Takeaway: TWTR’s growth strategy has a limited runway, and is likely to disappoint the street. Current valuations is beyond reason
Note this a summary of our current thoughts on TWTR. We go into far more detail in our Blackbook. Ping firstname.lastname@example.org for more information.
- HOLES IN THE BUSINESS MODEL: TWTR’s current business model has a limited runway for growth given headwinds we’re seeing across the main levers in its business model
- CONSENSUS ESTIMATES ARE AMBITIOUS: . Our concern is mostly on 2H14 and 2015, which is when we expect revenue growth to slow precipitously.
- TWTR PRICED BEYOND PERFECTION: We thought the $26 IPO price was lofty, $43 is beyond reason, and well in excess of anywhere FB or LNKD have ever traded on a P/S basis.
HOW TWTR MAKES MONEY
TWTR’s revenues are sourced primarily from advertising, which is predominately US (~75%), and “substantially all” of those revenues are derived from ads that users engage with. Those ad engagements, and resulting revenues, are driven by a combination User and Advertiser Engagement.
- User Engagement: driven by the number of users on their platform, their level of activity on the site, and the rate at which they engage in ads.
- Advertiser Engagement: this simply a function of the number of advertisers & size their ad budgets, and the price & supply of ad inventory.
Below we weigh TWTR’s growth prospects against its stated growth priorities and the headwinds/tailwinds facing its business model.
HOLES IN THE BUSINESS MODEL
In the diagram above, we highlight where we see emerging headwinds/tailwinds in TWTR’s business model; most of which comes on the side of user engagement, which is where we will focus below. In short, slowing US user growth combined with stagnant-to-slowing ad engagement is a recipe for a marked slowdown in revenue growth through 2015 (see our Blackbook for more detail). Summary bullets below
User Engagement: Headwinds/Tailwinds
- Monthly Active Users: TWTR’s US growth has been slowing, and management expects this to continue. The runway for US user growth may be limited here given that Twitter’s total user penetration levels (including inactive users) may be much higher than its monthly active user metrics suggest. The main issue is that US users are far more lucrative than international users (almost 10x higher in terms of ARPU), meaning domestic user growth trends will have a disproportionate impact on revenues.
- User Activity: Anecdotally, we see this as a tailwind in terms of management’s efforts to drive more content on its platform. However, we are not sure it will be if enough to drive meaningful growth in total user activity, especially in light of slowing US User growth
- Ad Engagement: A deeper dive into TWTR’s financials suggests that the company is barely monetizing it desktop users (especially in relation to FB), which we belief is due a poorly designed user interface (more detail in our Blackbook). We believe it’s recent surge in ad engagements has been driven primarily by increasing supply, which we suspect was due mostly to extending its desktop ad products to its mobile application. That said, TWTR’s only option for driving supply growth on mobile is to introduce new products, which could push users away at the same time. So as ad inventory growth slows, TWTR’s revenue growth will slow with it.
CONSENSUS ESTIMATES ARE AMBITIOUS
Consensus is expecting revenue growth of 80% and 59% in 2014 and 2015, respectively. Our concern is mostly on 2H14 and 2015, which is when we expect revenue growth to slow precipitously. Reason being that the tailwind from increasingly mobile ad supply will likely be fully annualized by that point, which means that the company’s revenue growth will be tied to new advertising products, which we expect to have a limited impact, and US user growth, which we expect to wane unless TWTR takes a more active approach to recruitment.
TWTR PRICED BEYOND PERFECTION
At $43, TWTR is now trading at close to $30 billion market cap on a fully-diluted bases. That puts TWTR valuation on a P/S basis well in excess of both the current and peak P/S multiples for either FB and LNKD.
it’s important to note that the trajectory of its share price and multiple expansion will be tied to its forward growth expectations, which are currently see as lofty into 2015. We believe that TWTR could trade as low as $25.00, which is 11x our 2015 Revenue Estimate of $1.57 billion.
Once again, this is the summary version of our thesis, and there is much more supporting data behind this analysis than what is shown above. If you would like to run through the analysis in more detail, please let us know.
Hesham A. Shaaban, CFA
Takeaway: I sold everything Europe.
I didn’t think the ECB would cut. But when they did, I sold everything Europe. I have no patience whatsoever for these people doing stupid things.
Cutting rates while growth was accelerating? Just incredible. Euro Down = European Stocks Down, for now. Our EUR/USD TREND line of support ($1.34) is credibly and deservedly under attack.
