Twitter's MAU Blues and Apple's New Highs

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Two of the biggest names in tech recently reported their earnings and saw very different reactions from the market. While Apple's (NASDAQ: AAPL) earnings and guidance were incredibly strong, what few numbers Twitter (NYSE: TWTR) did share in its report left analysts scratching their heads.

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On this episode of Industry Focus: Technology, Motley Fool analyst Dylan Lewis and senior tech specialist Evan Niu go over the main highlights from both reports, and what they tell investors about the health of the companies going forward. Find out why it's so unsettling that Twitter won't report solid numbers for their daily active users, what Apple's management had to say about rumors of a potential delay for the next iPhone, how Apple is growing its segments, and more.

A full transcript follows the video.

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This video was recorded on Aug. 4, 2017.

Dylan Lewis: Welcome to Industry Focus, the podcast that dives into a different sector of the stock market every day. It's Friday, August 4. We're running through some quarterly results from Apple and Twitter. I'm your host, Dylan Lewis, and I'm joined on Skype by fool.com senior tech specialist, Evan Niu. Evan, I know Twitter reported last week and we're a little bit behind on the news here, but I felt like we had to revisit this one for listeners.

Evan Niu: Yeah, it's a pretty widely followed company, a lot of people are interested.

Lewis: In my opinion, it was such a weird update and conference call. You get some of the standard numbers that you expect, but when we were digging through management's commentary on some of these results, it was just so weird, with some of the core metrics you would expect and their explanation for what's going on. Looking at what was actually happening with the business' top line, the revenue was actually pretty good. It clocked in at $574 million, which beat analyst expectations pretty comfortably. Of course, that's still a decline from the $600 million the company posted in the same quarter a year ago. Some struggles with their ad business leading to some of the issues there. The company is still losing money. No real surprise there. Where things start to get curious for me is what's going on with user growth. It was uninspiring. I think part of the reason it was particularly bad for them was, they were coming off of a quarter where they added 9 million monthly active users in the previous quarter, and that was as many as they'd done in the previous three quarters combined. So, I think a lot of people were expecting this to maybe be the period where Twitter is turning it around, and they come and show results, and my gosh, you couldn't come up with something worse to show after something like that.

Niu: [laughs] Yeah. Last quarter, like you mentioned, the previous quarter had 9 million, and it's like, that's the best in years. And then, all of the sudden they follow up with zero sequential growth.

Lewis: Yeah, the ended the first quarter with 328 million monthly actives, and that's exactly where they wound up three months later. Flat sequential growth.

Niu: It's important to look at the breakdown. 328 million, that's global. In the U.S. in particular, they lost 2 million, so international gained 2 million. But the U.S. is where they had the best monetization, so incrementally, that's a hit on their business, just because the international users, they don't really monetize those very well.

Lewis: I think the thing that's kind of curious about that is, Twitter maybe has never been more relevant in the United States. You think about the President of the United States using it to talk about a lot of the things he wants to do with his administration on Twitter, and it being constantly reported, and constantly in the news --

Niu: Or to cyberbully people, too. There's that. [laughs] 

Lewis: Yeah! And yet, they're struggling in the domestic market, which is curious to me. But, what's going on with MAUs is not great. But I think it's particularly bad for Twitter, because of basically what management said about some of these user numbers. First thing, looking at MAUs, management blamed seasonal factors for flat MAUs. But they didn't really have an explanation for why. 

Niu: [laughs] Yeah. I think CFO Anthony Noto was like, "We don't have the data on what's happening here." It's like, then why are you telling us it's seasonal, if you don't have the data to actually support that? It's kind of a cop-out, kind of like a lot of this quarter was a cop-out.

Lewis: I know you need an explanation, because any time you throw a flat number out there people are going to ask, "What the heck is going on?" But, to say seasonal factors, and not have anything to attribute it to, it's just mind-blowing to me. Then, you look over at how management spends so much time stressing the importance of daily active users, and using that as their proxy for engagement. They talk about how DAUs were up 12% year over year, and yet again, they refuse to provide the actual number for what's going on with DAUs. And, they say, despite positive DAU growth for the last three quarters, the ratio of DAUs to MAUs hasn't meaningfully changed since the company said it was slightly less than 50% in 2015. 

