(Courtesy of Seeking Alpha)
- Twitter-Google collaboration can serve as a catalyst to both increase user base growth and further increase monetization.
- Strong Q4 results have restored trust in management, easing future sell-offs following potential disappointments.
- Increased efficiency in monetization provides a cushion if user growth slows, decreasing downside risk.
Two key questions must be answered about Twitter (NYSE:TWTR) in order to properly value it. What is the eventual scope of the company’s influence? In Twitter’s case, analysts focus on MAUs or timeline views. Second, how and to what degree can this influence be monetized? Twitter’s collaboration with Google (NASDAQ:GOOG) (NASDAQ:GOOGL), to be unveiled over the summer, has the potential to both expand the scope of Twitter and increase the ability to monetize its influence.
For investors, it is important to highlight potential catalysts that will lead to the market realizing a company’s true potential. In Twitter’s case, all the good news from the recent annual report should already be accounted for in the stock price. Obvious potential catalysts are future earnings announcements and conference calls that will serve to highlight the company’s value. Other than the standard announcements, the key catalyst for the near term is the expected rollout of Twitter’s now signed collaborative deal with Google about which much has been speculated regarding the nature of the deal and how the integration will work. No matter the nature of the deal, it should have two impacts.
First, the deal will increase Twitter’s exposure to the non-user population. This may result in an increased user base or simply increased viewing of tweets. Users searching for information, which Twitter can provide well, initiate over a trillion Google searches every year. Specifically, Twitter canbetter provide real-time news than most results on Google searches. Often 140 characters, or a group of several tweets containing 140 characters, is enough to give the user the information for which they are searching. Google is hesitant to reveal exactly how many searches are done on its website, only stating the current figure is more than the 1.2 trillion searches in 2012. Exactly how much more is anyone’s guess. The number of Google searches had been growing, but growing at a slower and slower rate through 2012. The more important point is 1.2 trillion-plus searches every year will display several tweets. Compare that with 692.5 billion timeline views Twitter’s 2014 10-K. Non-users in particular will see an unprecedented number of tweets. Even if it’s a few tweets displayed per search instead of an endless list of Tweets a user follows, the uptick in the amount of times tweets are viewed is significant, especially promoted ones potentially displayed on Google searches.
In an ideal scenario, the public will see Twitter’s superior function as a newsfeed for instant updates on the latest events and create an account with the social network. The deal with Google can only serve to expand the user base and improve engagement with both users and non-users. Expanding influence has the potential to serve as a catalyst at a time when investors have been somewhat complacent with less than expected MAU growth, provided monetization stays on track.
Second, the integration should substantially increase Twitter’s advertising revenue. Limited tweets viewed on Google searches about certain results present a new and highly competitive advertising medium for firms. Promoted tweets on Google searches, especially those advertising daily or weekly specials for firms relating to the search, have the potential to be highly profitable. Take for example a common search for “pizza” or restaurant.” Users around the world searched the terms millions, probably billions of times every year. How much is it worth to national pizza chains like Domino’s or local restaurants to have their tweets, possibly advertising nightly or weekly specials, exclusively pop up on related Google searches? It’s worth a lot.
This is the most targeted advertising possible for companies, because they already know exactly what the user needs,. That’s the purpose of Google. Granted, Google does offer advertising on the tops and sides of the results, but tweets from companies promoting deals don’t feel the same way advertisements do, especially on mobile platforms. They are in a format familiar to many users, and if used properly, advertisements feel just like another user on Twitter communicating with the user. Many brands have been able to successfully promote themselves on Twitter without necessarilypaying directly for advertising, but this could change with the limited amount of tweets displayed on the integrated Google search page. Given the high demand for prime content space, the deal offers substantial upside to the already steadily increasing profitability of Twitter.
All this speculation and prediction about the deal begs the question, how do we know this integration with Google will be a raving success? The fact of the matter is that we won’t know until we see it. However, because of the strength of their recent earnings report, that does not matter very much. Integrating with Google is not what makes Twitter valuable. It is simply potentially valuable icing on the cake.
Twitter missed substantially on Q4 user growth, an event that has caused selloffs and second-guessing in the past. The lack of negative reaction to the miss on expected MAUs in Twitter’s latest earnings report (288 million MAUs vs. about 292 million expected) is telling. Granted, this must be taken with a grain of salt, as perhaps investors are crediting this miss to certain bug issues with the roll out of iOS 8, as Twitter management suggested. However, the most important takeaway is the lack of downside risk for investors based on slowing MAU growth, at least as long as investors trust management to explain it away. If user growth increases faster than expected (e.g. many Google users see the value of Twitter and create an account), it should give TWTR a large boost. If user growth continues to grow slowly for a quarter or two, the stock price will not overreact as long as management can come up with an explanation.
Investors are finally cutting management some slack because of the large uptick in profitability. Twitter’s large increase in monetization drove the stock up to its $48.01 end of week close after the Q4 earnings announcement, after barely touching $40 the week before. Revenues up 111% year-over-year encouraged bullish investors. More important than general revenues were operating revenues from advertising and data licensing were up 111% and 109% from FY2013, respectively. Twitter is generating advertising revenue more and more efficiently as they find better ways to target ads effectively, evidenced by increasing advertising revenue per 1,000 timeline views.
Although the annual growth rate from total advertising revenue slowed modestly, down from 121% growth in 2013, data licensing revenue growth rate more than doubled, up from 48% in 2013. This is partially attributed to a full year worth of revenue. Nevertheless, the value of data licensing should only increase as Twitter users generate more and more data every day and as data scientists devise more useful methods to extract information from this increasing amount of data.
These increasing revenues put Twitter well on its way to earning a GAAP fiscal year profit. Adjusted EPS beat estimates, coming in at $0.12. One important thing to note about profitability and related company structure is the alignment of employee compensation to increasing shareholder value. Stock-based employee compensation was $631.6 million in 2014. In a young, developing company like TWTR, aligning the interests of employees (in addition to management) serves to remind the company’s employees of their fiduciary obligation. Although this can drag down TWTR’s income, investors should view alignment of interests as a beneficial component of company structure in the long run.
Between newly found trust in management and the rapidly-increasing advertising and data licensing revenues, there’s a soft cushion to absorb the blow if the Google integration were to disappoint. The bottom line is that Twitter’s deal with Google is no longer something necessary to save a company not living up to expectations but a chance for Twitter to drastically expand its scope and profitability. At the beginning of 2015, some even cited the potential of Google acquiring Twitter as a reason to be bullish on an otherwise underperforming stock with substantial questions about management. The most recent earnings report has laid these questions to rest, at least for now. The Q4 increase in profitability creates a more stable track record that offers investors a large cushion against stagnating user growth, future issues with profitability and even a disappointment on Twitter’s collaboration with Google when it’s released. At this point, TWTR offers limited downside with great potential to significantly outperform the market during 2015.