Twitter (TWTR) is in the process of raising $600 million in debt, which will be the tech company's first foray into the junk bond market with unsecured notes. All of the debt that Twitter has taken on thus far has been in the form of convertible notes, a different debt instrument that can be converted into stock based on certain conditions. With the company's financials improving -- it has consistently posted solid cash flow and GAAP profits over the past two years -- Twitter may be able to enjoy some interest savings compared to similar debt.

Here's what investors need to know about Twitter's paper.

Woman walking by Twitter logo

Image source: Twitter.

Interest saved is interest earned

Credit rating agency Moody's assigned a Ba2 rating on the proposed offering of senior unsecured notes. That's two notches into non-investment grade territory, commonly referred to as speculative grade or junk. Twitter's corporate family rating is also Ba2 and Moody's considers the company's outlook to be stable. Twitter has a relatively short track record of profitability, which limits its ability to earn higher credit ratings, according to Moody's.

"Twitter's Ba2 rating reflects its growing niche position within social networking, benefiting advertisers through its reach and targeting capabilities, which has led to strong revenue growth and free cash flow generation," Moody's Senior Vice President Neil Begley said in a statement. "However, Twitter is small relative to its larger digital advertising and social networking competitors, and user engagement on social networks can be fickle."

In contrast, consider another company that regularly taps the junk bond market for capital: Netflix. The dominant video streamer has burned through over $2.9 billion in negative free cash flow over the past year, while the social media company has generated over $904 million in positive free cash flow during that same time frame.

Twitter is targeting a 4.5% yield, which is at least a full percentage point lower than the average yield on junk bonds, according to Bloomberg. That would put the annual interest cost associated with the notes in the ballpark of $27 million, which is $6 million less than if the company were paying a percentage point more. The notes will pay interest semiannually in arrears, or at the end of each period as opposed to the beginning.

Interest expense on unsecured notes is more straightforward -- cash -- compared to the non-cash interest expense associated with converts. For convertible notes, interest is not paid in cash but is instead accrued to the principle, increasing the number of shares that the bond can be converted to. Twitter recognized nearly $106 million in non-cash interest expense in 2018 related to its converts.

Twitter entering the junk bond market is also notable because it shows the company is confident in its cash flow generation. Companies sometimes issue convertible notes in part because they aren't able to fetch higher credit ratings and want to avoid having to pay high coupon rates in cash, preferring the potential dilutive (and non-cash) costs associated with convertibles.