Twitter (TWTR) has cemented itself as a cultural touchstone over the past decade with presidents using the platform to communicate with the public and the term hashtag entering the Oxford English Dictionary.
Despite the platforms prominence, shareholders have not been rewarded because Twitters business has failed to meet their expectations. Twitters user numbers have stopped growing and the platform now faces issues like increasing competition and negative user behavior. For Twitter to achieve the success of peers like Facebook (FB) it will likely need to move beyond its current advertising business model, although the viability of this is unclear.
Twitter is an important public forum which in many ways has become a cultural touchstone, but this importance in the public sphere has not translated into financial success. This lack of success could be attributed to the relatively narrow appeal of the platform, the potential of the platform being neutered by Facebook or difficulty monetizing the platform.
Twitter can be accessed through twitter.com, SMS or app with the companys focus on mobile. Content is largely user generated but there are also over 1 million media outlets who distribute Tweets in addition to Twitters platform partners. These outlets and partners add value to the user experience by contributing content to the Twitter platform which provides credibility and a measure of brand security for advertisers.
Twitter monetizes their platform by selling user data and advertising. Advertisers can target users based on Twitters interest graph maps which is based on interests, users followed, and actions taken on the platform amongst other factors. Advertising options include:
Twitter also enables advertisers to extend their reach beyond Twitter through MoPub and Twitter Audience Platform. MoPub is a mobile-focused advertising exchange which combines ad serving, ad network mediation and a real-time bidding exchange. Twitter Audience Platform allows Twitter Promoted Products to reach audiences beyond the Twitter platform while retaining access to Twitters measurement, targeting and creative tools. 86% of Twitters revenue currently comes from advertising on the platform with advertising outside of the platform aggregated under data licensing and other, which totaled $424 million in 2018. This compares to Facebooks $4.8 billion revenue from their advertising network in 2019. This is reflective of Facebooks much larger user base and potential data advantage. Revenue from data licensing comes from allowing data partners to access, search and analyze historical and real-time data on the platform.
Twitters platform has always been focused on its ability to provide information in real-time and this focus has increased as the company has sought to make it easier to follow and discuss events with expanded coverage of sports, entertainment and news amongst others. For example Twitter has previously live streamed NFL games and presidential debates.
To support its focus on covering events in real-time Twitter acquired the livestreaming app Periscope in 2015. Twitter tried to operate Periscope as an independent platform and was slow to incorporate Periscopes functionality into Twitter. Other platforms introduced similar functionality, like Facebook Live, Instagram Live, YouTube Live (GOOG) and Amazons (AMZN) Twitch yet Twitter failed to capitalize on the early lead Periscope gave them in the live streaming market. If Periscope was quickly integrated into the Twitter platform so Twitters large user base could be leveraged the acquisition may have been far more successful.
Twitter acquired Vine for $30 million in 2012 citing the natural fit between Vines short videos and Twitters short messages as the strategic reason for the deal. Similar to Periscope, Vine was operated separately, and Vines functionality was not introduced onto the Twitter platform. Instagram introduced 15 second clips in 2013 and Vine peaked shortly after this. Vine was slow to introduce advertising options for brands forcing them to rely on paying users to generate content. The lack of monetization and dwindling user base led Twitter to shut Vine down in 2016. Snapchat ultimately became what the creators of Vine had originally envisioned.
It appears the inherent limited functionality of apps like Twitter, Snapchat (SNAP) and Vine are part of their appeal, forcing users to communicate in a different and more creative fashion. The limited functionality that is a large part of these apps reaching critical mass also appears to be the reason for their limited success in the long run. Facebook's initial success was due to its exclusiveness, limiting users to students of ivy league schools. As Facebook began to reach critical mass it was quick to roll back this artificial restriction though and make their platform universal. Facebook has also been quick to introduce features which have widespread appeal. Facebook appears agnostic on how their platform is used provided the user base is engaged, whereas Twitter appears focused on the functionality of their platform.
Twitter has faced rising criticism in recent years due to issues like fake news, trolls and bots along with accusations that foreign agents may be attempting to control political outcomes. Periscope has faced similar controversies with problems around child pornography and bullying. In some ways social media platforms have become victims of their own success. These issues have always existed but platforms like Facebook have become such a large part of society that these issues cannot be allowed to continue. Twitter has recognized this and in 2018 took steps to reduce negative behavior on the platform. This included helping people see high-quality information, strengthening the sign-up and account verification processes and preventing the abuse of Twitter data.
Many of these measures are implemented through machine learning which has minimal cost but there is also a significant labor burden associated with content moderation, which could pressure margins over time. Social media companies have sought to outsource this problem as they clearly do not see it as part of their core value proposition. It is a function they are forced to perform and seek to do so in as low a cost manner as possible. Twitter has little option but to address these issues though as it risks losing advertising revenue if their platform represents a threat to brand safety. Research has shown that false content is more viral which is a huge problem for platforms that rely on capturing user attention through user generated content. If the negative aspects of Twitters platform are to be controlled in a meaningful way while the business continues to rely on an advertising model it will likely need more significant effort than outsourcing.
Twitter recently banned political advertising on its platform, but this is a symbolic move which does not address Twitters larger issues, which are inherent in the nature of the platform. The move will also have virtually no impact on Twitters finances as Twitter is not widely used for political advertising. Revenue from political advertising only contributed 0.1% to Twitters total revenue in 2018.
