Twitter (NYSE:TWTR)'s IPO was a hit as shares surged 73% on the opening day. Following the massive surge in the share price, I knew it wouldn't take long before short-sellers started testing Twitter's resilience. Recent reports have shown that short sellers are starting to circle around the company's shares as they get their first shot at betting against it. Approximately 5.5 million shares out of the 80.5 million offered were out on loan, which signifies a high short interest of 7%. Timothy Smith, executive vice-president at SunGard's Astec Analytics, claimed that the current cost to borrow ratio shows that short interest in the stock is definitely high.
Though it is not typical for short sellers to try to benefit from a high-flying IPO, I am not surprised by the high short interest in Twitter. Furthermore, I believe that at nearly $52 per share, Twitter is massively overvalued. Thus, I'd recommend investors to short Twitter as I expect its share price to drop significantly in the near future. Let's take a look at the reasons why I expect a drop in Twitter's share price.
Growth in the U.S. Is Slowing Down
Despite the fact that the U.S. accounts for roughly 30% of Twitter's monthly active users (MAUs), it contributed 77% of the company's total revenue. However, growth in MAUs in the U.S. is slowing down, and this can possibly hurt Twitter's growth potential.
In the past two quarters, Twitter grew its MAUs in the U.S. by only one million as compared to the prior year when it grew three million. What's worse for Twitter is the number of U.S. iPhone users using Twitter decreased from 27.2% to 27%. Twitter's growth in the U.S. market is slowing down at an alarming pace and this makes justifying its market cap even more difficult. Twitter has been posting losses for the past three years and this won't change this year as the company has already lost $134 million in the first nine months.
Underpriced IPO Was a Big Mistake
Even though an underpriced IPO means that a company will raise less money to invest in its business, it has a benefit. In most cases, an underpriced IPO witnesses a bump in its price very quickly, and Twitter is no exception to it. The spike in Twitter's share price has proven to be a good thing for the company's reputation. As most of you know, Facebook's overpriced IPO was a failure as its shares failed to stay at the level they were offered at. This created a lot of negative sentiment about Facebook's business and it took the company more than a year to reach its IPO price again.
While Twitter has successfully dodged such a goof-up, it may have made a different error by under-pricing its IPO. Let's do the math. By setting its final offering price at $26 per share, Twitter generated nearly $1.8 billion. However, given that demand (or hype) for Twitter's IPO was high enough to increase its final offering price, the company could've raised a lot more money if it had priced its IPO correctly. Considering that Twitter's share price surged to just above $45 per share, the company may have given up $19 per share. This means that Twitter may have sacrificed roughly $1.5 billion, which is more than the total revenue that it has generated till now.
Twitter could have used this money to expand its business via acquisitions or to enhance its global expansion and justify its present market capitalization, but now it doesn't look quite possible. I guess it will be safe to say that Twitter's underpriced IPO was an even bigger mistake than Facebook's overpriced IPO.
Valuation Is Too High, Drop Is Imminent
Presently, Twitter values its users more than Facebook and LinkedIn, even though its users bring in less in revenue than Facebook and LinkedIn users. In order to justify the $31 billion of market cap that it currently commands, Twitter will have to generate nearly $6 billion in revenue by 2019. However, if you look at the past numbers, this expectation will look unrealistic.
In 2012, Twitter generated $316 million in revenue. As of 2013, Twitter has generated $422 million in revenues in the first nine months. This is a significant increase and it puts the company right on track to hit the $600 million mark, but it is still very expensive as the company's price to sales ratio is still over 45!
Prospects Are Not Strong Enough to Justify Market Cap
As I already said, Twitter will have to generate nearly $6 billion in annual revenue by 2019 to justify its market cap, but the company's prospects, though interesting, don't look strong enough to meet any such expectations. Let's take a look at these prospects one by one.
Firstly, Twitter was hiring publishers before it went public, which indicates that the company has plans to play a major role in news. Twitter has become a major platform for sharing news. Sportsmen, movie stars, and many other celebrities have adopted Twitter for sharing news and this signifies news will play a crucial role in Twitter's future business. The company recently hired Vivian Schiller to help broaden its news coverage in the future.
Twitter also has numerous platform partners like BBC, CNN and The Times of India, which have integrated with the social networking website to serve as a platform to share news. In addition to that, the company's CEO, Dick Costolo, aims to convert Twitter into a "second TV" in order to generate over $1 billion in revenue before the end of 2014.
Furthermore, Starbucks has reached an agreement with Twitter that will allow users to send a $5 e-gift to a fellow Twitter user. This "Tweet-a-coffee" campaign gives a hint about how the company plans to enter the lucrative e-commerce market.
Even if Twitter is able to executive these plans flawlessly, it is highly unlikely that the company will able to enhance its revenue by a factor of ten in just five years as these plans are still in their early stages of development. This makes the short case even stronger, hence I will recommend investors to short Twitter at the current price.
Twitter could end up becoming a niche player for a select audience. Hence, even though Twitter's IPO was a success, it might not be able to grow as rapidly as needed to justify its market cap. Its valuation is too high and the strategies that it has lined up might not be enough to propel its revenue to levels high enough to justify the valuation. Hence, Twitter shares might slip going forward, making it a short play worth considering.