC) rose 38%, even though index leader, Apple (NASDAQ:AAPL), was up just 5%.
And Twitter's stock?
It's easy to forget that the original pricing on its IPO was $17-20. That range was raised to $23-25 before finally being set at $26.
On its first day of trading on November 7, 2013, Twitter opened at $45.10, before hitting an insane $74.73 in December. After enduring a few analyst downgrades that knocked out some of the froth, it's trading at about $60 -- still a good 131% above the $26 IPO price, and 33% above the opening tick.
Look at this beauty:
That $60 mark is still good enough to equate to a valuation that's obscene by even the raciest of momentum-stock standards, meaning sky-high expectations.
With Twitter, we're looking at a stock that's trading in the neighborhood of 30 times expected 2014 revenues -- oh, and did I mention that the company's expected to lose money?
Okay, okay, Twitter's not really expected to lose money, at least not by investors. Think about it this way: If a stock's trading at 30 times next year's revenues, then the crowd thinks estimates are too low.
Now technically, we can apply this line of thinking to any momentum stock, but there's a wrinkle in the fabric that makes Twitter far more interesting than the average high-flyer: Wall Street is trying to engineer a beat.
On Wednesday morning, Cantor Fitzgerald downgraded Twitter to a Sell rating.
This isn't interesting on its own: There are plenty of Sell ratings on Twitter. In fact, we fired up our Bloomberg Terminal and found that 10 of the 27 firms covering Twitter rate it a Sell.
That's a lot. If you want to make comparisons, Facebook (NASDAQ:FB) has 41 Buys, five Holds, and zero Sells. LinkedIn (NYSE:LNKD) has 20 Buys, 16 Holds, and zero Sells.
The average target price on Twitter is also just $45.13, implying a 25% expected decline.
But Cantor pointed out something very interesting. The big Wall Street firms that put together the Twitter deal have lower estimates on Twitter than other firms:
The analyst, Youssef Squali, calls the non-banking analysts' estimates "aggressive," but wouldn't it be more correct to say that the banking analysts' estimates are conservative?
A quick look at the make-up of consensus estimates reveals that analysts whose banks were involved with the TWTR IPO generally have estimates that are lower than those not involved. For example, FactSet's overall consensus 2014 revenue is $1,118 million (vs. ~$1,041 million for banking analysts), and consensus 2014 EBITDA is $138 million (vs. ~$98 million for banking analysts). For the stock to work materially from current levels, it would require beating not only consensus estimates, but the more aggressive ones from non-banking analysts as well, in our view.
Remember what happened with Facebook. Its May 18, 2012 IPO flopped because it was priced too high. Then, on July 26, 2012, it reported its first quarter as a public company. The numbers failed to impress, and the stock dropped 12% the next day to $23.71, or 38% below its $38 IPO price.
The Twitter IPO was the polar opposite. Investors were in love with its extreme growth, particularly in mobile advertising, and the first-day pop was huge.
And the subsequent rally implies that expectations have been on an upward slope, and the stock may actually be too high for Wall Street's liking.
Wall Street being conservative in its estimates may be a way of keeping expectations in check to give the company leeway in terms of beating estimates. Given its heady valuation, Twitter doesn't have to beat expectations -- it has to smash them.
And interestingly enough, those same banking analysts aren't terribly bullish on the stock in terms of ratings.
There were seven banks listed as Twitter IPO underwriters, two of which (Allen & Company and CODE Advisors) don't have equity research departments.
Let's go through the remaining five underwriters and examine their ratings:
Deutsche Bank (NYSE:DB): Buy, $50 Target Price (TP)
Goldman Sachs (NYSE:GS): Buy, $46 TP
JPMorgan (NYSE:JPM): Neutral, $40 TP
Bank of America Merrill Lynch (NYSE:BAC): Underperform, $36 TP
Morgan Stanley (NYSE:MS): Underweight, $33 TP
So out of the five, we have two Buys, one Neutral, and two Sells. That's not exactly super bullish, especially when you consider that the two firms with Buy ratings -- Deutsche Bank and Goldman Sachs -- are actually forecasting price declines.
Speaking of which, how can you have a Buy rating on a stock that's trading 20-30% above your target price?
Someone's got some 'splainin' to do...
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