Here’s Why We Raised Our Price Estimate For Twitter To $39

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TWTR: Twitter logo
TWTR
Twitter

We have recently updated our price estimate for Twitter’s (NYSE:TWTR) stock from $32 to $39, which represents a near 20% change in our valuation. We believe there is tremendous growth potential for Twitter as its total usage extends much beyond its 284 million monthly active users (MAUs); over hundreds of millions of users come to Twitter but don’t log in or access tweets through syndication across the web, and the company has not even begun to monetize this user base. In addition, the ad load coverage on the social network is low and the company is still testing newer ad products, such as video-based ads. We expect the average ad pricing to also rise in the long run, with improvements in ad targetability and the introduction of more popular ad formats on a larger scale.

We are also optimistic about Twitter’s profitability in our valuation model. We expect its adjusted EBITDA margin to rise rapidly from around 16% in 2014 to around 53% by 2022, as growth in sales significantly outpaces the increase in expenses over the coming years. However, if this margin increases to only 48% by the end of our forecast period, then it represents around a 10% downside to our price estimate.

Our $39 price estimate for Twitter’s stock is marginally lower than the current market price.We encourage our readers to tweak estimates in our valuation model to see the impact on Twitter’s price estimate.

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See our complete analysis for Twitter

Monetization Will Continue To Rise Rapidly

Twitter’s advertising revenue increased by 129% and 109% annually in the second and third quarter of 2014, respectively. We believe these advertising dollars will grow at a healthy rate in the future as well, driven by an increase in ad load (or coverage) as well as the roll out of better and newer ad products. Currently, the advertising coverage on Twitter is considerably low leaving significant room for introducing more ads on user timelines. Ad revenue per 1,000 timeline views has risen by over 80% in the previous two quarters, primarily due to increased delivery of ads on the platform.

In addition, improving the targetability of ads and adding more ad formats will lead to better click-through rates and ROI. This in turn will attract higher pricing and more advertisers on the platform leading to increased monetization. Twitter’s ad products, including promoted tweets, promoted video ads, website cards and mobile app downloads, are gaining traction and we expect their uptake to rise in the future. The company’s move to test newer ad products such as promoted video ads will enhance its ad format mix.

Twitter has done well to monetize the mobile platform — mobile devices accounted for 85% of total advertising revenue in the third quarter. With mobile Internet quickly gaining popularity throughout the world, Twitter’s ability to monetize this platform bodes well for its future revenue outlook. Recently, the company launched a new software development platform ‘Fabric’ for app developers, which if successful, could greatly boost Twitter’s reach across the entire mobile ecosystem.

Rapid growth in international sales is another tailwind for Twitter’s business. The share of international sales of overall sales has risen from 28% in Q1 2014 to 34% in Q3 2014. We expect this proportion to continue to rise, fueled by expansion in sales presence across the globe and the addition of more markets on Twitter’s self-service advertising platform (which primarily caters to small and medium-sized businesses).

Monetization Of Passive User Base Is A Big Opportunity

Apart from all the above factors, there is another less understood but important driver for Twitter’s revenue growth. In the recent earnings call, Twitter’s management outlined that apart from the 284 million MAUs on its platform, there are more than twice as many users who come to Twitter-owned properties but don’t login or access tweets through syndication across the web. We believe that over the long run, Twitter will also start monetizing this passive user base. To draw a rough estimate, if we assume that Twitter starts monetizing 200 million of these additional users, at a rate of 1/5th its average revenue per user in 2013 (which stood at around $2.70) — it would generate additional revenues of more than $100 million. In comparison, Twitter delivered around $595 million in advertising sales during 2013. Therefore our rough estimate is that monetization potential on this passive user base could be around 10-30% of Twitter’s revenues in a given year, if the company is able to monetize it successfully. Taking into account all the above factors, we expect Twitter’s sales to rise at a CAGR of 23% from around $1.4 billion in 2014 to over 7 billion by the end of our forecast period in 2022.

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