Don't Buy Into This Twitter Stock Dip Yet

  • Twitter reported a weak MAU and revenue growth rate YoY, coupled with weak guidance.
  • The company struggles to monetize live video, a product that could benefit the company in the long run.
  • In the short term, with growth at risk, I’m bearish on Twitter.

Twitter (NYSE:TWTR) reported its Q2 earnings on Tuesday, with mixed results, and disappointing growth and outlook figures that triggered a sharp correction in the stock price. Even though Twitter published disappointing results for a long period, its stock soared by more than 30% in the last three months, fueled by potential buyout rumors and hope that Twitter will follow LinkedIn (NYSE:LNKD) after Microsoft (NSDQ:MSFT) agreed to acquire the professional network for $26B.

Twitter’s earnings report brought investors quickly back to reality, clearing the hype and buzz about a possible buyout and highlighting the severe operational challenges the company faces. In June, Bloomberg reported that Snapchat attracts more daily users than Twitter, and the MAU (‘Monthly Active Users’) growth figures that were released reaffirm that Twitter is losing traction. This is an enormous disappointment as Twitter's Periscope is one of the best assets in the live video streaming segment and should enable the company to attract more users. However, Twitter is not utilizing the maximum potential of Periscope as Facebook (NSDQ:FB) and Snapchat are doing with their live video features.

TWTR_chart 2_022716

Twitter has been a growth story ever since it came online; the declining growth rate is due to an enormous failure by CEO Dorsey, and there are additional concerns about Twitter’s ability to drive future growth without significant change. I tend to agree with Wedbush analyst Michael Pachter, who noted that although Twitter remains “the place to go” for live broadcasts, the management has appeared complacent about the status quo and is not focused on the lack of user growth. Until Twitter focuses on attracting new users, driving increased use among existing users, and demonstrating its value proposition to people who don’t use the service, the analyst expects it will grow very slowly.

Since Twitter is having trouble translating its strong live video assets into sales, the company’s revenues, which are generated mainly from advertising (88% of total revenues), are experiencing a continuous decline. As shown in the chart below, the YoY growth rate is decreasing in both business segments and has reached its lowest level since Twitter went public. This declining trend is expected to continue in Q3, as the company has provided a weak guidance of $600M (midpoint), which is roughly flat to Q2 and much lower than the market consensus of $678M.

TWTR_chart 3_072716

When going over the earnings release, investors should keep in mind that Twitter signed a long list of partnerships to bring authoritative content to Periscope to generate user growth and drive ad sales. Content from the NBA, NFL, college sports, CBS, and other sources is expected to be the first step towards monetizing Periscope and utilizing its potential to the maximum. However, with its soft guidance, Twitter is signaling to the market that monetizing the video business will take longer than expected and will not come to fruition anytime soon. It is an enormous test for CEO Dorsey, who is still occupied with Square (NYSE:SQ), which is struggling in the e-payments market.

Dorsey’s challenge is even bigger when looking at the social network ad spending forecast by eMarketer, which projects a 7.9% market share for Twitter and a whopping 67.9% for Facebook. Not only must Twitter accelerate Periscope monetization, but it also must beat Facebook and Instagram.

I believe that Twitter has reached a plateau in its growth figures directly linked to its core platform, and the company should push harder to grow the audience for its video business. A growing user base, coupled with strong content popular with advertisers, will drive a long-term rise in ad sales. However, Twitter is expected to face intense competition on that front from Facebook, AOL/Yahoo (NSDQ:YHOO), Google’s YouTube, and others. I am bearish on Twitter for the short term, and I believe that the company will experience further pain before it will be able to thrive again. Twitter has a strong financial base to lean on during the "pain" period ahead; it has a steady gross margin of around 70%, $3B in cash and short-term investments, and a huge impact on world affairs. In the long run, I believe that Twitter will rise again, either through a buyout or by adding significant new features to its platform.

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