Twitter Q3 14A – Good company, bad stock.

Twitter is not the next Facebook.

• Twitter and Facebook are often compared directly against one another but in reality they are very different animals.
• Facebook productises its 1.3bn users who spend 18% of their smartphone time using its app and sells this data to advertisers.
• Twitter has a core of active users that generate content that is then viewed by hundreds of millions that are not logged in or don’t have accounts.
• Twitter sells content-relevant advertising that is distributed along with the tweets.
• More and more, Twitter looks like a broadcaster and less and less like a social network.
• There is nothing wrong with this model and Twitter is doing an excellent job of monetising the generated content.
• Unfortunately, the default position of the market is that Twitter will become the next Facebook which is why hopes and dreams get far ahead of what the reality can ever deliver.
• Q3 14A results are another classic example where revenues were ahead of expectations but the stock collapsed because the user count is showing no signs of reaching Facebook’s levels.
• Q3 14A revenues / adjusted-EBITDA were $361m / $68m ahead of consensus at $350m / $52m as execution of monetisation remained very strong.
• This is particularly encouraging given the recent shake-up at Twitter and gives me confidence in management’s ability to remain focused on what really matters.
• Guidance was also good with Q4 14E revenues expected at $440m-$450m with adjusted-EBITDA at $100m-$105m.
• This is comfortably in line with consensus at $447m and $99m.
• Despite this to stock collapsed 11% in after-hours trading as user numbers were 284m and still failing to show the kind of growth that is needed to reach Facebook levels.
• Twitter has significant reach but its user base is always going to remain a small subset of the number of people who actually see the content.
• The release of its Fabric SDK allows third parties to integrate Twitter into their apps which should increase its reach further.
• This will help monetisation but it will do very little for the total number of users that the company reports every quarter.
• Twitter is executing well and delivering on its financial promises but unfortunately the market remains riveted on the user count and its growth.
• It also holds on the idea that Twitter operates like Facebook and until that changes, the stock will remain mispriced.
• If the number of people who see the tweets continues to grow then revenues can still expand even if the user base remains completely static.
• This is why the way that the market values Twitter has to change before the stock can be properly priced.
• Remaining fixated on user numbers is the equivalent of valuing HBO on the basis of the number of shows that it makes rather than the number of people who actually watch them.
• Based on this reality, I estimate that a fair price for Twitter is in the low to mid $30s per share and I still see more downside.
• Until the market digests this, the stock will continue to bounce around as dreams are created and then dashed by reality.