Twitter Stock To Drop More Before A Rebound

  • Twitter is still growing its topline meaningfully despite not turning in a profit so far. Just look at revenue growth and gross profit margins.
  • International users may provides less revenue on a per user basis but Twitter should still pick up this low hanging fruit. Constant efforts to make the platform easier to use should help.
  • Higher engagement levels can equate to more advertising revenue. This platform above any other has the potential to really raise its game in this area because its the only true "real-time" social network.

Twitter (NYSE:TWTR) stock is currently trading at just over $26 a share (similar to IPO offering) which is a huge disappointment when you compare it to how Facebook (NASDAQ:FB) ($38 a share IPO offering) has rallied. What adds insult to injury is that the S&P 500 (INDEX:SPAL) is up 20% since Twitter's IPO which makes one believe - what would have happened in a down market?

TWTR stock chart

Source: Twitter stock price data by amigobulls.com

The stock dropped again after third quarter earnings due to only 4 million users being added in the third quarter and lower guidance for the fourth quarter. Analysts have basically left this stock for dead claiming that static user growth will not grow the bottom line meaningfully. Furthermore, with a forward price to earnings ratio of over 53, analysts still believe Twitter stock is way over-valued. This may be true but revenue  came in at $559 million last quarter which was a 58% year on year increase.

Granted the growth rate slipped a bit from previous quarters but this is still a huge growth rate over 12 months. Analysts and bears alike are stuck on the user growth number which seems to be the main metric they use to value the company. However, one thing is clear. The longer Twitter can keep its top line growth elevated , the more its price to sales metric should come back into sync. Its current price to sales ratio of 8.65 is just too high when you consider the company is yet to turn a profit. Nevertheless, turning a profit is not all that important (As Amazon shareholders know all too well) if gross profits are growing meaningfully and being pumped back into the business which in Twitter's case, they definitely are (see chart). Twitter has simply too much going for it to die a quick death. It will rebound once the new management gets their act together.

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Source: MarketWatch

Firstly, even though management on every earnings call tries to play down the MAU (monthly active user) growth metric, analysts remain concerned that this platform can become a mass market social platform. Furthermore, analysts seem to be punishing the stock for growing its "off network" revenue stream (11% of revenues last quarter compared to 2% from the quarter of 12 months prior) as margins are lower because these third party publishers obviously receive compensation for showing the twitter adds. This is where analysts don't take everything into account, in my opinion. My take on third-party publishers is this. If Twitter can grow the top line even with slipping margins in order to invest into products that could potentially grow the bottom line, then its the right thing to do. The perfect scenario of course would be for Twitter to be growing its in-house user base exponentially every quarter but that is not happening at the moment. Therefore instead of looking at the bearish argument, look at how this extra revenue stream can be used to grow the business and user-base accordingly. Every cent at the moment is going back into the business. The more products and initiatives Twitter can engage in (from this increased revenue stream), the more possibilities the company has in growing its 320 million user base going forward.

Secondly, user growth is static in the US as the platform seems to be locked on 66 million users. The US market accounts for approximately 65% of revenues which makes US users far more valuable to the company on a dollar basis. Revenues jumped in the US by 54% last quarter even though the user number only grew by 3%. The spike in revenues was due to excellent monetization by Twitter, resulting from high ad engagement driven by auto-play videos and other features. While I do feel that Twitter can eek more revenue out of its existing userbase, the company has to be very careful not to saturate the platform with ads. In saying this, it must be said there is ample room for growth internationally where user growth came it at 13% last quarter. Twitter's CEO Jack Dorsey has stated that the platform is getting easier to use every week which should enable the company pick the low hanging fruit internationally over time.

Furthermore, Twitter really stepped up the engagement levels of their users in the third quarter of this year (see chart below) which definitely bodes well for the future. The platform is going more and more towards live streaming with recently rolled out products such as Moments plus other services like "Vine" and "Periscope" which are growing nicely but have yet to be monetized. The misconception out there is that unless user growth is robust, Twitter won't grow meaningfully. Engagement levels can also grow the top line meaningfully and live events (definitely the direction Twitter is moving to) have the power to really make Twitter a "sticky" platform. Therefore, ignore "CPE" levels going forward. They will continue to fall due to huge surge in videos on the platform which show cheaper ads.

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To sum up, the more analysts beat down Twitter stock despite its robust revenue growth, the more value investors will begin to become interested. Revenue and gross profit numbers are still rising robustly. Net income is still in the red due to elevated investment but this company has ample room to grow its user-base, especially internationally. If Twitter can become the stand-out platform for following live events, then user growth will improve significantly over time due to much higher engagement levels (which will bring in more income) as compared to other platforms. I have no doubt that user growth and engagement levels will increase over time but until the former happens frequently, expect Mr Market to take a bearish stance on Twitter stock.

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