I’ve been a skeptic toward Twitter (NYSE:TWTR) for some time now, and simply put, I’ve been wrong. Twitter stock has seen choppy trading of late, but the broader trend is clear. TWTR shares are up 28% over the past year and have more than doubled since the beginning of 2017.
It’s worth noting that TWTR still trades below its first-day close after its 2013 initial public offering. That’s a cautionary tale for investors currently considering more recent IPOs like Lyft (NASDAQ:LYFT) and Beyond Meat (NASDAQ:BYND). But it might also signal caution for Twitter stock itself.
Admittedly, the news for the social-media firm has been good, particularly of late. Twitter’s execution has improved notably since I fretted about the company’s management exodus back in early 2017. It turns out, or so it seems, that the new managers have done a much better job than their predecessors. Fundamentals are improving, with a strong first-quarter report last month following a similarly solid fourth-quarter report in February. Revenue growth is accelerating, and Twitter usage is rising.
But valuation here isn’t cheap or even close. And that still seems a problem for TWTR stock at $40. Investors have let their expectations run wild in the past, both in 2013 and in the summer of 2018. This time, they might be right. However, those investors have to be correct on what looks like a very narrow bull case.
The Case for Twitter Stock
Despite running at nine-month highs, a solid bull case exists for TWTR stock. The social-media firm has improved in core metrics, particularly usage. Daily active users — or what Twitter calls “mDAUs” — increased 8% year-over-year in Q1. Overseas, the YOY growth was an even stronger 12%. On an average day, Twitter sees 133 million users.
More importantly, U.S. revenue increased 25%, while constant-currency international revenue climbed 15%. Both metrics outpaced user growth by a wide margin, improving revenue per user. Plus, Twitter is attracting users that actually engage with the platform. At the same time, the company is getting more money per user (and possibly per visit) from advertisers. That’s a reflection of the 23% increase in ad-engagement. Even better, the cost per engagement fell only 4%.
Spending is rising, a key risk I highlighted after the Q4 report. But that’s not necessarily a bad thing. Increased video content is driving costs higher, but video also drives higher ad spend and better-quality advertisers. R&D spend is driven in part to create a cleaner platform, and Twitter is having success on that front. Sales and marketing and G&A (general and administrative) expenses are rising roughly in line with revenue growth.
From a broad standpoint, the performance of late — and particularly in the last two quarters — is the bull case for Twitter stock coming to life. The company is showing why social-media businesses have been so valuable.
It’s also confirming why investors were at one point in 2013 willing to pay over $60 per share for TWTR. Platforms attract more users, and those folks inspire others to jump onboard. Advertisers, and then better advertisers, follow. And growth continues, potentially for years.
The Valuation Problem for TWTR Stock
And yet, TWTR stock incorporates quite a bit of growth. Even backing out some $5 per share in net cash, the stock now trades at about 33x 2019 consensus earnings per share. That’s after consensus jumped following Q1, moving to $1.06 from a previous 86 cents.
To be sure, the lesson of the stock market in recent years, particularly in tech, has been that the market will focus on the business over valuation. Investors — myself included — have missed out on huge gains while concluding that growth stocks are simply “too expensive.” And that may be the case with Twitter stock as well. Because in this market, trading at 33x earnings isn’t that expensive.
At the same time, however, 33x is not cheap. That’s particularly true in the social media space. Facebook (NASDAQ:FB), even after a strong rally of its own, trades at 25x 2019 EPS estimates. That multiple, like TWTR’s, backs out net cash.
Thus, TWTR stock should get a premium: its core platform seems to have less risk of being at a peak compared to Facebook. But with FB still in the early stages of monetizing WhatsApp and Instagram, it’s tough to see such a wide valuation gap facing TWTR.
Even Snapchat (NYSE:SNAP) presents an intriguing option, even if I’m bearish on that stock as well. Twitter’s enterprise value of $27 billion is almost double SNAP’s $14 billion. But Snap has a larger daily active user base; over 40% larger, in fact.
Snap isn’t nearly as effective at monetizing its users for revenue or profit. But from a long-term perspective, that isn’t necessarily a bad thing. However, if we assume that Snapchat and Twitter will have at least equally-valuable users, both names should have similar valuations right now. Quite obviously, that’s not the case.
And so, the case for Twitter stock here seems to require two basic assumptions. First, it requires that social media more broadly will remain a consistent part of worldwide internet usage. More importantly, it also requires that Twitter be the best of the three platforms.
To be clear, that doesn’t mean Twitter has to be the largest. Facebook at the moment has roughly 12-times the amount of DAUs. But to buy TWTR stock here over SNAP and FB means that going forward, Twitter’s platform needs to be the most persistent of the three. It can’t lose users, as Facebook might. It can’t be replaced by the “next” app, as Snapchat potentially could be. At the very least, Twitter in 20 years needs to look roughly as it does now: an active, important platform that inspires users and advertisers alike.
At this valuation, even that might not be enough. But that’s the baseline for TWTR stock to stay at $40 or higher, and it certainly seems possible. Twitter has a solid niche, an intriguing use case, and growing appeal to advertisers. That might be enough, but it still seems like a thin bet.
As of this writing, Vince Martin has no positions in any securities mentioned.