In this Market Foolery segment, Chris Hill is joined by David Kretzmann and Aaron Bush to check in on Twitter (NYSE: TWTR)in the wake of its first quarter earnings report. Revenue fell, but margins, cash flow, and MAUs were up, leaving followers of the company with some important questions. Among them: Is this a sign the company is putting itself in a better position to compete with other social media platforms? And where is this company ultimately heading?
A full transcript follows the video.
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This video was recorded on April 26, 2017.
Chris Hill: Let's start with signs of life -- I can't believe I'm saying this -- signs of life from Twitter.Shares are up 11% this morningafter a first quarter report that included, Aaron, a rise inmonthly active users. The revenue fell, forthose of you who actually pay attention to money. The revenue fell, but thatseems to matter less than the fact that monthlyactive users are on the rise.
Aaron Bush:Yeah,I think the 10% pop in the stock today isa little misplaced, in my opinion. I don't really thinkit was that great of a quarter,to be honest with you, Chris. I thinkyou could say it was a mixed bag. Revenue was down,margins and cash flow were up, users were up. Butultimately, I do think, when you piece it all together, the news is more bad than it is good.
Bush:I think so. On one hand,it's clear that Twitter is slowly making changes. They're slow, they'reungodly slow when it comes tohandling user issues like abuse andimproving the actual timeline. But they areimproving their cost, free cash flow is growing,the user base is growing, dailyactive users was up 14% year over year, which isactually pretty great. And I do think that's because ofsome of these efforts they put in placefrom theproduct perspective.
That said, revenue, youcan't just ignore that. That's huge. It's down 8% over the last year, and this is the 11th quarter in a row of adeceleration. The first quarter that it's down. That'spretty bad. I think the moral of the story here ispretty simple. Twitter's ads arecurrently not competitive withFacebookandGoogle,not even close. Andit's a huge undertaking for them to become competitive. So, you cancelebrate all these other wins, butat the end of the day, this isthe business. Turning the ship around is still a multi-year process, and the slower they move, the higher the odds of them getting whacked.
Hill:So,the people who are on Twitter itself, butalso reporting in the media, etc, who are saying, among other things thatCEO Jack Dorsey has bought himself some time, this was a good quarter, let's quiet down the drumbeat of, he needs to choose betweenbeing CEO of Twitter and being the CEO ofSquare. You're saying "No".
Bush:I think this is beyond him. This isbeyond what any one person can change at this point.I do think a lot of the changes that he has put into place have been positive, but revenue, youcan't overlook that.
David Kretzmann:Yeah,Aaron mentioned the competition fromGoogle and Facebook. As far as digital sales go,those are definitely the big giants in the room. But then, asTwitter is doubling down on its live videostrategy, they're starting to compete more withSnap, whichhas a very engaged user base. The growth therehas slowed a little bit, it'll be interesting to see what Snap's metrics look like, and how those compare to Twitter, as far as ad engagement and user growth. But, yeah, it'snot a good combination when you have users going up, but ad revenue going down. And Twitter saidthey expect that disconnect to continuefor the rest of the year. Thisprobably won't be the last quarter that revenue goes down.
In the meantime, their pace of stock-based compensation hasreceded a little bit, but their diluted share count increased over 1%just from the last quarter. So, in the process, asrevenue has completely decelerated and now is declining, their share count has climbed up. SoI went back and looked, ifTwitter wanted to bring its share count back to the same level it was in 2014,a few months after it went public, they wouldhave to spend $1.9 billion just to getback to that break even level with the share count. What that shows is, the bar thatthey have to cross at some point toreward shareholders isperpetually getting higher as they continue to dilute shareholders. So, that'snot a good trend to have when your revenue is dropping.
Hill:Andshare-based compensation,that's one of those things that,if you're the average investor, it'sunderstandable if your eyes gloss over, and it's easy to dismiss it and focus on the more headline-oriented things like revenue andmonthly active users. But when we talk about some of these tech companiespotentially putting themselves up for sale, youneed to recognize that share basedcompensation is a huge factor in that, the fact that they'regoing out and hiring people and convincing them to stay on board and not jump ship, a lot of thathas to do with, "Look, we'regoing to give you more shares." Goback and look atLinkedInbeingacquired byMicrosoft. Asmuch as anything, it was the share-based compensation within LinkedIn that made theleaders of that company go, "Wehave to figure something out quick."
Kretzmann:Yeah,because that's one of the main currencies they have for paying theiremployees. And competition between employers inSilicon Valley is not going to disappear. I think that's a dangerous thing for Twittershareholders and something to watch. At first glance,on the balance sheet, it does look pretty strong. We have net cash of $2.2 billion, as Aaronmentioned, you have free cash flow, which is going up, butstock based compensation is still a hugecomponent for that positive cash flow production. So, thebalance sheet, to me, isnot as strong as it looks on the surface, because $1.9 billion just to break even with your share count two years ago, that takes up most of their net cash today. Theinvestments that they've been making up to this point are not paying off. At some point, that trend has to reverse for shareholders to be rewarded.
Bush:Oneother thing that David and I were talking about earlier today is how slow they move, and what thatreally means when you look long term. I think it's easy to look at theseincremental changes andthink about where things should go. But the pace that they move, these larger tech companies likeFacebook and Google,they could do it at the snap of a finger, what these guys take six months to do.
Hill:I was going to ask you about that. It's,in some ways, anunfair question because unless you're spying onheadquarters at Twitter,there's no way for you to have the information to answer this question,but I'm going to ask it anyway. Why do you think that is?I've seen you write about this, I've seen other people touch on it. Thepopular image that we have of Silicon Valley is, among other things, it's a fast culture, it's a nimble culture. The way things move at Twitter, theymight as well be the U.S.Department of whatever. When youthink of bureaucracy, you think of Washington D.C. When you think of fast and nimble and cutting-edge, you think of Silicon Valley. Twitter'slack of speed is really astonishing.
Bush:I do think I know one big reason behind it. I think a lot of it stems fromthe very early days of the company. They never had tostruggle to reachproduct/market fit. So,never in their journey tofigure out how to improve what they're doing, theynever had an issue. They justthrew something out there and it worked. So then,they just kept on capitalizing on what worked, but never really changed the product itself. Now that they're up competing against thesecompanies that have been changing their platform atpretty innovative speeds for years now, they're finding that gap so much larger that it's just, in comparison, it takesso much more time to get out of.
Kretzmann:Yeah,it seems like Twitter just doesn't have near the focus on theactual product. What is their platform,fundamentally, compared to Snap or Facebook,where you have leaders that are so product-driven, and it driveseverything they do. From there, you find the business model that fits. But with Twitter, it seems like they're very scatteredtrying to figure out the direction of the company and what their actual product is.
Teresa Kersten is an employee of LinkedIn and is a member of The Motley Fool's board of directors. LinkedIn is owned by Microsoft. Aaron Bush owns shares of Facebook and Twitter. Chris Hill has no position in any stocks mentioned. David Kretzmann owns shares of Facebook and Twitter. The Motley Fool owns shares of and recommends Facebook and Twitter. The Motley Fool has a disclosure policy.