So you want to have an IPO: How NOT to report your first quarter’s results

Twitter reported results last night. They delivered revenue and EPS, for the past quarter and guidance, ahead of expectations. Nonetheless the stock fell 25% today. This was their first quarter as a public company and now they have a bit of a problem.

I have been writing a series of posts on the IPO process, starting here, and my goal was to work through the series chronologically, concluding with how to report your first quarter as a public company. I have not gotten to that point yet, but given the news, I thought it might be worth jumping ahead a bit. [Full disclosure: This note is not really about Twitter, but I wanted to disclose that I do own 20 shares of TWTR.]

Put simply, management teams should prepare their IPO materials with the first quarter in mind. It is the most important part of the IPO process, more important than the roadshow or the actual pricing on the day of the listing. Companies only get one chance to make a first impression, and the biggest mistake they can make is to mess up the first quarter out of the gate. The second biggest mistake is to miss the second quarter. These first quarters are important because investors remember them. Done well, they demonstrate to investors that a company is ready to be public. The road show that leads up to the IPO is essentially a set of promises, and the first quarter results are seen as a demonstration of the company’s ability to deliver on those promises.

People outside the Stock Market, look at these quarterly results differently. How much really changed in one quarter? Is Twitter really 25% less valuable today? Can one company change so much in just 90 days? Investors like Warren Buffet argue that “Mr. Market” can be irrational in the short term, and that a company’s intrinsic value does not change that quickly. All of that hold some truth, but in practical terms professional investors look at things very differently. They see the each quarters’ earnings as a reflection of wider trends. And if you build a financial model for a company, small changes in today’s conditions can have a big impact on how that model looks a few years out.

This holds double, or triple, for a newly public company. Investors in these stocks are still getting to know management teams, and still learning how to interpret management’s capabilities. Twitter is so big and important to the Internet that they will likely get a second chance to prove themselves. Smaller companies often do not get that second chance, or it can take years to recover. The stakes in the first quarters’ results go well beyond the numbers. These results speak to how management approaches the Street and their own ability to shape their message.

Prior to a company going public, investors have very little information about a company. During the IPO roadshow, companies get a chance to set expectations, but that is the last time they get to own the table. Once public, investors will trawl every data source they can to find information about a company, and will reach their own conclusions about what to expect. So it is very important for companies to go public on a set of expectations that they can deliver. As we will see in future posts, there are strong temptations to raise those expectations and set goals that are not easy to reach. I will argue that is the wrong approach to take. Better to set very low expectations, which can be met no matter what, and save the risk-taking for a later stage once the company has built a stable investor base who better understand the risks and the management team’s abilities.

By missing your first quarter out, you lose the people most interested in your story. And once lost, it is much harder to win them back.

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