The X-traordinary makeover of Twitter: Three ways Musk’s gamble plays out

It’s been nine months since Elon Musk bought Twitter.

Just when you thought he might have enough on his plate, Elon has swooped in to rescue the Twitterverse. Yep, in between launching rockets and digging tunnels, he’s taken on another seemingly impossible task – turning around the cash-burning bird app.

The turnaround journey has been tumultuous to say the least:

• Significant layoffs
• Product issues
• Competition from Meta with the launch of Threads
• A rebrand to “X.com”

Reports have suggested that Musk’s Twitter investment has so far been a dud, with the bird app’s valuation halving since he took ownership.

I was curious, so I decided to crunch the numbers.

Remember, Twitter is a private company, which means this analysis is solely hypothetical/my best estimate based on the historical financials of when it was public. Think of it as a ‘what-if’ scenario put together from whatever bits of data I could scrape together.

The financial teardown

Let’s start with a brief history of Twitter’s financial journey.

The table below summarises Twitter’s historical P&L in a nutshell.

• Revenue rundown: In the lead-up to the big sale, revenue stood at an impressive $5.2 billion. Approximately 90% of this income came from advertising sales, whilst the remaining 10% was a mix of data licensing and subscription revenue.
• Gross margins: The gross margins sat at around 60%, surprisingly lower than I expected for a tech giant. To put things in perspective, the mighty Meta flaunts a cushy 80% gross margin.
• Profit play: In the past 12 months, the EBIT took a hit due to some high R&D expenses and a flurry of stock-based compensation. But back in FY21, it generated $272 million at a modest 5.4% margin – which again, is pretty average.

The table below outlines Twitter’s cash flow story:

Remember these key points, as they’ll come into play later in the article:

• The last 12 months’ operating cash flow wasn’t great, at a measly $16.3 million – basically break-even territory.
• In its best year, FY2018, Twitter generated a whopping $1.35 billion in operating cash flow.
• Free cash flow gets smashed with lots of capital expenditure (CAPEX). The funny thing is, this usually doesn’t fit the bill for a tech company. There’s limited data in the notes, but let’s assume this CAPEX is discretionary “treat-your-office” splurges on fitouts and equipment.

Okay, now that we’ve laid out some context on how Twitter has performed historically, let’s take a look at what it looks like now under Musk’s takeover.

Elon’s epic move: The mega leveraged buy-out

Musk made the history books in the world of finance by undertaking the largest leveraged buy-out of all time – acquiring Twitter for a staggering $44 billion. He funded this acquisition with a combination of his own money, investor capital, and bank debt.

A leveraged buy-out (LBO) is when a group of investors or a private equity firm wants to buy another company, but they don’t have enough money to buy it outright. Instead, they borrow a significant amount of money from banks or other lenders to finance the purchase.

The term “leveraged” is the key here. These audacious buyers secure hefty loans to fund the acquisition, riding on the belief that the acquired company will mint profits to service the debt and pocket some extra for themselves. The borrowed money is often backed by the acquired company’s assets, so the stakes are sky-high.

Once the buyers acquire the company, they cross their fingers that the purchased company will generate enough profits and cash flow to cover the debt payments and make a profit for the buyers themselves.

LBOs can be risky, because if the acquired company doesn’t perform well or generate enough profits to cover the debt obligations, it could become difficult to repay the borrowed money, leading to financial troubles for the buyers. This is why most LBOs are conducted on more mature, cash-flowing businesses.

Twitter’s twist

The difference with Twitter is that it hasn’t had a great track record of being super profitable or highly cash flow generative. From the traditional lens of private equity investing, there’s an extreme level of risk with this deal.

Let’s start with the debt obligations that Twitter has to service every year.

This is the source and uses of funds I pieced together from Twitter announcements:

Musk’s deal was done with ~28% debt with 5 to 7-year terms, mixed with equity from both his personal stash and investor funds. Elon has significant skin in the game, with close to 80% equity ownership in the company.

Let’s break down these loans. The table below summarises the terms of the $13 billion loans:

A few things to note:

• The SOFR, the ‘Secured Overnight Financing Rate’, is a benchmark interest rate that reflects the cost of borrowing cold, hard cash overnight, backed by Treasury securities. Think of it as the foundation of debt costs. This rate isn’t fixed; it floats. So, when the Federal Reserve jacks up interest rates, guess what happens? Elon’s interest bill follows suit.
• The ‘spread’ is the extra slice of the interest rate pie that lenders pocket on top of the SOFR.
• The ‘all-in’ rate is the total interest rate charged on the loans, which you can see is pretty expensive right now, ranging from 11% to a whopping 16% per annum.

I calculated that in the first year alone, Twitter’s interest expense is around $1.65 billion! ?

And it gets worse. Once you calculate the principal repayments on these loans, Twitter’s debt burden soars to a staggering $3.33 billion that needs servicing year after year.

Interest repayments recap (buckle up, it’s anxiety time)

This will give even the most seasoned numbers enthusiast a twinge of anxiety.

Twitter’s operating cash flow leading up to the sale was a mere $16.3 million.

Even in its best year, FY2018, the company only generated $1.35 billion of operating cash flow. That’s less than half of what it needs to service its yearly commitment to lenders.

If you add this debt to the existing business, Twitter goes from a marginal break-even business to a roaring cash-burning monster, gobbling up more than $3 billion annually.

