Why Twitter Investors Have Something to Worry About

By Adam Levy Markets Fool.com

Shares of Twitter (NYSE: TWTR) are trading near all-time lows. After a slew of buyout speculation last year, Twitter investors are now faced with the hard truth that Twitter will have to make do on its own.

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Not only that, but Twitter's outlook for the first quarter of 2017 left much to be desired. Management expects EBITDA to fall by more than 50% and margins to decline significantly as it faces competitive pressure from Facebook (NASDAQ: FB) and Snap (NYSE: SNAP). What's more, Twitter made moves that COO Anthony Noto said would result in Twitter's financial results coming in on the low end of its guidance range.

Twitter investors have quite a bit to worry about.

Image source: Twitter.

The growing competition

On Twitter's fourth-quarter earnings call, Noto told analysts the industry has seen "an acceleration in the competitive environment for branded advertising since mid-January." He later added, "I think there's a number of factors behind that, more players, more innovation. Some of the competitors have a lot more at stake at this moment in time."

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That last comment is an obvious reference to Snap, which just went public and wants to show investors that it can meet the high expectations for revenue growth. Snap has also been very innovative with its advertising with its sponsored filters and lenses, although its biggest revenue opportunity still lies in video ads.

Facebook, likewise, has put its foot on the pedal with the growth of advertising on Instagram. The company recently announced the photo-sharing app surpassed 1 million active advertisers. Additionally, Instagram's Snapchat stories clone has over 150 million daily active users and it's already showing ads in the product just seven months after launching.

The majority of Twitter's revenue still comes from branded advertising. The growing competition for those types of ads will have a much more significant impact on Twitter than on Facebook, which boasts lots of small businesses buying direct response ads.

Going after the television market

Twitter's strategy going forward is to produce ad revenue growth by stealing ad dollars away from television. Management sees those ad dollars as a huge opportunity, so much so that Twitter started selling some of its ad inventory -- just like television networks do. It's offering guaranteed viewership for video ads.

Twitter is so focused on the market opportunity, in fact, that it's de-emphasizing some of its direct response ad units, promoted tweets, and ads from TellApart -- which enables businesses to target ads across devices. Instead it's focusing primarily on video and the ads it can run alongside it.

Twitter is facing stiff competition from other digital video platforms -- the same platforms mentioned above. Snap specifically points to the television ad market as a big opportunity for the company in its S-1. Management notes millennials are watching less television than their older counterparts -- spending more time in apps like Snapchat.

Facebook, meanwhile, is investing heavily in high quality content to seed its dedicated video feed within its flagship app. Instagram Stories also presents another high quality area of growing video ad inventory. The social network is also testing midroll ads for videos, in an effort to directly monetize its growing engagement in video.

While Twitter has several high-profile media deals in place, it still can't produce the audience of Facebook, Instagram, or even Snapchat. Not to mention YouTube (which is notably under a lot of pressure itself after some companies found their ads displayed next to what they deemed inappropriate material).

In the end, brands want reach; that's why they advertise on television in the first place. Twitter has scale, but certainly not at the same level as television and not at the same level as its competitors. Considering those television ad dollars are now Twitter's main focus, that gives Twitter investors something to worry about.

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Adam Levy has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Facebook and Twitter. The Motley Fool has a disclosure policy.