Like a lot of people, I have been following the action on Twitter ($TWTR) stock after Elon Musk bid to buy it. In public markets, it is often informative to look at price. Here is a chart of the last month’s price action.
Here is a chart since it went public. The data is presented in a weekly format.
The reason Twitter has piqued the interest of Musk has little to do with free speech. He is trying to unleash untapped value and thinks he can put together a management team to do it which would be a lot better than the current one. As a private, not publicly traded, company, they would face a different regulatory web than they currently do. That along with different ideas about how to monetize the platform makes it compelling given the fact that the stock has done nothing since going public.
Most of the time, this stock has languished below or around the IPO price($45.10). It can be easily argued that nothing of value has been built for shareholders. Tim Knight has blogged a lot about Twitter action over the years. What is truly interesting is the blog post at Tim’s blog of June 28, 2020, when Twitter lost its number one status to competitor Parler. If you follow social media, you know that Big Tech did everything they could to put Parler out of business. Then, Twitter cancelled Trump.
That aggressive and discriminatory action unmasked them for all to see. They aren’t the libertarian loving companies Silicon Valley said they were and neither is Silicon Valley. The bulk are left wing corporatists.
It’s pretty obvious that there is something wrong with the water when it comes to Twitter. Mostly, it is the management.
The question becomes the price and the strategy going forward. Is $54.20 enough? If you are a current or long-term shareholder, would you sell? Hey, the return over the current share price beats the rise in inflation!
Let’s take a peek at Twitter’s 10-K. This is the SEC filing that shows the balance sheet, the income statement, the statement of cash flows and all the requisite notes which accompany them. By the way, as a private company, Twitter wouldn’t have to do this anymore. The operations of the company might be quite a bit cheaper as a private rather than a public company. However, the downside is no access to public markets.
My guess is Elon has enough relationships with PE firms to have a steady stream of cash if he can install a management team that will actually grow the company.
Twitter is no longer a VC-backed company. VC-backed companies derive their valuation from an arms-length negotiation between a venture capital lead and management. Twitter only derives value based on its financial numbers, and the potential development of those numbers. Mr. Market values them every day.
Twitter currently has a headline valuation of $35 billion. The firms that invested in the venture capital market to invest in Twitter are the ones that made the real money. Public investors got nothing. That shows you why there is demand to invest in private markets by people who the IRS says are unqualified to invest there. That demand is one factor that also pumped up private market valuations.
Twitter pays zero dividends, so the only way an investor can get a return is on price appreciation of the stock. It has never paid a dividend and has no plans to pay one. The next date for reporting earnings is April 28th and if the drama isn’t resolved by then, it will be a big day. You can bet that current management is doing all they can to make the headline numbers work. A lot can happen in 8 days when the pressure is turned up.
Accounting is judgment, not hard and fast absolute rules. Those numbers you see on the income statements of Twitter follow Generally Accepted Accounting Principles (GAAP) but are the management’s interpretation of how they apply GAAP to their business. Musk’s team might have gone through those same statements, made different projections, and come out with different numbers.
For Twitter, an acid test ratio is a good thing to look at. Twitter is software and carries no inventory. Its primary costs are labor (people), the cost of leasing real estate (now empty buildings), and technological costs like cloud and computers. Twitter had roughly $5 Billion in revenue and lost $225 million from operations. Some tweaks and it might be profitable. Find another revenue stream, it could be profitable.
Twitter currently derives its value from its brand, network effects, and its ability to charge advertisers to access the platform. It is mostly a one-trick pony when it comes to generating revenue.
Their published acid test ratio is Current Assets=7.9B/Current Liabilities=1.3B or 6.07. In financial statement terms, this is really really good. However, when you delve into the notes on the financial statements things aren’t as rosy.
Twitter is on the hook for $1.8 Billion in leases. Adding it to the Current Liabilities doesn’t make Twitter financially insolvent. But, it decreases the acid test ratio to 2.54. You just can’t ignore that when you are looking at the financial health of the company. They owe it. They will pay it. Even doing the math to add the cost of the leases in a net present value method still gives them a decent acid test value. Elon saw that and given the “work from home policy” of Twitter thought turning their HQ in San Francisco would be better as a facility for the homeless. A large drop in the 1.8 billion they are on the hook for will increase their profit.
