Stockfoo
Twitter (NYSE:TWTR) has been the epitome of a mixed success story. It took the company years to report any substantial amount of revenue, relying almost solely on ads run on the platform without any real targeting metrics, then followed by years without making a profit, followed by an uneven profit environment subject to change with the winds of the US’s political discourse.
Twitter is going to go through obvious booms and busts for the next few years, as it tends to see higher ad revenues during election years or during large global or domestic events. But the core growth we saw over the past 2-3 years, I believe, is going to die down as the pandemic-era boom, which saw billons of people stuck at home for a prolonged period of time, comes to an end. Thank goodness.
But what that means for Twitter is that it is likely to shed active users over the next year or so, something which it has not consistently done since it was first founded. This means that the total addressable market for advertisers is going to shrink on the platform, causing revenue and profit loss as those advertisers go elsewhere for a better return on ad spend.
However, the biggest risk is also the most high profile one – the Elon Musk battle. Since the offer buyout price is up at $54.20 per share, a potential buyout will mean that any hypothetical short position will be subject to an instant and un-recoverable loss of almost 30%. Let’s discuss the factors.
The Current Figures
This is where, I believe, the short potential lies. Current expectations from analysts, aggregated by Seeking Alpha, call for the company to report a nice growth rate to both revenues and earnings per share, even as some market experts and myself (who is no market expert) expect the company to shed some active users over the next 6 to 12 months in the United States but also around the world.
The company is expected to maintain their uneven and sporadic reporting of EPS figures with a 426% rise expected this year, followed by a 23% decline in the coming year, 2 years of low double digit rises and a 10% decline in 2026. This is puzzling to me given the projected slowdown, even if I do anticipate activity picking up as we gear towards the 2024 United States Presidential Election, which will without a doubt boost overall platform activity.
When it comes to revenues, the analyst aggregates call for a small 4.5% increase this year, which is then expected to jump to low single digit growth for the next 5 years or so.
Expectations vs Reality
In reality, after reporting a 74% year-over-year increase in revenues in the June 2021 fiscal quarter, the company has reported slowing revenue growth, until it reported a 1.1% year-over-year decline in revenues in their most recent report. The company is expected to report near 0% growth in the coming 2 quarters as well.
| Jun ’21 | Sep ’21 | Dec ’21 | Mar ’22 | Jun ’22 | |
| Y/Y Growth | +74.2% | +37.1% | +21.6% | +15.9% | -1.16% |
(Source: Seeking Alpha Income Statement – TWTR – Y/Y Growth)
Furthermore, after reporting modest revenue beats in the past, the company’s past 3 quarterly reports have missed their projections by an increasing percentage – from a slight 0.4% to the past quarter where they missed their sales expectations by over 11%. Even if profits have been up and down with a 3,700% projections beat in the quarter before last to a miss of 400% in the third quarter of last year – revenues will tell the ultimate story and it seems to be trending in the wrong direction.
Margins Not Looming Too Hot
Another negative expectation of mine is the company’s margins and profits. This is split into 3 separate segments:
Cost of revenues have increased in the past few quarters, as it takes the company more investment to generate the same amount of revenue as they continue to compete with companies like Meta’s Facebook (META), Instagram and Snapchat (SNAP), which are attracting advertisers with their superior return on ad spending.
In the most recent reporting year, the company saw a slight increase in revenues but their gross profits were down by about $100 million relative to the previous year on account of this, meaning they have even less cash to spend to handle advertiser acquisition and potential other product launches.
Operating expenses have increased as well, resulting in the company paying an additional $200 million in SG&A (selling, general and administrative) and nearly $300 million more in R&D (research & development) expenses. All of these figures are annual.
This resulted in their operating profit going from a surplus of about $300 million last year to a loss of over $200 million in the past 12 months. This is a trend which I expect will continue for the coming quarters.
Debt and interest expense are also a worrying factor, especially as interest rates rise in the United States. The company has taken on a sizable amount of debt and as of the writing of this article, a lot of that debt was still at rates tied to interest rates, which have risen sharply in recent months.
The company’s long term debt load has increased from $1.7 billion in 2018 to over $5.2 billion as of their latest report. This is where things get a little murky – the company’s interest expense went from $152 million a year to $51 million a year after interest rates dropped to zero during the COVID-19 pandemic but have risen in the most recent reporting quarter to $63 million. I expect these figures to increase sharply over the next reporting quarter due to the interest rate increases and the company’s debt load increases.
Main Risks Is Still Elon Musk
Elon Musk has planned to buy Twitter for $54.20 per share. That’s nearly a 30% premium to todays price of around $42.00 per share, which means that if the deal does indeed go through by court order, which we should expect in the coming weeks, the stock price can shoot up overnight and there will be virtually no way to recover any of the losses as the buyout offer is final.
However, I do not believe that the buyout will go through. Musk has cited several issues with the company and it’s unlikely a judge, however powerful, can force a private entity to buy another one under the current economic conditions and given all the clauses in the deal. This does mean that Twitter will get a $1 billion windfall if the deal is terminated, but that shouldn’t do much relative to the company’s $32 billon valuation.
The other, albeit smaller, risk is the 2024 United States Presidential Election. I do believe that given the strength that certain political parties have had with fundraising off the platform during election cycles that given that the likelihood that the 2024 election will be a repeat of the 2020 one, there will be increased activity on the platform.
This will mean that we will likely see a bump in the company’s active users and will result in higher revenue and profits for the company. While this is a risk for the hypothetical short position, it’s hard to see it lasting long after that time period so a long term view will most likely overcome that factor.
Conclusion – Is It Worth A Short?
Right now my inclination is that the company is overvalued. With my projected growth rate, I believe a 20x forward price to earnings multiple is appropriate, valuing the company at about half where it is today, or $20.00 per share.
The main risk of a short is unlimited losses versus limited profits, but even so I believe that a combination of the buyout officially falling through while the company continue to lose active users without many alternatives will result in the company losing about 20% to 30% of its value.
Another important factor is that I have a mostly long portfolio, and with the increased chance of some form of a recession I’m looking for companies that would perform negatively even without one but will fall more than the rest if we do have one. Twitter fits that profile for me and is an added factor for my opinion that it’s a good medium term short position opportunity.
Although I remain cautious about the company’s long term prospects, I am bearish on their short and medium term prospects and as a result I will be taking a short position through equity shorts and some January & June 2024 puts at the $25 and $20 strike prices.
Be the first to comment