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Beware: This SPAC Bubble Stock Could Burst in 2022

Investors saw several highly speculative investments go to the moon in early 2021, only to crash back to earth over the past several months. Some of these players were pre-revenue and unprofitable companies going public via special purpose acquisition companies (SPACs).

Former President Donald Trump is starting a social media network and streaming service called Truth Social and TMTG+, respectively, taking the companies public under Trump Media & Technology Group in a SPAC merger with Digital World Acquisition (NASDAQ: DWAC). Investors are gobbling up shares, so here is what you need to know before buying the stock.

Challenging big tech head-on

Trump's headbutting with large media companies has been well-publicized, including his banishment from social media platforms like Twitter and Facebook (owned by Meta Platforms). I think Trump's logic behind this business venture is simple: If tech companies take his social platforms away, he'll start his own.

Image source: Getty Images.

Trump started Trump Media & Technology Group in early 2021, and serves as the Chairman of the company, with former Republican politician Devin Nunes as CEO. The company is going public via a SPAC merger with Digital World Acquisition, a blank-check company, built for the purpose of infusing money into a merging partner, in exchange for partial ownership in the combined entity.

Investors can buy shares of Digital World Acquisition, which will become shares of Trump Media & Technology once the SPAC merger takes place, following an eventual shareholder vote. The company has the opportunity to raise money throughout this process, recently announcing an additional $1 billion raised through a "PIPE" investment, which is when a company sells publicly traded shares to private investors such as hedge funds. Trump Media & Technology Group will use the funds from the SPAC process and PIPE investment to help fund its growth.

Trump Media & Technology Group will have two primary components: a social media platform and a digital streaming service aimed at Trump's fan base. The social media platform, called Truth Social, claims to be open and free of political discrimination. The streaming service, called TMTG+, will offer a variety of political, entertainment, and sports content.

There seems to be a lot of potential on the surface; established social media platforms and streaming services have hundreds of millions of users. The company's target market has a reputation for being devoted to Trump. But some big red flags stand out.

Potential financial and political risks

I want to first hone in on the financials behind a streaming business. Digital content can be a very tough nut to crack, and streaming companies have to either pay licensing fees for content or invest in creating their own. Netflix invests billions of dollars each year on content, has more than 213 million paying users to spread those costs out over, and is still generating negative free cash flow in many quarters.

It's clear from Trump Media & Technology Group's projections that it expects the streaming service to contribute the majority of revenue. The company will likely burn a tremendous amount of money in its early years because it is starting revenue from virtually nothing. It will have nothing to offset these costs other than its $1.25 billion in cash on the balance sheet following the SPAC merger. The company's projections don't even mention any information about profitability, only speaking to revenue projections, targeting $3.67 billion in revenue by 2026.

Meanwhile, investors need to consider that social media platforms like Facebook have come under political pressure for how they handle user data. The company is unlikely to receive any favorable treatment from politicians, whom Trump clashed with during his time in office.

What are investors getting at this valuation?

The enthusiasm of Trump's supporters could be showing up in the SPAC's share price, which has soared from its initial $10 to $80. So how does this translate to the stock's valuation? Based on the terms of the SPAC merger, Trump Media & Technology Group's common shares will be worth $2.25 billion at the SPAC's $10 price.

But at $80 per share, the company's market cap will be closer to $18 billion; this is before factoring in post-merger events like warrants, which could add additional shares when converted.

The company's investor presentation referenced Twitter as a comparable for its valuation. Twitter's stock currently trades at a price-to-sales ratio of just over six. But that's based on trailing-12-month revenue. Using Trump Media & Technology Group's 2026 revenue estimate of $3.67 billion, the resulting P/S ratio is just under five. Said differently, investors have to hope the company meets its targets and wait four to five years to reach a comparable valuation to what Twitter is today.

Unfortunately for investors, Trump Media & Technology Group is a story stock, which means that a narrative drives the price more than revenue or earnings. That doesn't mean that revenue and profits can't later justify a valuation, but investors are taking a massive leap of faith that everything will work out in their favor.

Remember this

Investors following most SPACs or speculative stocks over the past six months can see what happens when investor sentiment turns south. Shares of Digital World Acquisition are currently trading on speculative demand because there is no revenue for the soon-to-be Trump Media & Acquisition Group to base its valuation on. If you're going to buy shares, understand these risks, and don't be the one holding the bag if investor excitement dries up.

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Randi Zuckerberg, a former director of market development and spokeswoman for Facebook and sister to Meta Platforms CEO Mark Zuckerberg, is a member of The Motley Fool's board of directors. Justin Pope has no position in any of the stocks mentioned. The Motley Fool owns and recommends Meta Platforms, Inc., Netflix, and Twitter. The Motley Fool has a disclosure policy.


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