Twitter’s Monetization Issues Don’t Appear To Be Going Away

TWTR: Twitter logo

Twitter’s (NYSE:TWTR) struggle over the years to turn profitable is no secret for investors, but over recent quarters, the company’s path to profitability has become more difficult. This is primarily because advertiser interest in the social networking platform has been dwindling, and the better-than-expected recent growth in Twitter’s user base has also not been able to generate much interest. This, in turn, has led to a sizable year-on-year reduction in total advertising revenues for Twitter in each of the last two quarters. Although Twitter’s growing user base and its increasing focus on auto-play video ads helped the number of ad engagements over this period, these gains could not mitigate the impact of significantly lower ad revenues per view on the top line.

As it stands now, Twitter’s biggest issue is monetizing its user base, as well as its still relatively lackluster user base growth. The company acknowledges that it will take some time for its advertising revenues to catch up with user growth, as the allocation processes used by advertisers have a lead time of 6-12 months, and also because Twitter has had to spend quite some time convincing potential clients about the effectiveness of its platform as a marketing tool. This would also explain why Twitter has been focusing increasingly on video streaming to counter the headwinds its platform faces in terms of generating advertising revenues.

So how are Twitter’s revenues and profits likely to change over coming years? Below we discuss our forecasts for Twitter’s financials and our rationale behind them. 

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View our detailed analysis of Twitter here

Twitter’s Business Model In A Nutshell

Twitter’s current business model generates revenues from two sources: advertising and data licensing. The advertising business accounts for most of Twitter’s revenues (almost 90%). Twitter generates data licensing fees by granting clients access to its huge database of user-generated tweets for analysis and further use. Additionally, more than 60% of Twitter’s revenues comes from the U.S., although its international operations have seen steady growth over the years.

As of now, data licensing is Twitter’s fastest growing revenue stream, with 17% y-o-y growth in Q1 2017. In comparison, advertising revenues fell by 11% over this period. But the small contribution of data licensing services to Twitter’s top line resulted in an 8% reduction in total revenues y-o-y. While Twitter managed to mitigate the impact of shrinking revenues on the bottom line by slashing costs (largely through a reduction in headcount), this strategy is clearly not sustainable in the long run.

Our Base Case: Growth In U.S. User Base To Slow Down, ARPU Will Level Off

Our base case scenario for Twitter largely assumes that the Twitter’s user base in the U.S. – its core geographical market – will slow down going forward, and that Twitter will continue to struggle with monetizing its platform. The key trends we forecast for Twitter’s core revenue drivers are as follows:

  • U.S. active user base almost saturated: We expect Twitter’s U.S. user base to grow slowly over the next couple of years before settling around 72 million users. This is not much higher than the 70 million figure reported for Q1 2017. But it should be noted here that a sizable chunk of this user base consists of fake or spam accounts (including remotely-operated bot accounts). Twitter estimates about 5% of its user base falls under this category. Considering the heat Twitter has taken over recent months due to the proliferation of fake news through such accounts, the company will very likely have to weed them out going forward. This is expected to have a negative impact on the total number of U.S. active users in the near future.
  • Average advertising revenue per U.S. user to improve marginally: Twitter’s ability to provide companies access to an easy-to-segment audience base is a unique offering among social media platforms, and this should help its advertising revenues going forward. However, Twitter’s considerably smaller user base compared to competitors like Facebook, coupled with a projected slowdown in user base growth, will likely limit growth in advertising revenues going forward. While we forecast overall advertising revenues to grow over the long run (albeit at a slow rate), this translates to largely stagnant advertising revenues per user.
  • Data licensing revenues to witness brisk growth: Twitter generates roughly 500 million tweets every day, and data analysis companies sift through this massive database of tweets to convert it into actionable data for use by their clients. Twitter charges a fee for access to its database of tweets, and we expect these fees to grow at roughly 10% annually going forward.

Our base case scenario values Twitter at $11.6 billion – roughly 10% below its current market capitalization. The table below highlights our forecast for key operating metrics at Twitter.


This Is Where Twitter’s Recent Focus On New Content Comes In

As we detailed in the table above, Twitter’s strategy of monetizing its social networking platform in its current form will be met with stagnating revenues (unless international growth speeds up considerably). While this will lead to gross profits leveling off, the company will likely report growth in EBITDA thanks to lower SG&A and R&D costs down the line. Twitter was quick to recognize this eventuality, though, and has been making changes to its platform to include better content-delivery and streaming capabilities – allowing it to live-stream sporting events as well as news content. Notably, this move is aligned well with the growing popularity of internet-only streaming services, in tandem with a steady increase in cord-cutting among traditional cable TV subscribers.

We believe that in the future, Twitter can target sustainable growth by positioning itself along one (or more) of three strategies: by adopting a content-focused approach, a news-focused approach or a data-focused approach. We will quantify the impact of each of these strategies on Twitter’s revenues and profits in a subsequent research note.

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