TMB Recaps The Madness That Was The Twitter IPO

Judging from my Twitter timeline Yesterday, there was a lot of confusion over how the Twitter IPO worked and how to evaluate its success. Yesterday I tweeted that the common investor lost money on twitter despite its rise from $26 to $44 dollars per share, which is because only institutional investors were able to buy the stock at the IPO price. This post will clarify how is how IPOs work and why you and I weren’t able to purchase Twitter at $26 per share.

A company decides to file an IPO after determining it needs more capital and looks to the public in hopes of trading a share of future earnings for cash up front. The company that wants to go public partners with an investment bank (Goldman Sachs, Morgan Stanley and JPMorgan in Twitter’s case), then to generate interest in the company, shares their financial information and business plan to regulators, investors, and the public.

The investment banks take orders from their biggest clients like pension funds, mutual funds, and hedge funds, which get first priority to buy the stock. After the institutional investors the stock is opened to brokerage houses and lastly individual investors fight over the few remaining shares. Based on demand from these clients, the company determines an opening price, which for twitter was $26.

The investment banks then buy the stock, in Twitter’s case for $26 dollars a share for their clients based on the orders they took earlier. This all takes place before the opening bell on the date of the IPO. All the shares that are being offered are owned by the public the night before the IPO, so that on the morning when the NYSE bell is rung, the shares begin trading.

On the morning of the IPO, an experienced trader starts processing orders from the night before. When the market opens at 9:30, traders gather around this experienced trader to start placing their orders. It is the experienced trader’s responsibility to find the right “Discovery” price for a company’s newly offered shares, which may take a few minutes to an hour once the market opens. Twitter’s took nearly an hour to settle on a price of $45.10, which signaled the point that individual investors could start buying shares of the company.

When I posted about Twitter’s IPO yesterday, I said I was planning on buying. When you’re trading stocks, you can set what is called a “limit” so that your broker will automatically purchase a given number of shares of a particular stock when it hits a certain price. My limit yesterday for Twitter was first $30, then I adjusted it to $35 as rumors of the price floated about. When it was announced that it was going to open to individuals at $45.10 I canceled my limit order. I canceled my order because I felt that if the price hit $35 it would blow right by on the way to bottoming out around $15-$20 and I didn’t want the computer to try and catch a falling knife.

Twitter’s stock opened for institutional investors at $26 and closed the day at $44.90 earning a total of about $1.32B, but the average trader lost money since they were only able to buy in at $45.10 and the stock closed at $44.90. As always, the rich get richer.

The IPO was undoubtedly a success for Twitter, even if the average investor has so far lost money, but lets put the irrationality of investors in perspective. Yesterday Twitter closed at $44.90, after losing over $64M in Q3 alone. In contrast, Facebook closed at $47.73 (Twitter actually had a higher price for a while) and made a profit of over $2B in Q3.

Twitter is still losing money and lacks to coherent business plan. They are banking on integration with TV, additional advertising, and data mining their users, however they haven’t announced how they are going to specifically do any of those things. Most “experts” agree the price of the stock is going to fall back down to earth and settle somewhere around to $25-$29 range. As much as I love using Twitter, I don’t share the same fondness for the stock. For the time being, I’m going to remain an active twitter user and avoid being an active twitter investor.