Twitter (TWTR.US) deal Falling Apart: What Should We Know?
Elon Musk has officially unveiled his intention to back out of his deal to acquire Twitter. Musk insists that a lack of confidence in the actual number of bots on the platform has led him to make that decision. It seems that the tycoon is willing to pay the amount for the termination of the operation worth 1,000 million dollars, while the company initiates a legal process in this regard so that despite disbursing such a penalty, Musk is forced to comply the deal anyway.
On Friday, July 8, Musk officially sent notice that he will terminate the contract, in a context where the stock had already plunged sharply from the $50 level it was trading at when the deal was announced, shortly after was publicly known of 9% acquisition of the company by Musk, making the owner of Tesla the largest shareholder of the social network.
TWTR Stock Price
TWTR has been found trading below $33 per share, well below the acquisition price of $54.20 per share.
That price puts it below even its early days as a public company. Investors have made their assessment of the risk of the deal falling apart evident in their behavior for weeks, but this pessimism has gone too far. In April, shortly after the deal was announced, the price spread was uncompetitive, but now, after the recent drop, Twitter's stock is very attractive again for other reasons.
Key Twitter Metrics
In the last published quarter, Twitter had a slowdown in growth that was to be expected considering macroeconomic headwinds and posts from other social media companies. Revenue grew 16% to $1.2 billion, or 22% excluding one-offs from the sale of MoPub Acquire to AppLovin earlier in the year. TWTR generated a net profit of $513 million, which rose to $970 million if we take into account the sale of MoPub. Excluding that extraordinary gain, TWTR was unprofitable even on a non-GAAP accounting basis.
Twitter has not wasted time during this second quarter, the company has repurchased shares worth 2 billion dollars. Ending the quarter with $6.3 billion in cash versus $5.1 billion in debt. But the key is that the company itself had to review its numbers, specifically the users, who had previously miscounted and gave new numbers as follows:
While the difference wasn't that big (in fact the new growth rate is actually higher), part of Musk's suspicions stemmed precisely from this post.
Twitter deal in jeopardy
The deal seemed to be in good shape when the company revealed that, according to an internal review, less than 5% of users were bots. There was already a lot of skepticism about the deal, but on Friday, Musk officially filed a notice of termination of the deal, citing his lack of confidence in the number of bots on the platform. That he estimates close to 20% of all existing accounts on the social network. Shares of Twitter fell almost 8% in extended trading on Friday, but as we have seen at the start of this week, the stock has corrected an additional 6%.
Funny thing is, this might not be the end of the drama, as Twitter might claim that the bot problem isn't enough for Musk to unilaterally rescind the deal. Regardless of the $1 billion penalty, not to mention the legal commitment to acquire the company. It remains to be seen whether this latest move by Musk is just an attempt to lower the acquisition price and whether or not he will succeed in this change of heart.
The Delaware courts, where the dispute between the two parties will be litigated, have set a high bar for the parties to abandon their agreements. But target companies often choose the certainty of a renegotiated deal at a lower price or financial compensation over a messy court battle that can last for many months, as well as being more costly to the pockets of both parties.
Has the perspective on Twitter changed for other investors?
Unlike just a few months ago, when the stock had a slim edge over the $54.20 purchase price, the stock is now trading at attractive levels. The shares are trading at a 40% discount to the original purchase price, but even without a successful takeover outcome, the shares are trading cheaply in their own right. TWTR is now trading at just 5x estimated 2022 sales, closer to peers like Facebook, whose ratio is 3.23x.
This company is expected to grow revenue at a double-digit rate for the next few years. Mainly because the monetization potential of the platform is light years away from Facebook or Instagram. Twitter has a strong net cash balance and has been generating positive cash in its business for many years. Stocks have always had a high-risk character, but that has more to do with bearish sentiment in the tech sector at the current juncture than actual fundamentals.
The monetization capacity could generate a net margin of at least 30% in the long term. Assuming a PEG growth ratio over company growth estimates of 1.5x, Twitter could trade around 7x sales in 2027. This projects a potential share price of $112 per share, or 25% a CAGR for the next 5 years.
Risks
There are some risks to consider. In the short term, Twitter shares could trade lower due to both the failure of the deal and the fact that its competitors like Snapchat (SNAP.US) and Meta Platforms (META) trade at more attractive valuations. The long-term risk is that Twitter loses relevance and is unable to grow its user base, as that would threaten its organic growth story.
Although the change of heart of the largest shareholder and active user of Twitter Elon Musk is not positive news, the platform maintains a huge potential value that at current prices, one would be paying more than recent news, but the capacity for future monetization.
Technical analysis
The drama of the Musk purchase could cause the stock to maintain its bearish bias until the low zone marked by the lower range of the company's historical high trading volume zone, prior to the pandemic, to $26 per share. , a 52% drop from Musk's benchmark purchase price.
If the correction continues, the next benchmark for investors to watch will be the pandemic low of $20 per share, down more than 63% from Musk's offer levels of $54.2.
These corrections are similar to the potential correction that the general market could suffer due to the impact that the economic recession may have, both in the United States and in Europe.
Dario Garcia, EFA
XTB Spain
