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Will Alphabet Finally Buy Twitter?

Google has a great acquisition track record and should turn its sights to the beaten-down social media company.

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Back in 1996, Larry Page and Sergey Brin started the building blocks for what would become the Google search engine. In a few years, Google’s search capabilities were recognized for having “an uncanny knack for returning extremely relevant results.” Today, Alphabet Inc (GOOGL) effectively controls the market for online advertising.

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A savvy acquisition approach is another key ingredient to Alphabet’s success. Back in 2007, it acquired internet advertiser DoubleClick for $3 billion. A year earlier, it bought YouTube for $1.65 billion. Nearly a decade later, both look like absolute steals.

Alphabet should next turn its sights to Twitter Inc (TWTR). Twitter’s stock isn’t a steal, but it is beaten down and it could represent a bargain if its growth trends continue. The fact that it operates in what is arguably the fastest growing market (online advertising) is a huge positive. The space is currently seeing significant merger and acquisition activity, as such, TWTR could easily be snapped up soon.

TWTR’s Drawbacks

There is little denying that Twitter has failed to live up to its hype so far. TWTR points out that its success is based on user growth, which is slowing and actually flat by a number of metrics, such as monthly users.

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There has also been an unusual amount of management and director turnover. Founder Jack Dorsey returned to the helm of Twitter and has been working frantically to find a strategy to keep the lofty company growth projections a reality. However, current initiatives are unclear and look far from visionary.

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A key issue is that many users find TWTR confusing. It isn’t that easy to navigate, tweets can be easily missed, and advertisers are still figuring out how to best use Twitter’s website and mobile device capabilities.

Twitter’s Benefits

Despite the uncertainty surrounding TWTR’s future, it is still growing and it operates in perhaps the most appealing growth industry out there. Like GOOGL, Twitter is primarily an online advertising company. During its last two fiscal years, 90% of TWTR’s revenue stemmed from advertising or third parties advertising directly on Twitter.

Twitter has three primary vehicles for advertising clients: Promoted Tweets are traditional tweets that any user can post. Promoted Accounts appear where users are likely to follow a new tweeter. Promoted Trends appear at the top of trending topics for an entire day.

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It should be very encouraging to GOOGL that TWTR has more demand for advertising than it can currently fill. Monthly active users are growing, but at a decreasing rate. At the end of the first quarter, Twitter boasted 310 million MAUs, most of which were outside of the United States.

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Why GOOGL Should Swoop in to Buy Twitter – Now!

The online advertising market has incredible appeal. It is growing rapidly (20% annually) and represents one of the best secular growth stories (a trend that is expected to last for at least several years) in any industry right now.

The current problem is the space is highly concentrated. Google and Facebook Inc (FB) are the bona fide leaders today. According to a Bloomberg article earlier this year, this pair represented 64% of the $60 billion online advertising market in 2015. Google snagged $30 billion, or the lion’s share of the market … Facebook was a distant second at $8 billion.

The article detailed that the rest of the field is made up of rapidly growing niche players including Pandora Media Inc (P), LinkedIn Corp (LNKD) and Twitter. Yahoo! Inc. (YHOO) is still a player, but is much weaker and not growing much these days.

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Given the growth appeal, the stakes are high in the industry, which benefits the smaller players. For example, software giant Microsoft Corporation (MSFT) just announced it would acquire LinkedIn for $26.2 billion. LinkedIn’s stock jumped 47% the day the deal was announced. Earlier this year, Pandora was rumored to have hired investment banking giant Morgan Stanley to consider selling itself.

Yahoo! is interested in selling its internet business and it has been accepting bids. Final bids were due Wednesday July 6. Verizon Communications Inc. (VZ) is primarily a cellular mobile device provider, but submitted a $3 billion bid for the unit and is said to be a favorite to win the bidding war. Last year, it acquired AOL for $4.4 billion — primarily to benefit from the growth in internet advertising.

Bottom Line for Twitter Stock

Warren Buffett was also thought to be part of a group interested in Yahoo’s business. Given the rapid growth and interest from a diverse group of large (and cash-rich) acquirers, it is easy to argue that Alphabet would be foolish not to make a run for Twitter.

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So, despite all the negative sentiment surrounding TWTR these days, it is still a growth company. Revenue is projected to jump 20% in each of the next two years and reach $3.3 billion by the end of 2017. The average analyst profit target for this year is $0.52 per share and could jump nearly 30% to $0.66 per share next year.

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This suggests a forward price-to-earnings ratio of “only” 32, which could actually end up being cheap if growth continues at a 20%+ clip. Microsoft is paying in excess of 50 times LinkedIn’s earnings to fold it into its operations.

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Alphabet would lose out if it doesn’t make a play for Twitter. Investors may want to consider making their own play for some shares. A buyout would likely be at a hefty premium to the current stock price. Alternatively, the negative sentiment surrounding the name could allow Twitter to surprise on the upside given it operates in one of the fastest-growing areas of the market right now.

This article is from Ryan Fuhrmann of InvestorPlace.

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