Twitter (TWTR, Financial) is the popular social networking platform which is known as the world's town square. The stock had its IPO in 2013 at a $41 share price, before shooting up to over $62 per share. Since then, the stock has been volatile, despite growing users and revenues substantially. Profit growth has been slower than expected as Twitter has found it difficult to monetize the platform.
The stock slid down to $33 per share by the beginning of March 2022, mainly due to Twitter missing earnings expectations in the fourth quarter of 2021, a change in CEO (Jack Dorsey stepped down) and the rising interest rate environment.
Elon Musk then swooped in to offer to buy the platform at a $54.20 buy price due to his own personal grievances with the company, which has acted as a catalyst for the stock to pop by 48% since March 11. The stock still trades below the $54.20 proposed buy price, but the board has tried to stop the takeover by adopting a "Poison Pill." Let’s dive into the details and valuation to see whether their could be an arbitrage opportunity here.
Poison Pill
In order to try and stop the takeover attempt by Musk, Twitter’s board has taken a so-called Poison Pill. This is a shareholder rights tactic created in the 1980s to help companies protect themselves from hostile takeover bids. The strategy can be done in two ways, the flip-in and flip-over. The flip-in allows the existing shareholders (except the potential acquirer) to buy extra shares at a discount when the potential acquirer reaches a certain threshold of company ownership. The flip-over allows stockholders to purchase shares of the acquiring company at a discount if the hostile takeover is successful.
According to a filing with the Securities and Exchange Commission (SEC), Twitter's Poison Pill strategy has both a flip-in and flip-over trigger if Musk acquires a stake in the company of 15% or more. Twitter's poison pill will allow shareholders (apart from Musk) to buy one-thousandth of a share of Twitter preferred stock for each share of common stock they hold at the exercise price of $210. Each share of preferred stock would be worth twice the exercise price ($420).
The idea of this is to dilute Musk’s position. He could go from owning 15% of the company to less than 2%. Twitter's Poison Pill plan is set to expire on April 14, 2023.
Funding secured
Musk has recently announced that he has “funding secured” for $46.5 billion. This would enable him to bypass Twitter's board and go directly to Twitter shareholders with a takeover bid. Musk said he would provide $21 billion in equity personally and $12.5 billion coming from margin loans, according to an SEC filing.
According to a Bloomberg report, Musk registered three new companies last week in Delaware (a tax-friendly state) under variations of the name “X Holdings." An SEC filing states Musk plans to put money into one of the companies to fund the purchase of Twitter. These entities include: X Holdings 1 (proposed parent company of Twitter), X Holdings 2 (merge with Twitter) and X Holdings 3 (used to fund the transaction).
Is Twitter undervalued?
Twitter has grown revenues slowly since their IPO. However, in 2021, the company saw tremendous growth of 36%, with revenues jumping from $3.7 billion to $5.07 billion. Gross profit also jumped by 39% to $3.3 billion. On the other hand, the company is still producing a loss on the net income side of $221 million.
Twitter set ambitious targets for 2023, with plans to scale revenues to $7.5 billion and reach 315 million daily active users (DAUs). They currently stand at 217 million DAUs, which has doubled since the IPO. I recognized this trend last year, of growing users, revenues and profits but a declining share price and lower valuation. For full disclosure, that was when I invested in the stock. If you are interested to know more about my Twitter investment, you can check out my YouTube channel, Motivation2Invest.
In order to value Twitter, I have plugged the recent financials into my Discounted Cash Flow Model. I have estimated revenues to grow by 20% per year for the next five years. In addition, I have predicted operating margins to increase substantially from 16% to 25% in six years as the company monetizes the platform better.
Given these estimates, I get a fair value of $48 per share. The stock trades at a similar level right now and thus is fairly valued in my eyes. This share price is still below Musk’s proposed $54.20 buy price, which suggests shareholders would be getting a great deal if the company was acquired.
The GF Value line, a unique intrinsic value calculation from GuruFocus, suggests the stock is modestly undervalued at the current level.
Final thoughts
Twitter has become the de facto social media platform for people to see breaking news and speech tidbits in bite-size format. However, Musk has personal grievances with the company (which are beyond the scope of this article), and he believes he has a "duty" to try and "save the company." This doesn't really lend itself to the idea of acquiring Twitter at a fair value; he's willing to pay much more than the company is worth in order to gain control.
From a purely financial side, Twitter has grown revenues and margins substantially over the past few years but still has a long way to go. The stock price is now “fairly valued,” but I would expect plenty of volatility as if the takeover bid fails, the stock could correct down considerably. Thus, I personally see more risk and downside at this point. As I purchased shares in Twitter over a year ago, I have made substantial profit on paper and thus may sell while the news is good in the coming week.
