Quick Thoughts: Catching the TWTR Knife

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SEE LAST PAGE OF THIS REPORT Paul Sagawa / Artur Pylak

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February 9, 2016

Quick Thoughts: Catching the TWTR Knife

TWTR remains in a jail of its own making, languishing at multiples incongruous with its torrid sales growth and expanding margins. Given GOOGL and FB’s very strong ad growth, and press reports of sales well above plan, we expect a substantial 4Q15 beat on the topline and bottom line. Still, sluggish MAUs remain the bugaboo, a FB metric that ignores the nearly 2/3rds of monthly TWTR users that do not log in. This uncounted user base is growing nicely, thanks to a partnership with GOOGL and nearly ubiquitous links from media sites and apps, and will be targeted with ads going forward. We see three plausible upside drivers: 1) Product improvements and a fresh marketing approach under the new CMO reenergize MAU growth; 2) TWTR successfully targets ads to unlogged visitors and monetizes Vine and Periscope; and 3) The low share price attracts bids from GOOGL, FB, Tencent, or others. With pessimism deeply embedded in the stock, we believe that the biggest future threat is the share price itself, which erodes TWTR’s ability to retain employees.

  • Expect a 4Q15 beat – Strong ad sales from GOOGL and FB, along with news leaks in the media, suggest substantial upside from TWTR vs. the 48% YoY sales growth and $0.12 EPS expected by consensus. TWTR is the number 3 platform for mobile ads and has been growing its share over the past several quarters, with the introduction of innovative native formats spurring advertiser enthusiasm. With low marginal costs, stronger ad volumes and pricing should flow directly to the bottom line, offset partially by ramping marketing spending.
  • MAUs to remain sluggish, while unlogged views boom. The aforementioned leaks also suggest slow progress in driving MAU growth, throwing cold water on the earnings beat. However, we believe the agreement with GOOGL to list Tweets near the top of topical searches has likely driven substantial traffic growth from unregistered users. With a plan in place to target advertising to these visitors, management has an opportunity to pitch investors on expanding their perceptions of reach and engagement to include these potentially lucrative users. Moreover, strong uptake of TWTR’s separate video apps, Vine and Periscope, represents a further vector for future monetization that could be better emphasized by management.
  • Product changes on deck. Management has vaguely confirmed leaks that it intends to add algorithmic timeline filtering and an extension of the 140 character limit to the service, prompting vocal protests from power users. We believe that the TWTR elite will be able to preserve classic Twitter by opting out of the new defaults, and that new interface will greatly improve engagement from more casual users. We expect that the product changes will be supported by a long overdue marketing campaign to re-assert TWTR’s consumer value proposition and to counter perceptions that the service is difficult to use. We also expect continued innovation for ad buyers, like the just revealed First View video product.
  • Employee retention is TWTR’s biggest risk. At some point, TWTR’s battered share price becomes a self-fulfilling prophecy, as valued employees grow discouraged and leave. Arguably, the recent departure of four senior executives can be seen in this light, and the potential for more attrition will give CEO Dorsey even more urgency for change than the pressure from investors. Despite the turnover, we believe that the management team is greatly improved from a year ago, particularly with the addition of new Chief Marketing Officer Leslie Berland from AMEX. We also see turnover on the TWTR board as healthy, particularly in light of the company’s difficulty in addressing investor concerns.
  • Acquisition is a possibility – Trading below a $10B cap – far less than the implicit value of Snapchat (and its 200M MAUs with $100M in annual revenues) and other privately funded unicorns – TWTR, with 2015 sales likely topping $2.25B and firm standing in the cultural zeitgeist, is a rare bargain. GOOGL or FB would have no problem juicing those pesky MAU stats, while the addition of the dominant real time news distribution app (along with Vine and Periscope) would be hugely synergistic to either company’s core business. The real question, and for potential foreign buyers like Tencent, is whether a deal could pass anti-trust scrutiny, particularly in Europe, where both GOOGL and FB are under unusual regulatory pressure.

Conclusions – The MAU monomania gripping potential TWTR investors has the stock nearly 75% off its 52 week highs, trading at just 4.2x its likely 2015 revenues despite nearly 60% annual sales growth and non-GAAP profitability far above previous projections. By comparison, mighty FB carries an 15.2x sales multiple on its 42% TTM growth, while even beat up LNKD trades at 4.5x sales on its 24% growth pace. Of course, the concern is that stagnant MAUs are a forward indicator of future growth.

Thus far, the relationship between MAUs and revenues has been tenuous – the notorious stall began over two years ago and sales growth continues at a torrid pace, as TWTR has proved to be immensely successful in monetizing its native advertising platform. Looking ahead, we see three main factors that could change the MAU driven narrative of gloom and doom:

  1. Product improvements and effective marketing induce casual visitors to register, driving a reacceleration in MAU growth.
  2. TWTR successfully targets its non-logged-in visitors for ads, monetizing a huge and growing stream of traffic, while generating value from its emerging Vine and Periscope products.
  3. An interested acquirer puts TWTR in play – GOOGL, FB and Tencent would all have substantial synergies in a friendly deal, if allowed by antitrust authorities.

Our biggest concern for TWTR is that the dramatic depreciation of its shares threatens its ability to retain its key employees, and, potentially, discourages advertisers from long term commitments, making the falling market cap a self-fulfilling prophecy for the business. We do not think we are near that point of no return, and believe that, however late, management under new CEO Jack Dorsey can exploit all three of these factors to reverse the trajectory of TWTR stock.

Given this, we remain bullish on the prospects for 2016 and view TWTR as one of the very best bets in TMT for performance over the next several months.

Exh 1: Number of Monthly Active Users by Property

Exh 2: Key TWTR Comp Metrics

 

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