Looking Closer At Twitter

| About: Twitter, Inc. (TWTR)

Summary

Twitter went public prematurely: Two years after IPO and its performance is still lacking.

Twitter's revenue has become massive, but the company's constant search for growth keeps it far from profitability.

I'm going to wait a few more quarters before deciding if Twitter is finally a bargain.

Twitter (NYSE:TWTR) stock has been a rare throwback to the early 2000s tech bubble when unprofitable indie companies would be pawned off on the public, soaring 50%, 100% and even 200% on the IPO date, falling like a stone afterwards.

I bought TWTR the instant it IPOed and was lucky to profit from some of that hype before selling a couple of days after. People often say that day trading is bad, and maybe it is, but when it comes to Twitter it sure beat investing long term.

But looking closer at the company I see that the situation here is not all bad. Revenues are increasing and expenses are going down meaningfully. They also report a non-GAAP profit. The market may be going too hard on this stock and if the company focuses on lowering expenses instead of growth I feel like TWTR can once again start going up.

What I think About Twitter.

In my opinion it would have been better if the company had been bought up by a larger firm instead of going public. TWTR stock is now down over 60% from its IPO price and far from the heady days of $75 a share in 2014. But the good news is that the bleeding appears to have stopped and I think the company may even be undervalued.

I feel this way because the company's revenues are increasing nicely while losses are going down. I think Twitter should focus on consolidating its now significant revenue into profits and focus on monetizing the attention it is currently getting instead of chasing increasingly hard to find and expensive growth.

Why is Twitter performing so poorly?

The idea that a company should be made public while nowhere near profitability is something that should have died in the tech bubble. Granted, sometimes there are exceptions. For example, Amazon (NASDAQ:AMZN) is a firm that can lose money every year but still remain a well performing investment because the company's reinvested revenue is seen as deferred and compounding profits for the future. The market is not giving this same privilege to Twitter.

Some people find it hard to believe that a social icon as ubiquitous as Twitter is could be losing money. Twitter is everywhere. From the presidential elections to sports, celebs, musicians athletes, everywhere you look you see the brand's footprint. The company has over 500 million users, 332 million of which are active and it is one of the top 10 most visited websites on the internet.

The financial data suggest the market is going too hard on Twitter.

Here is the company's revenue for the last three years:

2015 2014 2013
2,218,032,000 1,403,002,000 664,890,000
Click to enlarge

This is fantastic growth. In fact Twitter's gross profit has been going up an average of 97% a year for three years. When we look further we see that the company has increased revenue from a meager 28 million in 2010 to over 2 billion within six years.

And a good portion of the companies spending goes into research and development. A total of $209,218,300 for these three years.

And here are its losses (net income):

2015 2014 2013
-521,031,000 -577,820,000 -645,323,000
Click to enlarge

Even when we subtract the R&D spending this is some pretty expensive revenue. But still, it has been decreasing by around 10% a year. So undeniably there is a bullish argument here. These losses are huge but they are decreasing - convincingly. Not only this, but total revenue is increasing also.

Non GAAP Profit:

Twitter claims to have non-GAAP profit which paints a different picture of the company's financial situation. This is calculated by removing the company's massive stock payments to employees from the profit calculation.

How you chose to view this is up to you, but note the scale of these payments: In 2014 this payout totaled 50% of total revenue. Facebook has a similar program, albeit only 10% of revenue. Twitter bulls can note that these payments are equity, not cash, and even though they seem excessive, compensation schemes like this one can be a useful tool for a growing company.

The Revenue:

Advertising dollars are still huge part of Twitter's revenue stream. According to the company's 10-K, advertising dollars make up 90% of the company's revenue with the remaining 10% being data licensing.

But if you thought the monetization style was Twitter's problem (as I once did) think again. When we look at the company's primary competitor we see that a staggering 97% of Facebook's (NASDAQ:FB) revenue came from advertising last year. However, Facebook managed to make GAAP profit with this monetization strategy while Twitter cannot. Advertising dollars are a finite resource and the two companies are fighting over the same plate - this does not bode well for Twitter.

Long-term growth potential

Advertising revenue can only do so much, especially when the company seems to have peaked in popularity. This is probably what causes the market's lack of faith in the stock.

In the fast changing social media landscape advertising revenue is simply not a safe bet. People will naturally move on to new things and trends that were once cool eventually lose relevance. On the flip side we see that companies like Amazon that actually sell a product or service, are much better at keeping a place in the customer's mind. Consequently, the market is quicker to forgive their lack of profits.

As we can see Twitter's user growth is expectedly slowing:

The peak was all the way back in 2009.

International growth is hampered:

For advertising revenue to be a real money maker it is highly dependent on the U.S market. This puts limitations on the company's potential for revenue growth by expanding overseas.

In an analysis from Trefs:

"Advertising revenue per 1,000 timeline views stood at an estimated $4.42 for the U.S. in 2014, more than five times the corresponding figure for the international segment."

This is simply because emerging markets like Brazil and India have significantly less purchasing power. So while Twitter is poised to surge in these markets a full fledged expansion there will mean more costs and more losses (on an already weak balance sheet) on top of a tighter spread between expenses and revenue. If I was running the company I wouldn't even bother.

Is branching out the solution?

Twitter has several options going forward, one of which is to branch out into more social media roles. Periscope, its live broadcasting service, shows promise for revitalizing the company, boasting over 200 million live broadcasts and new users. Live video is a booming segment and periscope could be a way for Twitter to get back in the game.

The NFL also has recently announced that it has selected Twitter as an exclusive streamer of its football matches. This privilege was not free, getting this position cost of the company between $10-$15 million. Nevertheless, I would say this was R&D dollars well spent.

Conclusion.

TWTR is not a terrible stock. Its value of around $15 is fair and I don't think it will drop from here in the foreseeable future. However, as it stands the company seems to be getting its act together. Revenue is growing nicely and inching closer and closer to GAAP profitability. However, if the company doesn't focus on consolidating its current market share into profits that day will take a long time to come. I have to see Twitter with a few more quarters of decreasing losses before I can really consider myself a bull on this stock.

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.