Are Profits Enough for Twitter?

Just about from the very beginning of its life as a publicly traded company, concerns regarding stagnant or nonexistent user growth have plagued Twitter (NYSE: TWTR). The narrative changed a little bit recently when Twitter finally posted its first profitable quarter ever (on a GAAP basis, too). In doing so, the company demonstrated that it can operate in a financially sustainable way, as the black ink was entirely delivered by cost-cutting as opposed to top-line growth.

Can profits be enough?

Maybe not

In a recent research note, RBC Capital Markets analyst Mark Mahany (via Tech Trader Daily) argues that Twitter still needs to deliver on monthly active user (MAU) growth. The analyst has upgraded his rating on Twitter shares from underperform to sector perform while increasing his price target from $18 to $31.

Twitter's string of daily active user (DAU) gains show that the company's product improvements over the past couple of years are resonating with users, which include things like algorithmic curation, a 280-character limit, and threaded tweets, among others. DAU growth started to accelerate in earnest in early 2016, and Twitter has been able to successfully maintain the momentum.

However, Twitter's MAU base still pales in comparison to Facebook (NASDAQ: FB). Twitter has fewer MAUs today than Facebook had in 2010.

But Twitter doesn't need to become Facebook. Twitter's financials are improving in their own right, and the company enjoys strong cash flow, Mahaney points out. Twitter generated $550 million in free cash flow in 2017, up from $444 million in 2016. In addition to cost discipline, Twitter is also getting better at managing its cash. Operating cash flow grew 9% to $831 million last year, while capital expenditures fell 12% to $281 million. Those two metrics, when combined, delivered the overall improvement in free cash flow.

In order to sustain ad revenue growth, Mahaney believes that Twitter will still need to continue improving the core product in order to put up "better MAU growth than the current low-to-mid-single digit growth rates that the company is reporting." Harassment and abuse remain persistent issues, the analyst notes, but it's not clear if Twitter can actually execute.

Mahany concludes, "We think this is a possibility, but it's very unclear to us that this is a probability."

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Evan Niu, CFA owns shares of FB. The Motley Fool owns shares of and recommends FB and Twitter. The Motley Fool has the following options: short March 2018 $200 calls on FB and long March 2018 $170 puts on FB. The Motley Fool has a disclosure policy.