Elon Musk Is Realizing Twitter Is No Tesla
Editor's note: Few feelings are worse than realizing you've been duped...
Tesla CEO Elon Musk nearly completed his purchase of social media giant Twitter – until he suddenly changed his tune, calling the deal into question. And Joel Litman, founder of our corporate affiliate Altimetry, believes Musk has good reason to get cold feet...
Joel has created a unique system that corrects the flaws and distortions built into the standard way companies report their finances. And the figures his playbook shows for Twitter may lend more insight into Musk's sudden change of heart...
In today's Masters Series, originally from the June 7 and 8 issues of the free Altimetry Daily Authority e-letter, Joel discusses what's causing the negotiations between Musk and Twitter to drag on... details why Twitter shouldn't be viewed as a growth opportunity... and explains how investing in a certain type of company can lead to outsized gains...
Elon Musk Is Realizing Twitter Is No Tesla
Elon Musk seems to be getting cold feet...
The serial entrepreneur's relationship with social media giant Twitter (TWTR) has been rocky from the start. It began when Musk bought a 10% stake in Twitter and hinted at joining the board.
Days later, Twitter CEO Parag Agrawal insisted Musk would not be joining the board. And just a few days after that, Musk decided to buy the whole company.
Back in April, Twitter's board accepted Elon Musk's buyout offer of $54.20 per share, a 40% premium to market value. Musk hinted at several changes he'd make, like adding an edit button to posts and introducing a paid subscription model.
With buy-ins from other investors and the board, it looked to be a surefire deal... until it wasn't.
Now, it looks like Musk is trying to blow up the deal from within...
No matter your thoughts on Musk, he's a smart man. He knows that if he simply walked away from the deal, Twitter could sue him for at least $1 billion in termination fees.
So instead, he keeps changing his acquisition requirements. First, he announced that he'd only agree to the deal once Twitter proved that fewer than 5% of accounts were "bots."
Twitter's official count has bot accounts pegged at 5%. Musk said he suspected the social media giant used flawed methods to determine bot count. He tweeted that his own estimates put bot accounts closer to 20%.
Analysts believe Musk is focusing on bots in an effort to negotiate a discount... or get out of the deal entirely.
But Musk has a point...
You see, advertising is Twitter's primary source of revenue. Advertisers pay for humans to see their ads... So if more than 5% of Twitter accounts are bots, it could be a problem. Advertisers likely won't be willing to pay nearly as much if their ads are going out to fewer people.
So if the number of bots is higher than Twitter says, the company might be worth less than Musk initially thought.
Plus, with the markets slumping, Musk's various equity stakes have taken a major hit. This means the equity he originally planned to put up as collateral for the Twitter deal has fallen. And Tesla (TSLA) stock is down 28% since Musk first announced the acquisition.
Between Musk's lower net worth and rising interest rates, financing for the deal becomes even more expensive – eating into possible returns for Twitter. No wonder Musk is looking for a way out.
At this point, Musk might have to decide whether the billion-dollar breakup fee is worth it...
By using our embedded expectations analysis ("EEA") framework, we can see what returns Twitter would need to justify its stock price.
Stock valuations are typically determined using a discounted cash flow ("DCF") model, which makes assumptions about the future and produces the intrinsic value of the stock.
And at Altimetry, we know models with garbage-in assumptions based on distorted generally accepted accounting principles ("GAAP") metrics only come out as garbage. Therefore, we use the current stock price with our EEA to determine what returns the market expects.
Looking at historical returns, we can see that Twitter's average Uniform return on assets ("ROA") is around 12%. This is in line with corporate averages – much lower than one might expect from such a large technology company.
Because of competition from other social media platforms, analysts project Twitter's Uniform ROA will fall to between 8% and 9% over the next two years.
Meanwhile, to be worth Musk's proposed purchase price of $54.20, Twitter's returns would need to reach all-time highs of 16%.
Musk may be getting cold feet due to the number of bot accounts... or he may simply be experiencing buyer's remorse. But no matter the reason, he would be right to back out – even if it means paying a large fee.
Thanks to Uniform Accounting and the EEA framework, we can see at a glance that $54.20 is an expensive price for Twitter stock.
Sure, $1 billion is a lot of money. But if it means Musk can renegotiate – or leave the deal entirely – it doesn't seem like too big a price to pay.
Plus, even if Musk can get a better deal, Twitter is long past its days as the "next big thing"...
That's a critical difference between the social media giant and the other companies that Musk has been a significant part of in the past.
While he believes he can unlock further value in the business, it still looks like he would be overpaying – especially since the market tanked after he made his offer.
But there's more to the story than price...
The returns Musk and his followers are after may simply be impossible to reach. This isn't anything against Twitter as a business. Rather, it has to do with the size of the company.
From PayPal (PYPL) in the early 2000s... to SpaceX, Starlink, and the Boring Company... Musk has been the main engine behind turning these companies into high-growth rocket ships. He invested a huge amount of his own initial capital in these businesses when they were new and tiny.
When each enterprise took off, Musk's wealth compounded to unimaginable levels. If you start with a big investment in a small company, you make a lot more money when it grows.
But large companies can only get so much larger. For example, Big Tech behemoth Apple (AAPL) sits at a market cap of more than $2 trillion. For its stock to rise 10%, Apple has to create the value equivalent of PepsiCo's (PEP) or Verizon's (VZ) entire market cap out of thin air.
This is what makes Twitter so different from Musk's other successful endeavors. In the past, he started from ground zero.
Let's zoom in on his most successful venture to date – Tesla.
In 2003, Musk became one of Tesla's earliest investors. He eventually gained control of the company, pouring in $70 million of his own money. As Tesla grew, Musk's investment compounded... making him wealthy even before the company's initial public offering.
When Tesla went public in 2010, it was a relatively tiny $1.6 billion stock. Yet Musk's investment in the firm had already ballooned from $70 million to $646 million.
Since then, the company's immense growth has sent its valuation soaring to more than $710 billion. And Musk has become the richest person in the world. He's now worth more than $215 billion, mostly thanks to his stake in Tesla.
You can see this immense growth below. If you'd invested in the S&P 500 in 2010, you would have quadrupled your money. But if you'd invested in Tesla in the same time period, each dollar would have turned into more than $150. That's a whopping 14,900% return.
To create tremendous wealth, you have to start with tiny stocks...
Twitter will never generate this type of return. For Twitter to climb 14,900%, its market cap would need to skyrocket to $4.5 trillion – three times as much as Google parent Alphabet (GOOGL).
For the potential to create life-changing wealth like a successful entrepreneur, you need to find tiny stocks that can compound over time.
It's next to impossible to bag a 10 times gain in a megacap company... let alone a 150 times gain. They're just too large. But for a company that's already tiny – say, below $1 billion or $500 million – those returns are much more attainable.
And that's why microcaps are our favorite area to invest in right now.
In short, true upside potential lies in turning a small company into a major one.
Tesla is an extremely successful example. And it's just one of the many cases that show starting tiny is the right way to go...
Best,
Joel Litman
Editor's note: Joel just released a special report discussing one of his favorite tiny companies that he believes is primed to explode higher...
It's a misunderstood auto-parts manufacturer that has fallen off the market's radar. But one of the greatest investors of the past four decades is taking notice – and so are we. If you want to learn more about this opportunity, including how you can set yourself up for potentially transformational gains, click here to get started.