Stock of the week - Twitter (07.04.2022)

• Twitter shares rallied over 20% on Monday

• Elon Musk became largest shareholder in the company

• Musk to be included in board of directors

• Tesla CEO may influence Twitter's policy to be less restrictive

• Potential economic downturn a source of concern for Twitter investors

Twitter (TWTR.US) attracted a lot of attention at the beginning of this week. Stock surged after it was revealed that Tesla CEO, Elon Musk, purchased a large stake in the company. Investors hope that Musk will take an activist role in the company and help steer it to a brighter future. Let's take a quick look at the company and what Musk's arrival may mean for the company.

Elon Musk takes 9.2% stake in Twitter

Elon Musk filed a SEC disclosure on Monday stating that he has acquired a large stake in Twitter. In a filing Musk stated that he now owns almost 73.5 million Twitter shares, or around 9.2% stake in the company. This massive stake has instantly made Musk the biggest shareholder in Twitter, surpassing stakes held by asset managers like Vanguard or BlackRock. Initial filing form suggested that Musk does not intend to take an active role in the company. However, this was quickly proved wrong as Twitter announced that Musk will be joining its board of directors.

Elon Musk became the largest Twitter shareholder after taking a 9.2% stake in the company. Source: Bloomberg, XTB Research

What does it mean for Twitter?

Arrival of a person at the company's board of directors does not have any immediate impact on the company's operations. However, depending whether such a person pursues an activist role or not, his or her actions can be of a significant gravity. Elon Musk has been an outspoken critic of any measures limiting free speech and considered himself a free speech absolutist. His large stake and appointment to the board of directors will give him some leverage to influence the company's policies. This means that following Musk's arrival, Twitter's policy towards content users post may become less restrictive. 

While support for unconditional free speech is glorious, it also entails some risks if converted into reality. Many tend to forget that activities undertaken by social media companies that limit free speech are rarely their own idea. In fact, the majority of such actions are being taken in the aftermath of new laws being passed. While social media companies are responsible for what users post, their responsibility is to quickly identify and remove any "hate speech". Having said that, should Musk decide to pressure Twitter executives into removing, he could destroy a few years worth of work.

Could Musk's involvement hurt Twitter?

While there is no doubt that Elon Musk is a successful businessman and him taking an activist role in the company could improve its operations, Tesla CEO also has some traits that could make him a burden for the company. He is following his own ways and is very outspoken on his Twitter account on many issues, including his companies, which has led to clashes with US financial watchdog in the past. He has also criticized Twitter in his posts. While it is unlikely that he will continue to criticize Twitter after becoming the largest shareholder in the company, it is also unlikely that he will change his ways. This means that risk of further clashes with SEC over his Twitter posts remains real. This, in theory, could lead to the SEC imposing limits on how Musk can use his Twitter account. It certainly wouldn't be a positive PR when the company's director is barred from using products of its own company. 

A look on financials

Looking past Musk-Twitter news, let's take a look at the company's financials. Twitter was losing money until 2018 when it reported a full-year net profit of $1.205 billion on GAAP basis. Profit increased further in 2019 before the company plunged back to loss in 2020. This was a result of the coronavirus pandemic that has made companies slash ad spending - Twitter's main source of revenue accounting for more than 80% of revenue. This should be a source of concern. Monetary policy tightening and high inflation create a real risk of US recession or at least slowdown. In periods of economic struggle, ad spending is usually the first victim of cost control measures taken by companies. Having said that, Twitter may have a rough few quarters ahead. Of course, it cannot be ruled out that the arrival of Musk will bring some new ideas on how to monetize Twitter's services but those would likely struggle during an economic downturn as well unless they are completely unrelated to current business and offer a high degree of diversification.

Ad revenue accounts for 80-90% of Twitter's total revenue and is considered to be a cyclical source of revenue, tied to the phase of the economic cycle. Source: Bloomberg, XTB Research

Twitter (TWTR.US) has been trading in a wide downward channel since the beginning of 2021. Announcement of Elon Musk taking big stake in Twitter and resulting 20+% share price spike raised hopes for the stock to snap a year-long downward move. Initial rally was halted slightly ahead of a key resistance area near $55.60. This zone is marked with the upper limit of an Overbalance structure and a 50% retracement of the whole downward impulse started in early-2021. Breaking above could hint at a bullish trend reversal. Source: xStation5