The thing is, Elon and his entourage knew this coming into the business. They’re no dummies.

This, my friends, was a turnaround tale right from the start, as it is clear as day that Twitter won’t survive in its current form.

And that brings us to the OPERATION TURNAROUND story.

OPERATION TURNAROUND

It’s been a climatic sequence of events for Titter, I mean Twitter…err X.com:

1. Phase One: Trimming the Fat

The first order of business was getting fixed costs down via mass redundancies. And boy, did they dive headfirst into it. In the span of six intense months, Twitter laid off about 80% of its workforce. From a bustling 7,800 strong, they’ve trimmed it down to a leaner 1,500.

2. Phase Two: Breaking the Ad Addiction

The second order of business was reducing reliance on advertising revenue. Elon’s ingenious moves took centre stage:

• Verified & Vouched: Enter paid verification. For a mere $8 per month, folks can sport that coveted blue checkmark, so they can digitally cosplay as “authentic celebrities” in the app.
• Subscribing to Influence: But the brilliance didn’t stop there. The blue-checked crowd can now gather “subscribers”, loyal fans who pay a fee for an influencer experience, à la OnlyFans. Twitter takes a tidy 10% cut on this newfound revenue stream.

These strategies were not a nice-to-have, but rather a must-have, as it was reported that ad sales have plunged 59%!

Why? Well, advertisers cited that the whole platform and saga was just chaos – and uncertainty is the enemy for corporate customers. But the biggest reason was due to trolls from “verified” fake accounts mimicking large brands.

Here are some gems:

It’s hard to predict second-order consequences when you make significant changes in a company – but shit, this is next level.

Okay, so how do these changes impact Elon’s financials?

I built this simple model to understand how the numbers might be looking, factoring in the debt, redundancies, and all these new revenue-generating initiatives.

Let’s take a look at what it will take to get the business back on track.

The Twitter Financial Model

I played with three scenarios in my modelling.

Scenario A: Business as usual

This scenario is based on the business continuing in its current state, being:

• Advertising revenue slashed by 50% due to brand boycotts
• Sticky data licensing revenue remains the same
• SG&A and R&D expenses are reduced by 80%, thanks to mass redundancies
• No investment in CAPEX (everyone uses their own laptop)

Here’s the result:

The outcome of this scenario is pretty dire. The company is profitable on paper, generating around $1 billion of EBITDA annually. But guess what? It’s still burning cash because of the debt servicing of $3.3 billion, leaving a cash burn of $2.3 billion each year.

In this scenario, Twitter will run out of cash by mid-2025.

Scenario B: The Survival Play

I then modelled the “Survival” scenario. The expense and debt assumptions are the same as Option A, but I reverse-engineered what new revenue the business needs to reach cash flow break-even.

The result?

Assuming that gross margins remain at 60%, Twitter needs to generate $3.67 billion of recurring revenue just to balance the books. This brings total revenue to a hefty $6.96 billion.

For context, in its best year, Twitter generated $5.22 billion of total revenue – so yeah, that’s quite a bit of blue sky revenue that needs to be generated.

Scenario C: The Ideal Flight

Of course, no good investor invests in a business just to break even.

So, I built a third “Ideal Scenario” to model what revenue Twitter needs in order to generate a sufficient return to investors of 20% IRR (the typical hurdle rate in private equity).

I assumed that Twitter would either be sold or IPO’d in year five at an exit valuation of 8.5x revenue – the same entry price that Elon paid for the company.

I’ll be honest, 8.5x revenue is still pretty toppy. Meta, for example, is currently trading at 5.35x revenue…

In this scenario, I calculated that Twitter had to get to $12.8 billion of annual revenue by 2027.

As you can see, there’s A LOT of blue sky revenue to be generated – which is why Twitter can’t remain a mere social media app.

This phoenix needs to rise, reinvent, and pivot dramatically.

Enter X.com: The everything app

Just last month, Elon announced the grand rebranding of Twitter to X.com. I couldn’t tell if the vision statement for X.com was satirical or not, because it sounded exactly like something Kendall Roy would create.

With X.com, Elon is building the “WeChat” of the West.

It’s a grand vision, necessary for Twitter to not just survive but to self-actualise.

It’s a big mission, made even tougher with a new opponent.

“Zuck has entered the chat”

In a blatant rip-off move by Zuckerberg, Meta launched Threads – “an app for sharing text updates and joining public conversations”.

Now, there are obvious similarities between the two apps. Both have news feeds, heart-shaped symbols for the universal ‘like’, and the ability to reshare content. The only difference is in the wording – retweets are called ‘reposts’, and tweets are called ‘threads’.

Apparently, it’s been quite a hit!

Elon is taking things rather personally. Not only is Twitter threatening to sue Meta, but he’s also thrown down the gauntlet himself – challenging Zuck to a no-holds-barred cage match.

Honestly, I couldn’t care if Twitter/X.com makes it. I just want to see Zuckerberg and Musk battle it out in an MMA cage fight.

I wouldn’t bet against Elon.

But if you had to choose between the two, Zuck has my bet.

Who knows? The outcome might just be as surprising as the apps they’re championing.

(Disclaimer: Building empires aren’t all fun and games, and tech duels shouldn’t be settled with body slams. Choose your favourite wisely.)

This article was first published on SBO Financial.