Twitter: Black and Blue, but Read All Over

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Twitter: Black and Blue, but Read All Over

For the past year, TWTR has been whipsawed on the volatility of its monthly active user growth and the revolving door of the company’s management ranks. While many investors are skeptical, the company recently outlined a narrative by which its revenues could rise tenfold in the intermediate term. We believe that the scenario, which relies on doubling its monthly active users, increasing user engagement, boosting ad density and monetizing unregistered users, is conservative. TWTR’s vast unregistered user base will be tapped as the company resolves functional problems in its app design and communications strategy. Moreover, a powerful secular shift toward digital advertising and rich new ad formats will support both higher ad loads and better ad pricing. We are more skeptical on TWTR’s ambitions to monetize unregistered users, but note that the potential to leverage the platform into new products is considerably greater than has been implied by management’s new narrative. Given less intensive infrastructure requirements than either GOOG or FB, we expect TWTR to deliver superior profitability as it gains scale, and project better than 80% GM and 50% EBITDA margins for 2019. Applying a FB like 19x multiple to 2018 revenues and discounting back at a 30% discount rate, reflecting considerable market and execution risk, we believe TWTR shares have more than 100% upside from current prices.

TWTR has had a rough 2014. Shares are off 35%+ YTD despite upside margins and triple digit sales growth, as investors are still fixated on a perceived plateau in users and engagement. In the wake of FB’s post-IPO struggles, TWTR had focused on monetization, failing to identify and address problems with the app that impeded adoption and engagement. At the recent investor day, management moved to reframe this narrative, offering a detailed strategy for addressing Wall Street’s specific criticisms and laying out an alternative scenario by which the company could see a 10x rise in sales and 40%+ EBITDA margins in the intermediate term.

Turning lurkers to registered users. TWTR has 284M registered MAUs, but another 500M monthly users that visit the service without logging in. The first step in TWTR’s strategy is converting as many of these casual users into MAUs as possible. A streamlined on-boarding process is more productive in completing account registrations and driving better initial engagement with the service. Richer content and customer education/communications should help to keep those users engaged as they come on board. With a more concrete view of TWTR’s unregistered audience and a credible approach for improving sign-on, we have more confidence that the company can meet its intermediate goal of doubling its MAUs with a longer term potential to crack the exclusive billion plus user club.

Boosting engagement. Raising the frequency with which users access TWTR and increasing the number of items viewed with each visit expands the inventory of ad slots that can be sold. To this end, TWTER intends to add more compelling content and boost its sharing and messaging capabilities. Better content organization (e.g. event/ interest specific timelines, location linked content, and new search tools) and recommendations (e.g. timeline highlights, alerts, trending topic notifications) have great potential for raising the utility of the TWTR app and thus, drive further engagement. We believe that management’s projection of a <5% revenue bump from engagement may prove to be conservative.

Increasing ad density. TWTR currently offers 1.3 ads per 100 items displayed in its users’ timelines. Management is targeting a 5% ad density, in line with FB, and should be able to meet or exceed its goal. Compared to FB, TWTR’s interest based user profiles offer better targeting, its information distribution focus offers better context for ads, and the primary use case makes advertising less obtrusive. TWTR’s goal of a nearly 4x increase in ad load, and thus, a similar rise in ad sales, could be conservative and embeds an assumption of flat ad engagement and pricing. Recently, TWTR ad prices have been in decline, but the appeal of new, rich media ad formats, better ad engagement rates and a secular shift toward mobile digital advertising in general could yield stable or rising net pricing going forward.

Monetizing unregistered users. Each month, 500M unique users visit TWTR without logging in, a base that is growing as quickly as the 284M registered MAUs. These engaged but unregistered users arrive via links to specific poster profiles, links to specific tweets, search engine results or by browsing the site directly, and their revealed interests bring a context for advertising that has, thus far, not been exploited. Management’s scenario envisions monetizing unlogged visitors at a $2.50 ARPU, half the current MAU ARPU and about 12% of the projected future MAU ARPU. This represents about 12% of future sales in TWTR’s scenario, possibly a stretch on its face, but does not include any monetization for the 185B syndicated tweet impressions per quarter nor any further growth in total unregistered users.

Pulling other levers. The TWTR scenario does not include revenue outside of timeline advertising.Still, sales of data remains more than 10% of TWTR revenues and is growing at a better than 100% YoY pace. The Vine video sharing service, the MoPub mobile ad exchange, and alternative channels for distributing TWTR content are identified revenue opportunities with potential to add meaningfully to future sales. Moreover, like FB and GOOG, we believe TWTR’s core content distribution business provides a platform that can be leveraged into linked services that can draw new users and generate incremental engagement. This optionality has real value.

Expanding margins. Because TWTR’s core franchise requires relatively less deep storage and processes far fewer user transactions – user searches, content uploads, etc. – it requires less investment in its data center infrastructure than do its more computing intensive peers FB and GOOG. As such, we believe steady state gross margins should top 80%, and that EBITDA margins, excluding stock compensation, could be 7-10% higher than management’s target range.

Answering the skeptics. TWTR management, with many missteps and executive changes in the near past, has not earned the benefit of the doubt from most investors. Increasing ad density and pricing have driven double digit growth, but TWTR needs to reaccelerate its MAU growth and sustain it over more than a quarter or two if it is to overcome the embedded skepticism and rerate. To achieve this, the company must deliver substantial improvements to its core product – eliminating friction in the on-boarding process and giving users much better tools to parse increasingly rich content. It also needs to effectively proselytize these changes to consumers. We believe that the new TWTR narrative is realistic and that the stock has substantial upside potential, but recognize that the near term hurdle is high.

For our full research notes, please visit our published research site.

 

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