Once the ugly duckling of the social media space, Twitter Inc (NYSE:TWTR) has suddenly turned into the hottest name in the digital advertising world. Moreover, Twitter stock has heated up nicely.
So far in 2018, digital ad giants Facebook Inc (NASDAQ:FB) and Alphabet Inc (NASDAQ:GOOG) have performed in-line with the broader averages, both rising about 10% versus an 11% gain for the NASDAQ-100.
Meanwhile, hyper-growth digital ad fledgling Snap Inc (NYSE:SNAP) is down more than 10% year-to-date thanks to revenue and user growth concerns.
As for Twitter stock, it is up nearly 70% year-to-date. Twitter stock now trades at $40, which is the highest this stock has been in more than three years.
Why the huge out-performance? The company’s advertising business returned to robust growth in the first quarter of 2018 after several quarters in a row of negative to mildly positive growth. The improvement in the advertising business is accompanied by double-digit daily active user growth, the sum of which is driving robust margin expansion and earnings growth.
But can this run continue?
I don’t think so. Twitter still has a ton of problems, like sluggish monthly user growth, deteriorating fundamentals among younger users, and live-streaming headwinds. Further, Twitter stock, even under a best-case scenario, isn’t worth anywhere near $40.
As such, I expect valuation concerns to short-circuit this rally in Twitter stock in the near future.
Here’s a deeper look:
Twitter Still Has Problems
Despite 10% daily active user growth, 20% advertising revenue growth, and six full percentage points of EBITDA margin expansion last quarter, Twitter still has a host of problems.
The biggest of those problems is platform relevancy. The company is trying to push live-streaming and video content to increase the platform’s relevancy in today’s crowded social media space. But despite those efforts, the monthly active user base is growing at just 2-3% year-over-year.
Moreover, while the daily active user base is growing at a faster 10% pace, DAU growth is actually decelerating. In 2017, quarterly DAU growth averaged 13%. In the first quarter of 2018, DAU growth was just 10%.
While live-streaming may provide a near-term boost to user growth, the longevity of this growth tailwind is questionable at-best because everyone is trying to do live-streaming. Thus, in the live-streaming world, all that matters is resources. Essentially, the live-streaming world boils down to whether or not you can outbid the competition for content and live-streaming rights.
Of those five players, Twitter is by far and away the smallest, and has by far and away the least resources. Thus, Twitter will have trouble competing for live-streaming rights against these tech behemoths.
This is crystal clear with the NFL live-streaming rights. In 2016, Twitter won a deal to live-stream NFL games through its platform. That deal was supposed to be a saving grace for Twitter.
But it never was because Twitter lost those NFL live-streaming rights to Amazon in 2017. And in 2018, Amazon once again outbid Twitter for the rights.
Beyond live-streaming concerns, Twitter is also facing a youth usage problem as the platform continues to lose mind-share among young users, according to a Piper Jaffray survey and a Pew survey. That is a big issue, because young users are what will drive tomorrow’s digital ad economy. If they aren’t on Twitter, then Twitter’s future doesn’t look great.
The Numbers Don’t Add Up
Most important, when it comes to Twitter stock, the numbers just don’t add up to a $40 price tag.
Best-case scenario is as follows:
- Twitter leverages its live streaming and video content strategy to increase platform relevancy and maintain present 3% MAU growth rate despite larger base
- Twitter utilizes live streaming and video content strategy to increase effectiveness of targeted ad solutions which, coupled with Data Licensing business growth, should drive steady 15% ARPU growth over the next 5 years to $15, from ~$7.50 last year (for comparison, Facebook’s ARPU is over the past 12 months is just above $20)
- Net profit margins continue to zoom higher, driven by improved ARPU trends, and reach 30% in five years, from ~13% last year and versus ~40% at Facebook
Even under these incredibly bullish assumptions that Twitter’s user growth remains healthy and ARPU and profit margins trend towards just shy of sky-high Facebook levels, Twitter stock still isn’t worth $40 today.
A 3% MAU growth rate puts the user base at roughly 380 million in 5 years. A $15 ARPU on that 380 million user base implies revenues $5.7 billion in 5 years. A 30% net profit margin further implies net profits in 5 years of ~$1.7 billion. Assuming stock comp drives the diluted share count towards 850 million, then $1.7 billion in profits translates into roughly $2 in earnings per share in 5 years.
Facebook and Google both trade around 25-times forward earnings. A similar 25-times multiple on $2 implies a four-year forward price target of $50. Discounted by 10% per year, that equates to a present-day value of $34.
And that is a best-case scenario. More realistically, Twitter doesn’t drive consistent user growth over the next several years. ARPU gets nowhere near Facebook levels. And profitability jumps to 20-25%, not 30%.
Under those assumptions, I think Twitter can earn around $1.50 per share in five years. Not $2. A similar 25-times multiple on that implies a four-year forward price target of $37.50. Discounted back by 10% per year, that equates to a present-day value of $25.
Bottom Line on Twitter Stock
I’m going to keep this simple: at $40, Twitter stock is grossly overvalued.
As of this writing, Luke Lango was long FB, GOOG, SNAP, AAPL, and AMZN.