‘@Twitter: Why It is Far Too Early To Be Focused Solely on Valuation; Initiating Coverage With
a Buy Rating’ is the title of a new report from analysts at Stifel Nicolaus. The report could have been authored in 1999 about Broadcast.com or Pets.com, but this time is different… The Twitter Inc (NYSE:TWTR) upgrade from Stifel has already been reported by several media outlets, so I wanted to look at WHY Stifel believes valuation does not matter here. Stifel attempts to answer that question with the following.
Twitter Inc (NYSE:TWTR) EV/Sales
Over time, if we project estimates out to 2016, social media revenue multiples converge tightly around 8.0x. Twitter is the exception in this group, currently trading at 15.0x 2016E sales, versus the other companies’ 8.0x average. From 2014E to 2016E, Twitter’s two-year CAGR of 53% is double the average of its peers.
This really is a question in itself. Stifel is saying that even if Twitter Inc (NYSE:TWTR) grows at a phenomenal 53% CAGR rate, it will still be expensive compared to its expensive peers, but…
Stifel continues with the following…
Twitter Inc (NYSE:TWTR) EV/EBITDA
Valuation multiples are a function of revenue growth and margin potential. After adjusting the EV/EBITDA figures for estimated growth from 2014-2016, Twitter exhibits a multiple in-line with social media peers. A 2014E-2016E CAGR of 131% discounts Twitter’s 2016E EV/EBITDA/G multiple to 0.4x, which is slightly below the 0.6x comparable average. We admit that examining EBITDA multiples to growth can be somewhat misleading due to the higher growth rates on a relatively small absolute base of operating profit.
However, we believe it can be constructive in capturing margin leverage in the analysis, as the high-fixed cost structures of social media result in high incremental margins and rate of compounding growth.
So now that Twitter is still expensive even compared to overvalued peers, Stifel has an answer; make up a new metric. Twitter is cheap on an EV/EBITDA/G so the stock is a buy. This might remind some of JCP being cheap on an EBITDARP basis (that did not end well).
After this, Stifel talks about sentiment regarding The Twitter Inc (NYSE:TWTR)
Relative to social media peers, Twitter has the lowest sentiment, as measured by the percentage of buy and sell ratings from all covering analysts. Although negative sentiment alone does not keep a stock from rising, pervasively-negative stock sentiment can lead to an exaggerated, strongly positive reaction to favorable earnings and other upbeat news.
Fair point about sentiment. However, being contrarian just for the sake of it is dangerous. Just because the consensus believes that a stock is a poor investment does not make the stock a good investment! Furthermore, the reason that so many analysts have a sell on the stock is because the price has skyrocketed a very short time frame. Following tradition most brokerage firms had a buy on Twitter before the huge and rapid rise in price.
Stifel continues with other arguments which it claims have to do with valuation, but they really are related to growth prospects.
Bottom line: If you are a value investor it is hard to understand how this stock is a buy based on valuation. If you just want to make up metrics you can make any security worth any price you want. Investors should do their own due diligence, but do not believe for a second this investment is cheap based on sentiment or valuation.
Disclosure: No position