Twitter (NYSE:TWTR) got its groove back in 2017. After years of being treated like the ugly duckling in the digital advertising space due to negative growth, Twitter’s digital ad business turned around in 2017 and TWTR stock tripled from $15 in April 2017 to $45 in June 2018.
But, at $45, TWTR stock was valued for perfection, and more. Thus, when far-from-perfect second quarter numbers hit the tape (monthly users dropped sequentially), TWTR stock spiraled downward. In a matter of days, the stock fell from $45 to $30.
That was the time to buy. The sell-off was over done considering that revenue and margin metrics continued to improve in the quarter. Plus, at $30, TWTR stock was reasonably valued.
Indeed, the stock has since rebounded to $35, a 15%-plus gain in roughly a month.
Unfortunately, I don’t think this rally will persist. At $35, TWTR stock looks fairly valued. Dreams and aspirations for this stock to get back to $45 levels in a social media world pressured by fake accounts and in an advertising world pressured by intensifying competition from Amazon (NASDAQ:AMZN) seem like overly optimistic goals at this point in time.
As such, I think it is time to fade the Twitter rally.
Twitter’s Narrative Is Good, But Not Great
The narrative surrounding Twitter is healthy and improving. But, it is far from perfect or great.
On the positive side, Twitter’s financial metrics are dramatically improving. The ad business is back on track thanks to new targeted advertising tools. Plus, daily user engagement is up, and that helps attract advertising dollars. Average revenue per user (ARPU) is also trending way higher, and gross margins are rebounding to their historic highs while the opex rate is stabilizing.
On the negative side, Twitter’s user metrics aren’t that great, and the growth isn’t all that promising. The monthly active user base actually dropped from 336 million to 335 million last quarter. Slow user growth has been a concern at Twitter ever since the company pushed across the 300 million user mark. Thus, a decline last quarter almost confirms that the user base is tapped out. Meanwhile, revenue growth was just 27% last quarter. That is good, but it is pretty slow for a small digital advertising company.
Overall, it increasingly looks like Twitter has carved out a niche for itself in the social media world as an instant news and reaction platform, and that within that niche, usage is going up. But, Twitter isn’t growing outside of that niche, nor will it in the foreseeable future. Thus, this a company with minimal user growth potential, meaning the whole growth narrative is driven by improved monetization of the current user base.
Putting all of your eggs in that basket is a risky move. That is especially true now considering that both Amazon and Snap (NYSE:SNAP) are making big pushes in the digital ad market. According to eMarketer, those two ad companies are gaining share in the U.S. digital ad market. Meanwhile, Twitter continues to lose share.
Big picture, then, the Twitter narrative is healthy and improving. But, it isn’t great. In fact, it’s far from great, because the whole growth narrative is dependent on improved monetization rates amid intensifying competition for digital ad dollars.
Twitter Stock Isn’t Worth Much More Than $35 Today
No matter which way you look at it, justifying a price tag in the $40’s for TWTR stock today is tough to do.
This is a slow user growth company. At best, over the next 5 years, Twitter adds a few million users per year, and rounds out to 350 million monthly users by 2022. During that stretch, monetization rates should improve. ARPU is up big this year, and has a chance to scale towards $13 or higher in 5 years. Gross margins should bounce back to historic highs, and potentially even higher as the high-margin data licensing business becomes a bigger driver. Meanwhile, healthy revenue growth should allow for opex leverage.
Putting that all together, I reasonably see Twitter netting $2 in earnings per share in five years. That would represent a 35%-plus annualized growth rate from last year’s $0.44 earnings base. But, 35%-plus earnings growth still isn’t enough to justify a price tag much higher than $35.
Applying a Facebook (NASDAQ:FB) and Google (NASDAQ:GOOG) multiple of 25x forward earnings to $2 implies a 2021-end price target for TWTR stock of $50. Discounted back by 10% per year, that equates to a 2018-end price target of just under $38. Considering we are only halfway through fiscal 2018, present value hovers right around the $35 range.
Bottom Line on TWTR Stock
Twitter’s narrative is improving. But, it is far from great. An improving but still not great narrative supports a price tag for TWTR stock of around $35 today, but dreams of this stock quickly rebounding to $40 or higher seem overly optimistic.
As of this writing, Luke Lango was long AMZN, FB, and GOOG.
