Reaffirming The Bullish Thesis For Twitter

| About: Twitter, Inc. (TWTR)
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Shares are up big over the last month, but still 33% off their 52-week high.

The stock has an interesting user base that could be more useful than Facebook's.

The company bested earnings expectations and has revised 3Q earnings upward.

There still appears to be plenty of upside.

As the world increasingly uses mobile devices, Twitter (NYSE:TWTR) continues to benefit from this trend. Twitter grew its unique visitors to 121.6 million in July - a 3.4% month over month increase, according to comScore. Facebook (NASDAQ:FB) continues to be the overall leader with 205.6 million, up 1.3% m/m. Both these social platforms have immense potential, most notably for advertising.

Twitter remains much smaller than Facebook, but the growth in revenues is ahead of the industry average and its reach is steadily increasing. There are some concerns whether its product is mainstream enough to justify the near 30x sales the stock trades at.

But Is Twitter wrecking itself?

Millions of people find Twitter useful, but the real question is whether it can reach the same level as Facebook. That might be hard if it continues to limit third party apps. It currently prevents third parties from using its API, hoping to prevent duplication of its platform. But there's marked concern over its in-house developed apps, which are relatively poor. Twitter's history of closing down third party apps will also lead to developers to be more cautious on building apps for the service.

And with Twitter's platform type, it's a force to decide on whether it wants to appeal to a large number of people who will use it a limited amount, or can appeal to a smaller number of people who will use it much more. Twitter is going for mass adoption, and thus, it's issue at hand is increasing engagement.

While we're up just 8% since our April note. At the time, we noted that,

Once Mr. Market can digest the fact that a slowing user base isn't necessarily a bad thing, and that a maturing user base is a positive for revenues, I'd look for more consistency and clarity in analyst estimates. For now, the fact that the highest 2015 analyst revenue estimate is 50% above the average, and the lowest is 20% below, gives me little reassurance that Wall Street can do a better job at predicting the numbers than my local Starbucks' barista.

Twitter still has a key opportunity when it comes to engagement, versus say Facebook, because it appeals to a different demographic. From April, we outlined the case that it wasn't about the number of Twitter users, but it's about the amount these users are engaging. We noted,

Facebook's core audience, percentage wise, is 18 to 24-year-olds, while Twitter's is 25 to 34. By 2018, the 35 to 44-year-old demographic will match the number of teens using Twitter. For Facebook, the percentage of teens using the site outpaces 35 to 44-years-olds by some fifteen percentage points. Marketers will flock to the platform getting engagement results. Older people deliver results.

2Q in review

Toward the end of July, Twitter crushed earnings. Shares soared over 25% on the news. Since 2Q earnings, shares are up 31% - holding up nicely. The social network posted 2Q earnings of $0.02 a share (beating consensus of a $0.01 loss) and revenues were $312 million (topping $282 million consensus).

One key was the growth in its monthly active users, which reassured us in the strength of the platform when it comes to generating advertising revenues and exploiting the potential of e-commerce. Revenues rose 124% y/y, driven by a 129% y/y gain in advertising revenues. Mobile accounted for some 80% of advertising revenues.

Monthly active users grew by almost 24% y/y to 271 million and mobile users grew by 29% y/y to 211 million. Timelines views (a measure of engagement) was up to 173 billion, increasing 15% y/y. The company guided for 3Q and full year 2014 revenues well ahead of consensus estimates.

We're also very encouraged by the company's progress in broadening its platform capabilities and revenue generating opportunities. Twitter is already looking into ecommerce, which would enable users to buy products and services on the platform itself.

Also, in a note back in March, we stated,

Another initiative involves embracing the "second screen." It's looking to help advertisers directly target TV conversations happening on Twitter, and then tailor ads to certain audiences. Advertisers can then insert tailored messages to a user's timeline.

We believe this is still a big opportunity. Almost every big sporting event, awards show or TV show has a real-time Twitter presence that is a huge market opportunity for advertisers.

Bottom line

2Q was more than bulls could have hoped for, and the 3Q guidance has gotten most of the market very excited. It's tough to look past the valuation, but we believe that investors who can will continue to be rewarded. Much like Google's perceived overvaluation a decade ago, Twitter still has key opportunities that will allow it to grow into its valuation.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.