I have a confession to make. When I first decided to look at the Twitter (TWTR), it was for one reason: I was bargain hunting. In the aftermath of Dick Costolo’s resignation as CEO, I wanted to see if I could pick up a social media stock cheaply.
That once small and quick chick is really just too bloated to fly. As such, I’m taking the other side and shorting Twitter stock in expectation of a crash.
Twitter Stock: R&D Expense for What?
Let’s start at the beginning. When you examine Twitter’s earnings report you immediately stumble upon one big fat expense — research and development (R&D). TWTR spends more than 40% of its revenue on R&D, and the question is, what the heck for?
There’s nothing revolutionary or earth-shattering (or even trifling, for that matter) to show for that much R&D. Facebook (FB), on the other hand, spends 21% of its revenue on R&D.
And FB, unlike TWTR, has an awful a lot to show for that kind of stake. FB users are constantly being bombarded with new features, new products and expansion into new fields. Take, for example, the manner in which FB was able to incorporate videos into its feed — Facebook videos shares now surpass that of YouTube.
Meanwhile, back at TWTR, there are no major achievement to write home about.
In reality, it kind of makes you wonder if Twitter might be distorting R&D expenses on its financials. After all, TWTR takes great pride in the fact that 50% of its workforce are engineers. Clearly, though, not all of those engineers are in development. Or could it be in fact that this is masking an even broader inefficiency?
We just don’t know the truth, but certainly, it doesn’t look good. Yet, even if we cut the company some slack, the R&D outlay is still disproportionate for Twitter stock.
Twitter Stock: Lean Product, Lean Expenses
Twitter’s product is lean and that’s all right because it’s as it should be. The original intent of Twitter was as a light, microblogging site. Of course, a lean product’s benefit should be that it can be managed by a lean company. For example, a common and useful way to gauge whether a social media company has a lucrative product is to compare engagement.
How engagement is calculated isn’t relevant to this discussion, but what it says is very important. Engagement measures how active your users are (which is another way of saying how lucrative your product can be).
According to data compiled from ComScore, Twitter lags Facebook by such a big margin that it’s painful. The data shows that FB is more than 18 times more engaging than TWTR. This means that Twitter’s users are less active and therefore less lucrative.
If your product is less lucrative then you need to find ways to make it profitable. Trimming spending would be the first step in helping Twitter stock.
The Bottom Line
OK, so we clarified that Twitter spends too much compared to its revenue. But a new CEO will be coming in (eventually). That CEO could slice and dice expenses so that the Twitter bird could regain its wings.
Theoretically, that’s the way it should work. But it’s just not that simple. Usually, spending as extravagant as this is deeply rooted in a company’s culture. That means that the new CEO, even the rock-star kind, will be bucking hard against a very entrenched mindset.
Think about it; while FB has been profitable for five consecutive years, Twitter hasn’t moved into the black even once. Twitter’s ledgers have been inked in red since its earnings since 2010. Even if a new CEO is eventually able to change the culture and cut through the flesh, we’re talking a long while.
Meanwhile, the company will continue to bleed and with the pricey valuation of Twitter stock, it’s a long way down. How long? That depends on what happens from here on out, Twitter stock could be heading towards $30, and that’s just the first stop.
As of this writing, Lior Alkalay held a short position on TWTR.