Twitter, Inc. Is Executing On Its Plan -- But Are the Tactics Flawed?

By Markets Fool.com

Twitter (NYSE: TWTR) reported earnings a few weeks ago, and while the stock has seen a bit of a pop on some growth numbers, the company's long-term plans are a bit worrying.

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In this clip from Industry Focus: Tech, Dylan Lewis and Daniel Sparks explain what Twitter's stated goals are and how well it's executing on them.Listen in to find out how Twitter is planning to increase GAAP profitability in 2017 and a few problems with those plans, what their recent move to shut down Vine says about the company, and how investors should feel about Twitter's financial plans for next year.

A full transcript follows the video.

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Dylan Lewis: Let's look back at what the company is trying to set out to do, and some ofthe commentary we got from them, how those align.

A little while back, they said they're looking to do three things: increase discipline, simplify the service, explain what Twitter is and why people should use it. And I think we saw a couple different moves that kind of got at that. One of them, not really touched upon in the conference call -- the decision of the company to move away fromVineand discontinued that app, which is something that had a lot of people scratching their heads.

Daniel Sparks:Yeah, the Vine move was interesting. It just really shows that getting rid of some of their stock-based compensation, which has really become bloated lately, is a huge emphasis as they strive toward GAAP profitability. Obviously, one way to do that is to take a segment of the company that's bleeding cash from paying employees and not making enough money, and just cut it all together. But there was a day when Vine was a big deal, with a lot of Vine stars. And a lot of the stars that are on the platform are still famous today, they've moved on toYouTubeandInstagram. So it highlights some of Twitter's missteps since Vine came on board, and an overall product execution problem they have had across the board.

Lewis:Yeah, and I think that gets at the idea of simplifying the service a little bit, and narrowing focus, getting more at the core product and what people are engaging with all the time, and focusing a little bit more on some of the performing assets that Twitter has. Looking at increased discipline, some of the things that got it that, at least one thing that caught my eye, was the company talking about driving toward GAAP profitability in 2017. How exactly are they going to get there? It seems like it's going to be pretty much are primarily cost savings, huh?

Sparks:Yeah. Like we were talking about before, you see the stock move up when things like this happen. They beat earnings estimates. But you look at why, and even this quarter, it did, as they scaled back some stock-based compensation, reduced some R&D costs, a lot of it has to do with cost-cutting. And of course, revenue came in higher, too. Outsized revenue growth probably helped. But as we look forward and see their plans to drive toward GAAP profitability, it looks mostly focused on cost-cutting. They do emphasize that they want to grow their core platform. But these things aren't certain. The only certain path they have right now is cost-cutting. For any long-term shareholders, you might look at something like that, and it's sweet and sour. It's nice that they are moving toward GAAP profitability, but to see that that's the way it's achieved, it's hard to say that's a great thing, and that it's something that investors should be excited about.

Lewis:Yeah, it seems like the company has decided to take a new focus on the cost structure of the business. They point specifically to sales and marketing, which used to be about 31% of revenue, and they are aiming for that to be somewhere between 22-26% in 2017. That is obviously going to be helped as Twitter reduces headcount by about 9%, as most of the jobs were in sales partnerships and marketing there. So, that's an easy way for them to scale back costs in that segment. They also pointed to cost of revenue, which was about 30% of revenue ex-tax. They're aiming for about 19-23% for 2017. They talked about exploring some different options with the owned and operated data centers they're using, and some of the infrastructure there, exploring some partnerships to help them bring down costs. Those are two major segments that they are looking at to help them get toward GAAP profitability consistently in 2017. But, again, what you're not seeing is them saying, "Outsized revenue growth, or boosting margins, or anything like that is what's going to get us there." So it's nice, they're cleaning up shop, they're trimming some of the fat. But it's not really the way that, as an investor, I would like to see them getting there.

Sparks:Yeah. Like I said, it's sweet and sour because, at the same time, they do need to cut some cost. When you actually look at the breakdown of their spending, you'll see that the sales and marketing, which, at the end of the day, ends up being, most of that sales and marketing expenses is employee compensation, stock-based compensation. When you look back to the second quarter of this year,before some of their cost-cutting, which was already under ways starting to take effect, which, some of that happened in the third quarter, ahead of this bigger cost-cutting, you'll see that the stock-based compensation was 28% of the company's second-quarter revenue. Forcomparison, a company likeFacebook, which is known for paying quite a bit in stock-based compensation, is only 12.5% of their revenue. So they definitely were getting a little bloated. So yeah, it's tough to say. Obviously, cost-cutting can be good, but like you said, we're not seeing those positive indicators, expanding margin, outsized revenue, those really being the focus.

Daniel Sparks owns shares of Facebook. Dylan Lewis has no position in any stocks mentioned. The Motley Fool owns shares of and recommends 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.