Niu: Right. Which kind of suggests that these DAU numbers are very small, which is presumably why they're hiding them. But, if the numbers are really small, then if you get growth off of a small base, that might be why the overall ratio isn't really changing much.

Lewis: But for that to be your core metric that you're focusing on as a proxy for engagement, and then to have two different measures of that metric not trending in the same direction, it's baffling to me.

Niu: Yeah, it makes no sense. It's interesting because this whole disclosure of DAUs is becoming more and more important, and more and more investors and analysts alike are raising eyebrows at this exact thing. Why won't you break this out, to the point where the SEC sent Twitter a letter in June asking them to basically justify it, exactly what we're talking about here, like, "You're saying this is so important, but you're not telling us what it is. How do you reconcile this obvious cognitive dissonance of saying one thing but doing the other thing?" It's the same defense, and it's a really poor defense. They're just like, "We think the percentage change is more important. The absolute number is not important." But then, why do you keep saying DAUs are so important? And it's even condescending, in a way, because they're like, "If we give you absolute numbers, that's going to confuse investors and distract them." You don't think investors can understand the difference and know what to focus on? Let investors choose, don't choose for them and assume they won't understand. It's kind of condescending to say that they're not going to be able to figure out the numbers if you gave them to them.

Lewis: Yeah, my feeling is, just give me the number. I'll do my own analysis if you give me the DAU number, and I'll understand the puts and takes. Management offered some commentary on what's going on with the DAU calculation and MAU calculation, to reconcile how the DAU number can be trending up over a period, but not mean that DAUs as MAUs is growing as a percentage. CFO Anthony Noto went on this long-winded explanation, basically saying that DAUs are calculated by averaging the number of users each day in the quarter, while MAUs are the average of the last day of each month in the quarter. So, you can think of the DAU calculation basically as an average of 90 days, whereas the MAUs are an average of three days. I can understand how that would lead to some lumpiness in the data, but to me, that's a terrible explanation, because the management team is the one that's deciding to calculate it that way. You have the data to work with, you're deciding that you're making a lumpy number. That's such a cop-out.

Niu: Exactly. They're going through so much effort to hide this. It's easier to just get it out there, you stop getting all this criticism and let investors figure it out for themselves. But they're doing all these gymnastics just to hide this and obfuscate it. And, certainly one thing they're afraid of is being compared to Facebook (NASDAQ: FB). In their response to the SEC, they very much said that they calculate it differently because they don't want to compare to other companies that do disclose DAUs, and Facebook is really the only one that discloses as much as there is. For example, they've said, "Because Facebook includes people who use Messenger in their DAU number, even though Messenger is a different application," but that's also poor reasoning, because Twitter also has a direct message of its service, it's just within the same app. Facebook has Facebook and then it has Messenger, in addition to its other messaging services. Messenger is fundamentally part of Facebook. Just because it's a separate app doesn't mean you're not using the service. So, that's also a poor reason. The functionality, it's effectively the same thing, both companies have feed of content and both companies have a messaging service. So, how does that make it not comparable? The whole reasoning falls flat.

Lewis: Yeah. This feels an awful lot like a therapy vent session for you and I, [laughs] talking through this. I think we've beaten the user growth and MAU/DAU conversation dead. So, why don't we try to move over to what's going on with the ad market dynamics for Twitter? One of the things that I kind of talked about last time we were looking at the results is, the platform's ad rates continue to free fall, and I think that's really troubling if you're relying on advertising for the majority of your revenue. Cost per engagement was down 53%, and that's on the back of a 64% decline a year ago. Now, historically, before the last couple quarters, they've been able to continue to grow revenue and stay afloat by making it up on volume. This quarter, total engagements were up 95%. But, it's clearly not happening to the extent where they're able to grow revenue anymore. We saw this last quarter, we're seeing it again this quarter with the year-over-year declines. And as MAUs are stalling, I just wonder how sustainable what's going on with their ad business really is.

