Elon Musk should stick to building rockets and electric cars. A lot of people have been saying that lately, and they’re right. After reducing the cost of transporting goods to space by 90%, and building the most popular electric car on this planet without spending a dime on advertising, he probably should stick to his core competencies. Of course, being the prolific entrepreneur that he is, he won’t. He’s also building bore holes and designing brain computer interfaces. And we haven’t even talked about his past businesses – like building one of the two most advanced AI labs in the world, OpenAI.
Given his track record, we’re surprised to see how low he’s stooping with Twitter. And by that, we mean why he’s choosing to dabble in something that can barely even pass for technology. If we had to rank all disruptive technologies based on meaningful impact, social media would be at the bottom. It’s done very little to progress society, and largely served to waste people’s time while making American youth believe that the most desirable profession is “social media influencer,” whatever that is. So, why did Elon Musk buy Twitter?
We wanted flying cars. Instead, we got 140 characters.”
Peter Thiel, 2013
Why Did Elon Musk Buy Twitter?
From the horse’s mouth, there are two main reasons why Elon Musk bought Twitter. The first is because he sees it as “a battle for the future of civilization.” That’s a rabbit hole we’re not interested in exploring because we’re investors. The second is that he sees an opportunity to transform Twitter into a universal app similar to how WeChat is used in China.
It’s difficult to estimate WeChat’s revenues because Tencent doesn’t break them out. Instead, they detail a segment titled “social media” of which “WeChat contributes a large amount.”
Let’s conservatively estimate that WeChat brought in somewhere around $10 billion in 2021 on 1.2 billion users. Net of cash, Mr. Musk paid $40 billion for Twitter. If Twitter becomes the next WeChat, that’s a $40 billion company producing $10 billion in revenues at a simple valuation ratio of four. As of their latest 10-Q filing, Twitter was bringing down about $4 billion annually with about one-fifth the active users, though that number has been growing steadily over time.
If your name is Cathy Wood, the WeChat thesis is probably reason enough to buy shares of Twitter, and indeed she has. The top-two holdings in Ark Invest’s Venture Fund right now are Freenome and Twitter at a 9% weighting each. We’re considering this fund as part of our alternative asset strategy, so we’d like to better understand the risks being taken here. As risk averse investors, we could care less about the bull thesis right now. Word on the street is that Twitter may not survive, let alone thrive. Since the ultimate goal for any business is to survive, today’s piece will focus on just that – Twitter’s ability to survive.
On a Wing and a Prayer
The man who showed the world how first principles thinking can be used to dominate entire industries would have anticipated the backlash when he acquired Twitter, and that advertisers would be pressured to pull back ad spend. He would have noticed the tremendous amount of bloat the company was incurring, a number that was increasing while revenues stagnated.
He would have performed a sensitivity analysis taking into account all possibilities, and would have had contingencies in place for worst-case scenarios. Or he could have just pulled the entire thing out of his backside, making up things as he goes along. We just don’t know, so let’s treat this like a case study on whether or not Twitter can survive using two key measures – debt servicing and profitability.
Debt and Profitability
Most of the outrage directed towards Twitter is coming from America, though concerns have been raised in the European Union as well. Let’s take off our ethnocentric goggles and examine Twitter in the context of global impact. According to the last 10-Q, here’s the breakdown of Twitter revenues by country/region.
Around 56% of Twitter’s revenues are exposed to the American outrage machine. Japan exists in its own little bubble as does the entire country (nowhere on this planet will you find a developed market more alien than Japan). The “rest of the world” category is a bit opaque, so maybe we can color that in with Twitter’s user breakdown by country seen below.
We’ve highlighted in yellow those countries which probably don’t care too much about America’s squabbling over hate speech vs free speech. If we exclude Japan, we’re left with a bunch of emerging markets with monetization opportunities that probably haven’t been fully exploited. You know the old saying – sell to the rich, live with the poor, sell to the poor, live with the rich. While America’s multinational firms might pull back the reigns on spending in their home country because of pressure from activists, they can still run ads across emerging markets where consumers are realizing more power as their economies enjoy rapid growth.
