Twitter's New Idea Could Turbocharge Returns

For frequent users, Twitter (NYSE: TWTR) is a must-have service that often helps drive news coverage and shape the national conversation. However, despite its outsized importance, the social media site has greatly underperformed the market: Twitter shares have only posted a 38% gain from the company's 2013 IPO price, versus the 60% gain of the S&P 500.

Much of Twitter's stock struggles were thanks to initial nosebleed valuations from bullish investors, so it's hard to blame current management for lagging performance. However, Twitter has suffered from poor stewardship as well, most notably its inability to root out fake, automated accounts (bots) that often parrot misleading information and harass other users. The end result is a company that provides a less-than-ideal environment for users -- particularly women -- and for its real customers: advertisers.

Open verification could help the company improve advertising

Twitter is now considering open verification. Until now, the blue checkmark was a status symbol only available to celebrities and newsmakers. In a Periscope interview, CEO Jack Dorsey noted [emphasis mine], "The intention is to open verification to everyone... and to do so in a way that is scalable so we're not in the way and people can verify more facts about themselves."

The latter part of Dorsey's comment is the most telling. While many in the financial media discuss Twitter's sluggish monthly active user (MAU) growth, there is another metric where the company has really struggled: cost per engagement (CPE). For example, Twitter's CPE fell 52% y/y in 2017, after falling 55% in 2016. Twitter has grown revenue during most quarters due to ad load, which has the potential to degrade the user experience.

The solution to falling CPE rates are twofold: more effective targeting to increase the efficacy of ads and guarantee an actual human audience. It's likely open verification will help on both fronts, first by increasing the amount of data collection, which will lead to more effective targeting, and second thanks to the fact a verified human user is, well, a human user. While it's likely Twitter will never reach Facebook's level of data collection, open verification is a good start.

Improving discourse doesn't appear to be Twitter's goal

It's possible open verification could help root out fake news on its site and improve harassment, as a recent study from MIT found fake news is 70% more likely to be retweeted than true news, but it's likely this isn't the main impetus for CEO Jack Dorsey's verification about-face, nor will it be the silver bullet anti-harassment advocates desire.

Parsing Dorsey's words, it appears he wants to open the verification process to everyone, but stopped short of saying the company would require it. Unless this carrot is paired with a stick -- forced compliance/verification, algorithms to de-emphasize tweets from non-verified accounts, or harsh enforcement of rules against anonymous accounts (one-strike policies) -- it's likely open-authentication will not fully solve Twitter's harassment problem.

Even if this occurs, it's likely abuse, harassment, and fake news will continue on some level. Astute observers will note that Facebook has also suffered from fake news, most notably during the 2016 presidential election, even with its tougher verification processes. Much of Facebook's fake news emanated from its non-human Facebook Pages accounts, which are subject to much less scrutiny than personal accounts. The logical corollary is that an account that is opened to abuse, harass, or spread fake news will choose to opt out of open verification if it's not required.

Twitter's move could anger a key stakeholder

While at first glance this is a wise move for a company struggling to convince skeptical brands to choose it over Facebook, there is another group of stakeholders that will be less enthused about the decision. Current verified users will most likely react unfavorably to open verification, as it devalues the prestige of the blue checkmark.

While this may sound insignificant, celebrities and newsmakers often have an outsized effect on social-media sites due to network effects. As an example, shares of Snap plunged when popular influencer Kylie Jenner trashed the app's redesign on Twitter. The solution to this is simple: the blue checkmark is simply a tchotchke, so assign another color checkmark to these celebrity users -- gold, perhaps -- or add upgraded functionality unavailable to the hoi polloi.

What investors should watch

If Twitter allows for open-verification, investors should watch its CPE metric. More user data allows better targeting for marketers and more effective ad campaigns. The move could turbocharge its stock returns by increasing the value of each advertisement, and allow the company to charge more for ads.

For investors, this is a strong step forward. However, without forced compliance, it's unlikely to limit the amount of abuse, harassment, and fake news on the site, which is becoming increasingly important to advertisers.

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Jamal Carnette, CFA has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Facebook and Twitter. The Motley Fool has a disclosure policy.