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Takeaway: Heading into China's 3rd Plenary Session, we are looking for concrete solutions (if any) to China’s ongoing credit binge and financial risks
- This weekend top-ranking officials will convene in Beijing for the Third Plenary Session of the 18th Communist Party Central Committee (NOV 9-12).
- Historically, the 3rd Plenary Session has been one of great change with respect to economic and financial market reforms that have ultimately shaped the Chinese economy in the years and decades following. Bold promises for meaningful reforms out of President Xi would suggest 2013’s version is likely to not disappoint.
- While a number of key socioeconomic strategies will be debated and outlined (such as rural land rights reform, nationwide social security, etc.) we are strongly of the view that some reforms are more impactful than others as it pertains to our long-term TAIL duration (i.e. 3Y or less). On that note, we are keenly focused on concrete solutions (if any) to China’s ongoing credit binge and financial risks.
“Hi I’m China, and I have a problem…”
SETTING THE STAGE
For much of the spring and summer months, we held an explicitly negative view on China’s structural economic growth potential. Specifically, we believed that a persistent rise in non-performing assets across the financial system would effectively tighten liquidity across the financial sector, at the margins, thus acting as a sustainable drag on incremental credit creation.
To review that thesis:
We first noticed pervasive risks in China’s financial sector upon completion of our proprietary EM Crisis Risk Model in mid-APR:
Digging deeper into the weeds confirmed much of what we already knew – Chinese credit growth has grown far too fast in recent years and a sizeable portion of that credit has done little more than support asset prices or existing liabilities in lieu of marginal economic activity:
The aforementioned dynamic has caused Chinese economic growth to slow, with the +7.7% YoY run-rate of headline GDP in the YTD threatening to claim the title of China’s slowest expansion since 1999. Moreover, forward-looking expectations for Chinese growth are even more lethargic:
We backed away from the short side of China in early SEP (click HERE and HERE to review why) and followed that up with an incrementally more sanguine tone in the subsequent months, as the Shanghai FTZ looked to be a meaningful enough catalyst to offset the aforementioned financial sector headwinds, at the margins (click HERE and HERE to review why).
With only 157 firms holding a combined capital of $829M having registered for the Shanghai FTZ (mostly in the trade and services industries) as of OCT 23, it’s pretty clear the aforementioned catalyst has not yet addressed our initial concerns surrounding the structural lack of liquidity in the Chinese banking sector.
Specifically, we thought there would be significantly more activity regarding the importing of fresh capital into China’s financial system; thus far, results have been largely disappointing on that front.
PREVIEWING THIS WEEKEND’S PARTY
Now that we have reestablished the facts of China’s financial sector headwinds, we can now focus on what Chinese policymakers must do to overcome them – especially if China is to achieve what Premier Li has recently termed, “a golden mix” of structural reform and economic growth.
Simply put, if Chinese policymakers are going to avoid seeing GDP growth slow materially from here in the coming quarters and years, they absolutely have to outline [and eventually execute upon] specific and credible strategies that are expressly designed to relieve the banking sector of its structural liquidity constraints.
I’ll be the first analyst to tell you openly and honestly I have absolutely no idea what they plan to do with regards to this key issue, nor am I able to accurately gauge the momentum (or lack thereof) for meaningful changes on this front. All I know is that China must do something.
“Something” would include, but is not limited to:
- Step 1: admit the country has a problem (i.e. it’s addicted to cheap credit);
- Step 2: clearly delineate which institutions and corporations are to be saved and which would be allowed to ultimately fail or forced to sell/restructure;
- Step 3: liberalize deposit rates so that weaker financial institutions are ultimately priced out of the market and forced to delever (CLICK HERE for more color on the threat deposit rate liberalization poses to China’s economy and general financial stability);
- Step 4: recapitalize the remaining or systemically important banks and concomitantly force banks to write down non-performing loans that are currently being systematically rolled over (the aggregate loan-loss provision ratio of 279% of NPLs at the Big Four banks is well in excess of the 150% regulatory requirement and only begins to highlight the magnitude of China’s current problem with evergreening);
- Step 5: introduce rigid targets for provincial-level GDP growth and subdued quotas for credit allocation to various industrial sectors so that banks don’t take steps 2-4 as a signal to inflate new bubbles; and
- Step 6: allow for corporate defaults, the proliferation of financial insurance products and a dramatic expansion of the mutual fund industry so that Chinese financial markets can eventually learn to appropriately price, hedge and allocate risk across the system.
With the convoluted structure of bank and securities market regulation in China – the CBRC, CSRC, MoF and PBoC all operate largely independently of each other – we have little faith that such a wide-ranging reform process would be able to be implemented quickly.
