I’ve been skeptical of Twitter Inc (NYSE:TWTR) stock for years — and continue to be skeptical. Twitter stock might seem cheap, given that it’s trading over 75% off its all-time high, and 20% below levels reached in mid-July. However, TWTR stock remains a highly valued stock with a lot of growth already priced in.
Of course, the problem is TWTR is a growth stock without much in the way of growth. Its monthly active users werew flat in Q2 versus Q1, and revenue actually declined 5% year-over-year in the quarter.
So where is the growth supposed to come from?
Probably not video, despite what Twitter claims. The pivot to video makes little sense in context of moves from titans including Facebook Inc (NASDAQ:FB) to Walt Disney Co (NYSE:DIS) to CBS Corporation (NYSE:CBS). And even if you overlook content challenges, TWTR stock has never proven it can monetize its existing platform anyway.
In truth, instead of growth Twitter Inc. is cutting back. That includes moves in 2016 to downsize 9% of staff and shutter its Vine app, along with a welcome effort to reduce stock-based compensation.
An ‘Advertising Recession’ For Twitter Stock
As is, Twitter stock already looks overvalued. But a recent analyst report raises an interesting question: What happens to Twitter if digital ad spending starts to dry up as partners sour on the social media platform just like many investors have?
In late August, Aegis Capital analyst Victor Anthony warned of a potential “advertising recession” in the broader U.S. advertising market. Anthony cited results and commentary from the two largest US ad agencies: Interpublic Group of Companies Inc (NYSE:IPG) and WPP Plc (ADR) (NASDAQ:WPPGY).
Anthony did argue that digital advertising could avoid the worst of cuts, given an increasing focus on spend there. But he argued that would leave only Facebook and Alphabet Inc (NASDAQ:GOOGL), through its Google unit, unscathed. That argument makes some sense: Google and Facebook already generate an estimated 99% of growth in US online advertising.
To be fair, it’s just one analyst report, and while industry insiders may see a recession on the horizon, that doesn’t mean it’s coming. But the report itself indirectly highlights a key problem for Twitter. Twitter revenue is declining and ad rates are plunging at the same time the industry itself is growing rather nicely.
In other words, this is a very good — if not the best — time to offer a huge inventory of digital ads. Increased online advertising is a target of thousands of companies of all sizes at the moment. Demand is high.
But Google and Facebook rule the roost, and everyone else — from Twitter to Snap Inc (NYSE:SNAP) and to everyone in between — could feel the pain.
TWTR Stock Will Tumble
Twitter remains a company valued at about $10 billion plus cash on its books. Yet its cash flow numbers are below the amount of TWTR stock it issues to employees. The business itself is not cash flow-positive without significant shareholder dilution.
That’s not a structure that can handle a downturn in ad spending. And that downturn will come at some point. Macro weakness could lead advertisers to pull back. As Anthony pointed out, retailers account for ~14% of ad spending, and they will continue to cut costs as sales and profits fall.
And Twitter’s troll problem likely is causing some companies to rethink using the platform, particularly after major advertisers left YouTube amid concerns about content earlier this year.
I’ve long argued that the core problem with Twitter stock is that the business is functionally unprofitable, but it’s worth remembering that the business is unprofitable at a time that should be great for that business. Online ad spending is rising. The leader of the free world is announcing policy on the Twitter platform. The U.S. economy is in decent shape.
It shouldn’t be that hard to show growth, and profits, in this environment. Yet Twitter can’t. And that bodes poorly for the company once that environment changes.
As of this writing, Vince Martin has no positions in any securities mentioned.
