Can Twitter Afford To Buy SoundCloud? Can It Afford Not To?

Twitter is reportedly mulling a potential acquisition of SoundCloud, although no announcement appears to be imminent.  Even if the companies are a good fit for each other, a deal seems unlikely in the short term, not least because Twitter would likely use stock rather than cash for the bulk of the deal’s purchase price. Its shares, however, have taken such a beating in recent months that Twitter would knowingly be buying from a position of weakness unless its share price rebounds.

When SoundCloud closed its $60 million Series D round of funding, the company was reportedly valued at $700 million.  It’s said that the funding took place in 2013, but wasn’t revealed until January. New shareholders such as Institutional Venture Partners would be seeking a return multiple on their investments, so any purchase price figures to be well above $1 billion, if not significantly more than that.

As of March 31, Twitter had less than $1 billion in cash and equivalents on its balance sheet, along with $1.2 billion in short-term investments. Even though it expects at least $1.2 billion in 2014 revenues, the company isn’t likely to blow so much of its cash on SoundCloud; it would likely use stock in any deal it might make to buy a company of that size.

For comparison, most of Facebook’s megadeals have involved a mix of stock and cash, with roughly 70% to 75% of the price coming in equity. The company’s biggest strike, the February deal for WhatsApp, cost it $4 billion in cash, but also about 9% of its outstanding shares -- worth about $15 billion at the time, including the employee retention bonus it’s due to pay out to WhatsApp employees. That’s a big chunk of equity, but Facebook also struck that deal when its shares were near an all-time high, saving it critical amounts of cash.

By contrast, Twitter shares are off 57% since peaking at $74.73 in December 2013, and have dipped roughly 50% since the day the SoundCloud funding news leaked. Internet stocks in general have lost value since the winter, but Twitter shares have done especially poorly, as some stakeholders have dumped shares following the expiry of the post-IPO lock-up phase.

At its current valuation of about $18.7 billion, Twitter would have to use a lot of equity to buy SoundCloud. If it wanted offer $1.4 billion -- double last year’s $700 valuation -- in stock, the buyout would require 7% of its equity. That’s a big hit for a company that would have needed to give up a lot less equity just a few months ago. The company could also cobble together a package that included debt, saving itself both cash and stock.

It’s not clear what Twitter paid for social data analysis company Gnip in April, but it was hardly in the same league as what SoundCloud would cost -- and even then, Twitter shares were worth more than 25% more than they are today.

If you’re wondering about the Google/YouTube buyout, to which some have compared a Twitter/SoundCloud deal, well, that 2006 all-stock deal cost Google about 1.3% of its shares. The $1.6 billion acquisition, of course, turned out to be an incredibly good deal.

So if Twitter’s going to make any big buyouts that require it to dig beyond its disposable cash reserves anytime, it’ll need to wait for its share price to rebound before it does.

SoundCloud declined to comment on the reported deal while Twitter did not respond to requests for comment.