If Microsoft Overpaid for LinkedIn, Then Twitter Is Way Overpriced

Image source: Twitter. Copyright Marisa Allegra Williams (@marisa) for Twitter.

When Microsoft (MSFT 0.46%) decided to plunk down $26.2 billion for LinkedIn (LNKD.DL), most analysts agreed it was a steep price for the Redmond-based company to pay. Not only was it a 50% premium over the stock's price at the time, it was 91 times the company's trailing EBITDA through the first quarter of the year. When LinkedIn reported its second quarter earnings results, it revealed Microsoft paid just 63 times the company's trailing-12-month EBITDA.

Twitter (TWTR) is now the biggest social media company tied to acquisition rumors, and those rumors seem to be the only positive factor driving up the company's stock price. Co-founder Evan Williams recently made a comment, or lack thereof, that led investors to believe the board was more open to considering a buyout, sending the stock higher last week.

But Twitter already trades for a premium valuation. Any company looking to acquire it would likely have to fork out even more than the company's current $13.7 billion market cap. At its current price, however, Twitter is trading for almost 300 times its trailing-12-month EBITDA. Does Twitter really deserve 5 times the multiple Microsoft paid for LinkedIn?

A look at the numbers

Both Twitter and LinkedIn use considerable amounts of stock-based compensation to make their adjusted EBITDA margins look good. They aren't the only tech companies that use stock-based compensation and report non-GAAP earnings results, but they're both heavily reliant on it. Here's what Twitter and LinkedIn's EBITDA look like over the trailing 12 months with and without stock-based compensation included.

Data source: Company financial reports.

Nearly all of Twitter's adjusted EBITDA comes from discounting stock-based compensation, while it accounts for more than half of LinkedIn's. These are real expenses even if they're not cash expenses, and thus need to be considered by investors.

Using adjusted EBITDA numbers, Twitter's EBITDA multiple is just 20 times and LinkedIn's is 27 times. But those numbers skyrocket when you factor in stock-based compensation. With Twitter using more stock-based compensation than LinkedIn, it becomes significantly more expensive than Microsoft's latest acquisition using an EBITDA multiple.

Will Twitter grow faster?

The typical reason the market assigns a higher earnings multiple to one stock over another is that it expects the higher-priced company to grow its earnings faster. Twitter is finally posting positive EBITDA numbers in 2016, and analysts think there's plenty of growth ahead. With an EBITDA of just $45.9 million over the last 12 months, it'd take less of an absolute increase to quadruple its EBITDA than LinkedIn's EBITDA, which is 9 times the size.

But analysts are expecting LinkedIn's EBITDA to grow to $1 billion this year, nearly 4 times its EBITDA last year. Twitter, by comparison, expects an adjusted EBITDA margin between 26% and 27% for the year. With analysts expecting total revenue around $2.56 billion for 2016, that works out to $678 million in adjusted EBITDA at the midpoint of Twitter's guidance.

That's actually a decrease in adjusted EBITDA from the trailing 12 months, but that's due to less reliance on stock-based compensation. Stock-based compensation expense fell 11% through the first half of the year.

But Twitter is coming up on the anniversary of a big round of job cuts, and its third-quarter forecast for stock-based compensation ($165 million to $175 million) is mostly above what it paid out in the third quarter last year ($165.9 million).

What's more, Twitter is forecasting another quarter of negative EBITDA, with stock-based compensation expense outpacing its adjusted EBITDA expectations ($135 million to $150 million). With little revenue growth, little EBITDA margin expansion, and little change in stock-based compensation, there's no reason to believe Twitter will show nearly as much growth in EBITDA as LinkedIn.

The potential might be there, but the company still isn't executing on that potential. With the stock currently trading around 300 times its EBITDA, it seems way overpriced compared to LinkedIn. And remember, the LinkedIn acquisition was deemed quite expensive.