November 3, 2013 – Twitter: Out of the Nest, Into the Sky

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TWTR sales growth will be driven by 5 factors: number of users, engagement by users, ad density, ad pricing and additional monetization vehicles. Monthly active users were up 39% YoY in 3Q13, with considerable further room for growth, given TWTR’s affinity for mobile. We expect a 25-30% CAGR through 2017. Timeline views per MAU were up 8% in 3Q, but had been growing at better than 16% previously. As TWTR’s media partnerships bear fruit, we expect engagement to reaccelerate somewhat in the near term and to average 8-10% growth over the next 4 years. Ad density is by far the biggest driver of TWTR’s 100%+ sales growth, with ad engagements per timeline view 2.5x vs. last year. FB’s results are clear evidence of users willingness to absorb more ads, and given our belief that TWTR is far more conducive for advertising, we project 60-70% annual growth in ad density going forward. In contrast, pricing has been declining 62% YoY as TWTR has increased the inventory offered in its ad auctions. We expect this to temper somewhat, with a mix shift to higher CPM video and increasing advertiser enthusiasm yielding a more comfortable 20-30% yearly deterioration. Finally, we believe that TWTR has substantial potential to offer new money making services on its platform, but have included no value for this optionality in our model. In aggregate, we are projecting ad sales growth of 60-70% and modeling $4.5B in 2017 revenues. Applying a FB multiple to that and discounting back at 30% yields a present value of $30B+. 

TWTR is far from saturation. TWTR has 232M MAUs, 75% with mobile access. That is over 13% penetration of smartphones, 9.5% of internet users, and 20% of FB’s user base. In developed markets, TWTR enjoys 24% penetration of internet users, vs. 22% in developing markets. 80% of potential developing market users are in countries where TWTR is well positioned, while 20% are in countries where TWTR faces competitive challenges, including 5% in countries, like China, where TWTR faces outright bans. Given its natural affinity for mobile service and the fact that many smartphone brands include it as a default app, we believe that TWTR can grow to at least 50% smartphone penetration in markets where it is well positioned, and 10% in markets where it is available but challenged. With more than 3.5B smartphone users expected by 2017, this suggests a target of 650-800M MAUs, and a 25-30% annual growth rate.

Engagement can improve. TWTR users visit their timelines an average of 7.5x per day. FB users view an average of 44 pages on the service each day. While page views are not the same as site visits – TWTR users may view multiple “pages” on each visit – FB engagement is likely a 3-4x multiple of TWTR on an equivalent basis. TWTR visits/MAU slipped sequentially in 3Q, but have been on a rising trajectory over the past 7 quarters. With new media partnerships kicking in, we expect user engagement to return to growth in 4Q. Assuming an 8-10% CAGR, timeline visits per MAU per day ought to exceed 10 by 2017, and could reach 11.

Ad density is increasing. The number of TWTR ad engagements, per timeline view, is 2.5 times higher today than it was a year ago. Still, sponsored tweets appear to be less than 1 in 50 posts for U.S. users. We believe that TWTR ads are relatively benign to the user experience, and thus, project that US ad density could triple again before becoming an annoyance to users. Outside of the US, where we believe ad densities are considerably lower, the increase could be considerably greater. With international timeline views outnumbering US by nearly 3 to 1, we believe ad density could increase at more than 60% annually through 2017.

Declining ad pricing could reverse. TWTR’s average revenue per ad engagement declined 62% YoY in 3Q13, a sharp deterioration from the 40% decline noted vs. the previous year. Given TWTR’s auction process for selling its ad inventory, the change in trajectory is likely tied to the simultaneous sharp increase in ad inventory made available. TWTR has only been selling ads for 3 years, and we expect prices to stabilize as ad buyers grow more comfortable with the efficacy of the platform, a phenomenon that has been apparent in ad pricing for Facebook and Google before it. Furthermore, we expect a considerable mix shift toward video advertising, carrying much higher CPMs, as TWTR’s broad roster of new media partnerships begins to bear fruit. These positive effects will be somewhat offset by a continued volume shift toward international markets, which carry lower advertising pricing. Net net, we expect overall ad pricing declines to decelerate going forward, averaging 20-30% annually through 2017.

TWTR could pull other monetization levers. Today, TWTR generates nearly 10% of its revenues from sales of its data to licensees. This stream has and will grow more slowly than advertising revenues, but should still account for 2-3% of sales in 2017. The MoPub acquisition could make TWTR a leading network for mobile ads on other sites, a potential source of significant new revenue. TWTR could also pursue other opportunities to monetize its primary service – e.g. premium content subscriptions, click-to-buy commerce, etc. – or to launch additional revenue generating services that leverage its user base and interest graph – e.g. a unified messaging platform, an Instagram-like photo sharing service, etc.. We have not included revenue from new products in our model, but the opportunity is there.

Revenue projected to grow at 60-70% CAGR through 2017. Assuming a 25% CAGR in MAU, 8% in daily user timeline views, 60% in ad density, and 20% decline in ad rates, TWTR’s advertising revenue growth rate would be just over 60%/yr and overall 2017 sales would be just under $4.3B. Taking the upper end of our user growth, engagement and ad density estimates, but applying a 30% annual decline in ad pricing, suggests 70% advertising sales growth and over $5.2B in 2017 sales. Our model, toward the lower end of this range, assumes 65% annual ad sales growth and projects 2017 sales of $4.5B.

TWTR is likely worth more than $30B. FB and LNKD both trade at trailing sales multiples of more than 20 times. If TWTR is able to grow at the rates that we believe that it can, applying a similar multiple to our projected $4.5B in 2017 sales would yield a future valuation of $90B or more. Of course, relying on future projections is extremely risky, but applying a 30% discount rate to account for that risk suggests a present value of more than $30B for the company. Even a 40% discount rate would value TWTR at $23B, about double the low end of the preliminary pricing range.

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

 

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