One of the hottest stocks in 2018, and one of the best rebound stories too, has been social media company Twitter (NYSE:TWTR).
Largely thanks to the advertising business returning to growth, profit margins starting to trend significantly higher, and the user base continuing to grow at a steady pace, Twitter stock has skyrocketed more than 80% higher in 2018. Above $40, Twitter stock is now trading at its highest levels since April 2015.
Bulls think this rally is just getting started. They point to robust profit growth as a reason to get bullish. Bears, meanwhile, think this rally is way overdone. They point to the valuation as a reason to be worried.
Who is right?
When it comes to Twitter stock, bull has beaten bear so far in 2018. But I think the back-half of 2018 will be a different story. At present levels, the fundamentals just don’t support the stock price. Moreover, ad revenue growth and profit growth rates will come down in the back-half of the year, and that should cause presently over-bubbly investor sentiment to sink.
Overall, I think Twitter stock is one to avoid here and now. Here’s a deeper look.
How Twitter Stock Could Get to $50
Most people would consider a best-case scenario for Twitter as a look-a-like Facebook (NASDAQ:FB) in five years. But if that happens, what is Twitter stock worth today?
Let’s take a closer look.
Facebook’s total revenue last year was $40.6 billion. Total monthly active users numbered 2.13 billion. That means that Facebook’s average revenue per user (ARPU) in 2017 was just above $19.
But that metric is Facebook total revenue divided by Facebook monthly users. Facebook total revenue includes Instagram revenue, which most market watchers peg at $4.1 billion for 2017. Thus, stripping out Instagram revenue, Facebook platform revenue in 2017 was $36.5 billion, and ARPU was just over $17.
By comparison, Twitter’s revenue last year was $2.4 billion. The monthly active user base was at 330 million. That implies 2017 ARPU of $7.40, a far cry from Facebook platform’s $17 ARPU.
Indeed, to get to Facebook’s $17 ARPU in five years, Twitter would need to grow its ARPU by over 18% per year. Last quarter, Twitter’s ARPU grew by just under 18%. Thus, if Twitter wants to match Facebook platform’s ARPU in five years, ARPU growth can’t slow down at all.
Is that possible? Maybe. Seems tough to do considering digital ad industry growth rates are slowing, and competition from Amazon (NASDAQ:AMZN) and others is ramping.
But let’s assume Twitter can grow ARPU by 18% per year to get to Facebook’s $17 levels in five years. The user base grew by 3% year-over-year last quarter. Let’s also extrapolate that out, implying around 380 million monthly users in five years.
An ARPU of $17 on 380 million monthly users implies revenues of $6.46 billion in five years. Aggressively assuming Twitter’s net profit margins soar to Facebook levels (40%) in five years, then $6.63 billion in revenues would flow into $2.58 billion in net profits. Assuming a higher share count of roughly 850 million by then, that equates to about $3.04 in earnings per share in five years.
A Facebook-like 25-times forward multiple on that implies a four-year forward price target of $76. Discounted back by 10% per year, that equates to a present-day value in the lower-$50s.
Why Twitter Stock Won’t Get to $50
Altogether, if Twitter can continue to grow its user base by 3% per year, get its unit revenue on par with Facebook platform’s unit revenue, and reach Facebook profitability levels, all within five years, then Twitter stock is worth more than $50 today.
Unfortunately, I don’t think any of that will happen.
3% user growth? Could happen. But I doubt it. User growth trends at Twitter are slowing, and with so many social media apps out there, it’s tough to see this company continuing to grow its user base by 3% per year over the next five years.
18% ARPU growth? Not happening. Twitter grew ARPU by 18% year-over-year last quarter because advertising revenue growth was over 20%. Advertising revenue growth was over 20% because it was lapping an 8% decline in the year-ago quarter.
Thus, on a two-year stack basis, revenues were up just 13%. This 10-15% growth will be the norm going forward, and that doesn’t exactly lend itself to high-teens ARPU growth.
40% net profit margins? Also, not happening. Twitter’s net profit margins last quarter were below 20%. Thus, in order to get to Facebook profit margins of 40% in five years, Twitter would need to expand net profit margins by more than 4% each year. That seems like a tall order.
Moreover, Facebook has such huge profit margins because it has such huge scale. Twitter, which likely won’t ever get to Facebook’s ARPU level and only has 336 million users, won’t ever get to Facebook’s scale. Therefore, Twitter’s profit margins will likely never look like Facebook’s profit margins.
Overall, when you look at what Twitter needs to do to justify its current price tag, it just seems like too much for this niche social media platform. My best guess is that ARPU grows around 10-15% per year to ~$13.50 in five years. The user base grows to 360 million. And profit margins head toward 30-35%.
Under those assumptions, I think Twitter does $1.86 in earnings per share in five years. A 25-times forward multiple on that implies a four-year forward price target of $46. Discounted back by 10% per year, that equates to a present-day value in the lower $30s.
Bottom Line on TWTR Stock
At current levels, a lot of things need to go right to justify further upside in Twitter stock. Unfortunately, I don’t think that will happen, and because of that, I believe Twitter stock is presently overvalued by a considerable amount.
As of this writing, Luke Lango was long FB and AMZN.