Twitter: Why Business Funding May Fall

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One thing that has always bothered me about Twitter (NYSE:TWTR) deal was how the bankers agreed to finance the deal. Originally, Elon Musk secured $46.5 billion in financial obligations, of which $13 billion was owed by Morgan Stanley (MS) and other financial institutions, $12.5 billion was a marginal loan to Tesla (TSLA) shares and $21 billion was an equity financing commitment by Elon Musk. Later, some terms were modified and the equity financing obligation was increased to $27.25 billion, while the marginal loan based on Tesla shares was reduced to $6.25 billion, while the debt obligation of $13 billion remained the same.

Now, this $13 billion will go on the books of the new company if it takes over Twitter’s business. If we look at Twitter’s most recent balance sheet (as of March 31, 2022), it had ~$2.28 billion in cash and cash equivalents and ~$3.98 billion in short-term investments. Together, this amounts to ~$6.26 billion. On the debt side, it has $3.56 billion in long-term convertible notes and $1.68 billion in long-term debt. So Twitter has ~$1 billion of net cash on its balance sheet.

A $13 billion loan will bring net debt closer to $12 billion. Net debt may be a bit higher if we assume cash is being burned from non-recurring operating expenses (investment banking fees, etc.), but let’s ignore that for now.

Looking at consensus estimates, Twitter is expected to post EBITDA of ~$1.31 billion in FY22 and ~$1.74 billion in FY23. So this means that the post-merger company will have net leverage (ie net debt/EBITDA) of ~9x EBITDA in FY22e and ~7x FY23e EBITDA. This leverage is quite high and given the worsening macro and advertising environment, there is a chance that EBITDA estimates (especially for FY23) could be further reduced by increasing the leverage ratio.

Let’s also look at this from a valuation perspective. Meta Platforms (META) is trading at an EV of ~6.8x FY22 consensus EBITDA estimate and ~5.7x FY23 consensus EBITDA estimate.

Now, if we look at Twitter’s past performance, it hasn’t been a huge wealth creator since its 2013 IPO at $26. While many investors, including the legendary Carl Ichan, have taken positions in the stock in the past, the company’s execution has been far from perfect and disappointing. Also, the stock faces several regulatory and competitive threats given the nature of its business. While we can debate whether banning former President Trump from his platform was the right move or not, it has upset a certain section of society and the political circle and resulted in a new potential competitor to Digital World Acquisition Corp. (DWAC). And it’s not just limited to the US. In CEO Parag Agarwal’s own country – India – the company often finds itself at odds with the federal government and a new competitor emerges.

So I don’t really consider it a quality job. The stock is trading at a high multiple thanks to Elon Musk’s offer and acquisition premium, but if we strip those out, I don’t think the stock should be trading at a multiple to the Meta.

Even some sell-side analysts said similar things. A few days ago, a Rosenblatt analyst said TWTR stock could fall to $11 a share based on fundamentals before recently reversing course and saying the legal arguments were in Twitter’s favor. A KeyBanc analyst present in the same interview also talked about the significant downside based on fundamentals.

So if we try to value TWTR using the same ~5.7x FY23 EBITDA multiple that Meta gets, we get an Enterprise Value of ~$9.9 billion for Twitter. [Calculation: $9.9 bn = 5.7 x $1.74 bn FY23e EBITDA]

This is bad. Net debt of $12 billion post-acquisition for a firm whose Enterprise Value is only ~$9.9 billion means not only a complete wipe-out of equity but also a reduction in debt. [Consider this example: There is an asset with an intrinsic value of $20. If one decides to buy it at $100 in hopes of turning it around with $70 of his/her own money and $30 of loan, and then suddenly realises that it cannot be turned around, it will mean in addition to him/her losing $70, the lender will also lose $10 if the deal still goes through.]

In the past, bankers may have bet on Elon Musk’s wisdom to fix Twitter, but with Musk wondering if he can fix the company and the stock market correction continuing, I don’t see why they’ll still be comfortable funding this deal.

Can Twitter be fixed?

Carl Icahn tried but failed.

Jack Dorsey is out without a fix.

Parag Agarwal has been appointed for it but seems to want to sell it.

Elon Musk wanted to try, but he has cold feet.

If this deal goes through, bankers could end up with debt extended to a highly leveraged company with little chance of a turnaround.

I was reading this interesting article in Fortune magazine that suggests that if Musk’s financing falls through, it may give him a way out of the deal provided he himself should not interfere with his financiers in their decision to leave.

I believe there are reasons in the financier’s own interests that can make them leave as I discussed above. So, I am less optimistic about the business and would therefore avoid the stock.

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