Twitter Inc (NYSE:TWTR) has found itself victimized by the scandal surrounding archrival Facebook, Inc. (NASDAQ:FB). The Cambridge Analytica scandal has hit the entire social media space hard. Interestingly, Twitter stock took a more significant tumble in percentage terms than did Facebook. Facebook has fallen about 16% vs. almost 20% for Twitter stock.

Snap Inc (NYSE:SNAP) and Alphabet Inc (NASDAQ:GOOGL, NASDAQ:GOOG) also felt the effects. Still, due to the revenue model of TWTR, I believe the market made the correct decision in punishing Twitter harder for Facebook’s scandal.

More Regulation on Data Sales Could Hurt Twitter

To be clear, I am not faulting Twitter Inc or its management for the Cambridge Analytica scandal in any legal sense. My assertion refers only to the price of Twitter stock. Like our own Luke Lango speculates, I predict all involved will receive a slap on the wrist and that data sales will continue. However, regulators may add rules to such sales.

Unfortunately for holders of TWTR stock, these rules would affect the company in the only area where it has shown revenue growth.

As Citron Research points out, data licensing revenue for Twitter rose from $282 million to $333 million over the last year. The company’s larger and only other revenue source, advertising, declined in the same period from $2.25 billion to $2.11 billion. Hence, more regulation in data licensing places the company’s current revenue model at risk.

Twitter Stock Still Expensive

This also occurs just as Twitter was starting to expect profits. Analysts currently predict earnings of 17 cents per share for 2018 and 30 cents per share the next year. Still, this places the forward price-to-earnings (PE) ratio at over 160.

For that, investors get a niche site. This niche serves as the megaphone of choice for celebrities such as Katy Perry and politicians such as President Trump. This gives Twitter a reliable and limited corner of the market.

However, most every other aspect of Twitter underwhelms. The number of monthly active users (MAUs) grows at a negligible rate. This rate plateaued at 330 million between the third and fourth quarters of 2017.

Moreover, amid the revenue decline, the company arrived at a positive operating income by cutting research and development (R&D) by one-third. They also cut their selling, general and administrative expenses by around 25%.

Expense cuts will not provide a long-term track record of profit growth. If revenue does not grow soon, one has to wonder if consensus income estimates will hold.

Facebook Stock Appears to Offer More Value

Compare this to Facebook. Even though FB loses to Snapchat among teenagers, Facebook still stands as the general-purpose social media site.

Also, even after its decline, Facebook trades at a forward PE of 22. Between 3Q and 4Q 2017, FB grew the number of MAUs over 3% to 2.07 billion. FB also grew its operating income by over 60%, even as spending on R&D and administrative expenses increased.

Cambridge Analytica creates uncertainty about revenue growth prospects. Still, FB’s strong balance sheet will help the company ride out any turmoil it could face. Twitter lacks such a luxury.

For these reasons, I believe the market made the correct call in hitting Twitter stock harder, despite only suffering indirect effects from the Cambridge Analytica scandal. I see this as not a buying opportunity, but as a sign the market overvalued Twitter in the first place.

And despite the overvaluation, Twitter stock trades only modestly higher than its IPO price of $26 per share from five years ago. All this time later, I would personally value Twitter stock in the low double digits per share at best.

Bottom Line on Twitter Stock

The market has made a strange but correct decision in punishing Twitter stock harder for Facebook’s misdeeds. TWTR stock has become a victim of circumstance. I predict FB will end up with a slap on the wrist, and the industry will face more scrutiny regarding data sales.

However, that slap hits Twitter proportionally harder. With overall revenues falling and data sales serving as its one current source of revenue growth, TWTR strangely becomes the biggest victim of FB’s misdeeds.

I believe Twitter is here to stay. However, with its success limited to niches, it has more parallels to Myspace (which is still in use) than to Facebook or even LinkedIn, owned by Microsoft Corporation (NASDAQ:MSFT).

Unless Twitter can find a new source of revenue, I believe consensus profit estimates will have to fall. In the end, buyers should treat Cambridge Analytica as a buying opportunity for FB, not for Twitter stock.

As of this writing, Will Healy did not hold a position in any of the aforementioned stocks.