3 Reasons Twitter Stock Could Fall

By Markets Fool.com


Source: Twitter.

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An early leak of Twitter's first-quarter earnings results on April 28 sent shares into free fall before the exchange halted trading. After trading resumed, Twitter stock continued to fall through the closing bell. Things couldn't get much worse for Twitter in the near term after the company reported revenue results that failed to meet analysts' expectations and lowered its guidance for the year.

Thinking more broadly, there are a few reasons Twitter stock may continue to fall even after giving up nearly all of its gains from earlier in 2015.

Small businesses continue to balk at higher ad prices
For the last two quarters, Twitter has shifted its ad pricing model from cost-per-impression (where advertisers pay each time a user sees an ad) to cost-per-action (where advertisers only pay when a user performs a desired action like following the advertiser's account).

Naturally, cost-per-action pricing is much higher because it delivers users who are further down the conversion funnel. Nonetheless, Twitter says that many businesses balked at the higher pricing and limited the amount they're willing to spend, despite the better leads Twitter is delivering.

If you look deeper into what Twitter is (or isn't) saying, the real problem is that Twitter's ads aren't converting as well as management believed they would. Twitter recently purchased TellApart, which it announced in conjunction with its Q1 earnings release, to help target its ads better.

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If Twitter's ads convert better, it could charge less per action, since it could achieve the action with fewer impressions. But if the TellApart acquisition fails to pay off with better conversion rates, it could result in further decline in Twitter's stock price considering Twitter spent $533 million on the acquisition.

The other factor that goes into ad pricing is the number of customers purchasing ads, and how much they're purchasing. Because Twitter's ad purchases operate on an auction system, having more ad purchasers means the ad prices will increase.

Twitter's management says it grew total advertisers last quarter at the same rate as the fourth quarter on a year-over-year basis. It declined to state how many advertisers that actually is, but management noted it had 60,000 active advertisers at its analyst day back in November. Failure to grow the number of active advertisers and the amount each of those advertisers are willing to spend will negatively impact Twitter's revenue and profit.

Competition continues to grow faster
Even as it tries to grow its total advertisers, Twitter can't forget about the big fish -- brand advertisers. Twitter's direct sales team, which specializes in brand advertising, still accounted for more than 50% of ad revenue last quarter. However, there's evidence that Twitter is having trouble retaining ad spend as competitors grow their user bases.

Snapchat continues to grow rapidly. Last August, the company reportedly had 100 million monthly active users. That number could be closer to 200 million (or more) at this point, according to some reports.

What's more, Snapchat is starting to attract brand advertisers with its Our Story and Discovery features. The company reportedly charges $0.02 per impression. It's worth noting that advertising on Snapchat is more like television advertising, because there's no way to directly convert ads into sales or traffic.

Meanwhile, Facebook's Instagram has already surpassed Twitter in terms of user count, reaching 300 million last fall. Facebook has been conservative with its advertising presence on the photo-sharing network, but the scale and format of posts has huge potential for revenue.

Analysts at Citigroup believe Instagram could generate $2 billion in high-margin ad revenue if fully monetized at its current engagement levels.For reference, Twitter expects to generate between $2.17 billion and $2.27 billion in total revenue in 2015.

Advertisers have a growing number of options to reach wider and more engaged audiences. As a result, Twitter could see pressure on its revenue growth from some brand advertisers shifting their ad spend to competing platforms.

Failure to effectively monetize its entire audience
For several quarters, management has told investors that Twitter's total audience is 2-3 times bigger than its active user base. At the company's analyst day in November, CFO Anthony Noto stated that logged-out visitors, which totaled more than 500 million per month at the time, could be worth 50% of the value of active users. He pegged the opportunity at $1.3 billion. He also noted there's an additional opportunity for people who see tweets through syndication on other websites and apps.

Twitter has taken steps to nurture its logged-out audience and convert them into registered users, including a revamped homepage. Its future plans include monetizing this group by showing them ads, but it's likely that those ad units will suffer from poor targeting, thus appealing largely to brand advertisers. This would limit the number of bidders (and therefore the price paid) for that inventory.

Twitter's efforts to monetize syndicated tweets have had mixed results. While it's convinced a couple of key partners, including FlipBoard (which has millions of users), to place promoted tweets in its syndicated ads, it's been unable to convince others such as ESPN to do so. For Twitter to make money from syndicated tweets, its objectives must align with its partners, which means that some syndicators will pass on the opportunity for a little more ad revenue.

Twitter has built up the expectation that its logged-out user base is worth more than $1 billion. Failing to live up to that expectation could result in a further decline in Twitter's stock price.

The article 3 Reasons Twitter Stock Could Fall originally appeared on Fool.com.

Adam Levy owns shares of Apple. The Motley Fool recommends Apple, Facebook, and Twitter. The Motley Fool owns shares of Apple, Citigroup Inc, Facebook, and Twitter. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.