Twitter At $10?

| About: Twitter, Inc. (TWTR)

Summary

As per a previous article, my fair value target for Twitter of $15 has been reached and breached.

Using a methodology I have developed to value growth stocks, my current fair value for TWTR is about $13-15 a share.

However, if bearish market conditions continue, or if the market overshoots, we might see the company at $10 a share.

A long time ago, in a galaxy far away, I said I was willing to pay about $15 in 2015 and $21 in 2016 for Twitter (NYSE:TWTR), based on the valuation model I described in the above-linked article.

Well, folks, the $15 a share mark has been reached and breached to the downside (though TWTR was trading above $15, as of noon Friday in New York). So the question is, is TWTR enough of a bargain to make me bullish? Let's look at selected highlights from the company's recent quarter.

A tale of increasing revenue and flat user engagement

First of all, non-GAAP diluted EPS came in at $0.16 for Q4, and $0.40 for the full year 2015. That compares to $0.12 for Q4 and $0.14 per share for the full year of 2014. That's a very big increase.

However, EPS does not count in this case, because any way you slice it, if we look at TWTR from an EPS standpoint, it is a very (and I mean very) expensive stock. So, while the year-over-year increase in EPS is great, it does not mean much in the eyes of the market (not yet anyway). Q4 revenue totaled $710 million, an increase of 48% year over year. Revenue for the full year came in at $2.2 billion, or an increase of 57% year over year.

That's a very good increase, and it's the main reason why I think TWTR is worth (or was worth) about $15 a share (please read my valuation logic in the article linked above).

As for Q1 2016, the company is guiding $595-$610M, which is below the consensus of $629.3M. This is a big minus for my revenue model. Please recall I put a lot of emphasis on price/sales in my evaluation of growth stocks such as TWTR. So, if revenue growth slows, my fair value also goes down.

For the full year 2016, analysts are forecasting $2.97 billion in revenue. Now, when I looked at my previous article on TWTR, I noted analysts were forecasting $3.23 billion in revenue for 2016. So, in other words, forecasts are being trimmed. I am assuming they might come down even more.

So taking my previous valuation approach of what I think TWTR is worth, my model now calls for the value of the company to be around $13.4 billion. And if we divide that by the current number of shares, that comes out to about $19.60 a share. That is down from $21 a share that I mentioned previously, however, that is still good. I should be bullish on TWTR right?

Hold on one minute, I said I was willing to pay 5X revenue for 50% revenue growth. If revenue growth decreases, what I am willing to pay also comes down.

The company did $2.2 billion in revenue for 2016, and if analysts get it right (and if estimates do not come down), TWTR should do $2.97 billion in revenue for 2016. That comes out to 35% revenue growth and not 50%.

So, based on this information, I would be willing to pay 3.5X revenue for 2016 for TWTR, minus a 10% discount for dilution, which comes out to a market cap around $10.5 billion. And, if we divide this by the current number of shares, that comes out to about $15.20 a share.

Those pesky engagement numbers

But wait, there is that pesky issue of user engagement we have to factor in. Similar to why I was bearish on Pandora (NYSE:P) (please consider Pandora Stock: How It Might Act Post Earnings), there is a limit to how much monetization can increase in the absence of an increase of users. Meaning, while TWTR is doing a good job of increasing revenue - as a result of better monetizing assets - if daily or monthly users do not increase, at some point, revenue will not increase either.

Now, while we do not know what TWTR's monetization limits per user is, investors realizing that eventually revenue will not increase will become more and more conservative with their approach and valuation of Twitter (as they have become).

As per the recent quarter, the company's monthly active users (MAUs) totaled 320M, which were flat sequentially, and only up by 9% year over year. What this means is that TWTR is probably approaching some kind of limit as far as user engagement (thus far that is).

So, I will factor in the low year-over-year increase in MAUs by putting an additional 10% discount to my valuation. As such, I would say that my fair value for TWTR is about $13.50 a share.

If we also factor in the general market environment - which are bearish at the moment - and the fact that markets always overshoot, I would say that there is a very good chance we might see TWTR trading as low as $10 per share before the stock rebounds and is probably more suitable for long-term investors.

Final thoughts

Am I being too conservative? Perhaps. However, my method of evaluating stocks such as TWTR has saved me many times from making big mistakes, and has also made me money at the same time. Since TWTR is very close to my fair value, this article is neither a short nor a long recommendation, but simply a reference to what I think it is worth.

And, while I am very sure TWTR will reach my targets at some point, I cannot tell you if it will go to $20 before it goes to $10.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.