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Morningstar | Twitter Reported Strong 4Q but Provided Lower-Than-Expected Guidance; Raising FVE to $30

Twitter reported a better-than-expected fourth-quarter top and bottom line, as the firm’s user monetization continues to improve. However, the daily active user count, which Twitter just began disclosing, confirmed our initial assumption that user engagement on the Twitter platform is lower than its peers, which may hinder faster ad revenue growth. This also supports our no-moat rating on the firm. In addition, as Twitter plans to further invest to improve engagement, enhance the platform, and operate more efficiently overall in the long term, operating margin is likely to decline in 2019, as indicated by management’s guidance. We adjusted our projections accordingly, and after rolling our model forward, we increased our fair value estimate to $30 per share from $28.50. Although Twitter shares are trading more than 10% lower in reaction to the company’s guidance, the stock remains in 3-star territory, and we continue to recommend a wider margin of safety before investing in this very-high-uncertainty name.

Fourth-quarter revenue came in at $909 million, up 24% year over year. Ad revenue grew 23% from last year to $791 million as Twitter continues to improve the monetization of its users. Data licensing revenue increased 35% from last year to $117 million. GAAP operating margin of 23% was 800 basis points above last year’s as top-line growth and gross margin expansion (mainly due to higher growth in the high-margin data licensing revenue), plus less growth in R&D and sales and marketing expenses, created further operating leverage.

Regarding the firm’s ad revenue, based on the monthly average user count, or MAUs, we estimate that revenue generated per user, or ARPU, increased 25% year over year, which is encouraging. The firm also began reporting its daily average user count, which stood at 126 million, up 9% from last year. While such growth is positive, it appears that what we initially said in July is coming to fruition: User engagement on the Twitter platform in the U.S., which is 52%, remains lower than Snap’s 79% (based on our estimate of Snap MAUs in North America) and Facebook’s 77%— although it has been improving over the past 12 months. At the end of the fourth quarter, Twitter’s overall user engagement was 39%, up from 35% last year and 36% in first-quarter 2018.

By our estimates, Twitter’s ARPU based on its quarterly daily active users, or DAUs, is only 50%-60% of how much Facebook generates per its DAU. While such difference may indicate that there is room for further ARPU growth for Twitter, we think it will be limited by the lower user engagement. In fact, in 2018, we estimate that while Facebook’s and Snap’s DAU-based ARPUs increased by 25% and 33%, respectively, Twitter’s went up by only 13%. Twitter is certainly taking steps to improve this, in our view. It is trying to make the platform easier to use for consumers. The firm is also trying to make ad buying faster and more efficient for the advertisers and their agencies. However, given the extent at which Twitter’s ARPU growth lags its peers such as Facebook, there is very high uncertainty about whether Twitter can improve user engagement enough to increase demand for its ad inventory.

Twitter provided first-quarter revenue guidance that implies a slowdown in top-line growth, in line with our internal projection. The firm also plans to continue investing in improving its user type and overall data security, which will create pressure on margin. Twitter will also invest more in creating a self-service and automated ad-buying platform for the smaller businesses, like what we have seen with Snap. We expect the higher operating expenses to push operating margin 150-300 basis points lower in 2019. However, we think the firm will benefit from those investments beginning in 2020 for a few reasons. First, we think an easier-to-use Twitter along with more relevant content will increase user engagement, which may attract more advertisers and will further drive revenue growth. Second, after implementing the self-service and automated ad-buying systems, growth in sales and marketing expenses is likely to decline. And third, the self-service systems will also attract more advertisers possibly increasing demand for Twitter’s ad supply. For the reasons above, we foresee some operating leverage after 2019 as the revenue is expected to continue to grow at a double-digit rate and as the additional investments will moderate a bit.