4 Red Flags for Twitter's Future

Twitter (TWTR) has generated volatile and ultimately dismal returns since its IPO. The social media company went public at $26 per share on Nov. 7, 2013 and started trading at $45.10. Shares would eventually rally to an all-time high of $77.63 on March 1, 2021.

These days, Twitter's stock trades below $40. Bulls retreated amid concerns about the company's rising expenses, vague plans for the future, and last November's abrupt departure of co-founder and CEO Jack Dorsey. The broader sell-off in high-growth tech stocks over recent months exacerbated existing pressure, pushing more investors to retreat.

Image source: Getty Images.

Yet Twitter still has high hopes for the future. The company expects annual revenue to rise from $5.1 billion in 2021 to at least $7.5 billion in 2023. It also estimates that monetizable daily active users (mDAUs) will grow 45% between 2021 and 2023, jumping from 217 million to 315 million. Twitter bets that it can boost ad prices and revenue per mDAU by prioritizing pricier "lower funnel" ads, which target potential customers, over cheaper "higher funnel" ads, which would typically be used to build a brand's presence.

Twitter's stock doesn't seem expensive at five times this year's sales. However, investors should be aware of four red flags before doubling down on the company's future.

1. Its $1 billion debt offering

Twitter's total liabilities rose 25% to $6.75 billion at the end of 2021, which caused its debt-to-equity ratio to rise from 0.7 to 0.9. Those liabilities included nearly $4.3 billion in senior and convertible notes. 

Data source: Twitter.

This February, Twitter priced another $1 billion debt offering of senior notes that mature on March 1, 2030, with a much higher interest rate of 5%. That offering will likely boost Twitter's debt-to-equity ratio to more than 1.

That leverage is still manageable, and the company only paid out $41.8 million in interest payments in 2021, accounting for less than 1% of the company's revenue. However, Twitter's debt-to-equity ratio is now comparable to Snap's ratio of nearly 1 and significantly higher than Meta's ratio of 0.3.

2. Expensive scattershot strategies

Twitter is taking on more debt to fund the research and development (R&D) of new products, which would presumably help the company achieve its 2023 goals. During last quarter's conference call, CFO Ned Segal estimated that Twitter's total costs and expenses would "grow in the mid-20% range in 2022 versus 2021" as it increases its headcount by "approximately 20%."

But it's unclear if Twitter can leverage that higher R&D spending to develop meaningful new products. Under Dorsey, Twitter rolled out a slew of new products, including a tipping feature for content creators, temporary "Fleets" that mimicked other platforms' stories concept, curated tweet topics, and Twitter Blue subscriptions for popular accounts. Yet none of these efforts have lit a fire under Twitter's mDAU or revenue growth.

Dorsey's successor, Parag Agrawal, has been expanding Twitter into an e-commerce platform by testing out integrated shops, online catalogs, and live video shopping experiences. However, Pinterest and Meta's Instagram have already established early mover advantages in the crowded "social shopping" market. With this in mind, it could be both difficult and costly for Twitter to rebrand and promote itself as an e-commerce destination.

In other words, Twitter is plowing a lot of cash into achieving its ambitious growth targets -- but its scattershot strategies could ultimately miss the mark and force the company to withdraw its guidance for 2023.

3. Pointless buybacks

If a company takes on more debt to expand its business, it doesn't make sense to launch big buybacks. Yet last quarter, Twitter began a new $4 billion buyback plan, which included a $2 billion accelerated buyback. 

In 2021, Twitter repurchased 16.9 million shares for $930.5 million at an average price of about $55 -- nearly 30% above its current price. It issued $1.44 billion in new notes that same year, which indicates a lot of its new debt was used to fund these poorly timed buybacks. Meanwhile, Twitter's total weighted-average share count actually rose 1% for the full year. 

In other words, Twitter repurchased its own shares to offset dilution from its own stock-based compensation (12% of its revenue in 2021) instead of actually reducing the number of available shares. Therefore, these big buybacks are aimed at helping Twitter's insiders instead of its investors.

4. The rise of alternative social platforms

Lastly, Twitter's rosy 2023 forecast likely doesn't account for the potential growth of alternative social media platforms like Digital World Acquisition's Truth Social and Rumble, which were both launched in response to Twitter's censorship standards.

Elon Musk also recently criticized Twitter's censorship policies and vaguely hinted at the development of a new social network. None of those potential challengers will grow into the next Twitter overnight, but they could gradually chip away at its audience and throttle its mDAU growth.

Low valuation, low hopes

Twitter's low valuation indicates the market is still pessimistic about its 2023 goals. Twitter's platform will likely remain around for a long time, but these four red flags are preventing me from touching its stock.