EUR 850.00 For Business Accounts Only

Morningstar | Twitter’s Better-Than-Expected 2Q Results Offset by Disappointing Guidance; Shares Remain Overvalued

Twitter reported better-than-expected second-quarter results but disappointed the market with its user count and adjusted EBITDA guidance, both of which, while below consensus, were still higher than our projections. Our positive takeaway from Twitter’s second quarter is that demand for its ads is growing, which helps the firm continue to increase the average revenue it generates from users, albeit second-quarter numbers were helped a bit by the World Cup soccer tournament. The negative is that, similar to Facebook, Twitter needs to increase its headcount, as it has to invest more in spotting and deleting bad accounts, managing content quality more effectively, and increasing its ad sales team, which altogether will pressure margins in the short term. Given the firm’s second-quarter results and guidance, we upped our 2018 and 2019 projections a bit, resulting in a $26 per share fair value estimate, up slightly from our previous $24. While the stock declined nearly 21% in reaction to management’s third-quarter guidance, we continue to view this no-moat and very high uncertainty name as overvalued and recommend investors remain on the sideline.

Twitter generated $711 million in total revenue during the quarter, up 27% year over year, excluding last year’s TellApart revenue. Advertising revenue grew 23% from last year, with strength in the U.S. and international markets. In addition, higher-margin ad revenue generated from Twitter’s owned and operated properties was up 29% year over year. As expected, higher ad revenue was driven mainly by further allocation of online ad dollars to video.

While Twitter’s total monthly average users, or MAUs, increased 3% from last year, they were down sequentially as the company’s account cleanup efforts resulted in a 1 million decline in U.S. users. Twitter expects the decline to accelerate in the third quarter, likely resulting in a loss of “mid-single-digit” million MAUs. We think the impact of lower MAUs was partially offset by continuing growth in daily average users, or DAUs, which indicate possibly more time per user spent on Twitter. However, the DAU/MAU ratio, which we view as a user engagement measure, remained below 50%. This is disappointing as some of Twitter’s peers such as Facebook consistently have had user engagement at around 66%.

While the user count came in below expectations, Twitter appears to be attracting more advertisers and/or ad dollars as our estimate of average revenue per user, or ARPU, was up 20% year over year. While some of this growth was due to the start of the World Cup in the second quarter, Twitter also posted year-over-year higher ARPUs in first-quarter 2018 after five straight quarters of a decline. In our view, increasing ARPUs also indicate that the impact of GDPR on Twitter ad revenue was minimal. However, the adoption of GDPR by publishers and advertisers will take some time. In addition, while we agree with the firm that Twitter’s advertising revenue may not be as hurt as others (such as Facebook), given that Twitter ads focus more on brand awareness rather than more specific user targeting, we continue to expect GDPR to weigh on Twitter’s data revenue growth.

Ad engagement continued to increase (up 81% from last year), resulting in what we view as possibly very early signs of ad price stabilization as the cost-per-engagement declined 32% year over year compared with declines of 56% and 52% in 2016 and 2017, respectively. In our view, growth in DAUs and ad engagements, combined with some steadiness in ad prices in the future, support our assumption of a 16% annual revenue growth during the next five years.

On the margin front, Twitter remained profitable and expanded operating margin to 11% in the quarter from an operating loss last year. This was largely driven by continuing growth in higher-margin data licensing revenue, further focus on generating ad revenues on O&O properties, along with further cost control. The firm will be increasing its headcount in the second half 2018 as it plans to invest further in research and development, increase its advertising salesforce, and strengthen its user and content quality management. As with Facebook, we think most of this is likely to become automated eventually, which will create further operating leverage for Twitter. We expect average operating margin of 17% during the next five years compared with a 2% operating margin in 2017.