DWAC - Digital World And Trump's Truth Social: A Balanced Analysis

2023-09-18 14:03:23 ET

Summary

• Digital World Acquisition Corp is a SPAC merging with Trump Media & Technology Group, owner of the social media platform Truth Social.
• DWAC is currently valued at $600 million and has generated significant investor interest because it'd essentially become Truth Social's publicly traded ticker post-merger.
• Truth Social has shown promising early performance metrics, but its growth may be limited by its strong appeal to a specific demographic.
• My expected value analysis suggests DWAC is overvalued, but qualitative factors make it attractive among SPACs and social media startups.
• I conclude the stock is a hold, but certainly worth monitoring.

Digital World Acquisition Corp. ( DWAC ), a Special Purpose Acquisition Company (SPAC), is poised to merge with Trump Media & Technology Group (TMTG), the company behind the nascent social media platform Truth Social. This anticipated merger has catapulted DWAC's market cap to $600 million, approximately double its liquid cash value . This analysis will delve into the impact of former President Trump's brand on Truth Social, scrutinize the platform's early performance indicators, and assess financial and market variables that could either accelerate or hinder its growth. My expected value analysis suggests that DWAC may be overvalued. However, qualitative factors, such as its association with the polarizing Trump brand and its unique positioning in the social media landscape, could justify a premium. Consequently, I recommend a 'hold' stance on DWAC at its current valuation, making it a SPAC and tech startup worth monitoring closely.

SPAC Mechanisms and the TMTG Merger

For those unfamiliar with the term, a Special Purpose Acquisition Company, or SPAC, serves as a blank-check company with the primary objective of taking other companies public, bypassing the traditional IPO process. In this context, DWAC, a Nasdaq-listed SPAC, aims to merge with Trump Media & Technology Group Corp. (TMTG), the company behind the Truth Social platform. This merger is a financial transaction and a strategic move that could impact the U.S. political and digital media landscape.

The recent amendment to the initial merger agreement between DWAC and TMTG is a noteworthy development. This amendment comes after DWAC engaged a new independent auditor and secured an extension for its financial reporting. While this is promising, it also comes after the previous auditor resigned , and the SEC charged DWAC with allegedly making false or misleading statements in its filings. Moreover, if the deal goes through, DWAC will have to pay an $18 million penalty as a result. So, overall, the merger has been highly contested and riddled with controversies.

Nevertheless, the latest amendment extends the deadline for completing the merger to December 31, 2023, giving both companies ample time to finalize the deal. Moreover, both parties have committed to conducting mutual supplemental due diligence, a crucial step in M&A transactions, before DWAC submits an updated registration statement to the SEC.

Both CEOs have expressed unequivocal support for the merger. Eric Swider, CEO of DWAC, seems to view the deal as a pivotal moment for the digital media industry, highlighting Truth Social's distinct market niche. Devin Nunes, CEO of TMTG, emphasizes the platform's commitment to free expression and anticipates that the merger will substantially accelerate TMTG's growth trajectory. While optimism abounds, it's crucial to note that the merger is still contingent upon regulatory approval and other variables. However, the merger is strategically designed to furnish TMTG with the essential capital for expansion, particularly for scaling Truth Social. Given the congruent strategic goals and proactive regulatory compliance measures, the probability of successful merger completion is increasingly favorable.

Truth Social’s Prospects

Truth Social has effectively capitalized on the Trump brand's magnetic allure to secure a foothold in a market dominated by giants like Meta ( META ) and X (formerly Twitter). Early performance metrics are promising: the platform claims nearly 2 million active users and garnered over 4 million U.S. app downloads in 2022. Though modest compared to Trump's 87-million-strong Twitter following, these numbers indicate a highly engaged user base. While the Trump brand-driven user growth is encouraging, it is essential to weigh the platform's niche appeal when assessing its investment potential. A successful SPAC merger with DWAC could inject Truth Social with the capital needed for expansion. This and easier access to capital markets for debt financing suggests growth potential. However, such scaling hinges on overcoming demographic constraints and market polarization.

However, the brand magnetism that has fueled Truth Social's initial growth also imposes significant constraints on its broader market appeal. Survey data reveals a stark political polarization among potential users: 77% of Democrat voters and over 60% of women have categorically stated they will not use the platform. This polarization extends to age demographics as well. The 18 to 34 age group , typically the most voracious social media consumers, shows tepid interest in Truth Social. Only 7% of this demographic plan to use the platform frequently, while half do not plan to use it. This suggests that Truth Social's growth trajectory may be hemmed in by its strong appeal to a specific demographic—male Republican voters aged 18 to 34. The platform's challenge is to transcend its perception as a partisan tool and diversify its user base to achieve sustainable, long-term growth.

