As widely reported, Elon Musk has recently taken a 9.2% stake in Twitter (TWTR) and a seat on the company’s board of directors. Does Musk’s involvement make Twitter an attractive turnaround stock?
Sizing Up Twitter Stock
In looking at potential turnaround stocks, our first step is to gauge investor sentiment. Do investors love the stock, or hate it? An ideal turnaround stock is clearly out of favor. The deeper the negative emotional sentiment, the better for accelerated gains once fundamentals improve. If, as Warren Buffett once said, “in the short run, the stock market is a voting mechanism,” then a useful way to assess the votes is with a stock chart. In looking at Twitter, we see that after its IPO in November 2013 at 26 per share, its stock surged to 70 twice, but that its current price is only modestly above its first-day post-IPO closing price of 44.90. The flat performance over nearly a decade (while the S&P 500 more than doubled) and the stock’s position in the middle of its long-term range suggest that Twitter shares are not out of favor. For Twitter, a 25 share price would be out of favor. On sentiment, we would rate the stock as “neutral.”
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Next, we look at the company’s valuation. Based on current 2022 consensus estimates, the shares trade at about 26x EV/EBITDA. On an absolute basis, this is expensive. For perspective, we consider a 10-15x multiple as reasonable for a mature but sustainably growing company. If Twitter traded at a 15x multiple, for example, it would be much more appealing, as expectations would be low. This multiple would imply a $30 stock, comparable to the $25 price if sentiment was negative.
Using the $2.4 billion consensus estimate for 2024 EBITDA, the shares trade at a reasonable 16x multiple. But this assumes that the company can generate nearly 50% annual profit growth compared to actual 2021 results – an aggressive assumption. Comparing Twitter’s current valuation to its nine-year history produces little useful information, given its wide 10-35x range, although perhaps 15-25x might be considered a realistic normalized range. Twitter’s often-mentioned peers trade at very different multiples: Snap (SNAP) at 68x, Meta Platforms (FB) at 9.5x, for example. We might use a 20x multiple as a reasonable starting point for our price target.
Many tech investors value companies using revenue multiples – we consider this metric modestly interesting at best. Revenues must eventually generate profits, otherwise the company is merely a non-profit public service entity or is destined to evaporate.
What might the fundamentals look like in a post-turnaround scenario? We look at a post-turnaround company because that is why we would be investing. We might assume that the company meets its “low 20%” revenue growth target and that it can generate EBITDA in line with the consensus estimates for 2024. If so, using the 20x EBITDA multiple described earlier, and assuming no incremental free cash flow or any changes in the balance sheet or share count, the stock is worth $52. This suggests minimal upside.
Raising the multiple to 25x would generate a $65 target, for about 35% upside – more interesting but insufficient given the risks involved. And this still assumes the company can meet its aggressive growth targets, which may be a challenge given its highly competitive industry, the fickleness of social media users and Twitter’s relative maturity as a business concept. From a risk perspective, accurately estimating revenues and profits in three years for a company like Twitter is a low-confidence project, requiring either more upside potential or easier fundamental hurdles to limit the downside. Overall, we would rate the valuation appeal as “neutral at best.”
We assumed no incremental free cash flow because the company doesn’t generate much. And with its plans for higher spending to increase its competitiveness, Twitter may not generate any free cash flow for at least a few more years. Further, the company underpays its employees in cash compensation (thus boosting cash flow) by providing generous stock compensation. Had the $630 million in stock-based compensation for 2021 been paid in cash, Twitter’s free cash flow would have been negative-$250 million, even excluding the one-time litigation payment.
And in each of the past few years the company has borrowed about $1 billion a year through convertible notes. These can eventually involve issuing new shares. All-in, stock options and convertibles led to a share count that increased by 50 million shares last year. At the current share price this equals $2.4 billion in value transferred to others, which is more than the company’s projected 2024 profits. Given this, Twitter looks more like a non-profit public service entity than a profit-making, viable company.
A good turnaround has a strong catalyst. One of the strongest catalysts is a new CEO, and Twitter has one in Parag Agrawal (since November 2021). He is sensibly re-focusing the company on basic execution, which has been lacking. Agrawal’s initiatives to force more accountability with a new “general manager” model and emphasis on performance metrics could lay the foundation for higher revenue growth and wider profit margins in 2-3 years. However, reining in Twitter’s loose culture may produce disarray, so the changes come with risks. However, without the new CEO, Twitter shares would have little appeal as a turnaround stock.
The Elon Musk Effect
So, back to Elon Musk. His involvement is another powerful catalyst. As the largest shareholder and one of 12 members of the board, he will clearly be heard. But he won’t have a dominant voice. One constraint on his power is his standstill agreement which limits his ownership to no more than 14.9% of the $40 billion market cap company. While Wall Street analysts and commentators have provided a vast array of opinions on his motivations, no one other than Musk truly knows them. From a turnaround investor’s perspective, this uncertainty expands the range of outcomes and hence risk, but is an overall positive.
If these catalysts drive meaningful improvements in Twitter’s revenue growth and profit margins, and sentiment rebounds, the shares could return to a 30x multiple on a potential $2.6 billion in EBITDA in 2024. Using these more optimistic assumptions, the shares would be worth nearly $85, about 75% above the current price. This would be attractive to a turnaround investor.
Somewhere between these scenarios is how a Twitter turnaround would likely play out. Patient turnaround investors might want to wait until the shares stumble, which might tilt the appeal more strongly in their favor.
Prospective investors would want to develop their own models, sensitivities and assumptions, then weigh their confidence and tolerance for risk. They might also compare this potential turnaround to others in the market – focusing on only the most favorable risk/return ideas.
In my Cabot Turnaround Letter and Cabot Undervalued Stocks Advisor newsletters, this type of analysis is what we do every day. Twitter’s turnaround may be interesting, but let us help you sort through the market to find the best ones.
Does Elon Musk’s involvement make you more or less likely to buy Twitter stock?
Bruce has more than 25 years of value investing experience, managing institutional portfolios, mutual funds, and private client accounts. He has led two successful investment platform turnarounds, co-founded an investment management firm, and was principal of a $3 billion (AUM) employee-owned investment management company. Now he is helping his Cabot Undervalued Stocks Advisor readers find those undervalued stocks that let you buy low and sell high!Learn More >>