Twitter: An Offer On The Way?

Summary

• Twitter reported an impressive first quarter results.
• It seems that the stock won't re-test its lows in the medium term.
• An acquirer would move now after Twitter's stock price stabilizing.

When Twitter (TWTR) announced Q4 results months ago, we issued a " sell" rating on the stock. The stock was down 15% after that. However, last week opened the possibility for a major turnaround in Twitter's depressing story, and increased the chances of the company having an offer in the coming months.

Impressing Q1 results

Last week, Twitter announced its first quarter results for the current fiscal year. What we liked in the report are two things; the surprising increase in DAU/MAU, and the higher FCF which is accompanied by lower stock-based compensation.

Twitter increased its DAU and MAU by 14% and 2.8% respectively. The quarterly increase in DAU gives Twitter 4 consecutive quarterly increases in DAU. Thus, it seems like a trend is being formed.

The number of daily active users is now up more than 17% since Q1 2015 levels. That's remarkable taking the negativity surrounding the platform into account.

It seems that Twitter management is knowing how to invest deep learning in the platform effectively. According to management's letter to shareholders, the company is continuously investing in deep learning techniques such as notification engineering, which is increasing engagement and bringing lost users back to the platform.

What also astonished us is the increase in Twitter's free cash flows. The company managed to increase its FCF (adjusted by capital leases) by 26% to $126 million. That increase is accompanied by 40% reduction in stocks issued as compensation to the sales and marketing team (SBC decreased 22% overall), which means that Twitter will have a high margin in substituting cash payments with stocks going forward to boost its FCF when it needs to.

Why the current valuation of Twitter is attractive?

Using DCF analysis, we believe that Twitter stock is rightly valued, which make it a suitable acquisition candidate. Using inputs of 8% growth in FCF over the next 3 years, 3% long-term growth, and a WACC of 8%, Twitter's enterprise value should be valued at $10.4 billion, slightly less than current valuation.

Very few technology companies are undervalued based on future cash flows (Alphabet (GOOG)(GOOGL) is among these few, we gave the stock a price target of $1154/share few months ago, the stock is up 12% since publication, read here). That's because investors are always putting a possibility for a break-through innovation which significantly lifts the company's valuation in a short period (as Facebook did when it announced its focus on mobile devices). That's why we believe that Twitter is trading at a very attractive price levels for a takeover.

Moreover, it seems that the worst is over for the stock. After the disappointing Q4 results in a supposedly hot quarter, and the $7 million stock purchase by Jack Dorsey which removed the possibility of any acquisition offer on the table, the stock dropped 23% before recovering all the losses in the last 5 trading days.

This makes possible acquirers anxious. Any increase in price means that they need to pay much more for the company at an exponential rate. Previously, those companies were watching Twitter stock go down in double digits every month, which postponed making any offer until the market finds a bottom. However, after strong Q1 results, especially on the DAU front, and the stock retracing 23% in 5 trading days, it seems that the stock has found a bottom and an acquirer would need to act quickly before the stock hitting new YTD highs.

What price would an acquirer pay?

Obviously, Twitter's valuation is mostly dependent on acquisition hopes. As we said before, DCF analysis shows that Twitter's value is nearly $17/share, unless we see a major breakthrough.

With no doubt, the market is having every right to put value on Twitter's data. That's because we are in the era of advanced connectivity. Its either in cloud, connected homes, connected cars, or intelligent marketing. The old model of monetization through advertising is no longer in the interest of big companies. Instead, companies would use this data to synchronize it with much bigger/profitable projects. The huge decline in cost-per-click for major advertisers like Alphabet, and Twitter gives a clear picture about the maturity of this segment. That's why valuing Twitter purely by using DCF analysis is a mistake. A DCF valuation should just be used as a margin of safety when buying a stock like Twitter.

The best way to value Twitter's data is by having the Microsoft (MSFT) acquisition of LinkedIn as a comparable. At that time, MSFT paid $65/LinkedIn registered user. If we assume a similar pricing, Twitter, having 328 million MAU, would be bought at an enterprise value $21.4 billion, or nearly double the current valuation.

New updates

Yesterday, Twitter announced the following streaming partnerships:

• A partnership with Bloomberg TV, where the later will launch a 24/7 live-streaming news channel provided solely for Twitter.
• A partnership with Vox Media, where the later will provide a weekly live show dedicated to gadgets.
• A partnership with BuzzFeed, where the later will launch news broadcasting live channel every morning provided solely for Twitter users.

That's in addition to streaming 20 regular-season games for the WNBA (Women's National Basketball Association).

While these partnerships are not expected to have significant financial impact (taking the NFL minimal financial impact as a basis), they open the way for more user engagement.

Last but not least, CEO Jack Dorsey bought another $9.5 million worth of Twitter stock. That makes the total stock purchases of $16.5 million in less than 3 months. This means that there is no current offer in the table, but doesn't remove the possibility of a near-term offer.

Conclusion

We believe that Twitter stock is poised for a significant increase in price. The stock just crossed the 200 day exponential moving average, paving the way for a bullish trend. In addition, the stock withheld the huge Q4 negativity, and hadn't broke the $13.7/share strong support level. This removes the possibility of a short/medium-term price depreciation, which means that if there is someone interest in the company, an offer would be made in the coming months. If that didn't happen, then it would be a strong signal that no acquirer is interested and the stock may sell-off again. It's a gamble that Twitter investors are going to take.

Cautious Investing to All.

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in TWTR over 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.