Twitter (TWTR) has had a miserable year. Its stock plunged more than 30% over the past 12 months, user growth slowed to a crawl, new advertising strategies flopped, and its CEO resigned. But now that the stock is close to its IPO price of $26 per share, many investors think that Twitter could be bought out.
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Rumors about Google (GOOG 0.74%) (GOOGL 0.55%) buying Twitter have swirled since the beginning of the year, and a false buyout report in July caused shares to briefly spike. But in my opinion, Twitter won't be bought out yet for three main reasons.
1. A massive purchase
Twitter's current market cap is about $18 billion. With an acquisition premium factored in, a potential suitor would probably have to pay $25 billion to $30 billion to take over the company.
I believe that there are two realistic suitors for Twitter: Facebook (META -0.52%) and Google. But neither company has paid anywhere close to $30 billion for a single company before. Facebook's biggest purchase to date was its $19 billion acquisition of messaging app WhatsApp. Google's biggest buy was its $12.5 billion purchase of Motorola Mobility, which it subsequently split up and sold.
At $30 billion, a suitor would be paying nearly $100 for each of Twitter's 308 million monthly active users (MAUs). Last year, Twitter generated $1.4 billion in revenues with 288 million MAUs, meaning that its average revenue per user (ARPU) was less than $5 per year.
2. A weak strategic fit
Of course, acquisitions aren't just about boosting revenues or profits. They can also establish the groundwork for ecosystem growth. However, it wouldn't make sense to buy Twitter for that reason either.
Facebook previously bought Instagram and WhatsApp because both apps served specific purposes. Instagram retained younger users and emphasized single filtered images. WhatsApp was a no-frills replacement for traditional SMS messages. Twitter, however, offers a mishmash of similar features but doesn't clearly focus on a single market. More importantly, both apps had soaring user growth when they were acquired. Facebook planned to grow those user bases first before monetizing them. Twitter's MAU growth, however, has declined every quarter since going public.
Google has repeatedly failed to establish a social networking presence, but it needs a growing social network instead of a dying one. Moreover, Google already has access to some of Twitter's best features. In February, the two companies signed a deal to bring tweets back to Google searches. That deal enhanced Google's search results with real-time tweets, which boosted the relevance of its targeted ads. Therefore, there's no reason for Google to buy Twitter's entire business. Google's new CFO Ruth Porat also plans to cut back on spending. This likely means avoiding massive acquisitions like Twitter.
3. Stock dilution
Another problem is that Twitter dilutes its stock by issuing more shares every quarter. It does this to pay employees with stock-based compensation, but this increases the market value of the company -- which we get by multiplying the stock price by outstanding shares -- without actual earnings growth. This raises the stock's multiples and makes the company look more expensive and less attractive as an acquisition target.
Last quarter, Twitter paid out $175 million (35% of its revenue) to its employees as stock-based compensation. That contributed heavily to its net loss of $137 million, and represents a huge percentage for an unprofitable company. Facebook (META -0.52%), which is profitable, only paid out 19% of its revenue as stock-based compensation last quarter.
Since going public in late 2013, Twitter's share count has risen 81% from 362.6 million to 655.7 million shares. If Twitter actually wants to be bought out, it needs to stop diluting its own shares and reduce stock-based compensation.
A realistic view
I'm not saying that Twitter will never be bought out. But as of today, Twitter's market value is too high, and the company is propping up that valuation with a vicious cycle of stock-based compensation and share dilution. Twitter also no longer has the user growth which attracts big tech takeovers.
Twitter CFO Anthony Noto told investors last quarter that Twitter did "not expect to see sustained, meaningful growth in MAUs until we start to reach the mass market" and that those efforts would take "a considerable period of time." Interim CEO Jack Dorsey stated that new ad features didn't have a "meaningful impact on growing our audience or participation." Those bleak statements suggest that Twitter stock will get even cheaper in the future, which could finally make it a more appealing purchase for larger companies.