In the upcoming merger, DWAC is set to join forces with TMTG, a media and tech company primarily known for its social media platform, Truth Social. Essentially, TMTG is synonymous with Truth Social despite its broader ambitions in subscription-based video-on-demand services. Financially , TMTG's fiscal year ending December 31, 2021, reveals a complex picture. The company reported $2.1 million in net sales, likely generated by Truth Social, and an equal amount in gross profit due to zero cost of revenue. However, this is offset by substantial operating expenses, including $2.6 million in R&D and $3.4 million in administrative costs, culminating in a net loss of $59.1 million. It also has cash reserves of $18.7 million against a liability of $78.3 million. In summary, TMTG is relatively tiny compared to the merger's valuation.

These contrasting dynamics—rapid initial growth driven by brand power versus limitations imposed by political and demographic factors—provide a nuanced backdrop for investors evaluating DWAC's valuation. The platform's concentrated but fervent user base could serve as a springboard for rapid growth, particularly if Truth Social rebrands itself as more than just a political mouthpiece. Yet, the demographic limitations, potential post-merger ownership concentration, and TMTG's seemingly exorbitant valuation multiple are significant concerns.

Valuation Considerations

Post-merger, DWAC will own a minority stake in the combined entity. At first, DWAC's stake would be roughly 23.7%, but after dilutive transactions, the S-4 filing says it'll likely be just 19.2%.

DWAC trades at a $600 million market cap, or about twice its cash value. This premium might only be justifiable if Truth Social can sustain extreme growth rates while diversifying its user base, a challenge that remains to be seen. In the proposed terms, TMTG was valued at an enterprise value of $875 million. However, this is puzzling after considering that TMTG's fundamentals (i.e., Truth Social's fundamentals) don't justify such a high valuation multiple. After all, TMTG's implied EV/Sales ratio is a whopping 416.7. Indeed, $2.1 million in yearly revenues still leaves ample room for growth but also indicates that TMTG is a highly speculative asset. Hence, the merger implicitly assumes that Truth Social is an asset with explosive growth, or this valuation wouldn't make any sense in my view.

The merged entity between DWAC and TMTG will boast approximately $1.02 billion in assets, primarily in cash, with minimal liabilities. This makes DWAC a potentially viral social media platform with Truth Social. The venture has already attracted $1 billion in private equity, so a premium valuation is justifiable. My back-of-the-envelope market estimate suggests a valuation range of $1 to $2 billion, based on a P/B ratio of 1 to 2 that accounts for Truth Social's assets and future growth prospects. However, there is a range of outcomes. Thus, I'll use an expected value approach.

My analysis outlines three key scenarios for investors to consider, each with my estimated probability. First, there's a 30% chance of an optimistic outcome where the merger succeeds, and Truth Social's revenue continues to grow, boosting the combined entity's valuation to $2 billion over time. DWAC's 19.2% stake would be valued at $384 million in this case. Second, a moderate scenario with a 50% likelihood projects a successful merger and a reasonable market reception, which could take the valuation to $1.5 billion. Here, DWAC's stake would be worth around $288 million. Lastly, there's a 20% risk the merger could fail, particularly given the ongoing scrutiny. In this case, the SPAC would likely liquidate, returning most capital to shareholders and dropping the valuation to its cash value of $293 million. All valuation scenarios suggest DWAC investors are paying a high premium to be part of Truth Social, which could be justified if growth materializes in the long run.

Closing Thoughts

Investing in DWAC fundamentally depends on one's confidence in the future trajectory of Truth Social. While the SPAC enjoys the tailwind of President Trump's brand and encouraging initial metrics from Truth Social, my analysis suggests a 46.8% downside at its current market capitalization. Factors like demographic constraints and post-merger ownership concentration amplify the risk profile.

However, akin to many startups, there exists a narrow window for Truth Social to experience accelerated revenue growth in the short term, which would serve as the sole rationale for DWAC's existing valuation. Given its speculative nature, I assign a neutral rating, largely influenced by qualitative elements. The initial user engagement for Truth Social is promising, notwithstanding its demographic and political hurdles. While the SPAC framework may offer the requisite capital for expansion, the platform confronts substantial obstacles, including demographic limitations and regulatory scrutiny, that could impede its growth. Consequently, DWAC merits close observation but warrants no further action at this time.

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