S&P is materially overstating the credit risk of Twitter (NYSE:TWTR) with its BB- rating. However, our fundamental analysis highlights a much safer credit profile for TWTR. The company's strong cash flows easily cover all their obligations including debt maturities. Moreover, their sizable cash build should allow them to service all obligations including debt maturities if their cash flows ever fall short. We therefore rate TWTR six notches higher at an IG3- credit rating, or an A- equivalent using S&P's ratings scale.
Moreover, convertible bond markets are materially overstating TWTR's credit risk, with a convertible bond YTW of 4.290% relative to an Intrinsic YTW of 2.130%.
Cash Flow Profile
This analysis uses Uniform Adjusted Financial Reporting Standards (UAFRS) metrics, or adjusted metrics, which remove accounting distortions found in GAAP and IFRS to reveal the true economic profitability of a firm. This allows us to better understand the real historic economic profitability of a firm as well as allows for better comparability between peers. To better understand UAFRS, please refer to our explanation here.
Below, we've included our Credit Cash Flow Prime™ chart for AMD. The chart provides a far more comprehensive view of credit fundamentals than traditional ratio-based analyses. By using Uniform Adjusted Financial Reporting Standards based metrics, it shows the cash flow generation and cash obligations related to the credit of the firm, adjusted for non-cash financial statement reporting distortions from GAAP. The blue line indicates the gross cash earnings (UniformFRS adjusted cash flow number) expected to be generated based on consensus analyst estimates and Valens Research's own in-house research team. The blue dots above that line include the cash available at that time while the blue triangles indicate that same amount plus any existing, available lines of credit.
The colored, stacked bars show the cash obligations of the firm in each year forecast. The most difficult obligations to avoid are at the bottom of each stack, such as interest expense. The obligations with more flexibility to defer year to year, such as pension contributions and maintenance capital expenditures, are at the top of the stacked bars. All of the calculations are adjusted for non-cash distortions that are inherent in GAAP accounting, including the highly problematic and often misused statement of cash flows.
If the company generates and has cash levels that are above their obligations, the risk of default is extremely low. Even if the cash generated yearly is close to the levels of the stacked bars, a company generally has the flexibility to defer payments of various kinds. For example, they can allow assets to age a little longer, or they can cut certain maintenance costs such as maintenance capex. While decisions such as those can create other business concerns, the issue in credit risk is simply this: Does the company have enough cash to service their credit obligations?
TWTR's cash flows would be able to service all obligations including debt maturities through 2022. Moreover, the firm's material cash on hand levels, sizable expected cash build, and robust recovery rate driven by substantially positive net working capital levels indicate that the firm should be able to access credit markets to refinance if they so choose.
Like most people, senior executives and board members do what they are paid to do. This is why TWTR's Form DEF 14A is key to understanding this company's fundamentals, something that credit agencies seem to be missing. Our Incentives Dictate Behavior analysis focuses on TWTR's senior executive compensation and governance. This analysis is meant to help investors understand corporate governance, how aligned a management team may be with shareholder interests, and the potential consequences of a management compensation framework to the business.
TWTR's management compensation framework is negative for debt holders. Their short-term compensation is not focused on any specific fundamental metric per their DEF 14A, while their long-term compensation is granted through restricted stock units and stock options that also are not tied to any specific fundamental performance metrics.
This compensation framework, which is solely focused on equity, may incentivize management to fund their operations with debt to limit incremental dilution to the company's equity. That being said, a compensation framework focused on improving stock price also could be favorable for the debt holders as the firm's bonds are convertible.
We provide analyses of companies' statements on earnings calls, termed Earnings Call Forensics. This analysis is meant to help assess a management team's confidence in their conference calls when discussing certain areas of the business such as operations, stability, strategies, their ability to manage business risks, and especially, their liquidity and solvency.
In the case of TWTR, the analysis of their Q4 2015 earnings call highlighted mixed markers from management. They appear confident about their advertiser penetration relative to TV and about their ability to drive user retention. They also appear confident about their moments feature. However, they appear concerned about the sustainability of ad load growth and about their ability to accelerate user growth. They also appear to lack confidence in their live event strategy, as well as their ability to balance growth and profitability.
Ultimately, a company's credit risk (or lack thereof) is driven by cash available against cash obligations. TWTR's credit risk is being materially overstated by S&P and convertible bond markets. Given TWTR's strong cash flows relative to all obligations including debt maturities, healthy liquidity profile, and robust recovery rate, ratings are expected to improve and convertible bond market spreads are expected to tighten once the company's fundamentals are recognized.
Our Chief Investment Strategist, Joel Litman, chairs the Valens Equities and Credit Research Committees, which are responsible for this article. Professor Litman is regarded around the world for his expertise in forensic accounting and "forensic fundamental" analysis, particularly in corporate performance and valuation.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.