Twitter: A Simple Business With Big Challenges

| About: Twitter, Inc. (TWTR)

Summary

Twitter would have to buy back 66% of its shares every year to have a P/E of 20 by the year 2020.

The slow growth in MAU is a serious problem for Twitter. MAU to revenue correlation is 90%.

Balance sheet growth in short-term investments outpaced total revenue growth.

Twitter is extremely risky for both long and short, any slight buyout rumor pumps the stock.

Introduction:

Twitter (NYSE:TWTR) has lost money throughout its short existence. To this day, the company still can't turn a profit. Yet there is some opportunity to increase user engagement and continue to grow revenue. The $10M NFL deal Twitter won in April could open new doors, but with slowing advertising demand, much more than the NFL is needed to save Twitter.

I have come up with some future scenarios of what it would take to finally make Twitter a value stock, both in the near term and the long term.

MAU growth

Twitter's Global MAU number is struggling to get past 320M. If you are wondering what Twitter considers an MAU.

"Monthly Active Users (MAUs). We define MAUs as Twitter users who logged in or were otherwise authenticated and accessed Twitter through our website, mobile website, desktop or mobile applications, SMS or registered third-party applications or websites in the 30-day period ending on the date of measurement. Average MAUs for a period represent the average of the MAUs at the end of each month during the period. MAUs are a measure of the size of our logged in or otherwise authenticated active user base."

(Source: Twitter 2016 Annual Report)

The slow growth in MAU is a problem for Twitter. It believes that returning to meaningful MAU growth in the future is dependent on improving its product and feature offerings to demonstrate its value proposition to a larger audience. If it is unable to increase the user base, user growth rate or user engagement, or if these metrics decline, the products and services could be less attractive to potential new users, as well as to advertisers and platform partners, which would have a material and adverse impact on the business, financial condition and operating results.

The correlation between MAUs and revenue since 2014 is 90% but it is in decline.

Click to enlarge

(Image by Michael A. Ball, data from Twitter)

The size of the user base and users' level of engagement are critical to Twitter's success. It had 320M average MAUs in the three months ended December 31, 2015, representing a 9% increase from 292M average MAUs in the three months ended December 31, 2014, and flat versus the three months ended September 30, 2015.

In the three months ended December 31, 2015, MAUs, excluding SMS Fast Followers, grew 6% year over year to 305M, but were down for the three months ended September 30, 2015. Twitter's financial performance will continue to be significantly determined by growing the number of users and increasing their overall level of engagement on the platform.

Click to enlarge

(Image by Michael A. Ball, data from Twitter)

Investment exposure.

Twitter is taking higher exposure in short-term investments compared to the revenue it generates annually. The 2016 Annual Report showed on the balance that it sheet grew in short-term investments compared to total revenue during FY 2015.

Click to enlarge

(Image by Michael A. Ball, data from Twitter)

This exposure mainly consists of short-term fixed-income securities, including government and investment-grade debt securities and money market funds. These securities are classified as available-for-sale and, consequently, are recorded on the consolidated balance sheets at fair value with unrealized gains or losses, net of tax reported as a separate component of accumulated other comprehensive loss. Twitter says that it has an investment policy and strategy to focused on the preservation of capital and supporting our liquidity requirements.

Click to enlarge

(Image by Michael A. Ball, data from Twitter)

U.S. government treasury exposures have grown significantly, and as you might be aware, the yields on government bonds have skyrocketed (resulting in price decline).

Click to enlarge

(Image by TOS)

Click to enlarge

(Image by Michael A. Ball, data from Twitter)

The following tables summarize unrealized gains and losses related to available-for-sale securities classified as short-term investments on the Company's consolidated balance sheets as of December 31, 2015, and 2014 (in thousands).

Click to enlarge

(Image by Michael A. Ball, data from Twitter)

Bond and equity market downside price moves are something of a concern, not only would Twitter's stock take a hit, but its balance sheet would also be contracting due to the high exposure in investment compared to expected revenue intake. The SPX Index is trading at 27X earnings currently, signaling its already overpriced compared to its historical average of around 18X.

Goodwill from December 2014 to December 2015 jumped 80% and pumped up the balance sheet, due to acquisition-related activity.

