Twitter: The Good, The Bad, And The Ugly

Jul.29.14 | About: Twitter, Inc. (TWTR)

Summary

Twitter’s strong revenue growth is expected to continue.

But the users growth rate and engagement remains a big concern.

The company is working on a number of product enhancements to make the product simpler and gain more subscribers, but we are yet to see meaningful results.

The valuation remains expensive.

Twitter (NYSE:TWTR) impacts the daily lives of millions of its users and has evolved into a go-to-resource for up-to-date information on news, events and sports. It has fundamentally changed the way people consume real-time news and information. Whenever a major event unfolds, from political upheaval in the Middle East to Academy Awards (33 billion tweets about the show in just two days), Twitter is very prominent. However, Twitter has its limitations, which at times can be frustrating. Twitter isn't as intuitive as other social media platforms, such as YouTube and Facebook (NASDAQ:FB), and its restrictive features like 140-character limit can sometimes easily put off its users.

Despite of Twitter becoming a leading one-to-many communications tool in developed and select developing markets, it is still a niche product. For all the loyal users who check twitter multiple times a day, there seem to be an equal number of people who just don't get it. Unlike many other social media platforms, Twitter can be difficult to understand and use for the novice.

While one can argue that Twitter still has a lot of room and opportunity for advertising on the service to grow and expand. For example, the increasing use of native ads in the Twitter feed as well as increased use of video can give a boost to revenue but do the current multiples justify these expectations? Simple answer is, no. Twitter faces challenges ahead as the company simplifies the product and attempts to make it easier and more intuitive for the average user. Facebook, on the other hand, I think offers much better risk/reward ratio compared to Twitter. You can read my article on Facebook here.

The Good - Revenue Growth

Twitter has reported strong revenue growth. The San Francisco, CA based company registered revenue and advertisement growth of 110% and 120% respectively in 2013. Moreover, in the first quarter of 2014, revenue grew by 120% and advertising by 125%. The company's average revenue per user (ARPU) in the U.S. is $2.79 and $0.35 outside the U.S. (which I think has significant room to grow) while the competitor Facebook has ARPU of nearly 3 times that of Twitter. Moreover, Facebook's ARPU will continue to rise while Twitter's service continues to attract few incremental users than investors expect and engagement concerns persist. That said, the growth in advertising revenues tells us that Twitter has found advertising formats that work for the advertisers.

From a revenue perspective, the reach and personalization of Twitter coupled with newer ad formats and greater acceptance of mobile will lead to strong revenue growth and Twitter can even exceed the market expectations. Revenues are expected to remain strong as advertisers are increasingly moving towards online and mobile. Twitter has established itself in mobile. It is a mobile first company with ~80% of its traffic coming from mobile.

The Bad - Subscriber Growth and User Engagement

It's the subscribers' growth, which is a concern. Twitter will find it increasingly challenging to attract substantial new users in the presence of the growing number of new and more user friendly networking sites. In order to address the issue of user growth rate and engagement and make the product simpler the company is introducing and has introduced several changes to drive increased engagement. The sign up process, with just a couple of steps, is much simpler compared to more than 10 steps earlier. To help users make the right connections from the outset and get the most out of the experience, Twitter is asking permission of new users to get access to their contacts. Users can now also add photos within a tweet more easily.

The point is Twitter is taking steps to make user experience simpler, drive increased engagement, and attract more users but to make the product more intuitive and make a huge impact the company needs to go further. As of now, the company's efforts regarding this haven't yielded any significant results as the migration to a simpler more intuitive service hasn't delivered any significant increase in engagement or subscribers growth.

Twitter's strategy to grow users comes from many small product iterations as opposed to one large-scale product overhaul. Over the past quarter alone, Twitter has rolled out numerous enhancements around enriching media in timelines (photo sharing/tagging, photo editing tools, GIFs, video previews) as part of its ongoing efforts to develop Twitter as a more interactive and visual platform. Twitter has also rolled out multiple desktop product enhancements such as redesigning desktop user profiles to make it easier for people to discover appropriate accounts to follow and developing interactive browser notifications. However, we are yet to see these efforts impact user growth or engagement. It will be interesting to see to performance of these unique product enhancements in the company's quarterly results.

The Bad Continues

As I mentioned before, Twitter needs to make its product simpler and more intuitive in order to attract more users and convince the masses of its value. While it has clearly become a mainstream product from media and entertainment perspective, from the user perspective, Twitter never really broke into the mainstream. Just take example of its monthly active users. On mobile and desktop combine, Twitter has only 255 million monthly active users. On the other hand, on mobile alone Facebook has more than 1 billion users (1.32 billion monthly active users on mobile and desktop combine).

Moreover, with all the new entrants in the market and the older players trying to gain a larger market share with more user friendly and tailored ideas, they can easily usurp Twitter's users. The company needs a constant growth in users and innovation to stay ahead of the curve.

Twitter also faces a gap in monetization outside the U.S. While 77% of accounts are outside the U.S., the company generates 70% of its revenue from the U.S. Twitter generates $3.47 per 1000 timeline views in the U.S. but only $0.61 per 1000 internationally. This dynamic needs to change and Twitter needs to close the gap in monetization outside the U.S. While admittedly Twitter's ad products are relatively at an early stage, particularly in international markets, the opportunity is still under-monetized when compared to Facebook.

The Ugly - Valuation

Twitter is down 37% YTD. With no expected earnings and no real free cash flow until 2015, Twitter is valued on revenue growth, user growth, and user engagement. As I mentioned earlier, revenue growth is not really a concern but the market is concerned more about the slower growth in Twitter's user base. The user growth has raised concerns among investors that the company might not be able to add as many users as expected.

Despite of the YTD underperformance, the company is still trading at a premium compared to Facebook and industry. Twitter has a whopping forward price/earnings ratio of 1666.7 compared to only 39.5 of Facebook. Twitter has EV/ Sales [ttm] of 25.3 compared to 17.9 of FB. On 2015 numbers, Twitter is trading at EV/Sales of 9.9, slightly below Facebook.

Facebook offers much better risk/reward compared to Twitter. However, I believe the market can become more positive on Twitter shares at Facebook-like multiples. As I mentioned earlier, revenue growth is not a concern. However, for Twitter to move further over the next few years and not just the next few quarters, the company needs to show real improvement in both user growth and engagement.

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Conclusion

The micro-blogging company is working on a number of product enhancements to make the product simpler and gain more subscribers. The fact that the management is altering the platform tells us that something isn't working. Slower user growth, less engagement, and monetization outside the U.S. is a big concern for Twitter. Despite of the YTD poor performance, Twitter is still trading at premium compared to peers. However, the fundamentals do not justify the current lofty valuation. Twitter needs to do much more than the recent product innovations and enhancements to convince the market that it can be profitable in the long-run and continue to attracted new users. I prefer Facebook over Twitter. You can read my article on Facebook here.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.