I’ve been bearish on Twitter Inc (NYSE:TWTR) stock for some time. But with the TWTR stock price near its highest level in almost a year, even this long-time bear has to admit the company has made some progress.
A blowout Q3 earnings report drove TWTR stock higher as did the promise of GAAP earnings in Q4. The headline numbers weren’t particularly impressive, as revenue still declined 4% year-over-year. But cost cutting has boosted margins, and Twitter’s valuation is starting to look a bit more reasonable.
Now, the hard work begins for Twitter. Management has admitted that costs are going to rise, and prices are going to fall. Driving the profit growth needed to support the still-high valuation, then, will come down to driving user growth and engagement. In essence, Twitter stock now looks like a play on the long-term viability of the Twitter platform. And though my bearishness toward TWTR stock has softened coming out of Q3, I’m still not willing to take that bet.
TWTR Stock Price Soars
As far as Q3 earnings go, the news likely is in the eye of the beholder. On one hand, revenue declined 4%. On the other, MAUs (monthly active users) did grow 4%, after minimal growth in the first half, and DAUs (daily active users) rose 14%, the fourth straight quarter of double-digit growth.
Margins improved as well, with the company citing a record for adjusted EBITDA margin. Cost cuts made this year have been a big help. As a result, adjusted EBITDA increased 28% YOY. (Bear in mind that figure declined as recently as Q1.)
The bearish interpretation of the quarter is that it’s better, but hardly good. Revenue still is declining, as it has every quarter this year. Margin improvement is coming from cost cuts which can’t last forever. Twitter has made an effort in limiting its heavy stock-based compensation. Q4 guidance suggests a drop from $613 million in 2016 to around $425 million in 2017.
And while Twitter might trumpet GAAP profitability in Q4, the fact remains that on a full-year basis, Twitter really isn’t that profitable, if at all. Guidance suggests roughly $785 million in adjusted EBITDA, more than half of that coming from share issuance. Most of the remainder is going to capital expenditures, guided to $300 million plus. “True” free cash flow remains minimal. There’s still a long way to go for Twitter to support the current $13-billion-plus enterprise value.
That’s all true. But for the first time in a while, I can see some reason why investors might think TWTR stock can get there.
Looking Forward on Twitter
The faster growth of DAUs versus MAUs proves that engagement is rising, which is good news for TWTR stock. On the Q3 call, COO Anthony Noto, considered the de facto head of the company given CEO Jack Dorsey’s efforts at Square Inc (NYSE:SQ), pointed to data monetization and “self-serve” offerings as potential drivers for incremental revenue growth. The margin improvements seen this year are more than I (and most investors) expected, and get Twitter to a point where at least it has a base for profit growth.
To be sure, TWTR still needs that growth, with the stock trading at over 30x on an EV/EBITDA basis, excluding that share-based compensation. How the company gets there will be the tricky part.
One clear issue is that pricing is still declining. The shift to video, of which I remain highly skeptical, is pressuring CPEs (cost per engagement). But Noto also admitted that Twitter had cut pricing on a “like for like” basis, in other words, charging less for the same type of impression. That alone creates a growth problem. From a revenue standpoint, lower pricing offsets any potential user growth Twitter might be able to drive going forward.
And the catch for TWTR stock post Q3 is that revenue growth simply has to restart. New CFO Ned Segal admitted on the Q3 call that “to the extent you see margin improvement, it’s more likely to come from revenue growth than it is cutting the expense base.” In other words, the cost cutting is at an end. If Twitter profits are going to grow, Twitter revenue has to grow as well.
A Straight Bet
So will that revenue grow? Honestly, I’m skeptical. Implied guidance for Q4 suggests a ~9% decline YOY in the quarter. The loss of the NFL contract to Amazon.com, Inc. (NASDAQ:AMZN) and the closure of TellApart are driving most of that weakness. Still, the legacy platform isn’t growing sales.
It doesn’t sound like pricing is going to improve. That leaves user growth and user engagement as the two key drivers. User growth remains disappointing. Twitter still doesn’t disclose the actual DAU number, but it’s almost certainly lower than that of Snap Inc (NYSE:SNAP), whose enterprise value is only modestly higher despite better growth in that figure. Engagement is supposed to be driven by video, but that raises pricing concerns.
Still, there’s a path here if the Twitter platform is as valuable as TWTR bulls and management believe it is. I’m still skeptical. I’d much rather pay up for social media leader Facebook Inc (NASDAQ:FB) than bet on a turnaround at Twitter. But I do agree that path at least is open, which isn’t something I would have said even six months ago.
As of this writing, Vince Martin has no positions in any stocks mentioned.