Opinion – Grain in Grain: Elon Musk may be making a common mistake of most investors

This past Monday, Twitter’s board approved the takeover offer by billionaire Elon Musk. When we looked at Musk’s track record, investors could tell he was doing a great deal. However, he may be making the same mistake Buffett made when he bought Kraft Heinz in 2015.

In 2019, Buffett confessed in an interview on CNBC, “We paid too much for Kraft. I was wrong somehow about Kraft Heinz.”

Musk may be falling into the same trap that many investors fall into, like Buffett: getting carried away with an acquisition and paying more than he should.

Many investors confuse the proximity they have with the company, get excited in the acquisition process and overestimate its value, paying more than they should for a share.

When we invest in a company, it is necessary to calculate what its fair value would be.

It makes no sense to pay a price above this fair value no matter how good the company is, as the return on investment will be less than the opportunity cost.

Some analysts commented that Musk could improve Twitter’s results. Even so, that he can, I show below that he is paying more than he should.

Also, fair value should not be paid considering the possibility of actually improving the result, as it is possible that this improvement will not be implemented.

After all, it would be overconfidence to believe that there are only incompetent executives in the current administration and that he could hire a whole team much better.

In fact, Twitter has worse results than another social network like Meta (Facebook).

The net margin, that is, how much of the company’s revenue is left over in profit (profit/revenue) from Twitter would be 11.3% according to Bloomberg and expected for 2023 by market analysts. While in the case of Facebook, the expected net margin for 2023 is 27.5%.

Even having a lower margin and showing sales growth not very different from the Goal, Twitter negotiates with a multiple premium in relation to Facebook. So it would already be relatively expensive.

If Musk manages to improve Twitter’s margin to 28%, that is, better than Facebook’s, Twitter’s expected 2023 profit will jump to $2.04 billion from the current $821 million.

However, even if Musk manages to implement this big improvement in earnings, Twitter would still currently trade at a Price/Earnings multiple of 19.3, with 2023 earnings. Facebook trades today at a Price/Earnings multiple for 2023 of 13 ,4.

However, Musk promised to pay an even higher price. Therefore, even if he manages to implement a huge improvement in Twitter’s results, the relative price paid would be double that of buying Facebook’s shares.

I don’t know if it will take him four years, as Buffett did, to confess that he was thrilled with the price he paid. Possibly the only rational ones were the Twitter advisers who approved the sale.

Michael Viriato is an investment advisor and founding partner of Investor’s House

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