The number of users on Twitter's platform has plateaued in recent years and this could be due to Twitter being a niche service with limited appeal relative to many other social media platforms. There is likely limited potential for international expansion as the platform already has significant international penetration, with the service available in 40 languages and 83% of users located internationally.
Figure 1: Twitter Monthly Active Users
(source: Created by author using data from Twitter)
Twitter switched from reporting Monthly Active Users (MAU) to Monetizable Daily Active Users (mDAU) which is likely at least in part to hide the fact they have been unable to drive user growth. dMAUs are defined as users who access Twitter on any given day that are able to be shown ads. The mDAU figure more closely aligns with revenue and shows that revenue growth is largely coming from an increasing proportion of users who are being monetized, not from a larger base of users or higher revenue per user. Twitter is making progress converting MAUs to mDAUs but without an increasing user base this source of growth will eventually dry up.
Figure 2: Twitter Monthly Active Users and Monetizable Daily Active Users
(source: Created by author using data from Twitter)
Twitters user base skews towards younger urban users who are highly educated and have high incomes. This is an attractive user base for advertisers which helps to explain Twitters relatively strong ability to monetize user hours on the platform.
Figure 3: Online Platform User Demographics
(source: Hootsuite)
Twitter may face increasing competition for advertising spend from other social media platforms as advertisers become more familiar with them. Twitter is relatively poor at creating brand awareness and driving ecommerce traffic and poor advertising performance could drive advertising spend away from the platform over time.
Figure 4: Percentage of Poll Responders Who Have Discovered Products on a Social Media Platform (U.S. 18-34 years old)
(source: Created by author using data from kleinerperkins)
Figure 5: Proportional Referral Traffic to E-Commerce
(source: Pinterest)
Twitter is unlikely to achieve significant growth in its advertising business due to a number of factors, including:
Twitter therefore needs to create alternative avenues for growth and is investigating options including an open protocol for social media and data portability across platforms. Twitters CEO has stated that he believes that value creation in social media is shifting towards providing recommendation algorithms and away from hosting content, which supports these strategies.
Twitter recently began R&D into creating an open protocol for social media which could allow competing interfaces for the Twitter platform to be developed and could also absolve Twitter of responsibility for content moderation. This initiative could move Twitter in the direction of becoming a protocol for the open internet (similar to SMTP for email or HTTP for world wide web) which many had envisaged for the platform in its early days. Twitter killed the openness of its platform in 2012 though by restricting what developers could do with APIs.
It is not clear how shifting from a platform to a protocol would benefit shareholders though. An open protocol for social media would likely require a shift in business model away from monetizing user attention. Companies generally dont profit from controlling protocols like HTTP, they profit by building applications on top of it. Potential business models include charging for premium access and storage, charging for data access and monetization through cryptocurrency. This work is nascent and even if it is successful would not have an impact on the business for many years.
Twitters work on an open protocol could also tie in with The Data Transfer Project, whose members include Apple (AAPL), Google, Facebook and Twitter. The Data Transfer Project is an open source project aimed at making it easier to move data between services, such as contacts, photos or conversations. So far this project has mainly focused on back end applications to enhance data portability but could soon involve consumer facing developments.
Twitters revenue began to plateau at approximately the same time as their user numbers and while they have been able to drive some revenue growth in recent years through increased engagement and monetization it has been little for investor to get excited about.
Figure 6: Twitter Revenue
(source: Created by author using data from Twitter)
Figure 7: Twitter Revenue Growth
(source: Created by author using data from Twitter)
Similar to revenue, Twitters profit margins have plateaued in recent years after the platform stopped growing. Increased content moderation requirements do not appear to be impacting the bottom line and Twitter remains quite effective at managing overhead costs. While a slight improvement in operating profit margins should be expected as a result of increased focus on expense management there is little reason to think Twitters margins will improve materially in the future.
Figure 8: Twitter Profit Margins
(source: Created by author using data from Twitter)
Figure 9: Operating Profit Margins for Social Media Companies
(source: Created by author using data from company reports)
Figure 10: Revenue Growth and Profitability for Social Media Companies
(source: Created by author using data from company reports)
Despite Twitters recent price pullback it would be difficult to characterize the stock as undervalued unless investors believe the future performance of the business will be materially better than its recent past. Twitters EV/S multiple is broadly in line with its own history and its competitors given its current growth rate.
Figure 11: Social Media Companies Growth and EV/S Ratio
(source: Created by author using data from company reports and Yahoo Finance)
Based on a discounted cash flow analysis I estimate Twitters intrinsic value to be approximately $33 per share. To create more value for shareholders in the future Twitter must find a way to drive sustainable revenue growth and higher margins in the face of increasing competition and potentially higher costs.
From the outside it is difficult to say where exactly Twitters problem lies, but there does appear to be a problem. As evidenced by failed acquisitions, management changes, organization restructurings, activist investors and generally failing to fulfill the promise of the platform. Given these previous issues and the challenges facing Twitter it is difficult to project a dramatic reversal of fortune going forward. Twitter appears destined to be a platform with far more societal impact than financial success.
Disclosure: I am/we are long PINS. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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Twitter: Business Transformation Is Required For The Stock To Soar - Seeking Alpha
