The danger of a secret IPO filing
Twitter has filed for its IPO in secret, to avoid the intense scrutiny that followed Facebook’s filing in 2012. While the company is following the letter of the law under the JOBS Act its refusal to show the world its S-1 hurts small investors.
Twitter tweeted to the world late Thursday that it had taken the first step in preparing to list itself on the stock market (an initial public offering or IPO) by filing an S-1 with the Securities and Exchange Commission.
In early 2012 Facebook was in the same place: it filed an S-1 with the SEC to begin the process of going public. However, Facebook’s S-1 experience was a little different — as soon as the document was filed it was posted in a public repository meaning media and analysts had instant access to it.
This document allowed readers a very intimate view inside the company’s financial health. Facebook, as the document showed, is incredibly profitable creating an operating income of $1.7 billion on $3.7 billion in revenue. It revealed that Facebook’s mobile self, its fastest growing division, had not yet been effectively monetized. It also showed that Facebook was about to hit a growth ceiling, and could not effectively compete in the fast-growing online market of China because of the “great firewall” and fiercely competitive rivals such as Renren, Sina and Tencent.
Immediately after this document’s release the media was abuzz with analysis of the S-1 and speculation on how the stock would fare during its first few weeks on the market. Many who had never invested in stocks before decided to give it their first go with Facebook, though for this low-information group an investment during Facebook’s first few weeks was not a profitable exercise.
This past May, The Atlantic ran a piece about the “human cost” of the Facebook IPO. It profiled one low-information investor named Uma Swaminathan who decided to place the majority of her retirement savings in Facebook’s stock shortly after it was open to the public for trading. She hadn’t read Facebook’s S-1, nor was she privy to notes from research analysts to institutional investors that outlined why Facebook’s stock was one to pass on. As the story ends, Swaminathan decided to hang onto her stocks with the hope that one day the price will bounce back and she can sell them at a profit.
Twitter, on the other hand, is going about things a little differently. Because its revenue is less than $1-billion, the Jumpstart our Businesses Act (JOBS) allows it to keep its S-1 private, visible to only a few select institutional investors and underwriters, until three weeks before its IPO.
The intent of the act was to allow companies to test the waters to see how some investors would receive the stock, and allay any concerns they may have. In competitive markets, it also saves companies from having to make their financial matters and internal risk assessments public — a gold mine for the company’s competitors.
Except Twitter doesn’t have any competitors in North America. Facebook and Google Plus might compete for people’s time, but neither offer a microblogging service just like Twitter. Thus, the privilege of keeping the S-1 private doesn’t help Twitter in that sense.
Where it does help Twitter is shielding it from scrutiny. Like Facebook, Twitter is an advertising company and its sustainability is tied to advertisers continuing to view Twitter’s ads as profitable. It’s revenues and profit are wholly dependent on advertisers continuing to purchase ads. In the future, hypothetically, Twitter could remain popular but the next big thing in advertising may come along stealing the company’s ad dollars and hurting its profitability. Perhaps Twitter’s executives have disclosed this in the company’s risk assessment in its S-1. Some institutional investors might know this, but medium sized and small investors will not. Without seeing the company’s margins, growth projections, revenue or operating income even experienced small or medium investors are as wise to the stock’s fundamentals as Uma Swaminathan was with Facebook’s.
The SEC made these S-1 disclosure rules for a reason. One of them was not allowing companies riding the social media bubble to game the system with a few big bank conspirators.