Twitter Investors Should Tread Carefully

 | Nov 07, 2013 | 1:00 PM EST  | Comments
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Twitter's (TWTR) highly anticipated IPO is certainly a sign of how far the market sentiment has turned over the past several years.

The widely-used micro-blogging network has priced 70 million shares at $26, up from a previous range of $23 to $24 -- a range that has also been raised before. The new price values Twitter at over $14 billion. It's likely that Twitter will experience a very nice "pop" on the first day of trading as a result of the immense market enthusiasm for the company.

Unfortunately, such enthusiasm is not backed by cash flows or at a minimum a viable forecast of future cash flows. Unlike Google (GOOG), which did an IPO in 2004 when it was demonstrating a profitable business, analysts are having a hard time understanding how to value Twitter. With some 230 million users, Twitter's base is nearly one-fifth of the users Facebook (FB) and it looks set to have a similar valuation based on user count. Today, Facebook has a valuation of some $120 billion.

Yet Twitter's path to profitability looks even more uncertain than Facebook. Most analysts expect that Twitter won't turn a profit for years. Twitter's share price is going to rely heavily on investor faith.

I don't think it's coincidental that Twitter chose to go public at this time. Underwriters and insiders clearly want maximum price for any public offering. The environment is certainly one with a high level of investor faith for today's crop of tech stocks. Brian Wieser, an analyst following Twitter at Pivotal Research Group, said it best: "Twitter will make Netflix (NFLX) look like General Electric (GE) as a bellwether of stability."

There's no denying that social media, the cloud and the ability to deliver content seamlessly is a lucrative industry. Companies like Twitter, Facebook, Google and Apple (AAPL) have transformed how the flow of information and communication is disseminated. They also have managed to aggregate billions of consumers together in way that no other media outlet, other than cable, has been able to do.

Twitter's valuation will be based on faith for some time to come. Investor faith can be shattered quickly. As a public company, Twitter's inner sanctum will now be available for all to see. Investor faith will be tested quickly in the coming months.

In a subtle way, the social media stocks are reminiscent of the dot com stocks of the late 1990's. Names like Facebook will carry on becoming the bellwethers of that space much in the same way that Cisco (CSCO) and Intel (INTC) did.

Left in the wake, however, will be many others who simply could not survive the market based on ideas and hopes. Twitter is clearly not one of those victims yet, but investors should really tread carefully amid all the enthusiasm.

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