With rumors swirling that Twitter may be acquired at any moment, with such suitor names thrown out as Disney, Salesforce, and even Google, overnight Citigroup released a scathing report explaining why a Twitter acquisition would be a bad idea. As the bank’s Jason Bazinet, who probably is catering to clients who are short TWTR says, “at a superficial level, this sort of transaction seems to make sense. With its recent BAMTech investment, Disney is taking early steps to pivot its cable nets business to the web. And, of course, Twitter recently took steps to move into live video including on-line streams of NFL games. That’s interesting. But, there are four reasons we don’t like this potential transaction…”
Here are Citi’s 4 reasons why a Twitter deal makes no sense:
Reason #1: History Suggests Internet M&A Fraught with Challenges
In the last 15 years, we cannot think of a single web based property that was successfully acquired by a traditional media firm. This includes both AOL/Time Warner (in 2000) and MySpace/News Corp (in 2005). If history is any guide, Twitter entails significant risks for the buyer.
Reason #2: Twitter Trends are Troubling
Two key US metrics – including monthly average users (MAUs) and ad revenue per MAU – have deteriorated sharply in recent quarters. Moreover, Twitter has experienced an unusual level of management turnover in recent years. These metrics suggest successful integration may be challenging.
Reason #3: All Cash or All Stock Deal Apt to Hurt Disney’s Stock
We ran the Twitter merger math two ways: 100% cash and 100% equity. The cash offer would lower Disney’s stock by $5 per share. The equity offer would lower Disney’s stock by $9 per share.
Reason #4: Unclear How Disney’s Content Helps Twitter
We believe both Yahoo! and Twitter lost significant money when they streamed NFL content over the web. That is, the NFL charged far more for the Internet rights than either firm generated in advertising. This suggests that even if Disney brings more content to Twitter, it’s unlikely to be financially beneficial (unless the NFL materially lowers the cost of on-line rights).
Of all the specific reasons listed, we found #1 the most convincing, courtesy of the following note and chart:
Despite the different business models, the Internet’s rapid top-line growth has attracted strategic interest from traditional media firms. Indeed, traditional media has tried – many times – to acquire various Internet firms. And, these acquisitions have occurred at all stages of the target’s arc.
- Back in 2000 – at the apex of AOL’s trajectory – AOL and Time Warner merged. It didn’t end particularly well for either firm.
- Undaunted, five years later, News Corp acquired MySpace. The MySpace acquisition occurred when the fledgling social media firm was still gaining popularity. But, again, it didn’t end well for News Corp or MySpace.
- A decade later, at the bottom of their respective arcs, AOL and Yahoo! were acquired by Verizon. And, MySpace – part of Viant – was acquired by Time Inc. Few investors are optimistic that Time or Verizon can materially improve the target’s prospects.
So, whether the Internet firm was on the rise, at its peak or in the doldrums, it’s difficult to point to a single successful acquisition in the Internet space by any traditional media firm.
Which leads to Citi’s stark condemnation of not only a Twitter purchase, but why most major media M&A in the internet space always fails. It needs no explanation.
Citi did not end there and had various other reasons why a TWTR deal would be negative for Disney, among them core differences in various business models:
If you dig a bit deeper into the social media business model, you’ll find stark differences:
- First, social media begins with a ‘user sphere’. Firms like Facebook encourage users to set up a relatively tight circle of close friends. At the other extreme, firms like Twitter cast a very wide net. You can get Tweets from anyone.
- Second, each social media firm receives a different amount of information about the user. Facebook asks for a lot of user information. But, Twitter doesn’t ask for much at all.
- Third, due perhaps to differences in the user’s sphere, Facebook enjoys much higher levels of user engagement. Users want to know about their close friends. Twitter….at the other extreme….sees far lower user engagement.
- Fourth, the propensity of these platforms to sign up users – due to the network effect – varies as well. Facebook has 1.71 billion monthly users. Twitter, on the other hand, only has 313 million monthly users.
These subtle differences have significant implications for the level of monetization – and subsequent value – the Street places on each firm. In effect, Facebook is far more valuable than Twitter. And, there is a reason.
Citi goes on to layout all the fundamental reasons why Twitter is a melting icecube, noting that “recent Twitter trends look troubling on two fronts: 1) Key metrics and 2) Recent management changes” adding that “from a profitability perspective, the trend is just as bad.”
The acquisition math also does not work:
“traditional media firms usually don’t succeed when they buy Internet firms. And, recent Twitter trends – including MAUs and management turnover – are troubling. But, what does the merger math suggest? If Disney pays a 10% premium to Twitter’s recent stock price, it would imply $18.5 billion of equity value. If we remove Twitter’s cash on hand, the net outlay would be about $15.0 billion.
If Disney pays Twitter’s equity holders 100% cash, at a 4% interest rate, this would result in $600 million of incremental interest expense. And, it would push Disney’s leverage from 1.1x to 2.0x gross debt-to-EBITDA. (We have assumed $500 million in synergies.)
And, if we hold Disney’s P/E multiple constant, it suggests an all-cash offer would reduce Disney’s equity value by about $4-5 per share.
Alternatively, we assumed Disney pays for Twitter via stock. This would result in about 163 million additional Disney shares ($15 billion / $92 per share). And, with $500 million of synergies, it would result in Disney’s equity falling by about $9 per share.
So, whether Disney pays for Twitter in cash or stock – or any combination of the two – we suspect Disney’s equity value would fall.
Citi’s Bottom Line on Disney buying Twitter: it would be a major mistake.
Any way we slice the data, we just can’t get enthusiastic about this potential transaction. As such, we’re maintaining our Buy rating on Disney. But, that means we hope the press reports are wrong and Twitter is acquired by some other firm.
Back in 2009 – seven years ago – we somewhat confidently suggested Disney made a mistake when it acquired Marvel. We were wrong. Marvel was a very successful acquisition for Disney. As such, if Disney is interested in Twitter, they may see something we don’t. And, Disney may be right.
But, any way we slice the data, we just can’t get enthusiastic about this potential transaction. As such, we’re maintaining our Buy rating on Disney. But, that means we hope the press reports are wrong and Twitter is acquired by some other firm.
Then again, in a world in which the cost of debt is virtually non-existent, all of the above may be irrelevant.
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