There’s an expression that financial crises strike when everyone who lived through the last one retires and there’s no-one left who remembers. On that basis, the second dot.com bubble should have taken longer than 13 years to inflate. Surely many investment professionals observed the Twitter flotation with a looming sense of deja vu.
These professionals would remember the nonsensical metrics used to justify the absurd valuations for loss-making businesses in 1999.
It’s hard to believe history should repeat itself so soon.
One quote in the media coverage of Twitter’s 73 per cent first day pop said: “While people don’t understand exactly how Twitter is going to make money, they understand the product. They use it all the time and it is exciting. They want to participate in the story.”
A few weeks ago, Mary Jo White, chair of the US Securities and Exchange Commission, spoke sense into the situation, when she commented: “It can be hard not to think that these big numbers [of users] will inevitably translate into big profits for the company. But the connection may not necessarily be there.”
It is the same mistake people make when they assume that a rapidly-growing economy will necessarily translate into a rising stock market. There is a connection but it is tenuous. The biggest determinant of the success of an investment is the price you pay at the outset.
Therefore, it required a great deal of trust for anyone who bought into Twitter shares at almost $50, or nearly twice the $26 issue price. The assumptions necessary to get to even the lower of these two prices are heroic. For example, revenue growth of around 50 per cent a year for the next five years, assuming that investors will be happy in 2018 to pay around 25 times earnings.
Both of these are plausible. Facebook has grown its revenues much faster than this in the past five years and many recently-floated tech stocks currently trade on more than 100 times earnings. However the experiences of MySpace , Bebo and Friends Reunited show that the outcomes in social media are pretty binary.
Twitter has handled its float cleverly. It learned from Facebook, anchoring perceptions about the price at a low enough level to make the aftermarket feel like a raging success. They could do this because existing shareholders held onto their stock and so had no incentive to push the price. They left more on the table than in almost any other IPO in the history of the US stock market.
Other technology companies will come to thank Twitter for this because they have laid the groundwork for what might be a veritable torrent of tech floats in the months ahead. Facebook killed the market stone dead for a year because of its hubris in the run up to its May 2012 IPO. Twitter’s caution has set up another 1999-style tech stock party.
This is exciting and depressing at the same time. Market manias are fun but stressful. There’s easy money to be made but with that comes the nagging feeling of both missing out on the gains and being set up to look like a fool when it inevitably goes pop.
