Twitter Pre-Earnings: Strong Growth In Monetization And Active User Base Is Expected

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Trefis
TWTR: Twitter logo
TWTR
Twitter

Twitter (NYSE:TWTR) is scheduled to report its Q3 2014 earnings on Monday, October 27th. The company’s stock has run up in the past few months as the last quarter’s results showed acceleration in revenue growth and active user base growth, coupled with significant improvement in the adjusted EBITDA margin. Though impressive, the second quarter results were partially driven by the FIFA World Cup, as higher engagement propelled user growth and international ad pricing.

We believe that, in the third quarter earnings release,  the company will continue to report strong growth across most metrics, along with improvement in non-GAAP profitability margins. However, in the long-run, we believe Twitter will have to show massive growth in its active user base and bring its monetization rates to levels comparable to its industry peers to justify the current market valuation.

Our price estimate for Twitter stands at $32, implying a discount of about 35% to the market price. We currently forecast total revenue and the EBITDA margin to increase to $6 billion and 51% by the end of our forecast period (2022). However, were these figures to reach $8 billion and 55% by 2022, our valuation of the company’s stock would increase by about 35%.

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See our complete analysis for Twitter

Recap Of Q2 2014 Results

Twitter posted revenue of $312 million in the second quarter, which represented an year-over-year increase of 124%. Advertising revenue grew by 129% annually to $277 million. This was primarily driven by 100% rise in ad revenue per 1,000 timeline views, as timeline views increased by 15%.

The adjusted EBITDA margin (non-GAAP measure) came in at 17% as compared to 7% in the same period a year ago. Several metrics including user growth and mobile monetization also showed impressive growth. All these positive developments have contributed to an increase of over 30% in the company’s stock price during the past three months.

In GAAP terms, Twitter’s profitability actually fell during the quarter –the operating margin came down to -48% as compared to -28% in Q2 2013. Stock-based compensation, which was recorded at $158 million in Q2, caused the wide spread between GAAP and non-GAAP margins. The company’s management guided adjusted EBITDA for Q3 to between $40 million to $45 million, which in margin terms amounts to 12% to 14%. However, in GAAP terms, the profitability will continue to be negative in Q3 and coming quarters, due to significant stock-based compensation expenses.

Ad Revenue Growth Is Strong, But Ad Pricing Is Facing Some Pressure

Twitter’s advertising revenue growth of 129% year to year  and 22.5% quarter to quarter during the second quarter was impressive, considering that mobile accounted for 81% of total ad revenues. With the rising adoption of smart phones and the increasing trend towards mobile Internet usage, Twitter’s ability to effectively monetize the mobile platform bodes well for its future revenue growth.

Ad-revenue growth can also be broken down into the number of ad impressions and average ad pricing. While the total number of ad engagements (or impressions) rose by 250% annually, the cost per ad engagement (or average ad pricing) came down by 35% year over year. This is a bit surprising and contrary to what Facebook (NASDAQ:FB) is witnessing.   In Q2 2014, FB saw 123% increase in average price per desktop ad, while the total ad impressions declined by 25%. [1]

We believe that Twitter still has a long way to go in terms of selling its ad inventory which is why the number of ads are growing fast. Additionally, it appears that currently there is oversupply which explains the decline in the average ad pricing. We believe the true test of Twitter’s ad products will come when it reaches optimal ad density and the average ad pricing becomes the dominant factor in determining the company’s ad revenue growth. For now, the path seems fairly clear. Twitter wants to sell as many ad slots as possible and considering the platform’s targeting capabilities, advertisers are likely to divert more of their budget towards marketing on Twitter.

User Growth Will Continue To Stay High In Third Quarter But Could Moderate Later

Twitter saw solid user growth during the second quarter, with average monthly active users (MAUs) rising by 24% year over year and 6% quarter over quarter to 271 million. U.S. MAUs rose by 3 million to 60 million, and international MAUs grew by 13 million to 211 million in Q2. We think the FIFA World Cup 2014 positively impacted this growth due to higher engagement; around 652 million tweets were sent related to World Cup Football 2014. [2] We expect the user growth in the third quarter to also benefit from this event as it lasted from mid-June to mid-July. We think the uptick in active user base growth seen in Q2 could be temporary, and could moderate by the fourth quarter of the year.

While tracking the user metrics for the third quarter, investors should also be cautious that around 14% (or 38 million) of user base accessed Twitter through different third-party applications, where Twitter can’t serve ads. [3] This figure had risen by 2% sequentially in Q2 and a further increase in this base should be a cause of concern. [4] In the event  active user base growth on Twitter slows down or use through these third-party applications increases rapidly in the future, there could be pressure on the company’s stock.

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Notes:
  1. Facebook’s (FB) CEO Mark Zuckerberg on Q2 2014 Results – Earnings Call Transcript, Seeking Alpha, July 23, 2014 []
  2. Twitter’s Official Blog []
  3. Why Twitter Investors Were Just Duped, Trefis, August 7, 2014 []
  4. Twitter’s (TWTR) CEO Dick Costolo on Q2 2014 Results – Earnings Call Transcript, Seeking Alpha, July 29, 2014 []