Niu: Right. There's a fundamental disconnect, because here they are touting all these engagement gains, like the DAU increases, and at the same time, ad revenue is falling down 8% year over year. We mentioned Trump earlier, and there was a lot of hope that Trump would boost engagement, which would subsequently boost the ad business. It seems, on one hand, it might be boosting engagement, even though, like we mentioned earlier, the U.S. user numbers are not great, either. But there's a big disconnect somewhere in there, and I think it boils down to execution, because they're not really successfully monetizing this engagement, and you can see that in the ad revenue numbers. 

Lewis: Yeah, and management keeps talking about declining ad prices as an opportunity. It becomes more appealing for advertisers to come to the platform and advertise on Twitter if it's more affordable for them to do it. The problem is Facebook and Google are scooping up market share in the digital ad space, and really they have a duopoly right now. I think advertisers have seen such great ROIs on that platform, and they know that all of the demographic trends are moving in the right direction for them, where they have these growing user bases and are maintaining their relevancy, that it's going to be really tough for Twitter to command any pricing power at any point. I'm sure they're going to hit a bottom just because of the way that pricing dynamics eventually work. You can only decline for so long before you hit some point of stabilization. But that's also not a huge bullish signal for me.

Niu: Right, and anecdotally, they mentioned in the letter that the increases in engagement are partially due to better targeting and better elements. But, anecdotally, when I'm on Twitter, compared to when I'm on Facebook, the ads that I see...I feel like they're less relevant, and they're not very well targeted. Not that I click a lot of ads in general. But the stuff I see on Facebook is incrementally a bit more relevant like, it's a little more interesting than the stuff I see on Twitter. I just don't think Twitter is very good at targeting. They don't have as much user data, because they're a much more narrowly based service, so they don't have an opportunity to collect as much data, which also means they can't target as well. To their credit, they're saying that they're getting better.

Lewis: Speaking of user data, if you're looking for bright spots in this report, the data licensing business for Twitter is doing well. It's up over 20% year over year. Right now, it only makes up about 15% of revenue, but it is higher-margin revenue. Management said that $1 in data revenue is worth $3-$4 in ad revenue due to the difference in profitability there. And you see that a little bit bear out in the financials where the company hit a 31% EBITDA margin, earnings before interest, depreciation, taxes and amortization. That's the best they've done as a public company. So, as that business grows, that's something to be interested in. The problem is, it's such a small portion of Twitter's top line right now, and a lot of the user issues that we're talking about ultimately feed into that business, as well. It's not something that's siloed, that's apart. The relevancy and value of their data licensing business hinges on how many times people come back to the platform, how many times people use the platform, and how important it is to people's lives.

Niu: And it's kind of an interesting reversal from the mentality they took a few years back. When they first went public, this data licensing revenue was, again, pretty profitable. But in all the other filings, they kept predicting, saying, "Data licensing is going to continue to be a smaller and smaller part of the business as the ad business grows." But now, of course, fast forward a couple years, they're having so much trouble growing the ad business that now they're trying to turn that story around, like, "Hey, look at this data licensing business! We're going to try to grow that again!" Whereas a couple years ago, they weren't really concerned about it, because they were focusing on the ad business. So, I think it's an interesting reversal if you look at management's mentality of how they approach these two parts of the overall business.

Lewis: Yeah, and they said they're going to explore new ways to expand that. In the coming quarters, I would not be surprised to see that make up a larger portion of revenue overall, particularly as they figure out what's going on the ad side. This is all to say, Evan, I'm still not sold on the turnaround of Twitter's core business. I don't know about you.

Niu: I've never really been sold on it. Even beyond the DAU disclosure thing, it's this exact same problem that has plagued Twitter literally since day one, which is, user growth is just not great. Its service remains hard to use. There's a steep learning curve, it doesn't really appeal to mainstream people, and most mainstream people can get what they need from the news, because the news covers what happens on Twitter and then they'll embed the tweets. So, you see the tweets right there, you don't have to login, you don't have to go to Twitter yourself for a lot of people. So, I just don't know how they can ever address that core problem, which is, the service is hard to use, and most mainstream people don't have a need to use it.

