TL:DR – Twitter could be a win for Elon and his investors (details provided), but the political risks are clouding the outcome.
we simply attempt to be fearful when others are greedy and to be greedy only when others are fearful
Warren Buffet, Berkshire Chairman’s letter 1986.
The timing of Elon Musk’s Twitter bid may have been an act of greed when others were greedy!
Hence Musk’s efforts to reverse the deal when, just after he made the unconditional offer, fear overcame greed in the markets. This was due to a dramatic reversal of the Feds “free money” policy, the root cause of a decade and a half of “greed”.
The result of Musk’s failure to terminate the deal (or dramatically lower the purchase price) is that he must now, in a recessionary environment, turn around a company that he has significantly encumbered with debt of $13b https://reut.rs/3Vu5OBQ
We examine the financial, operational, organizational, and strategic issues around the Twitter transaction to assess whether Musk will emerge – once again – victorious from his latest tilt at a windmill.
Looking at Twitter’s financial performance to date: it hasn’t been stellar…it’s been downright awful. In every conceivable financial measure, Twitter has performed miserably, and has been getting progressively worse, particularly after the assumption of control by Parag Agrawal.
Since its listing, the financial history of Twitter has been about an out of proportion growth of operating expenses and direct costs of revenue. With a minor exception during the pandemic of 2021, these costs have consistently grown faster than revenue. An unsustainable model
Another, simpler view of expenses vs income, to underscore just how unsustainable was Twitter’s trajectory, particularly as we move beyond a world of ‘free money’. I believe the firm would have had to look for ‘strategic alternatives’ before the end of 2022 – and large lay-offs.
If we compare key financial measures of Twitter with Meta – it’s most direct competitor – the results look dismal; the direct costs at Twitter appear to be twice that of Meta’s, while the operating costs at 30% higher. This has been thematic of Twitter’s financial history.
Even in comparison to a manufacturing company, with the huge direct costs of that industry, Twitter is shamed. The contrast with Tesla highlights the profligacy of Twitter…and the characteristic modesty of the typical Musk operating model.
The problem at Twitter is not just the number of employees – it is also the lack of productivity coupled with the extremely high cost per employee. A comparison to its peers shows a company with extreme costs and a loss per head compared to high profit per head for competitors
These are the sorry, bare financial facts. What follows are the conclusions I believe we should draw from those facts, and the implications for the Musk acquisition.
First: Twitter has struggled since its listing because it has managed its resources ineptly. Despite the popularity of its product, and reasonable revenue growth it has been unable to generate meaningful profits which have shrunk and disappeared despite top line growth.
Second: attempts by the company to expand its TAM by investing in adjacent markets such as video, podcasting has largely failed, including acquisitions such as Vine (video) and Periscope.
The lack of a strategic approach to these acquisitions illustrates how Twitter fails to understand the opportunity the platform affords; therein lies the opportunity that Musk sees in the acquisition.
Twitter claims 217 million monetizable daily active users, and this has grown at about 17% per annum over the last 5 years. It’s used by 23% of US adults with very desirable demographics. It’s also widely used in Japan and India. The sky should have been its limit, it was poised to fly; instead it has plodded along, rooted to the ground. Where does Elon Musk take it?
Before we examine that, we must weigh the impact of his lofty goal for the Twitter purchase: “A trusted digital town square”. This is not a political piece, but the acquisition has become the focus of political passion, and this will have a significant impact on the outcome of acquisition, strategically and financially.
I understand the passion. Elon Musk grew up – as I did – in South Africa, and remembers the repression and censorship of that time and place. Those who emerged from that know the rationalizations that squeeze the freedom of expression from public discourse.
This is what I believe to be the driving force behind his absolutist support for the ACLU position regarding free speech, and his opposition to the concept of “free speech for me but not for thee”.
Making matters worse is the Musk’s habit of tweeting, uncensored and unthought remarks, his blunt talk and childish, often confrontational humor – “I reinvented electric cars and I’m sending people to Mars on a rocket ship, did you think I was going to be a chill, normal dude?”
Adding to that are the events surrounding the first days of Musk’s takeover of Twitter. In an extremely ill-advised, and irresponsible tweet he linked to a highly spurious report about the Paul Pelosi attack in a questionable web site, deleting the tweet after an outcry.
This, together with the turmoil accompanying the immediate lay-offs and mass resignations led to a fraught atmosphere, and seemingly chaotic transition, scaring off corporate advertisers, many of whom announced a suspension of advertising on Twitter.
Shortly after taking control, Musk, working almost around the clock, focused on several key issues, among them bloated staffing, bots, code quality, and revenue sources. His first attempt at reform was to roll out a paid “Blue Check” to indicate a verified account.
This move proved disastrous, perversely permitting a huge spike in bot accounts impersonating real people due to the rushed and poorly structured release. The feature had to be hurriedly withdrawn, adding to the sense that Twitter was out of control.
Musk recently provided a deck he presented in a company talk on November 26. It is in 2 parts:
1, Current State,
2. Future of the Prduct
What follows is a brief summary of Musk’s presentation:
Current State: The graphs are light on scale and fuzzy on dates, but they show all-time highs in sign-ups and user active minutes, with peaks in monetizable daily active units. Also, lower hate speech impressions, while reported impersonations after peaking, dropping to new lows.
Future of the Product: The forthcoming product enhancements describe an “Everything App” including” advertising as entertainment, video, encrypted messaging, longform tweets, a retry at the Blue Verified program, and a payments function.
Taking all this, and based on the comps I cite from the companies in the graphs above, I have done some scenario testing to determine the financial viability of Musk’s plans. If we take his goals, and given his operating track record of running extraordinarily lean ships, I believe he can achieve industry leading margins along these lines:
Direct Cost: 20%
Operating: 35% (G&A 5%, S&M 15%, R&D 15%)
Pre-tax Income: 45%
With a margin of 45%, we can calculate the target of revenue that Twitter needs to achieve: at the very least, it needs revenues of $2.6b just to cover the interest bill. At revenues of $5b Twitter’s profits would exceed $1b per annum after interest. Beyond these levels, Musk and his investors would begin to reap significant rewards on their investment.
Absent a significant push-back from the market from the political atmosphere Musk has created, it is easy to imagine that, displaying the product marketing, engineering, and operating skills that he has demonstrated, that he will handily exceed the revenues of the legacy Twitter.
There are plausible paths to a win. The platform has very solid foundations, and Musk has an ambitious plan to add signifcant capabilites that could attract an even larger community. He has a very strong record at building very exciting products that customers love, from his earliest days at Zip2, through the X.com and Paypal era, and at Tesla and SpaceX, and he has a clear vision for Twitter.
However, the unknown is the impact that the political battles he is choosing will have on him and on his businesses, but most particularly Twitter. What is certain is that these fights have dramatically raised risks across all his holdings for all shareholders. It would behoove him to get his head down, and do what he does best…drive the company to achieve the seemingly impossible with the implausible.