I’ve been bearish on Twitter Inc (NYSE:TWTR) for some time now — and that bearishness looks like foolishness at the moment. TWTR stock is soaring. Twitter stock has gained 39% just since the New Year; it’s more than doubled over the past six months.
In some sense, I understand the gains. I wrote after the company’s third-quarter report in October that there was a least a path to upside. And Q4 earnings were strong, admittedly. But I certainly didn’t believe that upside was coming so quickly — and I’m skeptical it will last.
Twitter has made some progress. Generally accepted accounting practices profitability in Q4 is a nice win. But Twitter stock has added over $10 billion in market value in just six months. A company that couldn’t sell itself at $25 16 months ago now trades at $33. And yet neither user growth nor revenue growth is all that impressive — and the stock still trades at steep multiples to EBITDA and free cash flow.
I’m not betting against TWTR stock at this point. Many short sellers have been burned badly over the past few months. But I can’t help but think that this round of enthusiasm will fade unless Twitter can post even stronger results going forward.
Are TWTR Stock’s Numbers Really That Good?
Twitter trumpeted its GAAP profitability in the fourth quarter, which admittedly is some progress. Performance has improved steadily as the year went on. Adjusted EBITDA rose 43% year-over-year in Q4, after growing just 3.4% through the first three quarters and declining in the first half.
And so there is some room for optimism looking ahead. Comparisons will be easy over the next six months, particularly in the first quarter. I’ve long criticized Twitter’s excessive stock-based compensation, but the company is making progress on that front. Share-based comp expense was $615 million in 2016. It’s guided down to $350-$450 million in 2018.
There is some good news here, particularly in terms of profitability. But most of the gains have come from cost-cutting. In Q4, for instance, even on a non-GAAP basis, R&D spending fell 26% year-over-year. Sales and marketing dropped 12%, and G&A was flat.
That type of cost-cutting isn’t sustainable going forward. Twitter is going to have to grow revenue. And yet the company still isn’t at that point. Revenue rose 2% in Q4; it declined for the full year. User growth was flat in Q4 versus Q3. Ad engagements are up, thanks to the company’s shift to video; but pricing is down big, with cost per engagement down 42% year-over-year in the fourth quarter.
Here, too, there’s some progress — particularly on the advertiser front. Twitter long has been an afterthought in digital advertising compared to Facebook Inc Common Stock (NASDAQ:FB) and Alphabet Inc (NASDAQ:GOOG,NASDAQ:GOOGL). If it can start to compete, and take some share from those rivals, revenue growth may follow. But that’s still an “if” — Q4 results don’t guarantee that type of success.
TWTR Stock Looks Expensive
And at a certain point, even improved growth has to be priced in. TWTR stock now has an enterprise value of about $21 billion. It’s more valuable than its Chinese counterpart, Weibo Corp (ADR) (NASDAQ:WB), despite a smaller user base and much weaker growth.
Meanwhile, the new round of merger and acquisition (M&A) speculation seems to ignore the fact that Twitter was up for sale barely a year ago — and not all that much has changed. The user base isn’t much bigger. The company has added video and improved advertising, but revenue has risen 10% total over the past two years. Closing TellApart has provided a headwind, but that aside, it’s not as if Twitter is some impressive growth machine.
And yet the stock trades at 50x 2019 EPS estimates, a multiple that seems to assume substantial growth or a huge M&A premium. But who’s left to buy Twitter? Alphabet, Walt Disney Co (NYSE:DIS), and Salesforce.com, Inc. (NYSE:CRM) all passed last time around. Tencent Holdings Ltd (OTCMKTS:TCEHY) and Verizon Communications Inc. (NYSE:VZ) have been floated as suitors this time, but CEO Jack Dorsey said just this week that “there’s a lot of strength to our independence.”
Any bid at this point would have to be over $40 per share — implying a likely 60x multiple to free cash flow and roughly 35x adjusted EBITDA. Those are big numbers — assigned to growth stories like Dorsey’s other company, Square Inc (NYSE:SQ). Twitter simply isn’t that kind of company. And unless it becomes one, investors buying the recent gains are going to be disappointed.
As of this writing, Vince Martin has no positions in any securities mentioned.