Lewis: Yeah. And I just don't like the idea of management deciding to not give the full picture on something that's clearly core to the business. The DAU/MAU thing is maddening to me, because it feels a lot like Twitter is talking out both sides of its mouth right now, and it's frustrating. It's not what I want to see from management. We're obviously going to keep talking about them, because it's a super interesting business to watch, but I'm staying far, far away. [laughs] 

Niu: Me too. I've never touched Twitter's stock. [laughs] Long or short, either way.

Lewis: On the flip side, Apple's earnings report looked pretty darn good.

Niu: Yeah, it was a pretty strong beat. It's funny, because seasonally, the June quarter is usually a boring quarter, but this one was such a good report that it sent shares to all-time highs, and now Apple is approaching and $800 billion market cap thanks to this report.

Lewis: Yeah, looking at the big numbers, we have revenue at $45.4 billion, which beat estimates by $500 million. Earnings came in at $1.67 a share, which also beat expectations. So, great stuff on the top and bottom line. Like you said, stock jumped on the news, new all-time highs. Why don't we look at some of the different segments here, starting out with the iPhone?

Niu: iPhone, they sold about 41 million units, which was a little bit ahead of consensus expectations. But, with all the talk, there are so many iPhone 8 rumors, and this is going to be a pretty big product cycle this year. For most people who follow Apple even remotely, they know, we have a new iPhone coming, don't buy an iPhone now, wait a couple months to buy an iPhone. So it's pretty crazy that they were able to put up such a strong number, given the fact that, Tim Cook has acknowledged that these types of rumors have been hurting the business, particularly within the last few months, at least last quarter, quarter before this. He very much acknowledged that it's hurting demand. So, the fact that they were still able to come in with a relatively strong number for a summer quarter, I thought, was pretty strong.

Lewis: And this segment continues to make up the lion's share of Apple's top line, in addition to some really solid stuff over on the unit side. Average selling price looked pretty good, too, came in at $606, which is up from $595 a year ago. I think what you're seeing there is the influence of the Plus models, and some of the higher-value models in their product line. 

Niu: Right. And with all these rumors that this next one is going to be really -- I've seen reports that the next iPhone could cost anywhere from $1,000 to $1,400. $1,400 sounds a little nuts, but the point is, I think they are going to try to pack a lot of new features into this new one, and obviously that will only help average selling prices going forward. I can imagine this is going to be a massive cycle, with what they have in store, depending on if they can actually produce enough of them. The big feature being, potentially, an OLED display, and OLED displays are quite expensive. And the way that Apple always prices its products is, they have their own margin profile they want to maintain, so if one of their components is expensive, that's going to translate into a bigger increase on the actual retail price, compared to, for example, if another manufacturer wanted to include the same feature but was willing to sacrifice on margins. But Apple charges for their features, so any big new feature will cost you. So, I do think there's going to be some upside for ASPs going forward.

Lewis: Yeah, they're always happy to pass along costs to the customer, and it seems like people are happy to pay for it. [laughs] I'm certainly guilty of that. One of the other segments that has gotten a lot more attention in the last couple of years is Apple's services segment. This just keeps humming along. This most recent quarter, it came in at $7.3 billion, which is good for 22% growth year over year.

Niu: That's an all-time record, too.

Lewis: Yeah, it's crazy. And Apple's services business is now a Fortune 100 company, which is baffling. That's huge.

