October 8, 2013 – Twitter: How Tweet it Is!
TWTR’s S-1 affirms its considerable growth and profit potential. Sales have more than doubled YoY, driven by 44% growth in users, 16% growth in visits per user, and 23% growth in ad revenues per visit. We believe that all of these metrics will continue to improve on a steep trajectory, given TWTR’s unique and advantaged position as the primary Internet distributor of time sensitive information and its detailed insight into its users interests. Immediate opportunities from TV/media partnerships and a record of innovation with its product, such as Twitter Cards that allow users to embed rich media files, give us confidence that sales deceleration from its current triple digit pace will be gradual. Moreover, the successful launch of Vine hints at opportunities to expand the applications available to the TWTR user base and create future vehicles for monetization. We also believe that gross margins will expand from the current 64% to better than 80% as the business matures, and that positive EBITDA will grow to positive net earnings quickly as sales outpace investment in R&D and marketing. Reasonably assuming a 3 year annual growth rate of 60-65%, mature operating margins of ~25%, and applying a FB/LNKD trailing sales multiple suggests a year end 2016 valuation of $50B.
TWTR is a unique info distribution service, NOT a social network. Twitter’s business is asymmetric, delivering news, commentary, rich media content and links from the community of newsmakers – e.g. media outlets, journalists, government agencies, artists, businesses, executives, celebrities, etc. – to a much broader community of followers. It is uniquely valuable because of its immediacy, its focus, its ease of use, the scope of information available, and the scale of audience that can be reached. In most of the developed world, there is no viable alternative and economy of scale and network effect barriers make market entry daunting to would-be rivals.
User growth still on steep curve with plenty of runway. TWTR has 218M monthly average users (MAU), up 44% YoY. 49M of those users were in the US, up 22.5. For comparison, FB’s 1.15B MAUs were up 21% YoY in June, with 142M in the US and Canada, up about 9% YoY. 75% of TWTR’s MAUs access the service on mobile devices, suggesting penetration to just 26% of American smartphone owners, and 12% for the rest of the world. With the increasing public profile of the service as it is heavily promoted through TV tie-ins, advertising, sports and other venues, we expect adoption to continue apace for the foreseeable future.
Engagement can also increase. TWTR measures engagement by timeline views, which rose 68,5% YoY worldwide and 45% in the US during the June quarter. The average views per user are more than 7.6 per day globally up 16% YoY, with Americans visiting more than 9 times a day. Several factors should continue to drive views higher going forward – i.e. growing penetration into smartphones, closer tie ins to TV and sports, increasing rich media content, improved apps, and growing public awareness.
Advertising density can increase considerably. TWTR measures its ad density as advertising revenues per 1,000 timeline visits. On this metric, ad density rose 23% YoY to $0.80, or roughly $0.18 per MAU per month. TWTR restricts the inventory of placements available to advertisers in its auctions and charges its advertisers based on the level of user engagement with its ads. We believe that the amount of advertising served to TWTR users could increase significantly, noting FB’s success in raising its ad load to levels far above TWTR. Subjectively, TWTR ads integrate smoothly into the timeline, fit naturally into the context of an information distribution service, and are typically well-targeted to user interests – a product of TWTR’s “Interest Graph” data base of who each user follows and how they engage with the tweets that they receive. Moreover the Amplify program promises to add well-accepted pre-roll ads to desirable videos from TWTR’s media partners. As such, we believe that TWTR is less likely than FB to experience user push back on rising ad density.
Ad pricing is likely slipping today, but should improve long term. The S1 points out that TWTR’s ad prices are somewhat lower for mobile placements, and that mobile is increasing as a percentage of its total. Mathematically, this will sap ad pricing, although we don’t expect management to provide the detail in the future. Still, we feel that this negative will reverse for several reasons. First, the likely influx of premium-priced video ads from the Amplify initiative will drive an immediate increase in CPMs. Second, 65% of TWTR’s ad sales are already on the mobile platform – the mix shift is likely to slow and any discount for mobile ads should vanish with time. Finally, advertisers are slow to appreciate the value of new online ad vehicles – TWTR has been selling ads for less than 3 years, and should see more robust demand as its track record of efficacy is better quantified and appreciated.
TWTR is well positioned to add new apps. The successful launch of the Vine video application illustrates TWTR’s opportunity to leverage its scale, interest graph, advertising platform and user base to expand its base of revenue generating services. We believe this represents a significant, but difficult to quantify, additional value to the TWTR platform.
Business model offers significant cost leverage to scale. As confirmed in the S1, COGS consists primarily of data center costs, which have significant economies of scale and which rise to support the growing volume of tweets and timeline visits. While this is obviously tied to growth in penetration and engagement, it is not driven by ad density, and as improvements on this aspect of the business drive revenues, gross margins should improve accordingly. Operating expenses should grow much more slowly than sales, particularly once stock related compensation costs are recognized through the IPO. EBITDA has been positive for 5 quarters, and while GAAP earnings have been consistently negative, we believe that they could turn profitable before the end of 2014.
TWTR deserves a significant premium vs. the obvious compares. FB and LNKN each trade at slightly better than 12.5x forward sales, on respective 2014 top line growth expectations of 32% and 41% respectively. TWTR should be able to deliver better than 60% growth for the reasons addressed above, with considerable more runway to sustain the growth trajectory than either of the social networking stalwarts. Furthermore, it seems likely that management has taken a conservative approach to advertising density pre-IPO, giving it dry powder to spark added growth out of the gate.
For our full research notes, please visit our published research site.