Quick Thoughts: TWTR’s lock-up expiration feeds the bears. Time to buy.

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–          The expiration of TWTR’s post-IPO lock up triggered a significant sell-off, taking shares to an all-time trading low of just over $32, off 45% in less than 3 months. This is a serious overreaction.

–          TWTR is growing revenues at better than 125% on well-received monetization initiatives and is on a trajectory toward 40%+ EBIT margins. The current price is a significant buying opportunity.

–          TWTR’s much publicized user growth slowdown is the result of management inattention – the app must be fixed and the company must communicate its compelling use cases to consumers.

–          The fix will take time, but. leadership is in place and the app is being redesigned to push to the 70M+ latent users that have the app but don’t use it. Expect user growth to pick up by year end.

After delivering top and bottom line beats last week and a subsequent sell-off on skittishness over user growth, Twitter is taking another beating today on its lockup expiration. Twitters IPO experience contrasts its larger social network rival Facebook, which saw substantial share sales at IPO followed by months of sub-IPO pricing and a post expiration pop of about 13%. For Twitter, executive insiders and strategic investors avoided selling at IPO and even went so far to assure investors during the latest earnings call they would not sell at lockup expiration. As of noon today about 60M shares traded and eventually closing at 135M, a high volume for a name that typically sees 14M shares trade on an average day, but far from an insider fire sale. While it’s not clear who is selling today, there is no new material information coming out of Twitter. I’m extremely bullish and view this selloff as a major buying opportunity.

The weakness in Twitter began with its 4Q13 numbers, which delivered in spades on both the top and bottom lines, yet disappointed on the total number of monthly active users. When this story persisted into the 1Q14 results posted last week, investors rushed for the exits as investors expressed their doubt that the company could sustain its revenue trajectory against such tepid and decelerating user and usage growth. Extrapolating the recent adoption trends to long term sales and profitability models suggests a stock that could stall well before it delivers on its promises.

I think this is a very myopic view point. Yes, Twitter’s total monthly active user count has stalled, and, yes, user engagement, as measured by timeline views, has similarly slowed, but management has had very little time to address the issue since it came to light. As CEO Dick Costollo mentioned in a post-release interview: “User growth was something that just happened to us” rather than something that the company worked for. The primary Twitter App is poorly designed. It is confusing, offering little help to newbies looking to get started and alienating many that try. It is inflexible, forcing users to wade through a monolithic fire hose steam of content, rather than allowing multiple channels, each targeted to a specific interest area. This can and WILL be fixed. After the 4Q13 bloodletting, Twitter management acknowledged its app problem and pledged to fix it, hiring Google Maps honcho Daniel Graf in mid April to head up its consumer product efforts. It is silly to expect the fruits of change to have been apparent in the March quarter.

Expect major improvements to the Twitter user experience to roll out over the rest of the year. Once fixes to the consumer app are well in place, expect Twitter to get aggressive in advertising its compelling use cases. In the time when the company was simply waiting for user growth to “happen to us”, there was no advertising to speak of, and the consumer narrative around Twitter turned to “Why would I want to Tweet?” – an obviously naïve sentiment to any seasoned user. For the large majority of people, Twitter is not about tweeting for the most part, but rather, about reading tweets from others that you follow, and on topics on which you are particularly interested. Once Twitter makes it easy to find and read the content of primary interest to its users, and aggressively markets its use case, I expect that the user growth will pick up dramatically. Remember that most smartphones sold in western markets ship with Twitter already installed. We estimate that there are more than 70 million smartphone users in the US alone that don’t user Twitter on a regular basis, but that could begin with a simple click on the app icon. This is a big leg up. Management also sees a significant opportunity to juice its international monetization, which generates just $0.60/1,000 timeline views vs. $3.47 in the US. The upcoming World Cup presents an opportunity for the company to drive revenue upward in 2Q 2014 as the event fits perfectly with TWTR’s use case for consumers outside the US.

While investors wait for Twitter’s efforts to re-accelerate user growth to deliver results, there is still a LOT to like about the company. It is launching an OS agnostic in-app advertising product, driven by its MoPub acquisition that should make it a player in placing ads across the mobile market. It is poised to offer analytics to advertisers, based on its recent purchase of Gnip, that leverage Twitter’s immense user data bases. It is expected to attack the “app install” advertising market, that has been such a lucrative business for Facebook. Its planned launch of an integrated bidding system will make advertising buys easier for media buyers and marketers, co-opting some of the value third party ad tech companies have been able to muster. These advertiser friendly innovations should keep the monetization levels moving even as Twitter works through its confusing app and begins to communicate its story to the population of skeptical could-be users.

Even with fairly conservative growth and monetization assumptions, our TWTR valuation calls for a fair value of $30B, reflecting that the company is currently trading at a 33% discount. We believe the company is doing the right things and will keep surprising to the upside on both sales and earnings. Meanwhile, one quarter in the not too distant future, user growth will show that spark and the dream will be alive again. I see the current weakness as a significant buying opportunity for a company that stands to be the primary medium for the distribution of information over the next 20 years. That has GOT to be worth more than you will pay for it now.

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

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