What You Need to Know About Investing in the Twitter IPO (TWTR)

Nov. 7, 2013

Business Digital Reporter

A banner adorns the facade of the New York Stock Exchange in advance of Twiiter's initial public offering, Nov. 7, 2013, in New York.

Kathy Willens/AP Photo

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While the media and Wall Street are all atwitter over Twitter, it's a poor bet for the average investor, warns Santosh Rao, senior analyst and head of research for Greencrest Capital.

"It's not for amateur retail investors because it's a fool's game," Rao said. "You don't have all the information. The big firms have all the information and they know the real value."

Rao explains that IPOs are typically not priced based on a firm's "true fundamentals" and assets, like cash. Instead, an IPO's price is a matter of demand and supply.

He adds that in Twitter's case, there are not that many shares being issued: only 70 million initially, and most going to institutional investors.

Read More: Twitter IPO (TWTR) Priced at $26 Per Share

And Twitter's main goal is not to attract retail investors for the first day of trading. While companies are interested in getting cash from stock investors (in other words, liquidity), companies are typically interested in long-term investors, Rao said.

If the stock does pop today, many institutional investors will sell once retail investors can buy Twitter shares.

"And then they get burned," Rao said. "Most of the value is already in the price. When it comes out for trading, it's already fully priced and more, so there's not much left on the table. If the bankers did the job right, there shouldn't be too much pop."

Read More: How Twitter's IPO Will Work

Morningstar's Rick Summer had given Twitter a fair value estimate of $26.

"Still, we recommend investors be disciplined and purchase at a discount to our fair value estimate," Summer wrote in a research note on Oct. 31.

Depending on the stock's trading price on Thursday, Twitter could potentially blame its investment bankers for pricing its IPO too high or low.

"So the bankers have a very delicate job and have to get it just right," Rao said. "Ideally, they would leave a little upside."

If Twitter and its investment bankers expect the stock to jump up to $32, they probably would price it at $29 "and leave a little bit there," Rao said.

But Twitter will already have made the majority of its money, some $1.82 billion.

"Even if you get in, you have to get in and out so fast, it's really for the professionals," Rao said, pointing to Facebook's IPO in May 2012 as an example.

Facebook's IPO, which had a more aggressive valuation of $100 billion, as opposed to Twitter's maximum of about $13.6 billion, was priced at $38 a share. In early trading, many investors bought Facebook stock at $42 a share only to see the stock later flatline or drop. A technical error on Nasdaq's part didn't help Facebook's IPO ride. Of course, the road smoothed for Facebook investors and after the shares dropped by half they have since rebounded to around $49 a share.

"Assuming no glitches in the stock exchange, I would say in general, stay away," Rao said of Twitter. "Wait for a pullback which it always does. Let the initial dust settle."

Rao is hoping to see Twitter's business model develop.

"I'm sure stock will pull back down the road and then you get in at that buy," he said. "Net net for retail guys: don't chase it."

In case you're wondering, Twitter has never made any money. Twitter had sales of $254 million in the six months ended June 30, up from $122 million it generated in the first half of 2012. But the social messaging service's net loss widened to $69 million in the first half of this year, from a net loss of $48 million in the same period a year earlier.

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