Thursday, November 7, 2013

Money left on the table at Twitter.

Twitter [TWTR] went public today.  The asking price was $26, but the stock immediately traded up and is now trading at close to $50.


So is this good news or bad news?   

The answer, of course depends on who you are asking.

From Twitter's point of view, they sold the stock cheap - very cheap.  The stock was underpriced by about $45-26 = $19 per share.  As they sold about 70 million shares today, the total underpricing was roughly $1.3 Billion.   This is sometimes called the "Money left on the table" and by any measure, this is a pretty big sum.   Jay Ritter of the University of Florida, keeps track of these things and has a nice summary of past IPO underpricings.  In 2012, the total left on the table for all IPOs was about $2.78 Bn, but this is dwarfed by the height of the tech bubble in 1999 when the total was $36 Bn.

From the people who bought the IPO - this turned out great.  And we're not talking about people trading the IPO this morning - we're talking about those who were allocated shares by the Investment Banks.   These investors saw a huge one day return.   But there is a dark side here - as there is plenty of evidence that Investment Banks give allocations of these desirable IPOs to their best clients.  So Twitter's shareholders have given up a huge chunk of cash to so that the IBs can provide a nice present to their clients (beats a set of golf clubs or Frozen turkey for Christmas).  This practice (giving your clients IPO allocations) is called spinning.   Prof Ritter writes about it here.   

So by my counting, the score card is Twitter 0, IBs and their clients $1.3Bn

The next question then is how much is TWTR worth?

At $26, twitter has raised about 1.82 Bn.  But the company has about 575 million shares outstanding (most of which are not part of the initial IPO.   So Twitter has only sold about 12% of the company to the public at this point.   The valuation at IPO was about $26*575M = $15Bn.  But at the price above, the valuation is closer to $49*575M = $28Bn.  It is likely that Twitter will conduct further equity issuances over the coming months, gradually increasing the amount of shares held by the public, and raising more cash as it does.


Finally, what about those traders who bought the IPO at the higher price today?  

What does the future hold for them?    Of course we can't predict what TWTR stock will do, but the evidence shows that buying an IPO stock at the first day closing price is a terrible investment.   On average they underperform the market over the next 3 years by 19% per year.  But larger IPOs do fair better, so there may be some hope (Facebook is doing pretty well).   That said, I will stick with my Index Funds.