Twitter Inc (NYSE:TWTR) is overvalued, and I’ve believed so for years. And while I’ve never shorted the shares, I still never cease to be amazed at the many permutations of the bull case for TWTR stock.
There have been so many reasons for why “now is the time” to own Twitter stock. After its fall from 2015 levels around $50, TWTR was a turnaround play. CEO Jack Dorsey’s return was greeted with much optimism, but with investors somehow willing to ignore that he was also the CEO of Square Inc (NYSE:SQ). There was a focus on cost-cutting that would improve margins.
A $10 million deal with the NFL in 2016 was touted as a huge driver for what was then a $15 billion stock. (I woke up this morning to see the market cap is now “a bit” off from that, at $9.6 billion.)
Then Twitter was going to sell itself to everyone from Walt Disney Co (NYSE:DIS) to Alphabet Inc (NASDAQ:GOOGL) to Salesforce.com, Inc. (NYSE:CRM). How’d that go?
Twitter rallied again. Q2 earnings tanked TWTR stock. And now the shares are rising again, trading near $17. The new driver appears to be video, even though that has little chance of changing Twitter’s long-term outlook.
Through all the bull cases, however, there has been one simple, consistent problem: Twitter is not profitable.
Excluding the huge amount of Twitter stock used to pay employees, it’s not even close. Twitter stock can’t maintain any upside until that changes. And I remain highly skeptical that it ever will.
The Numbers Behind Twitter Stock
Based on third quarter guidance, Twitter is on pace to generate about $700 million in Adjusted EBITDA this year. That figure excludes a projected $450 million in share-based compensation: TWTR stock given to the company’s employees. That figure isn’t a cash cost, but it’s real nonetheless, as each compensation share dilutes existing shareholders.
How significant is the dilution? Between 2014 and 2016, a Twitter shareholder saw the size of his stake in the company (on a percentage basis) shrink by about 15%. In that two year period, Twitter added 100 million shares — nearly all of them through share-based compensation.
Depreciation and amortization are non-cash charges but capital expenditures aren’t. They are guided to the $300 million-$400 million range for this year. And Twitter has about $25 million in cash interest expense related to its convertible bonds (it also books non-cash interest charges as well).
In other words, that $700 million figure, which sounds like a profit, actually implies negative free cash flow excluding the issuance of shares. Ignoring changes in working capital, and assuming $350 million in capex, Twitter will generate about $325 million in free cash flow this year. It will do so by issuing $450 million in stock.
That’s the core problem here. Twitter does report non-GAAP net income — but that, too, excludes dilution. And this isn’t a new problem. Twitter reported $444 million in “adjusted” free cash flow in 2016. Share-based compensation was $615 million.
Twitter, as a company, does not generate cash on its own merits. It only creates positive free cash flow through the heavy issuance of Twitter stock.
So the question, then, is how does that change?
Twitter Is Unprofitable
The answer might be that it doesn’t and it won’t. Twitter’s profits actually will marginally improve this year against 2016 — even with a likely decline in reported Adjusted EBITDA. That figure, with stock-based compensation added back, was $136 million last year. It seems likely to clear $200 million this year.
But that’s after a first half that was better than the second half appears to be. Q3 guidance suggests a modest improvement in earnings before dilution but not much (about $35 million vs. $25 million). It’s certainly not enough to get reported profits enough above dilution to cover interest expense and any necessary capital spending.
And what changes going forward? User growth has stalled out. Not even the free publicity and engagement driven by President Donald Trump’s use of the platform has helped on that front. Snap Inc (NYSE:SNAP) might be a disappointing stock, but as a platform, it is attracting younger users, some of whom likely could have helped Twitter grow.
Advertising rates are falling, and as a result revenue actually declined in each of the year’s first two quarters. The shift to video will accelerate that rate compression, and the need to pay for content will pressure margins.
Twitter at the moment is a toxic contribution. It’s functionally unprofitable. Revenue is declining. And margins are likely to compress. For all the other discussion, those core problems remain. Together, they create a stumbling block to the next bull case for Twitter stock.
TWTR Stock Is a Sell
Really, what’s left for Twitter to do?
Is it really going to become a major player in media by airing second-tier, Pac-12 sports and SportsCenter knockoffs? It’s clearly been for sale for years, and no one was interested. Going forward, there’s probably not a lot of demand for a no-growth, unprofitable business, particularly at a $10 billion valuation (plus cash on the balance sheet).
Twitter is a neat tool and an interesting platform. But it may be that there’s just no way in sight to monetize it to a point where it generates real, consistent profits. That doesn’t mean Twitter is going bankrupt soon.
But it does mean that valuing Twitter stock at $10 billion is something close to lunacy.
As of this writing, Vince Martin did not hold a position in any of the aforementioned securities.
