Don't Discount Twitter Just Based On The Latest Earnings - Twitter Earnings Q3 2015

  • Twitter stock fell 10% plus in the aftermath of Q3 earnings on the 27th of October primarily due to the less than 1% sequential growth in its MAU metric and low revenue guidance for Q4.
  • Net Loss printed in Q3 is coming down compared to the second quarter of 2015 and the quarter of 12 months prior. This is encouraging with revenues still growing meaningfully.
  • The stock is a buy but still not at these levels. Watch the price to sales ratio. The company may not be worth $20 billion+ when you consider that the company still hasn't turned a profit since going public

Jack Dorsey has a lot of work to do to turn around Twitter (NYSE:TWTR) and we got a glimpse of how investors currently feel about the trajectory of the company after Q3 earnings with the stock declining 10% in after hours. Even though the company is trying to downplay the importance of monthly active user growth, it is still by far the most important metric which investors look to when valuing the company.

Twitter Earnings - What Went Wrong?

Twitter only grew its user base by 4 million users which definitely confirms continuing slowing growth. Analysts had expected 324 million (or an 8 million gain) but the company reported only 320 million. Revenue came in at $569 million which beat analysts expectations of $560 million but year on year growth declined slightly from 62% to 58%. The company's adjusted EPS of $0.1 easily beat analysts expectations of $0.05. However what compounded the user growth stagnation and the subsequent stock sell-off was the company's guidance for the fourth quarter. Twitter is guiding between $695 to $710 million in revenues for the fourth quarter which is well below original analyst expectations of $739.7 million. The company did $479 million in revenues in the Q4-2014. Assuming the company delivers $700 million in revenues next quarter, that will be a 46% growth rate meaning that bit by bit Twitter's revenue growth is slowing which is worrying considering this metric was the company's one real shining light. Nevertheless I still see Twitter as a strong buy once the share price comes back to more reasonable levels. Let's discuss.

Firstly 1% sequential in monthly active users and 8% growth on a rolling year basis will simply not be enough to lure big advertisers into Twitter over time. Although the company is trying to downplay the importance of this metric, it still is crucial despite the company's efforts in trying to increase engagement levels among its users.

What's Dragging Gross Margins?

Advertising equated to 90% of the revenue number for Q3-2015 but worryingly gross margins declined to under 65% due to the fact that 11% of its revenue count is coming from off network placements. Off network means that there are third party publishers involved who receive compensation by placing twitter ads on their platforms. Now there are both positives and negatives in using ads on third party networks. The positive is Twitter can still grow its revenue substantially even in the absence of sluggish user growth. The 11% revenue count in Q3 of this year was only 2% in Q3 of 2014. So yes Twitter can tailor to more advertisers than many analysts believe, due to using third parties, but it will come at a price. What price? Well the negative is margins will more than likely drop as revenues rise. This is why it is much more beneficial to grow its user base meaningfully to keep margins elevated. This has to be the company's main objective.

Twitter Is Cutting Net Losses

The second reason why I still see potential in Twitter (at an attractive share price) is the net loss number it printed, which came in at $132 million. This metric is why the company could easily beat EPS projections going forward like it did this quarter. Why? Well, when Dorsey was ratified as the company's CEO, he immediately announced a mass lay off in the company which was definitely needed in my opinion. Revenues were increasing but net losses were also compounding quarter over quarter. Well I believe that has come to an end with the company's quarterly net loss figure of $132 million. The chart below shows that Q3-2014 printed a net income loss of $175 million, while last quarter, it printed a loss of $156 million. Having revenues rise and losses fall has to be good for the company, long term. Furthermore we probably have not seen the effect of the afore mentioned lay-offs in the financials thus far so expect losses to decrease further as we go into 2016.


Source : CSI Market

When you delve deep into the numbers, it is quite obvious that the company has improved meaningfully in its "ad engagement" metric which increased by 165%. This metric (which shows ample runway for growth) should alleviate some investor's fears about the company's slowing user growth rate. It seems that Dorsey is on the right track here, through new products such as "Moments" and the soon to be launched "140plus". If engagement levels keep increasing at this rate, revenue growth will stay elevated despite the current sluggishness in its MAU metric. The company's current price to sales ratio is 11.19, which is still too high for value investors to enter. However if the company can continue to increase its revenue substantially without moving the share price, this metric will come down substantially. Many investors are waiting on the side-lines to enter into this stock when its share price becomes attractive. However with a market cap of more than $20 billion which is still more than 11 times revenue, it still looks on the expensive side, for the time being.

Twitter Earnings: Summary

To sum up, Twitter to me is an attractive stock because of the products coming down the line, very good monetization execution and revenue growth. If it can sort out its MAU growth, this stock has a lot to offer. Watch its P/S ratio. There may be some downside left in Twitter (as management are guiding sluggish user growth over the next 12 months). However if the company stays over 50% with revenue growth, and total ad engagements continue to flourish, this company could offer some real value going forward.


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