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Morningstar | Twitter Reports Impressive 3Q Results and In-Line 4Q Guidance; Shares Overvalued. See Updated Analyst Note from 25 Oct 2018

Twitter reported third-quarter results that beat our internal projections and consensus. Double-digit revenue growth in advertising and data in all regions was impressive and created operating leverage, pushing margins higher. However, the firm continues to face difficulties in expanding its monthly active user base. Plus, the numbers indicate slight growth deceleration in the daily user count, which we think points to low user engagement growth and the absence of a network effect moat source. Monetization did improve, which may be a sign of better effectiveness of the ads. With solid performance during the third quarter and slightly higher guidance, we increased our top- and bottom-line estimates slightly, resulting in a fair value estimate of $28.50 per share, up from $26. While the shares had declined 37% since the end of second quarter and returned to 3-star territory (from 2 stars), after Oct. 25's 15%-plus bounce in reaction to third-quarter results, and despite our higher fair value estimate, we now view this no-moat name as overvalued.

Total revenue came in at $758 million, up 30% year over year (excluding TellApart from last year), driven by growth in advertising (29%) and data (25%) revenue. Strength in U.S. and international markets continued, which we think was partially due to the upcoming midterm election in the United States and other events such as the World Cup. Also, as more advertisers have been implementing broad-based campaigns on Twitter (especially those related to new brand or product launches), demand for online video ads has continued to grow, which pushed Twitter’s ad revenue higher.

Twitter’s monthly average user count declined 9 million (3%) from last quarter and 4 million (1%) from last year as the firm continues to work on creating what it refers to as a healthier environment on the platform. The impact of the GDPR implemented in Europe also drove the user count lower. While daily average users grew 9% year over year, it was a slowdown from 11% seen in the previous quarter. In our view, this may indicate that overall user engagement, which is the ratio of DAU/MAU, has probably weakened as such deceleration in DAU growth was accompanied by decline in MAUs.

In terms of monetization, we were impressed by what we think was 2.5% sequential growth in average revenue per user. We think this was driven by a smaller decline in price per ad, as it was down 14% year over year compared with last quarter’s 32%. In our view, lower growth in ad inventory, or ad engagement, probably drove the improvement. ARPU did decline nearly 12% year over year, but this was a bit better than the 13% decline in the second quarter.

Adjusted EBITDA came in at $295 million during the quarter, representing a 39% margin (up 4 percentage points from last year) as the impressive top-line growth created operating leverage. Third-quarter operating margin stood at 12%, a significant improvement from last year’s mere 1%, which included the lower-margin TellApart business. While we expect the firm to continue to increase head count and invest in improving its user type and overall data security, we project additional margin expansion throughout our 10-year projection period, mainly due to continuing top-line growth and further adoption of programmatic ad buying by Twitter’s advertisers and their agencies.

Management’s fourth-quarter guidance of adjusted EBITDA implied around $810 million-$861 million revenue (based on midpoint adjusted EBITDA margin guidance), which we view as slightly conservative given the midterm election in the U.S. On the basis of this assumption, along with better-than-expected third-quarter results, we upped our 2018 revenue estimate and now expect 23% growth, up from our previous 21% assumption. We think such growth will generate operating leverage that will push operating margin to 12%, significantly higher than last year’s level near 2%. We model a 10-year average operating margin of 23%.