Elon Musk Doesn't Want to Buy Twitter Anymore, and Neither Should You

Twitter's (TWTR) stock tumbled to a four-month low on July 8 after Elon Musk formally terminated his $44 billion takeover bid for the company. In a Securities and Exchange Commission (SEC) filing, Musk's legal team said Twitter had breached the terms of the deal by making "false and misleading representations" regarding the social media platform's number of "fake or spam accounts."

The legal team also said Musk had "reason to believe that the true number of false or spam accounts on Twitter's platform is substantially higher than the amount of less than 5% represented by Twitter in its SEC filings," and that an inability to gauge its true monetizable daily active user (mDAU) count obfuscates the growth prospects of its core advertising business.

Image source: Getty Images.

Twitter responded by filing a lawsuit against Musk. In a tweet, chairman Bret Taylor said the board remained "committed to closing the transaction on the price and terms agreed upon with Mr. Musk and plans to pursue legal action to enforce the merger agreement."

As this legal battle drags on, Twitter's stock is likely to stagnate and remain far below Musk's "best and final offer" of $54.20 per share. Is it too late to buy Twitter's underwhelming stock, which has actually delivered a negative return since its first post-IPO trade in November 2013?

Why did Twitter underperform the market?

When Twitter went public, then-CEO Dick Costolo claimed the platform could reach 400 million monthly active users (MAUs) by the end of 2013. It broadly missed that target, started losing MAUs instead, and ultimately replaced that metric with its current mDAU metric in 2019.

Twitter's mDAUs rose 13% to 217 million in 2021, and it claims it can reach 315 million mDAUs by the end of 2023. That target seems extremely bullish since it would require Twitter's mDAU growth to accelerate to about 20% in both 2022 and 2023. It also claimed it could generate $7.5 billion in revenue in 2023 -- which would require its revenue to grow at a compound annual growth rate (CAGR) of 21.5% over the next two years.

Data source: Twitter. YOY = Year over year.

Twitter hasn't withdrawn that guidance yet, but analysts expect its revenue to only rise 16% this year and then grow just 22% to $7.2 billion in 2023.

In April, Twitter also admitted that it had miscalculated its mDAUs over the past three years by counting multiple accounts for single users as separate mDAUs. Twitter claims that miscalculation only affected about 2 million mDAUs, but that mistake -- which only surfaced after Musk placed his bid -- raised red flags regarding its spam accounts.

Twitter's co-founder Jack Dorsey, who succeeded Costolo in 2015, launched new features like its short-lived "Fleets" feature, organized "topics" for tweets, new tipping services, and "Twitter Blue" verified subscriptions for top accounts -- but it still struggled to expand beyond its niche.

Dorsey resigned last year and was succeeded by Parag Agrawal, who focused on increasing Twitter's mix of higher-value ads and rolling out new e-commerce features to become a "social shopping" platform like Pinterest and Meta Platforms' Instagram.

Twitter shouldn't have sued Musk

Twitter has continued to grow over the past three years, but its earnings growth has been messy. In 2019, its net income was inflated by a $1.21 billion tax benefit. In 2020, it posted a net loss after incurring a $1.1 billion tax charge and COVID-19 expenses.

In 2021, it racked up another net loss after paying $766 million in legal fees to resolve a class action lawsuit regarding its MAU growth forecasts back in 2014. The impact of those taxes and legal fees can be seen in the gap between its reported and adjusted earnings, which exclude those charges:

Data source: Twitter.

This May, Twitter settled a privacy lawsuit with the Department of Justice (DOJ) and Federal Trade Commission (FTC) for $150 million. If Twitter sues Musk, it could rack up even higher legal fees this year.

Analysts expect Twitter to generate a net profit of $540 million this year, partly due to its recent sale of MoPub to AppLovin (APP -3.49%) for $1.05 billion, but to post a much lower net profit of $130 million in 2023.

Twitter would net a $1 billion termination fee from Musk if it simply lets him walk away. That seems to be a smarter and more cost-efficient decision that would finally allow Agrawal to reset Twitter's business.

It's not the right time to buy Twitter stock

Twitter's stock still isn't cheap at nearly 40 times next year's adjusted earnings. The macro headwinds will likely force it to abandon its ambitious growth targets for 2023, and its decision to sue Musk instead of accepting the termination fee raises additional red flags. Simply put, it's still not the right time to buy this volatile social media stock.