Twitter came out swinging with its Q2 2014 earnings release. The microblogging site announced solid revenue growth as always and even beat earnings estimates. More importantly, the company displayed positive trends in its user growth and engagement metrics, or so it seemed. Twitter is up about 15% since its earnings release on 29 July 2014. The stock price was up 20% the day after the results were announced. The fact that it has corrected by about 5% thereafter offers little comfort, since the stock still trades at very expensive valuations. Twitter currently trades at a price-to-sales multiple of 27. We analyze if such lofty valuations can be justified by revenue growth alone.
Twitter revenue growth and monetization
Undoubtedly, Twitter's Revenue growth has been one of its virtues, and some would say, its only virtue. In Q2, Twitter's revenue growth accelerated for the 5th quarter on the trot to clock its highest growth post IPO. Revenue grew at 124% YoY to $312 million. The icing on the cake was the 6-9% upward revision of its full year revenue guidance to $1310-1330 million.
Twitter reported a revenue of $1.6 per 1000 Timeline views. Timeline Views are similar to pageviews reported by other internet companies. Twitter's monetization rates have been growing at a fast clip and have propelled revenue growth even as user growth and engagement (timeline views) have been sluggish in the recent past.
Twitter's Ad revenue per 1000 timeline views has been accelerating consistently on a YoY basis, touching 100% YoY growth in Q2 2014. This aspect of Twitter's business might continue to improve at least in the near term, as the company embarks on new initiatives like video ads, app installation ads and reportedly, even e-commerce.
The fact that Twitter earns the bulk of its revenue (72%) on mobile platforms deserves a mention here. The company has also been strengthening its mobile ecosystem with new deals and acquisitions. In recent times, Twitter has acquired Namo Media, which focuses on native ads, and Tap commerce, involved in retargeting of users on mobile devices. Twitter's other acquisition MoPub, the mobile ad buying platform, is strongly positioned with its reach of 1 billion iOS and Android users. Though Twitter's inventory isn’t being sold through the platform currently, it's likely that the same will be done in due time. With MoPub, Twitter is in a great position to leverage these initiatives as well as deals like the $230 million, two-year advertising deal it entered into with the large ad agency, Omnicom.
To sum up, Twitter's monetization rates are likely to rise, at least in the short term. However, monetization alone cannot drive revenue growth in the long term. That's where the user growth and engagement metrics come into the picture.
Twitter user growth
Starting from Twitter's first earnings release after its IPO, user growth has been a concern. If you look at Twitter's user growth (QoQ %) and absolute user addition numbers, there's a clear decline throughout FY 2013. Further, Q1 has typically seen a rebound in user growth historically. So, shifting focus to Q2 2014, there's a good uptick in user growth here. However, there's a good chance some of that is due to the impact of the FIFA World Cup, which might have helped Twitter break its all-time user engagement records. If that's true, a dip in user growth may be in the cards post Q3.
Twitter's CEO Dick Costolo claimed that the FIFA World Cup boosted only user engagement and not exactly the user growth.
However, a bigger concern has emerged out of Twitter's recent earnings release. The company's updated earnings presentation revealed that 11% or 30 million of its users accessed Twitter solely through third-party apps/platforms. Further, 8.5% or 23 million users used third-party apps that "may have" automatically contacted Twitter's server without "discernible additional user-initiated action." Twitter obviously can't serve ads to these users, thus implying that the active user base for an advertiser is only about 241 million users.
An interesting WSJ article has detailed the implications of this development. To sum, user growth isn't as great as it seemed initially.
Twitter user engagement
Twitter's user engagement has been another area of concern with growth in engagement levels slowing significantly by the end of FY 2013.
In line with our detailed estimation of Twitter's user engagement metrics for the quarter, Q2 2014 saw a rebound in this metric as well. To share a few stats, the World Cup generated 672 million related tweets, of which over 300 million tweets were recorded in June 2014. Further, user engagement records like tweets during an event and tweets per minute were broken on multiple occasions during the event.
Since the most engaging final fortnight of the World Cup happened post Twitter's Q2, we can expect an even bigger spike in user engagement levels to be reported in Q3.
The big question is, will Twitter's engagement levels continue to grow after Q3?
Twitter currently trades at a Last Twelve Months (LTM) Price to Sales (PS) ratio of 27, which translates to astronomical valuations. Consider a comparison with Facebook which generates about 10 times the revenue and still grows at a healthy 60 odd percent. Facebook trades at an LTM PS multiple of 19. Here one should note that Facebook also delivered a net profit margin of 27% in Q2 vs Twitter's loss margin of 46% and has nearly 5 times Twitter's active users.
Valuing Twitter using Facebook's PS multiple, we arrive at a price of $32 a share, implying a 28% correction from its current price of $44.15 a share.
Why valuations have soared post Q2 is quite baffling. Revenue growth was great, but it always has been. Twitter was punished in the past because of its poor user growth and engagement levels. So, if user growth isn't actually as great as it seemed and engagement levels were being boosted by a popular event, how is this situation different from those in the past quarters? Revenue growth might continue to remain strong in the near term, fueled by improving monetization rates, but, in the end, Twitter valuations seem to have factored in more than there actually is. Twitter is a risky bet at these valuations and could be very vulnerable to any negative outcomes in the coming quarters.