Twitter (NYSE: TWTR) is off to a great start in 2018. After reporting its first-ever quarter of GAAP profitability, the market rewarded the stock with a big run up in its price. (GAAP is "generally accepted accounting principles.") Investors were likely encouraged by management's comments that it expects to maintain profitability over the course of full-year 2018.
But there are reasons to believe the market may be getting ahead of itself. With shares up about 29% year to date (even after a recent pullback), Twitter's stock valuation has skyrocketed, but the underlying company hasn't changed much.
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Still a slow-growing platform
The biggest growth drivers for a digital platform like Twitter are user growth and engagement. Twitter lags behind the competition on both fronts.
Facebook (NASDAQ: FB) consistently posts monthly and daily active user growth of about 15% each quarter, despite the fact that it now has 2.1 billion monthly active users on its platform.
Snap (NYSE: SNAP)'s Snapchat is also growing daily active users faster than Twitter. Snapchat daily users increased 18% in the fourth quarter, compared to Twitter's 12% growth.
While Twitter's daily active users are showing better growth over the last year, monthly active users are barely budging. At some point, daily users will no longer be able to grow without Twitter expanding its reach.
Twitter isn't very good at monetizing its users
Even the users it does have, Twitter is struggling to monetize effectively. Twitter's average revenue per user in the fourth quarter was $2.22. By comparison, Facebook generated $6.18 per user, with a much higher percentage of users coming from outside of the United States.
Twitter has seen its average price per ad engagement fall considerably, down 42% year over year in the fourth quarter. That's due, in large part, to the shift to autoplaying video ads.
Management expects a turnaround in ad revenue in 2018, driven by better return on investment for advertisers. Overall, it expects sequential revenue growth to look more like 2016, which implies about 5% revenue growth for the full year, based on its first-quarter guidance. For reference, analysts expect Twitter to produce 10% revenue growth this year.
The easy path to profitability is over
Twitter turned a profit in the fourth quarter by cutting operational expenses, including both marketing and research and development. Management has warned there's no more room to cut costs, so expenses should grow in line with revenue this year. That statement is a bit confounding, considering it also expects to turn a GAAP profit this year -- it can't do that if it posts the same profit margin as last year.
Regardless, Twitter's expenses will start climbing again this year, and it's not clear the revenue growth will be there to support them. Twitter will have to start generating more revenue per user and driving efficiencies elsewhere if it wants to grow profits. With competition from Facebook and Snapchat, that's not going to be easy.
Twitter stock is really expensive
Twitter's ratio of enterprise value to EBITDA is nearly three times as much as Facebook's. If you strip out stock-based compensation and other expenses to get to Twitter's adjusted EBITDA, the ratio looks a bit better -- 23.9 -- but it's still well above Facebook's. Importantly, Facebook is growing its bottom line a lot faster than Twitter, so there's no reason Twitter deserves such a premium.
Twitter looks a lot better on a price-to-sales basis, but you have to consider that Twitter isn't growing its revenue very quickly. Management's comments imply just 5% growth year over year, and analysts are expecting just 10% growth this year and next year. Facebook's revenue, in contrast, is expected to grow 36% this year and 27% next year.
Snap is considerably more expensive than both, but it's still showing a lot of strength on its top line. Analysts expect it to grow about twice as fast as Facebook, and its multiple is mostly in line with those expectations.
While digital advertising isn't exactly a zero-sum game, Twitter is poorly positioned to capitalize on the secular growth of the industry with advertisers looking to other platforms first. That's why its revenue growth is expected to continue lagging the competition, and why it deserves a much lower multiple.
Don't call it a comeback
Twitter has had a great start to 2018, and the stock has had some momentum over the last six months or so. But the market seems to be getting ahead of the fundamentals: Twitter's revenue and profit growth are fairly meager, and still unclear at that. I would much rather own one of the bigger companies in digital advertising than take a chance on Twitter.
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