- A buyout already seems to priced into Twitter stock valuations following Friday's ~21.5% rally.
- This could deter potential suitors, or dissuade them from offering a significant premium.
- At these valuations, the downside risk could be greater than the potential upside.
Shares of San Francisco, California-based Twitter (NYSE:TWTR) shot up on Friday, after CNBC reported that the company could be up for sale, with salesforce (NYSE:CRM) and Alphabet (NASDAQ:GOOGL) among potential suitors. With Twitter shares ending the day ~21.5% higher, numbers suggest that a buyout is already priced in. This could deter potential buyers, or affect the premium they eventually offer, if a buyout is really on the cards. For investors, the downside risk could be greater than the potential upside right now.
A Buyout Seem To Be Priced In Already
Estimating A Buyout Price For Twitter Inc
To estimate the price at which Twitter could potential be acquired, we'll take one more conventional, and one less conventional approach to arrive at two separate estimates.
In June this year, Microsoft acquired LinkedIn for $26.2 billion, paying a generous premium of nearly 50% over its valuation at the time. That's the closest available comparison, and its close enough to help us make a reasonable estimation of the price at which Twitter could get bought out. Then there are other cases, like Facebook's acquisition of WhatsApp which defy conventional valuation logic, at least according to some sections of the market. We'll estimate a comparable buyout price based on that case as well, but for starters, let's take the more conventional approach.
Also Read: Stay Away From Twitter Inc Stock For Now
Going by the numbers, the LinkedIn buyout lends us a good reference point, on which to base estimates.
Microsoft bought LinkedIn at $26.2 billion, implying a Price to Sales (P/S) ratio of 8.15 times Trailing Twelve Months (TTM) sales. At that multiple, with Twitter's TTM revenue of $2.47 billion, a comparable buyout offer could be worth $20.12 bullion, representing a near 26% upside to Twitter's current valuation of $16.01 billion. That said, investors should bear in mind that LinkedIn trumps Twitter on nearly every financial parameter, and naturally, commands higher valuations, making this a very generous estimate.
|TTM Revenue ($ million)||3215||2476|
|TTM Losses ($ million)||-219||-409|
|Latest Quarter YoY Growth %||35%||20%|
|TTM Revenue Per Active User ($)||31.2||8.0|
|Cash & Investments ($ million)||3160||3588|
|Long Term Liabilities ($ million)||1363||1610|
|TTM Free Cash Flows ($ million)||300||246|
|TTM Operating Cash Flows ($ million)||895||578|
*LinkedIn numbers as of June 2016, when the buyout was announced
Adjusting For The Premium LinkedIn Enjoys
LinkedIn's relative financial strength is reflected in the premium valuations the stock enjoyed over Twitter, prior to the announcement of its acquisition by Microsoft. On June 10 this year, LinkedIn shares traded at a P/S ratio of 5.4, while Twitter shares traded at a P/S multiple of 4.1, implying a significant 24% discount.
So, one would want to adjust the buyout price we arrived at earlier, to incorporate this discount. Such an adjustment leaves us with an estimated buyout price of $15.35 billion, implying that a buyout has already been priced into Twitter stock valuations right now, given its market cap of $16.01 billion.
The Counter Argument
Some might argue that Twitter is en route to a turnaround given its exciting initiatives in live streaming, which could potentially lead to higher engagement levels and revenue growth. For such investors, the perceived value of Twitter could lie anywhere between it's current market cap and the buyout price of $20.12 billion, we had estimated earlier, or possibly even higher.
Since valuation in itself tends to be quite subjective, it's likely that estimates by other analysts could differ. However, it's worth noting that Twitter valuations have already run up significantly since its last earnings release, even before the company has recorded any notable improvements in its fundamentals. Since July 27, Twitter shares had spiked ~18% as of Thursday, and now stand ~43% higher.
Talking of subjectivity in valuation, Facebook's acquisition of WhatsApp comes to mind. Almost exactly two years ago, Facebook acquired WhatsApp for a whopping $22 billion, paying $55 per user, in a deal that defied conventional valuation logic. Even if one were to assign Twitter such rich valuations, it's value would work out to $17.5 billion, 7.5% higher than Friday's close.
Some might argue that Twitter has significantly higher revenues compared to WhatsApp's $10.2 million at the time. But that's sort of offset by the fact that WhatsApp's user base of 450 million users was growing rapidly, as opposed to Twitter's. And of course, also by the fact that some sections of the market thought the deal valued WhatsApp like a miracle drug.
Summing It Up
Following Twitter's Friday rally of over 21%, the stock now seems to have priced in a buyout. For more optimistic investors, the target price could be higher. But going purely by the numbers, Twitter shares seem to have factored in a sale already. Even going by less conventional valuation methods and assigning the stock with rich valuations, the upside seems limited to about 7.5%.
Such steep valuations might deter potential suitors or discourage them from offering a significant premium over Twitter's current valuations, implying that further gains could be limited. If a buyout isn't announced in the near term, the downside risk appears to be greater than the potential upside from here.
That said, its possible, though unlikely, that Twitter could get bought out at a significantly higher price than estimated, making it an investment best suited for deep pocketed, speculative investors with the required risk appetite.
See our recent coverage of Twitter.