TWTR: What the Street is Missing

Takeaway: Monetization has been TWTR's largest growth driver, but will soon emerge as its biggest headwind as the runway is shorter than most think

NOTE SUMMARY

  1. WHAT'S DRIVING TWTR'S GROWTH: Monetization has been TWTR's largest source of growth since 3Q13.
  2. WHAT'S DRIVING MONETIZATION: We believe it is increasing supply more than anything else.
  3. WHAT ABOUT INDUSTRY-LOW AD LOAD: That is inclusive of desktop, which it is barely monetizing.
  4. WHEN DOES MONETIZATION TURN: Growth begins decelerating in 2H14/2015 when it starts comping against the 2Q13 supply shock.

WHAT'S DRIVING TWTR'S GROWTH?

TWTR has received a string of upgrades as of late, largely on the basis of valuation. However, we do not believe the sell-side is giving due consideration to what is really driving the TWTR's growth trajectory.  

TWTR defines its three growth drivers as:

  1. User Growth: Monthly Active Users (MAUs)
  2. Engagement: Timeline Views/MAU
  3. Monetization: Ad Revenue/Timeline View

Over the last two earnings releases, the Street has soured over waning trends in MAUs and engagement.  However, Monetization has been firing on all cylinders, driving accelerating growth dating back to 1Q13.  The question is why?  

We could just assume that TWTR enhanced its ad targeting ability, which drove the surge in ad engagements (which is how TWTR gets paid).  However there's a more plausible and tangible explanation, which is increasing supply.

TWTR: What the Street is Missing - TWTR   Growth Drivers

WHAT'S DRIVING MONETIZATION?

The metrics in the chart below are the sequential change in ad engagement and ad pricing as reported by management (-.86 correlation dating back to 2Q12).  We believe the ongoing deceleration in pricing is a reflection of an accelerating level of available ad inventory (supply).  

Twitter's ads are purchased through its self-service ad exchange, where the price is determined through a bidding process.  We estimate the average cost/ad engagement (price) has cumulatively declined 85% over the last 2 years.  We believe a surge of increasing ad inventory led to this decline;  The tight correlation between ad engagements and pricing during the period suggests rising supply has been its largest source of monetization growth.

TWTR: What the Street is Missing - TWTR   Ad Engagement vs. Pricing

BUT WHAT ABOUT ITS INDUSTRY-LOW AD LOAD?

This may be true, but this statement is inclusive of the desktop, which TWTR is barely monetizing.  The overwhelming majority of its revenue and growth has been driven by mobile.  In 1Q14, desktop revenue grew only 15% y/y (vs. 197% on mobile).  The relatively sluggish desktop growth reinforces our view that TWTR's desktop UI is poorly designed for monetization.  That said, mobile will likely remain its key source of revenue growth.

However, the very important distinction between mobile and desktop is screen size. TWTR can only add so much ad inventory on its mobile platform before pushing users away.  

TWTR: What the Street is Missing - TWTR   Mobile vs. Desktop Rev

WHEN DOES MONETIZATION TURN?

It's hard to pinpoint the quarter, but we're expecting monetization growth to decelerate meaningfully beginning in 2H14 and into 2015.  That is because of what happened during 2Q13; the quarter that TWTR saw its sharpest drop in ad pricing (-46% q/q), which we believe corresponds with its sharpest surge in supply.

TWTR has benefited from the 2Q13 supply shock in each subsequent quarter since on a y/y basis.  And while pricing has continued to decelerate each quarter since (hence supply has risen), it hasn't been to the same magnitude as 2Q13.  

When we look out to 2015, consensus is assuming 61% revenue growth (on top of the 91% consensus growth in 2014).  We've already seen waning growth in Users and Engagement, which means monetization needs to pick up more of the slack next yeart. 

That said, it will only get tougher to comp against that 2Q13 supply shock in 2H14/2015, because the more supply TWTR introduces moving forward, the more likely they are to push mobile users away.  

TWTR: What the Street is Missing - TWTR   Rev Trajectory

TWTR: What the Street is Missing - TWTR   HRM vs. Cons 2Q14

If you have any questions, or would like to discuss in more detail, let us know. 

Hesham Shaaban, CFA

@HedgeyeInternet