On Tuesday shares of Twitter (NYSE:TWTR) plummeted by 18 percent. The reason for the plunge was the fact that the “lockup” period ended, meaning that May 6 was the first day that insiders were allowed to sell their shares on the open market.
The stock has already had a rough 2014 with shares down 50 percent. Of course this is after an incredible run up since the November IPO. Furthermore, while the stock is hitting new lows as a publicly traded company, for many of the insiders that were locked into their positions until today, $32 per share is an incredible price to realize. While I’m sure the insiders who sold their holdings would have rather gotten $50 per share, they are likely sitting on triple digit, or even 4-digit, gains on their initial investments.
Given that Twitter was already trending downward, and given that we will potentially see more shares hit the market as the lockup period expires, I don’t think the downtrend is over. Nevertheless, there is little doubt that Twitter plays an integral role in today’s social media world, and management has done an excellent job finding ways to monetize this platform. As a result, I believe that there is some point at which there is sufficient value in Twitter shares for value investors to start buying.
But it is difficult to know where this point is for a couple of reasons. First, Twitter isn’t generating any earnings, and so it is impossible to assign a price to earnings multiple on the stock unless we assume that revenue growth will outpace expenditures so that at some point in the future the company will have earnings. But this could be in 2015, or maybe it won’t be until 2020.
Second, we could assign a value to the platform itself, but we have nothing to compare it to. Twitter — like many other leading social media platforms — is unique, and it is impossible to make an apples to apples comparison the way we can with two different drugs, or two different brands of clothing. In order to make some sort of apples to apples comparison, we would have to go back to earnings power, and again this is very difficult to predict.
Given these points it is no wonder that Twitter insiders are happy to unload shares onto the market at 20+ times revenue and at 40 times gross profits.
Nevertheless at some point the stock will reach a point at which we will be able to project earnings and earnings growth. For now, however, in order to get a rough idea of the company’s earnings potential we can look at revenue and revenue growth. The company trades at about 20 times revenue, which is extremely high. But at the same time revenue is growing at a triple digit pace. The bulls argue from this point that the stock is cheap, but we have to keep in mind that such rapid growth is unsustainable for an extended period of time. However, 75 percent growth is sustainable for the next several years.
Now a company such as Amazon (NASDAQ:AMZN) trades at a level now that is in line with its revenues about three years from now. If Twitter were to also trade at its revenues three years from now it would be worth about $4.3 billion, or about a fourth of its current valuation. But if we assume that the company can maintain its current growth rate of 120 percent or so then it is worth about twice that.
So, while it is difficult to value Twitter, using rough estimates, it is clear that the stock is overvalued. At the same time it is rapidly declining in value. As we have seen with other social media IPOs there is a period of weakness in the months following the IPO before the company finds support. We saw this with Facebook (NASDAQ:FB) and Groupon (NASDAQ:GRPN) as well. I suspect we will see something similar with Twitter. The stock will fall until people start wondering why the company has any value in the first place, and this will be the time to buy.
Of course Twitter and similar companies aren’t for the faint of heart. It is a very difficult investment to make. Long term it can be very lucrative, and if you buy at the right time I suspect that it can be one of the best investments you ever make. But above all else, be patient and wait for the stock to come down in value.
If you want to delve deeper into Twitter and see what analysts as well as the company management thinks, we have you covered. After Twitter announced first-quarter earnings on April 29, we put together some critical questions from the company’s earnings conference call. Here’s a recap:
1. What are Twitter executives looking at?
One of the issues at the heart of the conversation surrounding Twitter — maybe the issue — is metrics. Specifically, which metrics matter? Which metrics actually signal growth of Twitter’s core business machine, the social platform that serves ads to its users?
The answer to this question isn’t exactly clear. For example, there’s a fairly justifiable focus on user growth (or, reach) because Twitter’s entire business is predicated on having a sufficiently large user base. The value of a social network is, at least in part, a function of the size of its user base in both the eyes of other users and in the eyes of advertisers. The sheer size of Facebook’s user base is, arguably, one of its greatest competitive advantages over smaller and ostensibly more nimble (niche, at least) social networks like Twitter. Twitter’s 255 million MAUs are just a fraction (about 20 percent) of the 1.28 billion MAUs Facebook ended the first-quarter with – are just a fraction, even, of Facebook’s 802 million daily active users, 1.01 billion mobile MAUs, and 609 million mobile DAUs.
Apparently suspecting that MAU growth doesn’t quite capture the whole picture, Diana Kluger from JPMorgan Chase asked Costolo “if you could prioritize to us which metrics you’re looking in order of importance.”
