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Summary

  • Twitter's 2015 consensus revenue growth rate of 66% does not justify its excessive earnings multiple.
  • Looking at "Price Earnings to Revenue Growth" ratios, Twitter is 80% more expensive than Facebook.
  • Taking both Facebook's and Google's "Price Earnings to Revenue Growth" ratios into consideration, Twitter is worth $39.

Yesterday, Janney Capital Markets implemented a rare downgrade of Facebook (NASDAQ:FB) citing concerns of decelerating growth that will "raise valuation concerns through 2015."

Despite their value apprehension on FB, Janney maintained their "buy" rating on Twitter (NYSE:TWTR), whose price target they increased from $48 to $60 following TWTR's less than stellar 2Q earnings release in late July.

Now, is it appropriate to downgrade FB at $75, trading at a 2015 P/E ratio of 37x while raising the price target of TWTR from $48 (representing a P/E ratio of 132x) to $60 (representing a P/E ratio of 166x)?

Sure. If the growth rate makes sense.

But does TWTR's growth rate justify its earnings multiple? Let's find out by comparing "Price Earnings to Revenue Growth" ratios (which is the P/E multiple divided by revenue growth rate).

Why not just use PEG ratios (which are P/E multiples divided by earnings growth rate)? Well, I have a point of contention with the consensus earnings estimate of TWTR for 2014. It's expected to be $0.10 per share. The problem is that consensus earnings are GAAP measures and, year to date, TWTR's GAAP earnings are -$0.47 per share thereby implying $0.57 of GAAP earnings for 2H2014.

That's completely improbable. Since there's limited seasonality and we can still expect ~$380M of Stock-based Compensation expenses in the second half of 2014, it appears that 2014 consensus estimates were either wrong or non-GAAP or both. Moreover, 1Q14 GAAP earnings were -$0.23 and 2Q14 GAAP earnings were actually slightly worse at -$0.24 so there's no trend to indicate that the next quarters would yield positive GAAP earnings, let alone an average of $0.285 per quarter in order to arrive at the 2014 consensus estimate of $0.10!

As such, you can't compare stated 2014 consensus earnings of $0.10 - that are clearly inaccurate - to what appears to be a more reasonable 2015 consensus earnings estimate of $0.36 ($0.09 per quarter seems like a decent normalized run-rate). Intuitively, with TWTR's 2015 revenue growth expected to be 66%, a 2015 earnings growth of 260% ($0.36/$0.10) is not achievable!

So I've chosen to analyze the implied value of TWTR and its peer group using P/E multiples and - instead of earnings growth rates - another income statement line item, revenue growth rates. I've substituted bottom-line growth for top-line growth. In the end, it's more important that the metrics are apples-to-apples, influence earnings and are relative measures (compared to other companies).

Hence, the "Price Earnings to Revenue Growth" ratio.

FB is expected to have 2014 revenue growth of 56%, declining to 34% in 2015. There's the deceleration of growth that Janney cited.

TWTR is expected to have 2014 revenue growth of 104% but that rate is decelerating to 66% in 2015. Apparently, there are no concerns about this level of deceleration, which I would imagine is a function of it growing at almost twice the rate of FB.

Keep in mind, however, that FB's 2014 revenues of $12.2 billion are over 8x more than TWTR's $1.4 billion. Said differently, though FB's revenues are growing at half the rate of TWTR in 2015, it faces inertia having to increase 8x the amount. So +30% growth on a base of $12 billion is much more impressive than +60% on a $1.4 billion base.

The "Price Earnings to Revenue Growth" ratio

As such, it appears that at its current price level, TWTR's high rate of growth is more than adequately priced into its stock, relative to FB.

2015 Price Earnings to Revenue Growth ratio comps

TickerP/E multipleRevenue growth ratePEG ratio
FB37x34%1.1
TWTR132x66%2.0

Source: Yahoo Finance

Examining the appropriateness of the applied Price Earnings to Revenue Growth ratio shows that TWTR is excessively valued when compared to FB, trading at an approximately 80% (2.0/1.1) premium on that metric!

Adding Google (GOOG, GOOGL) into the foray, another internet company with components of social media whose revenues also rely heavily on advertising, we arrive at the same conclusion; that Twitter's P/E multiple is simply too high.

2015 Price Earnings to Revenue Growth ratio comps

TickerP/E multipleRevenue growth ratePEG ratio
FB37x34%1.1
TWTR132x66%2.0
GOOGL18x18%1.0

Source: Yahoo Finance

Conclusion: So How Much is Twitter worth?

Using FB's Price Earnings to Revenue Growth ratio of 1.1, let's add a 50% premium to that metric for no reason in particular... call it a "small cap irrational social media premium"... a sort of generous catch-all for unexpected upside surprises on future revenue growth. We get a revised metric of:

1.1 x 50% premium = 1.65

and applying it to TWTR, we arrive at a 2015 P/E multiple of:

1.65 x 66% 2015 revenue growth rate = 108x

and that warrants a TWTR stock price of approximately:

2015 consensus EPS of $0.36 from Yahoo Finance x 108 = $39

Note that without my arbitrary premium, the warranted stock price would be $26.

Is that fair? Who knows. But it's more appropriate relative to how its larger but much more profitable competitors trade.

Competitors, I might add, that are expected to completely dominate worldwide mobile internet ad revenue in 2014 with Google having a 46.8% share and Facebook 21.7%, dwarfing Twitter's share of 2.6%.

Source: Twitter's Valuation Does Not Make Sense