Would Tencent Really Buy Twitter Inc.?

MarketsMotley Fool

Shares of Twitter (NYSE: TWTR) surged nearly 10% on Jan. 26 after Citron Research's Andrew Left declared that the stock could climb more than 44% to $35. Citron's bullish take on Twitter is unusual, since the firm specializes in short positions.

Left, who stated that he had bought shares of Twitter in the high teens, told CNBC that the "engagement levels on Twitter and the relevancy it's playing in our society can't be denied." In a tweet, Left claimed that Twitter could also be a potential takeover target for Chinese tech giant Tencent (NASDAQOTH: TCEHY).

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That's an interesting idea, but could China's biggest social networking company really gobble up one of America's top social media platforms?

Why a buyout could happen

Tencent dominates the Chinese social media market, with 980 million worldwide monthly active users (MAUs) on its WeChat mobile messaging app, 653 million MAUs on the older QQ messaging platform, and 568 million MAUs on its Qzone social network.

But it clearly wants to expand its overseas presence -- that's why it bought a 12% stake in Snap (NYSE: SNAP), the maker of Snapchat, late last year. That investment fueled speculation that Tencent might buy the entire company, which still trades at a discount to its IPO price.

But on a fundamental basis, Twitter looks like a more attractive investment than Snap. Twitter has an enterprise value of $15 billion and an EV/Revenue ratio of 6.4. Snap has a lower enterprise value of $14 billion but a much higher EV/Revenue ratio of 19.9. Twitter is profitable on a non-GAAP basis, but Snap remains deeply unprofitable.

Only 69 million of Twitter's 330 million MAUs came from the US during the third quarter; the rest came from overseas markets. Therefore, buying Twitter could enable Tencent to significantly boost its international presence. Tencent could then integrate WeChat's live video platform into Twitter's oft-neglected Periscope app to create a massive worldwide live streaming ecosystem, integrate its massive video game portfolio into Twitter feeds, or sell its ads to a much wider range of markets.

Tencent could also create a localized, censored version of Twitter for the Chinese market, which would be more likely to be approved under the management of a Chinese company. Twitter has been blocked in China since 2009, but relaunching the platform in China could help Tencent compete more effectively against microblogging king Weibo.

Why a buyout might not happen

Investors should note that Tencent takes large stakes in a lot of companies. It owns more than 20% of JD.com, the second largest e-commerce company in China, and about 25% of Activision Blizzard -- yet few analysts claim that those investments will lead to full takeovers.

Tencent generally makes smaller full acquisitions, like its $400 million buyout of League of Legends publisher Riot Games in 2015. Therefore, Tencent might take a stake in Twitter, but the chance of a total takeover at $35 per share -- which would value the company at about $26 billion -- seems unlikely. Tencent finished last quarter with 87.34 billion RMB ($13.8 billion) in cash and equivalents, so it would need to fund that purchase with stock or debt.

Tencent would also likely avoid Twitter for the same reasons as its other previous suitors. Its year-over-year MAU growth rate of 4% last quarter seems anemic, its stock-based compensation expenses remain high (17% of revenue last quarter), and it remains plagued by controversies about cyberbullying, fake news, and fake users.

Finally, US regulators under the Trump Administration have repeatedly blocked Chinese takeovers of US companies -- including Canyon Bridge's bid for Lattice Semiconductor, China Oceanwide's bid for Genworth Financial, Orient Hontai's bid for AppLovin, and Alibaba affiliate Ant Financial's bid for Moneygram International.

This means that it's highly unlikely that regulators will allow Tencent to take over Twitter -- especially when it's President Trump's favorite means of communication.

What will likely happen

I'm not a fan of Twitter as an investment, since its MAU growth is weak, its advertising revenue continues to slide, and its live video efforts are falling short of expectations. Twitter's stock might look cheaper than Snap's, but I doubt Tencent wants to buy the entire company and inherit all its problems.

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Leo Sun owns shares of JD.com and Tencent Holdings. The Motley Fool owns shares of and recommends Activision Blizzard, JD.com, Tencent Holdings, and Twitter. The Motley Fool recommends Weibo. The Motley Fool has a disclosure policy.

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