What am I smoking? Clearly, I have lost my sanity. Every rational investor on the planet believes that Twitter (TWTR) is wildly overvalued. Even the most bullish of bulls believe that it is fully valued. Regardless of how it is calculated, the upside gain/downside risk ratio is microscopic when determined by traditional criteria. Have I succumbed to sensationalism as a shameless tactic to increase my page views? Maybe. Call me a dreamer, but I remain optimistic that I can eventually earn the minimum wage for my SA submissions. This is my beta trial.
I decided to do an article on TWTR after I ran the numbers. My initial impression was that every penny of upside was priced into the stock at the end of the first trading day. I expected my analysis to confirm this. After all, TWTR's book value prior to its IPO was a miniscule $1.09 ($4.18 post-debut). Once completed, I planned to move on to more promising investments. Well, I did confirm it. Based on certain metrics, I wouldn't touch TWTR on the long side. That's not the story, though. The intensity and persistence of bullish investor sentiment regarding social media firms is the real story. I believe that it will continue for at least twelve months, probably more. If this happens and TWTR [Facebook (FB) and LinkedIn (LNKD) as well] maintains its new user growth rate, the price could reach $74 by end of next year. In my opinion, this is an extremely rare case where the "buy high and sell higher" strategy looks reasonable. TWTR is a pure growth story. Value investors need not apply.
I present the data in the same sequence as my analysis. First, TWTR's operating results:
Several aspects are noteworthy. First, the CAGR column clearly shows a company in its early-life high growth phase. Revenues are soaring. Second, cost of revenues is growing at a much lower rate than the top line demonstrating the benefits of scale. Third, expenses are growing at a lower rate than revenues. Always good to see. Fourth, operating losses are growing at a still-lower rate although, ideally, this will reverse soon. Fifth, CF Ops has turned positive. Again, good to see. The only negative aspect is the high percentage of A/R. As you will see later, though, TWTR's proportion is lower than its two comrades so I guess it is not an issue at this point.
Here are the operating line items compared to revenues:
Note the dramatic increase in the proportion of revenues derived from advertising services. TWTR's ability to maintain the current growth rate in its user base and the revenues that come with it is central to my bullish thesis.
Here are the data for Monthly Active Users (MAUs):
Note the high compound growth rates. This is an impressive degree of market uptake. TWTR has barely scratched the surface of potential users, though. According to the company, there are 2.4B Internet users worldwide and 1.2B smartphone users. This implies a market penetration of only ~11% of all Internet users and ~16% in the mobile space. Also note the high growth rate of advertising revenue. This is due to the high growth of its user base. The growth rate of revenue per user is about the same as the growth rate in the user base. Ideally, TWTR would be increasing its revenue per user at a faster rate than the growth in its base. Increasing this metric is a central part of TWTR's strategy going forward, but maintaining the growth rate in the user base is essential for share price appreciation in the near term.
Let's look at Timeline Views:
Note the disparity in ad revenue/user in the U.S. versus international. In Q3'13, the figure of $2.58 is more than SEVEN TIMES greater than the international segment's $ .36. This is the specific target of the company's strategy of increasing its "per user" monetization because the international user base is larger and growing at a higher rate than the U.S. user base. This year, the timeline views/MAU should grow more than twice as fast internationally compared to the domestic market. The ex-U.S. arena is where the growth is.
The only negative aspect of the data is the sequential decrease in revenue per ad. TWTR states that this was due to excess inventory caused by a change in its targeting algorithms. I am sure this is true, but the discounting is substantial so I recommend that longs pay close attention to this metric henceforward.
The company disclosed that 76% of its average MAUs were accessed via mobile devices in Q3'13 versus 69% a year earlier. This is a key data point in the market's current valuation of the firm. Institutional investors perceive that TWTR is superbly positioned to monetize mobile users.
Finally, let's look at the comps:
The traditional metrics of P/S, P/B and EV/Revenue all shout out TWTR's overvaluation. But, as I stated earlier, this is not the story. The market value per user says it all. The message it sends is that institutional investors perceive an equivalent value in each company's individual user. In other words, despite TWTR's trailing metrics in almost every category, the market believes that it (and LNKD) will be able to monetize each user similar to FB. Under this assumption, TWTR's market cap should grow at the same rate as its user base.
Therefore, assuming a CQGR of 15.7%, TWTR's current share price of $41.65 will be $74.63 in twelve months. Before you start typing your critique, please note that this calculation ignores the 14.6% CQGR in revenue/user. I could argue that the price target is rather conservative without this benefit.
Institutional investors' enthusiasm for social media stocks is extraordinarily intense at present. When you look at the growth rates of the three leaders and the fundamentals of FB and LNKD, the reasons are self-evident. What's not to like? All three companies look like they will rule the online world. Considering the potential untapped global market for each company, well, only the sky is the limit. Institutional support for these three will remain unrelenting for many months to come. This situation reminds me of the early stage of the Internet boom in 1995-96. Investors' enthusiasm bubbled over for five years before falling flat in early 2000. By definition, investor sentiment is fickle and can change quickly, but I don't see it happening for quite a while if the companies can maintain their user base growth rates and demonstrate their ability to drive monetization.
Where will I be in this scenario? I may jump in if and when a low-risk entry presents itself. In the meantime, I'll be sitting at my computer responding to all the "Are you crazy?" comments.