Niu: Right. On a trailing-12-month basis, it's now a $27 billion business, which is larger than Facebook, for example. This is very high-margin stuff. It's growing very quickly. Apple Music is one big driver. They didn't give an update this quarter on how many subscribers there are, but the last update was at WWDC in June, so just a couple months ago, and there were 27 million Apple Music subscribers. That's pretty strong. They just keep adding subscribers. Spotify has maintained their lead with 60 million right now. But both Apple and Spotify are marching higher, so both are benefiting from the growing market for overall paid streaming music that people are willing to pay for again. The other bit they mentioned was iCloud storage, which was interesting, because I don't really think they have a very strong value proposition with cloud storage compared to some of their competitors. But they did mention they're seeing some nice revenue growth from selling those iCloud storage plans, which are subscription plans. They also mentioned that paid subscriptions, which is a number they've only recently started to disclose, continues to go up. We're now at 185 million paid subscriptions that are going through all of their stores combined. Those aren't individual customers, that's just the number of subscriptions, so, one user may have multiple subscriptions. But, that's up from 165 million last quarter, and 150 million the quarter before that. So, over the course of six months, they've added 35 million paid subscriptions, and they get a 15% cut of that revenue -- they get a cut, and the cut changes based on how long that relationship is there. But either way, that's a very profitable revenue coming in, and it's recurring, it's consistent. So, this business is really doing well.

Lewis: In a lot of ways, this was a surprising quarter. We talk about how this is kind of what we think of as the summer doldrums, right before they kick into fever pitch with, theoretically, at least, the new iPhone release. But, I think one of the biggest surprises, looking at their report and some of the commentary here, was seeing the iPad segment register some really solid growth. This is a segment that I think a lot of people have written off.

Niu: Right. It's been really weak for many years. I think what they finally figured out is what's going to unlock unit sales. Unit sales were up 15%, and that new $329 iPad they introduced in March is clearly a hit. And that's the lowest price they've offered on a relatively new 9.7-inch iPad to date. Clearly that approach is working, because they basically did what they did with the iPhone SE, which is take more current specs, put it in a more or less recycled form factor, but then drop the price and be really aggressive with it, versus the historical strategies they've always had which is, when you introduce a new product, you reduce the price on the old product and step it down. Now, what they're doing is releasing newer products that are still combinations of old products, but they're coming in really aggressively. $329, that's almost an impulse buy for what that iPad is capable of. And you can see that, because average selling prices were basically flat sequentially -- so, it was $435 or so -- and they also introduced a 10.5 inch iPad Pro, but that was in June at the end of the quarter, so that probably had less of an impact. I'm sure there were some nice sales there, but as far as the whole quarter goes, that $329 iPad is definitely doing well. I had an article that charted the growth, and iPad's units have been declining for years and years, and all of the sudden you get this huge spike in unit sales. So, I think investors were very encouraged with that, even though, in terms of revenue, it didn't really do that much. The revenue was kind of flat, I think it was up 2%. So, revenue-wise this is not a huge uplift. But the units, that's a really strong unit number. And, of course, for Apple, it's all about growing the installed base, and once you get people first time in, they'll upgrade eventually. So, there's some long-winded benefits there.

Lewis: And that's one of the things that ultimately feed into that services segment revenue, too. The more people that are holding onto their phones, using their Mac devices, using their iPads, that's going to bolster the strength of services, which is super high-margin revenue. So, that cycle is great to see, even if it's in a segment that people haven't really been paying too much attention to lately.

Niu: Exactly. And they also mentioned, tying this all together, that the number of people -- because, there's a lot of people who buy these devices and don't really spend much money on apps or Services. And they have mentioned, consistently, over the last couple quarters including this quarter, that the number of people who are transacting on their stores is increasing, it's something vague like, it's double digits. But there's growth within the installed base of people who are starting to become more active and actively spending more money, too. So, yeah, to your point, it's all tied together as they build the installed base, even if there's not the immediate benefit. You still have a good chance to make more money later on through services and content sales, and more and more people are doing that.

Lewis: Evan, the big question looking at Apple and digging through a lot of the financial media about the company lately, has been the concerns with the potential delays in the iPhone. And when I think we look at what management provided for commentary, I think some of those fears are alleviated a little bit. Some of those concerns we can dial back, because it seems like looking forward, we're going to be more or less on schedule with what the standard iPhone schedule release is.

