Elon Musk’s takeover bid rocked many on Twitter (NYSE: TWTR) shareholders. While we are positive about the corporate struggle around the company, the deal is unlikely to go through as management has begun active resistance and the the price offered by Musk is not attractive enough. Indeed, Twitter has been impressive with solid growth, but the company is struggling to be efficient, and according to management’s forecast, there will be no significant improvements by the end of 2022. According to our valuation, TWTR is trading at a slight premium to our estimate of fair value. We value stocks as a Hold.
The Musk vs. Twitter saga continues
While Elon Musk’s recent transformation from visionary entrepreneur to activist investor was unexpected, it is in line with the outrageous behavior of the world’s richest man. As Twitter management takes a “poison pill” to defend against a hostile takeover, Musk goes on the offensive. On Saturday, the billionaire tweeted the lyrics to Elvis Presley’s hit “Love Me Tender”. It appears Musk hinted at a takeover bid to Twitter shareholders bypassing the board, with an offer to buy stock at a fixed price.
Musk also criticized Twitter’s board for its treatment of shareholders, citing the fact that board members hold a very small combined stake in the company. Indeed, the board of directors holds only 0.2% of the shares, excluding Jack Dorsey. However, this argument is true for all large technology companies whose majority shareholders are the co-founders and early investors. For example, PayPal’s board owns less than 0.1% of the company’s stock.
Jack Dorsey added fuel to the fire when he said Twitter’s board had “constantly been the dysfunction of the business”.
Let’s be honest, there have always been questions to the management of the company. While Facebook/Meta (FB) and Snap (SNAP) steadily improved their margins, Twitter only promised the moon in the future. Corporate disputes can benefit shareholders. However, we doubt the deal will be completed on the current terms. Musk is offering $54.20 per share, implying a 2023 EV/S forward multiple of 6.29x, which is in line with the pre-pandemic five-year average and below the five-year average including 2020. Musk’s offer does not involve a bounty. for the control of the company, and it is even below the historical multiple.
No improvement signal
Peter Lynch said to buy when there are signals to improve company fundamentals. Although Twitter has been steadily increasing its revenue and daily active user base, the company has always struggled with profitability. We don’t see any signs of improvement yet.
Management has projected that by the end of 2022, revenue will grow by an impressive 20%, driven by accelerating mDAU growth and investment in ad tech. However, at the same time, management expects an increase of around 20% in total costs and expenses (excluding non-recurring items), which means that operating margins should be around -14.3 % (with revenue growth of 20% and total costs and expenses of 25%) to -9.70% (with both indicators increasing by 25% year-over-year).
Despite the expected decline in capital expenditures to $900-950m from $1,011m in 2021, FCFF is also expected to be negative due to lower margins and an increase in net working capital.
In addition, thanks to strong stock-based compensation, the number of shares outstanding has increased by an average of 2.18% over the past five years. Management expects SBC spending to be $900-925 million by the end of 2022, 14-15% higher than 2021. Although the board has authorized a takeover of 4 billion dollars, it is not yet known how many years it will last.
TWTR Share Valuation
Our DCF model is based on several assumptions. Since 2018, Twitter has grown mDAUs to an average of 5.2 million users per quarter, excluding the second quarter of 2020. The company still has significant potential for user base growth as a one of its major peers, Facebook has 1.9 billion DAUs, which is 8.8 times more than TWTR. So we expect Twitter’s mDAU momentum to continue. The forecast of future average revenue per user is based on the average quarterly dynamics of the indicator over the past six years. By multiplying the expected number of users by the ARPU, we get the expected revenue for future periods.
Although the gross margin has been volatile, the average growth since 2013 has been 0.58 percentage points per year. We expect this trend to continue. A similar methodology is used to forecast operating costs and therefore operating margins.
Depreciation and amortization expenses have increased by an average of 7.8% per year since 2016. We expect this trend to continue. We expect capital expenditures as a percentage of revenue to be in line with the past five-year average over the next seven years, which is in line with management’s guidance for 2022. The terminal growth rate is 5%. The assumptions are presented below:
Based on the assumptions, the expected dynamics of the main financial indicators are shown below:
With a cost of equity equal to 10%, the weighted average cost of capital (WACC) is 9.5% because Twitter has low financial leverage.
With a Terminal EV/EBITDA of 17.3x, the model projects a fair market value of $33,812 million, or $40.5 per share. Thus, the downside potential is around 13%.
You can see the model here.
As previously reported, on the EV/Sales multiple, Twitter is trading at around a five-year average.
On futures multiples, the company doesn’t look cheap either.
While we are positive about the impact of the attempted takeover of Twitter, this deal is unlikely to materialize. On the dry end, TWTR is a company that has seen solid revenue growth but still struggled to be efficient. It looks like by the end of 2022, the company will not only increase its operating loss, but will also post a negative FCFF. According to our estimate, Twitter is trading at a slight premium to its fair market value. We are neutral on the company.