Let’s start by making some assumptions.
- Twitter loses 50% of ad revenues in America
- Elon Musk kicks 70% of the dead weight to the curb
- Twitter’s new “blue checkbox for $8.99 a month” feature achieves a 0.5% penetration of total users (roughly 3X the current number of blue checkboxes)
In the below table, we’ve taken the “before” from Twitter’s last 10-Q and then plugged in the “after” using the above assumptions.
As you can see, getting to profitability is possible even with the dramatic drop in ad revenues. If some of the newly available ad inventory can be sold, and the blue check subscription service is moderately successful, Twitter will be a profitable business that’s no longer burning cash and may even be able to service the $83 million monthly interest payments.
Musk has warned of Twitter’s possible bankruptcy (something he’s done with his other companies), and that event would likely be triggered by an inability to service debt. Prior to the acquisition, Twitter had around $6 billion on their balance sheet. If we allocated a billion towards getting to profitability, that leaves $5 billion for servicing debt – a runway of about five years. Generally speaking, Twitter can survive for about five years before the weight of all that debt comes crashing down. The firm needs to focus on generating positive operating cash flow to service debt. Then, they can start thinking about thriving.
An MBA Case Study
You can be sure the acquisition of Twitter will end up being a Harvard Business School Case Study that MBAs of the future will pore over. They’ll be asked to form groups and brainstorm about what Mr. Musk might do. If usage remains the same or increases while ad inventory skyrockets, what might be used to fill those gaps? Perhaps Mr. Musk’s other companies might step in to fill the void?
This is a man who can sell ice cubes to Eskimos. You might recall his recent foray into selling cologne where he sold out 30,000 bottles of “Burnt Hair” and raked in $3 million. Imagine what he could do selling real products, like maybe those electric vehicles he’s building. Major automobile manufacturers typically spend several billion dollars – each – on ad spend while Tesla spends nothing. That could change, or Musk might decide to advertise other products he’s trying to accelerate – like the Tesla Powerwall, or Starlink’s global internet capabilities. While Musk’s intent is to wean Twitter off ad revenues in the long run, in the short run, ad revenues can support the company until subscriptions come to fruition.
Musk appears to be taking a “move fast and break things” approach to operating Twitter which involves starting with a blank slate. He’ll throw tons of stuff at the wall and see what sticks. While there’s a small chance Twitter might not survive, we’re not going to know the outcome for a while. As we like to say, it’s not over until the big, beautiful woman with a myriad of health-related issues belts forth a tune.
ARK’s Venture Fund
We’re always having internal discussions about the viability of investment opportunities, and the question was raised as to whether Cathie Wood made a wise choice investing in Twitter, a position that’s now the largest holding in ARK’s Venture Fund alongside Freenome (both positions have a 9% weighting as of 11/30/2022). That’s the primary reason why we wanted to explore the chances of Twitter surviving as we’re presently considering a position in ARK’s Venture Fund as part of our alternative asset allocation strategy. We’re less concerned with the fund’s bets and more concerned with the increased weighting in publicly traded companies which is starting to look more like a Baillie Gifford investment vehicle rather than a way to get pure play exposure to startups. While we plan to do some additional exploring of the startups this fund has decided to invest in, the odds we’ll climb on board are getting slimmer by the day.
Conclusion
The “hate speech” vs. “free speech” drama begs the audience to fall into the trap of debating politics. As investors, we have no opinions to offer on that debate except to say that what Patreon defines as “hate speech” is a crock, and PayPal’s plan to fine people for hate speech wouldn’t be out of place in the CCP. All the controversy seems to be creating a great more deal of usage for the Twitter platform which only spurs growth.
Perhaps Twitter represents the last bastion of hope for humanity as Musk often says, but that’s not why investors got behind one of the world’s most successful and prolific entrepreneurs with a single text message. The opportunity here lies beyond the shores of America. All Musk needs to do is make sure the company survives long enough to realize his master plan. Would we invest in Twitter? Nope, but given his track record of performing against the odds, we wouldn’t bet against him.
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