TWTR: Beyond MAUs

sagawa

The bull-bear tug-o-war over TWTR has been one sided, with the stock 40% off its May highs. Is it a buying opportunity or a falling knife? 5 key issues will determine the answer: 1. Can TWTR reaccelerate growth in registered MAUs and/or monetize its nearly 1B unique (including non-logged in) monthly visitors? 2. Can TWTR sustain its real-time information leadership against FB, AAPL, Snapchat and GOOG’s moves into news distribution? 3. Will new services like Moments, Periscope, and Vine bring new users and revenue opportunities for TWTR? 4. Ad pricing dropped 40% in 3Q, but total engagements rose 165% – does this signal opportunity or saturation? 5. Can Jack Dorsey drive change, build morale and excite investors as a part-time CEO in the midst of the Square IPO? We believe that the worst cards may be on the table, with positive news on these issues as potential catalysts to reverse the long erosion from its post IPO highs. We believe that 4Q14 seasonality may have been unusually strong, reducing our concerns over below consensus 4Q15 guidance. Longer term, we believe 50%+ sales growth is possible for several more quarters with improving bottom line leverage, particularly as force reductions play out. The current share price is at the very low end of a wide range of plausible valuations, leaving more upside potential than downside risk.

TWTR metrics have failed. In retrospect, TWTR’s choice to follow FB’s lead in emphasizing registered monthly active users (MAU) and timeline views (TV) has been a serious error. Like YouTube, TWTR users need not be logged in to access content or engage with ads. TWTR has more unregistered monthly visitors than registered MAUs, with US monthly unique visitors up 90% YoY as of July. Yet this rapid growth users has not been reported to or accepted by investors. TWTR stopped reporting TVs a year ago, as it did not represent the growth in the number of tweets each user saw. Time spent, calculated by 3rd parties, is misleading – TWTR’s concise nature is a benefit, and drives much content consumption off site, making a comparison to FB unenlightening. Unfortunately, the engagement metric that we’d like to see – the number of tweets seen– is not reported and difficult to estimate.

TWTR can monetize unregistered visitors and convert them to MAUs. TWTR MAUs have stalled, with just over 11% YoY growth overall and just 2% growth in the US, for a total of 313M worldwide. Meanwhile, management reports more than 500M unlogged-in consumers visit the service each month. Through their content searches, these unlogged visitors offer more than sufficient basis for effective advertising, similar to the way in which GOOG serves ads to its unlogged users, and TWTR is now looking to target this audience. Meanwhile, TWTR is also encouraging this massive informal user base to register by improving the unnecessarily complicated on-boarding process, by introducing more user friendly products, and by educating consumers about its use cases through advertising.

TWTR’s real time content is unique. Amongst TWTR’s 320M MAUs are many thousands of newsmakers – celebrities, sports stars, CEOs, politicians, etc. – AND the reporters that cover them. These verified posters deliver information as it happens, sometimes actually making news by the process of tweeting. In contrast, FB’s new Notify service will push breaking stories from established news organizations, with the editorial and curatorial processes delaying and filtering the news. AAPL’s iOS9 News app takes a similar approach. GOOG’s news is necessarily delayed by its process of indexing the web. Relative to all three, the information available via TWTR’s feeds is much faster, much broader, and much more comprehensive because of the way it is contributed, something that will be very difficult for any rival to replicate.

TWTR can leverage new products. Power users may love the firehose of their timeline, but the base app is overwhelming for many consumers. TWTR is moving to greatly ease the process of building a personalized timeline, but also creating new products that package the underlying content into more digestible formats. The recently introduced Moments creates curated slideshows around popular and breaking topics, discoverable via TWTR, GOOG search, or links, and ripe for native advertising. Periscope has become a de facto standard for ad hoc video conferencing, able to leverage TWTR’s strong penetration amongst celebrities and news makers to build an early content advantage against would be competitors. Vine, acquired in 2012, has 200M MAUs of its own. These apps, and new ones based on TWTR content, can be monetized on their own and can also draw new users to the core app.

Ad sales are growing very nicely. TWTR’s native ad format – sponsored tweets interpolated into user timelines and charged only when they stimulate user action – is unusually unobtrusive for users and effective for advertisers. Ad revenue per MAU has increased 48.2% YoY, offsetting the tepid 11% MAU growth and driving total ad sales up 60.1% over the past 12 months. Within this, ad engagements were up 165% in 3Q, but cost per engagement (CPE) was down 40%, leading some to assume issues with advertiser demand. Management pointed instead to a sharp rise in auto-play video ads, which carry a much lower CPE – akin to a similar dynamic for GOOG’s YouTube ad prices. Management also suggests that its current ad density is just 1/3rd of its long term target, leaving plenty of runway.

@Jack a good choice despite part-time status. Obviously, it would be better if CEO/founder Jack Dorsey were dedicated full time to TWTR. Still, during his interim term after the departure of Dick Costolo, Dorsey executed long needed product and organizational changes, while strengthening morale within the company. As a founder and board member, he brings a deep understanding of the strengths and challenges of TWTR. He also has a strong team, led by COO Adam Bain, himself a candidate for CEO and a likely departure if a CEO had been hired from outside. Bain will have to pick up more of the slack of the next several weeks as Dorsey handles the IPO of his other company, Square, but there is finally evidence of a strong strategic plan going forward.

We expect TWTR to continue its strong growth and to deliver surprising profitability.  For all of the rhetoric to the contrary, TWTR is growing – revenues and reach, if not registered MAUs. Sales guidance for 4Q of $695-710M was below consensus expectations of $740M, reflecting deceleration but also welcome conservatism against a difficult compare and in the face of fierce FX headwinds. The impact of initiatives to monetize unregistered visitors and to drive conversion to MAUs will likely take at least a couple of quarters deliver progress, but new ad formats and the ongoing shift of spending to mobile should sustain revenue growth in the interim. Meanwhile, job cuts could show meaningful improvement to margins as soon as this quarter. Trading at half of FB’s trailing sales multiple, we see substantial upside, assuming that TWTR is able to deliver the right answers to these questions.

Please see our published research page for the full note.

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