Niu: Right. I think that was a big question mark going into this release. What's guidance going to look like because of all these expected delays and reports of manufacturing yields being low or trouble making the OLED displays or what have you. So, their guidance calls for revenue of $49 [billion] to $52 billion next quarter. At the high end, that $52 billion, would represent a new record for the September quarter. So, I think that exudes a lot of confidence. For example, last year, the iPhone 7 launched mid-September, so they had about two weeks in the quarter where they had that launch effect. That's an important comparison point for this quarter. If they're forecasting that this quarter will be even bigger, it downplays all those fears that there's delays related to the launch, because there have been so many reports that this thing might be delayed. The flip side is, it's possible that, if they're going to price this thing really expensive, they can maybe drive a lot of revenue growth on a relatively small number of units. So, that could be the missing piece of, maybe there are delays, and maybe there are low yields, but maybe they're going to charge enough for what they do have that they can put up this overall top-line number. But, overall, it's a pretty strong guide, I think, to the fiscal fourth quarter.

Lewis: As a shareholder, it's been an interesting two years or so with Apple. You had a lot of people a year ago or so fearing that we'd hit the saturation point, we wouldn't see these supercycles coming in anymore, that people were going to be holding onto their phones for longer. And it's been pretty awesome to see the company blow it out of the water over the last year in the face of some of those concerns. I've been someone that's been like, yes, I'm holding onto my shares, I'm not doing anything with them, this company is humming along, they're doing so much to return capital to shareholders, they're in such a strong position on their balance sheet with all the cash that they have. I think it's about $250 billion at this point right now. There are so many great things with this business that, even if there are little hiccups or delays with the iPhone, this is what we would expect to be a weak quarter for them, and they still put up incredible growth. I'm just sitting tight and watching because it's been a great run so far, and I certainly wouldn't want to cut it short.

Niu: Yeah. I've also just been sitting on my shares. I was pretty happy when they jumped to all-time highs. I wasn't really expecting that. But, yeah, there's so many parts of this business that are so strong. There are definitely some weak spots, Greater China being probably the biggest one. And there's a lot going on there, so it's hard to pinpoint. But, this is so strong. With all this delay stuff, Tim Cook is acknowledging it, this might be hurting in the short term, but it's still good for the long term, and it bodes well for the future, I think it was what he said on the call. And yeah, these sales are not lost. Apple has such good loyalty that, if people have to wait a couple months for their new iPhone, they will do that. Very few people are going to go out and buy an Android phone. It's really just a matter of timing, shifting a sale from one quarter to the next, which is ultimately pretty short-term concern. The bigger picture remains very much intact.

Lewis: Yeah, and it's great to see. I'm certainly part of that, as an iPhone owner, and some of that will likely upgrade whenever they make the new phones available. Listeners, Evan has a ton of really great Apple coverage over on fool.com. If you want any of the stuff that he mentioned, specifically that piece that had the iPad chart, shoot us a note over at industryfocus@fool.com, and we'll make sure to get it over to you. Evan, anything else on Apple, Twitter, you weekend plans, anything like that before I let you go?

Niu: No. I'm going to take it easy this weekend. It's been a busy week with earnings season.

Lewis: Yeah, earnings season gets stressful. Well, I will leave you to that. Have fun relaxing with the kids.

Niu: You too, man. 

Lewis: Listeners, that does it for this episode of Industry Focus. Like I said, if you have any questions or you want one of the pieces that we mention on the show, just reach out, industryfocus@fool.com, or you can tweet us @MFIndustryFocus. If you're looking for more of our stuff, you can subscribe on iTunes, or check out the Fool's family of shows at fool.com/podcasts. As always, people on the program may own companies discussed on the show, and The Motley Fool may have formal recommendations for or against stocks mentioned, so don't buy or sell anything based solely on what you hear. Thanks to Dan Boyd for all his work behind the glass. For Evan Niu, I'm Dylan Lewis. Thanks for listening, and Fool on!

Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Dylan Lewis owns shares of GOOGL, Apple, and Facebook. Evan Niu, CFA owns shares of Apple and Facebook. Evan Niu, CFA has the following options: long January 2018 $120 calls on Facebook. The Motley Fool owns shares of and recommends GOOGL, GOOG, Apple, Facebook, and Twitter. The Motley Fool has a disclosure policy.