Twitter (NYSE:TWTR) reported third-quarter numbers that missed estimates across the board, and Twitter stock tanked in late October.
Revenues came in lower than expected, and revenue growth slowed dramatically quarter-over-quarter. Margins missed the mark, leading to a miss on profits, too. The guide came in much weaker than expected, especially on the revenue front.
The implication from the third quarter report? Twitter’s growth narrative is slowing. Not good news, especially for investors, because heading into the print, Twitter wasn’t priced for slowing growth. Consequently, shares tumbled, and they haven’t recovered since.
Today, TWTR stock trades more than 30% off its 2019 highs.
Time to buy the dip? I don’t think so. Unfortunately for bulls, it looks like the Twitter slowdown is not temporary. Rather, slower growth is here to stay because of rising competition. So long as slower growth sticks around, Twitter stock will likely be stuck in neutral around $30 per share.
Competition Is Killing Twitter
In a nutshell, there’s a bunch of new competition in the digital ad landscape, and Twitter is having trouble maintaining big growth in the presence of this elevated competition.
Two years ago, there were basically three important players in the U.S. digital ad market: Facebook (NASDAQ:FB), Alphabet (NASDAQ:GOOG), and Twitter. Over the past two years, though, there has been an influx of new players into this market. Both Snap (NYSE:SNAP) and Pinterest (NYSE:PINS) have aggressively upped their digital ad efforts. Facebook has continued to expand digital ad real estate on Instagram and Messenger. Viral Chinese video app, Tik Tok, has started to roll out ads.
In other words, over the past two years, the competitive landscape in the U.S. digital ad market has gone from a three-player oligopoly to a multi-player market. As it has, Twitter’s growth has consistently slowed.
Throughout 2018, Twitter reported 20%-plus revenue growth rates. Through the first half of 2019, revenue growth rates dropped below 20%. In the third quarter, Twitter reported sub-10% revenue growth. Next quarter, the guide calls for another sub-10% revenue growth quarter.
Coincidence? I don’t think so. As competition has picked up, Twitter’s growth has slowed, because the company is having trouble differentiating its value prop to advertisers from other social media platforms.
Unfortunately for bulls, this competition is only getting stiffer. That is, Snap, Pinterest, Instagram, Messenger, Tik Tok, and others are all still in the early stages of their digital ad ramps. As those platforms continue to ramp over the next few years, the digital ad market will only get more competitive.
The implication for Twitter? Growth will continue to slow, and that’s bad news for Twitter.
Twitter Stock Doesn’t Have Much Upside Potential
Considering that slow growth is the new norm for Twitter, Twitter stock doesn’t have much upside potential from here.
The logic is simple. At over 30-times next year’s earnings, Twitter trades at a big growth multiple, but this isn’t a big growth company. Revenues rose less than 10% year-over-year last quarter, while profit margins compressed year-over-year, and adjusted EBITDA dropped more than 10%. Next quarter is expected to be more of the same.
Looking out over the next five years, growth rates won’t collapse, but, revenue growth will likely remain in the ~10% range as secular digital ad tailwinds are offset by competition headwinds. Margins will stabilize and even improve some. But, at only 10% revenue growth, there isn’t much firepower for big operating leverage.
With Twitter, then, you have a mild growth company with mild upside margin drivers, trading at a big growth valuation. That’s not a great combination.
By my numbers, ~10% revenue growth plus tepid margin expansion will drive earnings per share towards $2 by fiscal 2025. Assuming Twitter at that point fetches a Facebook/Alphabet valuation of ~25x forward earnings, then a fundamentally supported 2024 price target for TWTR stock is $50.
Discounted back by 10% per year, that equates to a fiscal 2019 price target of roughly $30. Consequently, TWTR stock is trading exactly where it should be considering that growth is slowing.
Bottom Line on Twitter Stock
Long term, Twitter stock will be just fine, because Twitter has crafted an enduring niche for itself in the social media and digital ad landscapes. But, increasing competition in both of those landscapes means that slow growth is the new norm here.
Considering that slow growth is the new norm, recent weakness in Twitter stock makes sense, and the “buy the dip” thesis doesn’t become compelling until about $25.
As of this writing, Luke Lango was long FB and PINS.