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Dheepan Ramanan
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Long term investor focused on technology stocks. Current technology consultant focused on delivering sentiment analysis in social media.
  • Fail Whale: Twitter's Cautionary Tale  0 comments
    Feb 11, 2014 11:03 AM | about stocks: CRM, CTSH, FB, TWTR

    As Oasis said "What's the Story Morning Glory?", Twitter(TWTR) tanked Thursday morning to the tune of 24%. I have been watching the stock and it's massive post IPO run-up with a great deal of caution and curiosity. However, I have been thoroughly bearish on the prospects of the stock. This criticism is founded on their business model which has several foundational problems for growth and for monetization.

    1. What's the difference between a service and a business?

    Plenty of great businesses start as out as an idea for a service. Facebook started out as a way to help college students "connect", Google began as a way to find information. However, a service alone is not a business. A business finds a way to transform it's service into a way to make money.

    Common sense, but what then is TWTR at the moment?

    As a metaphorical conjecture, let's compare Twitter to the New York Times. The NYT offers a great service to the general public with fantastic coverage of news with in-depth analysis. But clearly they have had contemporary difficulties of translating that service into profits, even with an explosive growth in page views. You wouldn't bet on the New York Times to become a highly profitable company as they haven't shown any ability to be one in the recent past.

    The same holds true for Twitter, the greatest achievement of Twitter so far has been as a service, one that has broken down barriers of communication between figures of authority and the general public. A service that has radically transformed coverage of media events.

    However, they have shown little to no aptitude in monetizing that service in the past.

    2. Revenue growth is great, but how are you improving your business model?

    Twitter loves to highlight it's growing revenue and user base numbers, but let's take a deeper look at what's going on.

    Year

    2010

    2011

    2012

    2013

    Revenue

    28,278

    106313

    316933

    664890

    Expenses

    -95,757

    -233724

    -394016

    -699220

    Net Income

    -67,479

    -127,411

    -77,083

    -34,330

    Margin

    -239%

    -120%

    -24%

    -5%

    Twitter started as a disastrously inefficient business in 2010, and has since improved to have the margin of an underperforming retailer, and posted a net profit (if you don't include stock based compensation) for Q4 2013. These results, despite the growing revenue do not give you a grave deal of confidence in their leadership or expertise in monetizing their business.

    When looking at Twitter's growth in MAU's and monetizing, we have seen gains but clearly much worse relative performance, this is especially in comparison to Facebook at 1.056 billion MAU's, and $7.46 per user.

    Metric

    2010

    2011

    2012

    2013

    MAU's

    54,000

    117,000

    185,000

    241,000

    MAU/Revenue

    $ 0.52

    $ 0.91

    $ 1.71

    $ 2.76

    Net Gain per MAU

     

    74%

    89%

    61%

    Let's look at 2014's projections,

    Projections

    2014

    Revenue (Low End)

    1,150,000

    Net Income (Low End)

    150,000

    Margin

    13%

    Twitter anticipates a 13% margin next year, which would be less than Google (GOOG), Baidu(BIDU), and Facebook(FB). Let's look at what this picture would mean in terms of monetization and MAU count.

    Projections

    2014

    MAU's (30% Growth)

    313300

    MAU/Revenue

    $ 3.67

    Net Gain per MAU

    33%

    After making an assumption for 30% growth in MAU's (same as Q4 2013), we see that TWTR needs to improve efficiency by another 33% to meet their revenue goal. Both these targets seem to indicate much slower than growth in the past, again pointing to difficulties monetizing Twitter's business. If those figures held, Twitter would be 202% less efficient in monetizing it's users than Facebook was for last year. TWTR can help make up some of that ground with mobile app install ads, but you have to question as to how the company will double its efficiency in the next couple of years just to match the efficiency of Facebook.

    Common sense dictates that Twitter is used more as a news aggregator, something to "check-in" than somewhere to spend several hours interacting. This is because outside of power-users, most users' content is not interacted with, meanwhile in Facebook your friends comment, like, and give their opinions on content you post. The IRL connection is why mobile app install ads can work so well on Facebook, apps are vetted by people who you know, who recommend a product. Given that the average Twitter user spends 21 minutes every month on the platform (source), this confirms my suspicion that Twitter is more of a news source than a place of consistent and enduring social interaction.

    In that sense there is more potential for Facebook to generate more income out of the 6.75 hours most users spend per month than for Twitter to squeeze out exponential returns on 5% of the same amount of time. This is compounded by the fact that the user base seems to be slowing, and is much smaller than Facebook. To neutralize the opportunity cost, one would have to provide evidence that Twitter plans to radically change how users interact with the platform.

    3. Sometimes it's better to invest in companies profiting off of a service, than the service provider.

    Despite my unflinching bearishness on the prospects of Twitter as a business to invest in, I recognize the value of Twitter as a public service.

    There is tremendous value in Twitter as a data rich source for businesses to mine for insights. I see the biggest money makers from Twitter to be companies that supply B2B connections to the data. Twitter's data partners and companies that specialize in creating social media insights will likely to the ones to be profitable from Twitters growth.

    One example is GNIP (private), GNIP is one of the few official data partners of Twitter, and operates a social media firehose that has full archival access to Twitter. GNIP supplies this firehose to other firms that provide social media analytics and data aggregation such as Salesforce (CRM). In exchange for access to the data, GNIP gets paid and in turn passes off a piece of the profits to Twitter. As a smaller, and leaner operation, I would estimate that GNIP has much better margins and room to grow as demand increases for Twitter data.

    Another company that is publicly traded that will benefit from Twitters growth is Cognizant(CTSH). Cognizant provides consulting and analytics services, including incorporating social media analysis in innovative ways for their corporate clients. As Twitter grows, so will its influence on public discourse. As a result companies will look to invest more in service providers who can provide actionable insights using Twitter data. I believe investors stand to do better from investing in companies like Salesforce and Cognizant, than they do from investing in Twitter.

    Disclosure: I 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.

    Themes: long-ideas Stocks: CRM, CTSH, FB, TWTR
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