Why Twitter's Upcoming Earnings Might Be Ugly

By Markets Fool.com

Image Source: Twitter.Copyright Marisa Allegra Williams (@marisa) for Twitter, Inc.

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After interest in a sale of Twitter (NYSE: TWTR) reached a peak earlier this month, management asked for potential acquirers to conclude negotiations by October 27. That date is particularly noteworthy because it's when Twitter reports its third-quarter earnings results. The request from management could indicate that its third-quarter earnings results will be disappointing, and it wants to finalize a deal before those numbers go public.

Now that interest has died down and it's unlikely that Twitter will get a deal done before the end of the year, that leaves investors in a tough position. Shares have already fallen about 30% from their peak last week as of the close Monday. With the potential for poor earnings results later this month, the worst might not yet be over.

Expectations are already low

Twitter's outlook for the third quarter when it released its second-quarter results was for revenue in the range of $590 million to $610 million. That's essentially flat from the $602 million in revenue Twitter reported in the second quarter, and up only 5% from last year's $569 million.

Additionally, it expects adjusted EBITDA between $135 million and $150 million. It reported adjusted EBITDA of $175 million in the second quarter and $142 million in the third quarter last year.

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Management points to its investments in video as a reason for the slowdown in revenue and earnings growth. It believes that in the long run, the transition to video will pay off in higher-value advertisements comprising the majority of its ad inventory. Currently, the company is seeing customers transition from traditional promoted tweets to video ads, and spend hasn't been as incremental as expected.

Analysts expect an earnings decline

Analysts expect Twitter's earnings results to come in below last year's results for both the third and fourth quarters. Overall, they expect non-GAAP earnings to decline 10% to $0.09 for the third quarter. The good news for investors is that analysts have mostly kept their expectations the same since Twitter released its underwhelming third-quarter outlook.

Analysts expect revenue growth to come in closer to the high end of Twitter's outlook, at $606.4 million. And they expect fourth-quarter revenue growth to remain consistent with the third quarter -- albeit off a larger revenue base.

If Twitter goes negative

Twitter's outlook and analysts' expectations are already so low that Twitter is flirting with negative growth. Twitter reported a decline in active users in the fourth quarter of last year, and it sent the stock plummeting. Granted, expectations were somewhat higher back then, but the company was able to continue increasing revenue despite the decline.

The stakes are even higher now that Twitter is exploring a sale. A lot of the value in Twitter stock is still tied to the fact that many buyers see it as an eventual takeover target. However, a company with declining revenue doesn't demand nearly as much attention or as high of a valuation as a company that's still growing and has a lot of potential left. As a result, a decline in revenue or users could cause the stock to plummet more than another company's stock would if it reported similar results.

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Adam Levy has no position in any stocks mentioned. The Motley Fool owns shares of and recommends 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.