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Written by Ophir Gottlieb, 6-10-2015

Twitter is a social media platform so its business is advertising, wholly and completely. The firm will either present a compelling and differentiated advertising tool for its customers or it will not. But where we are right now, somewhere between a growth company and a niche player, is not equilibrium. Twitter stock will rise or fall abruptly from here and we'll find out pretty soon.

At the end, I'll give Twitter bulls a reason to believe in upside because the firm may actually have a unique and compelling differentiator in the online advertising space. But, if Twitter misses revenue projections again, and takes forecasts down again from already lowered levels, all bets are off. The stock could get smashed.

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Twitter collapsed off the most recent disappointing earnings report. The revenue miss was unexpected given the very strong results two quarters ago. You can read my prior report Exactly what happened to Twitter stock after earnings. Here's the revenue through time (quarterly) and the line that was missed.

All shareholders knew the possibility of an abrupt stock decline if the growth numbers came in soft. Of particular concern was the full year forecast which was brought down significantly. We also found out on June 8th from the WSJ that Twitter’s Growth Among Investment Professionals Stalls.

Here is the most recent consensus estimate for revenue (adjusted down) and EPS next quarter, along with the actual realized revenue from last quarter.

There was a lot of bad news last quarter, however, there has been some misguided discussion that Twitter is somehow "small." Every minute there are 277,000 tweets sent. Twitter is enormous, it's just incomparable to Faceboook (which gets 2.5 million shares per minute).

Let us not miss the dual realities that TWTR is growing faster than all but one firm in technology of relevant size (market cap > $22 billion) and that the firm missed projected growth badly. In the scatter plot below we have included all technology firms with market caps greater than $22 billion. The y-axis is one-year revenue growth (TTM) and the x-axis equal spaces the companies (rank).


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Even with that incredible growth, the firm accounts for less than 1% (0.89%) of on-line advertising, which means both that there's room for growth and an urgent need to convey a compelling value proposition to advertisers that's different than Facebook and Google. Periscope is cool, but it's not a compelling differentiator, yet.

Here's a look at the fundamentals, which today are awful, but a stock price is about the future.
TWTR is down -24.9% over the last three months and down -3.6% over the last six months. The stock price is up +3.7% over the last year. Before we dig into the fundamental trends that drive the rating, let's look at a two-year stock chart with 10-day momentum (on the bottom). We can see how close the stock is to essentially its all-time low.


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Revenue (trailing-twelve-months) has increased for ten consecutive quarters to all-time highs for every quarter since the company has been public.

When a company grows revenue 98.30% year-over-year, we must recognize the added importance of top-line growth, perhaps even above and beyond earnings, free cash flow and margins. Regardless of the low two star fundamental rating, if revenues continue to explode, everything could follow suit for TWTR. Of course, that is the biggest "if" in the room.

Let's look at Revenue (TTM US$ Millions) in the chart below.


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Net Income (after tax profit) over the trailing twelve months (TTM) for TWTR is actually rising, but its still a substantial loss. For the most recent trailing-twelve-months (TTM) the company reported net income of -$608 million. The hemorrhaging losses appear to be over.

In our next chart we plot Net Income (TTM US$ Millions) in the blue bars and the quarterly results in the gold line.



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Levered Free Cash Flow per Share (TTM) is a critical determinant of stock price since market cap is the present value of all future free cash flows. For TWTR the metric is actually positive, even with the net income losses.

For our next chart we plot Levered Free Cash Flow per Share (TTM) in the blue bars through time. Note the falling bars from a year ago.



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Research and Development (US$ Millions) in the most recent quarter for TWTR was $190 million, up 27% from last year and nearly 300% from two-years ago. There is an unfortunate tendency for stock based compensation to fall into the R&D bucket for many firms (which is absurd), so take these numbers with a grain of salt.

R&D per dollar of revenue for the latest quarter is $0.435. Last year this measure was $0.596 (it's falling).

In our final time series chart we plot Research and Development (US$ Millions) in the blue bars. Note the rising bars from one-year ago.

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Summary
Twitter is a social media platform so its business is advertising, wholly and completely. That requires not just large usage (which it has) but also a compelling and different value proposition from the two existing giants (FB and GOOGL).

Here comes the bullish argument
Twitter's differentiator, in part, is its real-time delivery system. The simplest example would be a TV network pumping ads about a show that's starting in just minutes through Twitter -- no other advertising platform is capable (or as good) of that. Other examples surround news and investing. Think of other real-time deliveries that are needed, the examples are endless.

The firm must find ways to demonstrate how that (and other differentiators) is in fact either complimentary to the current advertising echo system, or simply better than the exiting echo system. If it does that, it will be worth more than $50B. If it does not, it will survive with a small piece of the advertising pie and likely go from a growth valuation to a rather stagnant one.

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