How Much Is Twitter Really Worth?

The original article, part of the Morning Monte series, was published here.

Internet microblogging platform Twitter Inc TWTR owes most of its market value to speculation.

Models demonstrate the substantial gap between short-term fundamentals and Twitter's valuation at $38. Fundamental investors looking for long opportunities should steer clear of this name.

A basic fundamental model is of limited use for the valuation of a company like Twitter. On a GAAP basis, Twitter is posting net losses and is expected to continue doing so for coming years. Twitter's riskier profile necessitates a high required rate of return, which is set at 10 percent. Assuming a 10 percent required rate of return, the long term residual earnings growth rate implied by the market price of $38 is 12.5 percent.

Remember, residual earnings are abnormal earnings in excess of the required return on book value, meaning the 12.5 percent implied residual earnings growth is very high.

Even with very bullish long term residual earnings growth parameters ranging from 11-15 percent, a standard Monte Carlo simulations suggest that Twitter is overpriced at $38. The simulator above estimates a mean share value under $30.

Company Background

Twitter, Inc. is an internet information provider operating a platform for text, image, and video-based social networking and information sharing. The company offers products for users, advertisers and developers. The company generated 88 percent of its total revenue from promoted products designed for advertisers in Q1 2015.

Promoted products include tweets, accounts and for which advertisers pay. Twitter also offers subscription access to its public data feed, which contributed 11 percent of revenue during the first quarter of 2015.

Twitter had 302 million monthly active users during Q1 2015, an 18 percent increase year-over-year. The company's net revenue was $436 million during that same period, a 74 percent annual increase. $147 million in revenue was generated outside of the US during Q1 2015. Twitter’s assets totaled $5.64 billion as of March 31, 2015.

Bull Case

Twitter is a very popular and useful platform which is still in a high growth phase. Q1 2015 adjusted EBITDA exceeded guidance by more than 10 percent and non-GAAP earnings per share of $0.07 beat analyst estimates. Monthly active users (MAUs) grew 18 percent annually and 4.9 percent sequentially in the corner, a positive development following sequential MAU growth under 2 percent in the preceding quarter.

Despite a negative reaction after falling short of analyst forecasts, the top line grew 74 percent year-over-year in Q1 2015. Concerns about lower-than-expected revenue growth may be overblown, as management explained foreign currency exchange rates created a 600 basis point revenue growth headwind.

Twitter still has a number of viable avenues to future growth. Revenue per 1000 viewers has been rising quickly and was the major driver of top line improvements despite decelerating MAU figures. Monetization remains materially lower in international markets than in the U.S, indicating opportunity for future periods.

An increasing focus on video is good for revenues because video typically has higher engagement rates. Twitter's acquisition of Periscope and addition of real-time streaming video to its platform will exploit engagement benefits and meet consumer demand for video content. Rolling out new capabilities, like e-commerce with a pay now button are potential growth drivers even if user growth remains slow.

Bear Case

In Q1, Twitter missed revenue targets and reduced both sequential and annual guidance. While falling short of guidance and analyst forecasts is bad news on its own, Twitter's history of reversing prior guidance numbers and the fiasco which led to Q1 2015 earnings information being leaked prior to market close have some investors questioning company leadership.

With such a speculative story, market participants can be very reactionary.

User growth has been much slower than investors initially anticipated, evidenced by share prices well below their prior highs approaching $70. 288 million active users is a relatively small figure relative to Facebook Inc FB, so the slowdown in growth could signal the approach of a disappointingly low ceiling to potential user base size.

Twitter also lacks the data collection capabilities as Facebook. While Facebook may not be a fair comparison for Twitter, it is nonetheless the benchmark many analysts and market participants use. As such, Twitter has a hill to climb to satisfy increasingly wary investors.

Discussion

Despite a steep drop in stock price following Q1 2015's earnings release, the current price of $38 still includes substantial speculation. As an unprofitable growth stage stock, Twitter is not an appropriate opportunity for investors concerned solely with fundamentals. It will take several years to attain clarity regarding Twitter's realistic user base potential and the company is still devising ways to effectively monetize those users.

Any long position is a bet on substantial MAU growth and future introductions of innovative monetization techniques.

The most important metrics for investors to track going forward are advertisement revenue per 1000 views, MAU growth, and user engagement.

Contributors: Ryan Downie, Soid Ahmad

About Prudena

Published: 5/5/2015 10:10:06 AM UTC

NOTE: The Morning Monte is high-level, and any investment requires a deeper analysis than is presented here. The comments in the Morning Monte are intended to help guide your research and ground you in the fundamentals of the company. In no way should the comments in The Morning Monte be taken as advice to buy or sell a particular equity. Some of the statements are forward looking. As such, these statements are speculation--so beware! The comments represent the views of the author and are not necessarily the views of PRUDENA™.