Costolo’s answer provided some meaningful insight. He recognized that there are various metrics that compete for the attention of analysts and executives alike and that “it’s not binary,” but revealed that his team is focusing on engagement. “If you think about over the course of the long term, we’re going to drive up engagement, we believe, over all of these axes,” he told Kluger. “But the current focus on increasing the value of a single timeline has this multiplicative effect, as we’ve seen, on monetization.”
Timeline view volume (engagement) increased 15 percent on the year to 157 billion, or 614 per MAU. Advertising revenue per timeline view (monetization) increased 96 percent on the year to $1.44 — a 3 percent sequential decline was cited as seasonal.
2. What is Twitter’s use case moving forward?
It’s no secret that Twitter has competition. It’s also no secret that Twitter struggles with a little bit of identify crisis. With Facebook — by now a massive business machine hungry for growth — dominating the landscape, Twitter has been forced to defend its use case. This means identifying what about its business is unique and valuable, and what ultimately will keep and increase users and increase engagement. The company has had to prove that it understands why people use its service over others, and that it knows how to capitalize on that understanding.
Anthony DiClemente of Nomura Securities summoned this specter, asking Costolo what he’s doing in when it comes to differentiating Twitter’s use case. “We think of Twitter as this companion experience to what’s happening in your world,” Costolo responded. “And I really see that as the consistent use case over time,” he added. Costolo revealed that as a platform, his team believes that Twitter “is already incredibly mainstream.”
Costolo then underscored his answers to the metrics questions. Namely, he said that, “Now what we need to do is help that world of users who already experience Twitter every day understand the value, the increased value of the log-in experience.” In other words, dig deep, and grow through increased engagement and more sophisticated monetization — and not, specifically, through aggressive user base growth.
3. How important are idiosyncratic events?
“You mentioned the Olympics as a live event that was a driver of behavior in the quarter,” DiClemente, the analyst from Nomura continued. “I just wondered if can you talk about other idiosyncratic events like the plane that went down in Malaysia or the events in Ukraine, and how those compared to something like the Olympics in terms of being a driver of the KPIs that you’re looking at.”
Twitter CFO Mike Gupta took the question, and he made one key observation about how different types of one-off events may or may not be a boon for the company. That distinction is the difference between one-time events that are naturally commercializable, like the Super Bowl, and one-time events that are not naturally commercializable, like the situation in Ukraine. Advertisers are not flocking to Twitter to serve ads orbiting the situation in Ukraine, but they do flock to Twitter to serve ads orbiting the Super Bowl.
So while the situation in Ukraine increases engagement on the Twitter platform, it doesn’t necessarily directly stimulate business activity. There is no doubt some benefit from increased timeline views, but it’s unclear how meaningful this is.
4. What about global competition?
Twitter is not an American phenomenon. In the first-quarter, Twitter reported U.S. timeline views of 46 billion, up 16 percent on the year but accounting for just 29 percent of the total. Moreover, international timeline view growth of 15 percent was not meaningfully lower than timeline view growth in the U.S. As a share of total MAUs, the U.S. accounts for just 22 percent, and MAUs grew much faster internationally (+27 percent) than in the U.S. (+19 percent) in the first-quarter.
Understanding that Twitter is an international — global — platform, Jordan Monahan from Morgan Stanley asked a high-level question: “We’re wondering, do you think that over time that users tend to congregate around a single global service? Or do you think there are regional differences that would actually prevent that from happening and natives kind of short messaging and communications just inherently more local and more regional?”
The question is a pretty heavy one, and heavier still in the shadow cast by a Facebook fat with the acquisition of WhatsApp. If users are going to congregate around a single global service, is that service going to be Twitter? What does Twitter look like if it’s not?
“I think that platforms like Twitter don’t see that kind of regional differentiation,” Costolo said in response to Monahan’s question. Costolo brought up examples like KakaoTalk and Line, mobile messaging apps that are ostensibly competitors with WhatsApp, and added that “we see a broad global distribution of our users.” Costolo’s implication is that Twitter has some meaningful advantage over these services.
5. Where are ad loads and where are they going?
“I was hoping you could talk a little bit about where you are on ad loads,” said A. Justin Post of Merrill Lynch. This is one of those issues at the intersection of usability and monetization: how much advertising can Twitter support without jeopardizing the user experience? What is the capacity and, more specifically, where is the current ad load in relation to that capacity?
Gupta answered, saying that Twitter’s ad load remains “very low.” Low ad room has afforded the company some flexibility — as Gupta put it, “We’ve had the luxury of being able to improve ad revenue per timeline view and monetization without impacting our ad load.” This is basically a best case scenario, maintaining the user experience while increasing monetization. Gupta highlighted progress in Twitter’s ability to deliver relevant content, putting the right ads in front of the right viewers — a trick that advertisers will pay for.
Here are Twitter’s earnings slides.
Disclosure: Ben Kramer-Miller has no position in Twitter, Amazon, Facebook, or Groupon.