Takeaway: Sorry for the delay, struggled with the setup. We're bearish into 4Q and beyond, but see 2Q upside, and the 3Q guide could go either way.

KEY POINTS

  1. THESIS REFRESH: We covered our TWTR short ahead of the 1Q16 print due to expected 1Q/2Q upside since we underestimated the auto-play mix headwind.  For now, we're keeping TWTR on our Short Bench, but our thesis hasn't changed; we still can’t see a way to fix the model given the damage TWTR has inflicted on it over the past 2+ years.  We believe problem with the TWTR story had been that the pre-Dorsey regime was scared of the street.  Instead of rebasing expectations early on, TWTR chased estimates with rampant increases in ad load, in turn pushing its users away.  We had previously estimated that TWTR had churned through nearly 40% of its US user base (Aug 2015 survey, n=7.5K); in turn shifting the US user story from organic growth to recapture, which may be tougher to achieve.  That said, monetization is now even more challenged since TWTR is struggling to capture the user/engagement growth necessary to drive its longer-term revenue growth.  We also now suspect that the model is in worse shape than we initially believed after segmenting its Ad business.
  2. CORE PRESSURE: The main drivers of the Ad model right now are Auto-play and its Non-Owned & Operated business (non-O&O).  We estimate that auto-play was roughly 60% of its total 1Q16 ad mix, and that it drove roughly 40% of its total 1Q16 Ad revenue growth.  TWTR’s non-O&O business was its second largest source of Ad revenue growth in 1Q16, but it also exhibited a notable seasonally decline in 1Q16; suggesting it’s no longer an unbridled tailwind.  More importantly, we estimate that Ad revenue growth in its Legacy O&O business (ex Auto-Play) was only in the high-single digit range in 1Q16.  So when we look out to 4Q when TWTR has comps of both a full quarter’s worth of auto-play ads and more mature Non-O&O Ad revenues, the core Legacy O&O business would likely need to reaccelerate off of 1Q levels to get to the 20% Ad revenue growth that consensus is assuming; a challenge given what will likely be flattish user growth.  Granted, we’ll see some benefit from its content deals and a potential lift from the election cycle, but we doubt it will enough to fill the void vs. our 4Q estimate of low- to mid-teens growth.
  3. BUT TOUGH SETUP: The 3Q guide will likely be the key barometer for the print given our diverging expectations for 2Q vs. 4Q.  For context, if TWTR handily beats 2Q estimates with the 3Q guide roughly inline, we suspect the stock moves higher.  On the other hand, if TWTR guides to a material deceleration in 3Q revenue growth into the mid- to high-teens, then we suspect 2Q results will not matter.  We suspect mgmt may sandbag the 3Q guide in order to bring down 4Q expectations; largely because it appears mgmt tried to do so with the 2Q guide, which implies either a y/y decline in its core Legacy O&O business or no sequential growth in either its Non-O&O business or Auto-Play product.  But that's just speculation; we're really not sure how mgmt will approach the 3Q guide.  We're going to sit this one out given the growing wave of negative sell-side sentiment and short interest that remains somewhat elevated.  We think we'll get another shot at the short later this year; if not, we can still look forward to 2017 consensus estimates, which are calling for a reacceleration in Ad revenue growth to the mid-20% range, holding steady throughout 2017.

Let us know if you have any questions, or would like to discuss further.

Hesham Shaaban, CFA
Managing Director


@HedgeyeInternet

TWTR | Thoughts into the Print (2Q16) - TWTR   Non O O 1Q16

TWTR | Thoughts into the Print (2Q16) - TWTR   Incremental Ad Revenue by Source 1Q16