Click to enlarge

(Image by Michael A. Ball, data from Twitter)

In Millions of USD

As of 2016-09-30

As of 2016-06-30

As of 2016-03-31

As of 2015-12-31

Goodwill

1,184

1,186

1,123

1,123

Click to enlarge

Q3 2016 Goodwill showed a slight decline of just over 5% compared to the 2015 balance sheet.

In a recent Annual Report published, Twitter shows that sales and marketing have the biggest cost, followed by research and development. The breakdown in expenses as a percentage of revenue is shown.

Click to enlarge

(Image by Michael A. Ball, data from Twitter)

Twitter's revenue shows good historical momentum and is linked to MAU growth. It would need to dramatically slash expenses for GAPP EPS to finally be positive. Management reported that it is laying off 9% of its worldwide workforce. The cutbacks should fundamentally impact margins for the better.

Click to enlarge

(Image by Michael A. Ball, data from Twitter)

Click to enlarge

(Image by Michael A. Ball, data from Twitter)

You can see, revenue has always been lagging the enormous cost it takes to run Twitter. Management currently has minimal options available to improve this other than cutbacks on staff.

Click to enlarge

(Image by Michael A. Ball, data from Twitter)

With only two streams of revenue, advertising (90% of revenue) and data licensing (10% of revenue), in September, Twitter began broadcasting NFL games on Thursday night. It was paid a reported $10M to broadcast 10 games. This was intended to regain support from advertisers.

The WSJ said "Twitter will show the live CBS feed on its mobile app and website, along with running commentary of tweets and commercials from brands such as Budweiser and Bank of America. It is the first of 10 such Thursday night National Football League games in a $10M deal Twitter won in April.

Mr. Dorsey, a Twitter co-founder who returned as CEO last year, has made video central to his turnaround effort. The social media company is hoping to attract advertisers' bigger video ad budgets by becoming a prime destination to watch live events. But it is a tough sell that will require time and strong execution-two things Twitter is short on these days."

A long road to profit

If we look at the growth from 2014 to 2015 as reported in the 2016 annual report and assume this was constant every year (not likely), at the current assumed rate by FY 2017, revenue should be slightly more than expenses.

Click to enlarge

(Image by Michael A. Ball)

Keeping with the assumptions of growth in revenue and growth in cost and expense, we will assume MAUs grow at a similar pace (for model simplicity). Shares currently are 714M outstanding. Twitter has not hinted at buying back any stock from what I am aware.

Click to enlarge

(Image by Michael A. Ball, data from Twitter)

For this purpose, we will keep shares outstanding at the current level, then show what rate of buybacks would be needed to have a 20 P/E valuation. Currently, EPS is negative and will be shown at zero on the chart.

Click to enlarge

(Image by Michael A. Ball)

Year

2018e

2019e

2020e

2021e

2022e

2023e

2024e

2025e

2026e

PE

7,056.64

2,992.92

1,471.72

780.02

432.47

247.04

144.12

85.40

51.20

Click to enlarge

By 2026, Twitter could have a PE of 51. In 2020 the PE ratio would be 1471.72. Still an expensive stock, even with an unlikely model assumption.

By 2026 at a constantly assumed growth rate, EPS would be 0.36.

After adjusting the buyback rate, and assuming the $18 share price, Twitter would have to buy back 66% of its shares every year until 2020 to get to just under 20X earnings.

Year Estimates

2017e

2018e

2019e

2020e

PE

8,727.90

815.75

117.63

19.67

Click to enlarge

If we drop the buybacks to 20% YoY the results are.

Click to enlarge

(Image by Michael A. Ball)

The numbers speak for themselves, even with continuous growth rates Twitter still would take an extremely long time to be an attractive stock.

Consider that I was including buying back stock in the model, Twitter shares increase historically, so if I was to flip the model and add shares at a rate of 5% YoY, the PE would look like this by 2023.

Click to enlarge

(Image by Michael A. Ball)

Conclusion:

Twitter is not a good long-term investment and requires a lot of work by management to turn the company profitable, It needs a new business model what brings more revenue in cheaper than it is currently. Twitter's basic model is not exactly converting the billions in revenue into profit compared to its social network rival Facebook (NASDAQ:FB). It is hard to argue why Twitter would be the main platform for social media in the future if it does not change.

Any significant legitimate rise in share price is usually due to buyout rumors, multiple companies have been rumored to buy Twitter in the past but none seem to have stepped up to the plate, this showing yet again that value at current levels simply does not exist in Twitter.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a short position in TWTR over 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.