But, perhaps, a bit more troubling, is the convertible debt notes they issued when the stock was trading all-time highs. Cash on the balance sheet is shown as $2.2 Billion. But, in March of 2021, the company issued $1.44 Billion in convertible debt notes. They come due in March of 2026. The notes account for a little more than half the cash on the balance sheet. In March of 2021, the stock was trading at its highs.
Twitter doesn’t have the cash flow to buy back its own stock. It’s in “we want to issue more common stock and dilute our current shareholders’ mode”.
More troubling for equity investors is this: There is no interest rate on the March 2026 convertible debt note. No coupon payment is due. Instead, for every $1000 invested in the note, you receive 7.6905 of common stock. The conversion price is $130.03 per share. Recall, that the stock is trading at ~$46 per share and Musk’s buyout offer is ~$54. Regular readers of this blog will remember these facts are already priced into the stock today, but it’s a definite overhang on the appreciation of the stock.
The notes can also be paid back in cash but Twitter has no sinking fund built to pay them off. It’s clear the management team is going to pay in common shares. The issuance of those notes was no different than a bridge round in venture capital.
Twitter has continuously accessed the debt markets with notes senior to the common to raise cash and invest in operations. Some of those notes are convertible into stock and the average price of conversion as calculated by the Twitter finance team and approved by the board Audit Committee and auditors is $80.20 per share.
I don’t see how the current trajectory of the company will pay the noteholders off. Where are they going to legitimately generate the kind of cash to pay for ongoing operations and pay off bond holders to retire the debt?
I bring these points up because in some cases, they aren’t convertible until the note matures. Hence, the noteholders have a very compelling case to listen to a buyout offer that has a strategy behind it that will appreciate the stock price by 2x. The current management team has not publicly articulated any strategy for outsize growth.
The next question is what strategy should the board and C-level management take? If they take the bid, they are all out of jobs.
The poison pill approach has been floated but poison pills are pretty lame. When I was on the CME board and we were putting together the offering documents we had a lengthy debate about poison pills. Only Professor Merton Miller and I voted against having one. I felt like I was in good company. Alas, the rest of the board voted for it on the recommendation of the investment bankers. The rationale was to stop the company from being a takeover target upon IPO.
Poison pills protect bad management. If they don’t want to be bought, they wouldn’t need one.
In many cases, companies are bought due to synergy. They are in the same line of business. One car company buys another car company.
A company can buy another company to extend its line of business. A big worry here is concentration of competition. Unfortunately, we haven’t done a good job of that as a country in many industries so we have a lot of concentration. Health insurance is a perfect example. Another example of this might be Procter and Gamble buying an upstart laundry detergent brand.
In rare cases, companies are bought because they have so much cash on their balance sheet and management can’t figure out what to do with it. Hence, it will cost Musk $2.2 billion less since he will use Twitter’s own cash to take it private.
By the way, businesses don’t have a lot of excuses to keep more than the minimum amount of cash hanging around in the bank. They should be paying dividends with it or buying back their own stock if they can’t figure out how to invest in the business to grow it. Personally, I am a gigantic fan of eliminating any tax on dividends to encourage companies to pay them.
Conversely, you might look at the Twitter buyout this way. At $54/share Musk’s offer is $42 billion. As I said above, the market values Twitter at $35 billion. He could certainly buy a competitor for that amount of money. Gab, Parler, Gettr, and TruthSocial are competing platforms. But, they don’t have the reach, and the network effects of Twitter. Musk has calculated that you can buy Twitter cheaper than the total cost of building out a viable competitor with the same reach and network effects.
If I were a Twitter shareholder, I’d be inclined to roll the dice with Elon. How bad could it be given the past performance of the management team?
Great analysis. The board will commit suicide before giving into Musk. I'd be excited to embrace a twitter that's been given some oxygen. Look at what happened to MSFT when clown balmer was shown the door in '14. Busted higher from a 14 year range.
This is very enlightening Jeff. Thanks for sharing!