Elon Musk's bid to take Twitter private was a success. The business itself? Not so much.

As Fortune reported: Twitter "announced its Board of Directors had unanimously accepted Musk’s $44 billion buyout, which will value the company’s shares at $54.20. Twitter will become a privately held company once the deal is completed."

When acquirers agree to pay a big premium for a target, they harbor a blueprint for chopping costs, luring lots more customers, and otherwise improving operations to recoup the extra billions and then some. But Musk has announced no plans to make Twitter a better business. And nearly everything about Twitter needs fixing. Its user growth is flagging; its operating costs and capital expenditures are excessive; and it's vulnerable to invaders in field that's easy to invade. "Twitter can't make their product unique; they're a slightly more robust version of group texting," says David Trainer, CEO of investment research firm New Constructs. "Its shares shouldn't be worth more than $10 or $15." Goldman Sachs isn't a fan either, stating that sans Musk, Twitter's basic business is worth $30 to $36 a share.

Put simply, Musk is vastly overpaying for an enterprise in decline that shows no signs of rebounding. Sure, the quarter-of-a-trillion-dollar man is parking just 15% of his net worth in Twitter, but he's also doing what every other corporate raider would consider deranged: burning billions.

Twitter's slowing growth

After losing a total of $2.3 billion from 2013, the year it went public, through 2017, Twitter booked strong profits in both 2018 and 2019. It appeared to be pursuing the classic tech model of youthful deficits followed by fast-ramping earnings that would make its big market cap make sense. That didn't happen: Growth in the social media's Twittering customer base slowed dramatically. Over the five quarters from Q1 of 2019 to Q2 of 2021, its monetizable daily active users swelled by 39% or 52 million, an average of 10 million every three months. But in the 18 months through the end of 2021, its customer base rose by only 31 million, half the pace of 2019 and early 2021. As core revenue growth slowed, costs exploded. Between 2019 and 2021, sales rose by 47% while expenses rocketed 80%. The company blamed the ramp-up in costs on heavy spending for the new personnel and infrastructure needed to propel the next wave of expansion.

Instead, it appears that Twitter simply needs to spend a lot more to keep the same customers and attract each new recruit. It's especially troubling that its capital expenditures in 2021 reached an all-time high of $1 billion, almost double the figure in the flush days of 2019. Those outflows saddled Twitter with negative free cash flow of almost $400 million. Yet in late 2021, the board instituted a $4 billion buyback program. Those funds can't come from profits, since Twitter is losing money. So it could be tapping cash from its treasury, and maybe even borrowing, to back the repurchases. Hence the policy makes Twitter's fortunes a lot riskier by lowering its financial cushion during tough times.

Underperforming

To gauge Twitter's performance, I asked accounting expert Jack Ciesielski to provide an analysis of its cash generation versus the growth in its assets. In other words, how profitably is Twitter deploying all those outlays on computer systems, new acquisitions—it acquired seven young media players in 2021—and its other investments? Ciesielski deploys a metric called cash return on assets, or COROA. He starts by taking cash from operations, then eliminates the impact of leverage and taxes by adding back interest and federal and state levies paid in cash. Share-based comp is subtracted, as a real cost that temporarily inflates cash flow, since the hit, in the form of dilution, comes later when restricted stock and options vest. He calls the numerator "operating cash flows." As a denominator, COROA uses average assets for the year, but adds back accumulated depreciation to count all the spending on plant and equipment in the company's lifetime. Hence, COROA is an excellent proxy for how much pure cash a company generates for every dollar invested in the business.

Twitter is a case study in getting bigger and less profitable at the same time. Since 2016, its adjusted assets have doubled to $14 billion last year. But its operating cash flows haven't stayed flat in the low-$600-million range. Since the close of 2019, it's added almost $1.7 billion in assets and has seen operating cash flow shrink by over 80% from $958 million to $158 million. Put simply, Twitter is investing more and more billions in building its platform, and generating less and less cash. The more it spends, the less it harvests.

Barriers to profitability

For Trainer, Twitter lacks the "moat," or rampart, to prevent rivals from luring today's tweeters to their own sites. "Twitter's really a glorified chat room," he says. "It hasn't done much to evolve. Competitors wouldn't have a hard time building a similar model from scratch, and it's already facing competition from Instagram and Snapchat. I remember vividly what happened to such onetime market leaders as AOL's Messenger and Friendster." Twitter's conundrum, he adds, is that it can't boost profits without antagonizing its customers. "To get more profitable, Twitter would need to run far more ads," he says. "And the blizzard of ads gets in the way of using the product. People don't want to be bombarded with ads instead of reading what they want to read and publishing what they want to publish." If ads get too intrusive, tweeters will move on to rival platforms. That's why Twitter keeps spending more and more as its stream of new customers keeps slowing.

Elon Musk is a great visionary. So far, his goal for Twitter is creating a great, buzzing public square for open expression. But Musk also loves to make money, and like most billionaires, he takes losing it personally. He will be the owner, host, and principal voice in this arena of his dreams. But it may swallow his cash by the billions.