The Risks Of Buying Twitter Inc Stock On Buyout Rumors

  • Twitter Inc shares have rallied 10% following rumors of a buyout by Steve Ballmer and the Saudi Prince.
  • The rewards of buying into the rumor could be significant, but the risks aren't negligible either.
  • Should you buy Twitter stock now?

San Francisco, California-based Twitter Inc (NYSE:TWTR) shares have jumped by over 10% in the last two days, on the back of yet another round of buyout rumors. This time around, rumors have it that ex-CEO of Microsoft, Steve Ballmer, and Saudi Prince Alwaleed bin Talal could be looking to take the microblogging giant private. What’s possibly adding credibility to the rumors is the fact that both Ballmer and the Saudi Prince already own a sizeable stake in the languishing social media company. For investors, the rewards of buying into such a rumor could be significant, but the risks aren’t negligible either.

What’s Cooking? Twitter’s Latest Buyout Rumor

Twitter shares ran up 7.25% on Wednesday when rumors of a potential buyout began doing the rounds, followed by a 2.95% gain on Thursday. This isn’t the first time a buyout rumor has lifted the stock, and it probably won’t be the last. What’s possibly got everybody excited is that both Ballmer and the Saudi Prince already hold sizeable stakes in Twitter.

Prince Alwaleed’s first investment in Twitter dates back to 2011, before the company went public, when he invested $300 million in the microblogging platform. He later doubled his investment in Twitter, in early October 2015, following which, Prince Alwaleed and his investment company Kingdom Holding Company owned a combined stake of about 5% in the company with a combined ownership of nearly 35 million shares.

Likewise, Steve Ballmer also announced (on Twitter) his ownership of a 4% stake in Twitter, around the same time, in October last year.

Ironically, as quoted by Fortune in March 2016, he wasn't as thrilled about the investment six months down the line:

Asked Wednesday night about his Twitter stake, Ballmer said it has helped to teach him a lesson.

“I don’t want to be an investor,” he said sheepishly at the Fortune Brainstorm Tech dinner in San Francisco.

Twitter shares, which now trade at $18.13 have fallen drastically since October 2015, losing nearly 40% of their value since.

The Risks And Rewards Of Buying Into The Rumor

Buying into such rumors can seem like an attractive proposition, and justifiably so. More so, after the near 50% premium that Microsoft placed on LinkedIn very recently. On several occasions, analysts have drawn parallels between LinkedIn and Twitter because both companies languished for quite some time, having fallen from the stratospheric valuations that they once enjoyed.

LinkedIn shares which once traded at about $276, had halved in value when Microsoft announced it's acquisition of the company. Twitter's case is now even more compelling, given that it trades at less than one-fourth the value it commanded at its peak. That's the argument that most analysts have used to suggest that Twitter is ripe for a buyout.

The potential rewards could be significant, even with a more conservative premium of 20%-30%. However, the risks aren't negligible either.

For starters, look at some of the other big acquisitions that have taken place in this space. Be it Facebook's acquisition of Instagram, or Microsoft's acquisition of LinkedIn. Leave aside the debate about the pricing of these acquisitions, and you can still see some synergies. It's easy to see how the acquired entities fit into the larger scheme of things for the buyers. However, it's hard to see why Ballmer or the Saudi Prince would want to acquire the company, especially in its current state. It's not impossible, but it does seem improbable.

Further, when you look at the numbers, if these rumors end up being just rumors like several others in the past, investors will almost certainly lose heavily. Twitter's revenue growth rate, which was hitherto its one unquestionable virtue, isn't as robust anymore. The latest earnings release saw the company's Year-On-Year (YoY) growth rate fall to 20%, from 61% a year ago. The company is nowhere near profitability on a GAAP basis, and the loss margin expanded to 18%, after having improved for two-quarters to about 13% each.

After slowing down for three quarters, Twitter's stock based compensation has jumped again, implying even more dilution of equity for shareholders. The company's Q3 revenue guidance suggests a YoY growth of 7% at the higher end, and needless to say, there's no significant progress in user addition. Further, the stock isn't cheap at 5.5X sales (Price to Sales ratio).

In recent times, buyout rumors seem to be the only triggers that lift the stock significantly. So, if these rumors don't materialise the stock could fall back to $15 or below, where it traded in June, pre-earnings, implying a significant potential downside of about 20%.

Summing It Up

This isn't the first time rumors of a takeover have emerged. Back in April 2015, Recode carried a story with the line "There are many reasons why Twitter is an attractive takeover target." The opening lines from a more recent story on CNN money from Feb 2016 read, "Does Twitter's only hope lie with a #takeover?"

That, in a nutshell, summarizes the risk that exists in the current scenario, and how things have changed for Twitter. In the absence of a buyout, Twitter could fall back to its pre-earnings level of $15 or below, implying a potential 20% downside from here. Buying into this rumor would be best suited for investors who are willing to speculate and absorb some corrections if any, in the near to medium term.

Vikram Nagarkar Vikram Nagarkar   on Amigobulls :

Neither Amigobulls, nor any members of its staff hold positions in any of the stocks discussed in this post. The author may not be a certified/registered investment advisor, and the opinions expressed should not be treated as investment advice.

Buying and selling of securities carries the risk of monetary losses.Readers/Viewers are advised to carry out their own due diligence and consult their investment advisors before making any investment decisions.

Neither Amigobulls, nor the author have any business relationship with any of the companies covered in this post.

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