Someone I know wrote this and was hoping for my/other people’s thoughts. Not a lot of actual discussion about markets here, but I’m curious to see what you guys think:
A couple weeks ago, I decided to short Twitter when it was trading around $45 a share. Yesterday, I “doubled down” on my short when it hit $64, and today – Christmas Eve 2013 – it crossed the $70 barrier. Obviously, my P&L (profit and loss) from this trade is not looking good at the moment. I certainly don’t have my life savings invested, but it is enough to find annoying. Maybe I am just too stupid or stubborn to know when to cut my losses, but if the stock continues to rise, I will simply continue to short more shares. Here are 10 reasons why I plan to do so:
Twitter breaking $70
1. Call me pigheaded, too theoretical, shortsighted…but I still believe that markets are relatively efficient. Ostensibly, the IPO price should have reflected all information held by knowledgeable market players –including the expectation of future positive developments – and these are smart guys who did their homework. I haven’t see any new unexpected news suggesting the stock should be up 50%, much less nearly 200%.
2. Twitter is trading at half the market capitalization of Goldman Sachs. This to me screams insanity. There are individual traders at Goldman who have singlehandedly brought in more revenue than Twitter has in its best quarter. And Goldman is a lean, badass machine employing 32,000 of the industry’s top business minds with a lot of real assets to boot. Twitter is 2000 geeks (smart ones, granted) – but c’mon, are they really nearly 10 times better at generating profit [i.e. “Doing God’s work”] per head than the Goldman guys?
3. Twitter is replaceable. The platform itself is a relatively simple concept that could be replicated by a team of competent programmers. Twitter’s first-mover advantage is huge, but look how that turned out for MySpace. If you gave me $10 billion, I’m pretty sure I could hire enough employees away from Twitter to rebuild a competitor that would run it to the ground in a few months.
4. The market capitalization should reflect the riskiness of the investment. Let’s face it, the discount rate for a start-up with uncertain, and in all likelihood very volatile revenues should be considerably higher than that for an established company with consistent earnings. This means, especially in light of the long time horizon before the site begins to generate any meaningful earnings, Twitter’s projected future revenues must be MUCH GREATER than those for a blue-chip company with a $40 billion market cap. We’re talking possibly bigger than Goldman big.
5. I have never seen anyone even attempt to justify a fundamental valuation of $70/share. Even the most optimistic experts seem to be calling now for $50-60, and I can’t help but feel that those upward revisions are more due to the stock’s recent momentum rather than any real expectation about value.
6. Let’s not forget the tech and housing bubbles. The current price is fueled by speculation and hype. Obviously, like any bubble or pyramid scheme, you can be “wrong” fundamentally and make good money. It wouldn’t surprise me if the price hits $80 or even $90 before retreating to $60, but I’ll just use that as an opportunity to short more at an even more outrageous over-valuation.
7. The free float now is a very small percentage of the total stock outstanding. As demand for the hot issue was high and supply artificially much lower than what’s truly there, the price has continued to be bid up, and I think a lot of it is by people who feel an emotional attachment to the company. As more equity holders cash in their stakes and the float increases several-fold, I think it will be very hard to find buyers at these ridiculous prices.
8. The user base is limited by factors outside Twitter’s control. According to estimates from a model on Seeking Alpha, Twitter would need to have well over 2 billion monthly active users by 2019 to justify its current valuation. The user base is already beginning to asymptotically level off, and there is no way that 2 billion people are going to use Twitter – even Facebook, with much greater mass appeal, will be lucky to get there by then. The world population is just 7 billion, so there’s only so much room to grow.
9. Ad revenue is also limited and will level off. I stopped listening to Pandora recently because the ads just got too frequent. Twitter certainly has room to grow its advertising revenues significantly, but at a certain point the cost will outweigh the benefit, and if that happens both users and advertisers will gravitate to other social media.
10. The downside potential significantly outweighs the upside. I think you can make a pretty fair argument for the downside being a $15 billion market cap. Can you make an equally compelling argument for an upside of $65 billion? Haven’t heard this one yet. Even so, you would have to assume risk neutrality for a $40 billion valuation to make sense, and data (as well as common sense) repeatedly show that investors are risk averse.
I don’t think you’re dumb if you bought (or are planning to buy) Twitter. Clearly, you foresaw something I didn’t, and I’m glad for those of you who have been successful with this play – I just think it’s a house of cards that sooner or later will come crashing down. In my opinion, a fair valuation now would be $15-30 reflecting base case to moderate upside. In a couple years, if Twitter can continue to impress, then I think $30-40 is a reasonable target.
Here’s the link: http://shortingtwitter.com