That said, we’d settle for Chinese policymakers simply admitting to the fact that the country has a structural liquidity problem and subsequently outlining credible strategies to address it over the long-term TAIL. If they do not, we’d argue that Chinese tail risk – or a “hard landing” as it is more commonly referred to – should and would eventually heighten dramatically in the eyes of global investors and capital allocators.
PLAYING CHINA FROM HERE
Lastly, for those of you looking for answers with respect to our intermediate-term TREND duration, please review our OCT 24 note titled, “IF YOU HAVEN’T YET HEARD, CHINA IS TIGHTENING MONETARY POLICY”. Specifically, the PBoC’s recent tightening of monetary policy is in-line with our call for China to take a brief trip to Quad #3 (i.e. #GrowthSlowing as inflation accelerates) within our proprietary GIP framework here in 4Q13.
It’s worth noting that Chinese property price pressures have continued to accelerate since then, with the latest data out from the China Real Estate Index System’s nationwide property price index (100 cities) showing prices up +10.7% YoY on average in OCT vs. +9.5% YoY in SEP. Moreover, OCT marked the 17th consecutive month of sequential appreciation (+1.2% Mo M vs. +1.1% MoM prior). Moreover, property price trends in China’s 10 major cities continue to outpace the national averages, with prices up +15.7% on a YoY basis and +2% on a sequential basis.
On that note, both Shanghai and Shenzhen have recently taken a page out of Beijing’s playbook by lowering peak LTV ratios on mortgages for 2nd homes to 30%, down from 40% prior. Perhaps that’s a signal that this weekend’s plenum may bring about broad-based tightening in the property market. The implementation of a nationwide property tax – while a huge positive for currently impaired local government finances over the long term (as would be expanding the muni bond market) – would obviously be serve as a meaningful blow to demand in this key segment of the Chinese economy.
All told, the 3rd Plenary Session has historically been one of great change with respect to economic and financial market reforms that have ultimately shaped the Chinese economy in the years and decades following. Bold promises for meaningful reforms out of President Xi would suggest 2013’s version is likely to not disappoint.
While a number of key socioeconomic strategies will be debated and outlined (such as rural land rights reform, nationwide social security, etc.) we are strongly of the view that some reforms are more impactful than others as it pertains to our long-term TAIL duration (i.e. 3Y or less). On that note, we are keenly focused on concrete solutions (if any) to China’s ongoing credit binge and financial risks.
Please feel free to email us with any follow-up questions; have a great weekend,
Associate: Macro Team
So, there are basically two kinds of economists/pundits. Those that acknowledge and accept the unpredictability of both the monthly BLS employment data and the market’s reaction to it and liars.
The fact that the October employment data would be hostage to a host of distortions –higher sampling error, seasonality in education hiring, and government shutdown impacts on gross hiring, hours worked, the headline and U-6 unemployment rates - has been pretty well advertised (BLS).
Given moderate estimates (+120K) and the expectation for negative impacts from the government shutdown, the balance of risk heading into the release was to the upside as a weaker number could be explained away by the aforementioned distortions while a higher number (in spite of the negative drags) would drive renewed policy uncertainty.
Optically, the October Employment figures were solid. But since the prevailing lens with which the market is filtering the payroll data is less a fundamental one than one with an eye towards the implications for prospective Fed policy adjustment, its perhaps best to take a brief cerebral sojourn and interpret today’s release through the eyes of a Fed head.
That interpretation would probably read something like this:
The labor market data is good, but not great – with that “goodness” up for debate given the distortive effects of the shutdown. The unemployment rate remains above target, Labor Participation remains at trough levels (although it’s partly a secular/demographic driven), inflation is still well below target and wage inflation remains subdued. Fiscal policy will remain an uncertainty/headwind through at least February of next year, credit market liquidity is in decline, and housing/credit activity has slowed subsequent to the expedited back up in rates that followed our last hint at incremental hawkishness.
If past is precedent, such an interpretation = no policy change without further confirming evidence.
THE DATA: Steady with an extra side of caveat….
STEADY GROWTH: As we highlighted alongside the September release – while the absolute NFP numbers have been trending lower since 1Q13, on a rate of change basis, the YoY growth and 2Y growth rates have been relatively stable over that same period – a dynamic largely stemming from the existent seasonal distortion in the data.
This dynamic held in September has employment growth held steady while absolute net job gains declined sequentially. October again looks similar with the 2Y growth rate holding right in line with trend. We continue to expect seasonality to drive strengthening headline improvement in the employment data over the next 6 months with peak positive impact occurring in March
A TALE OF TWO SURVEY’S: The largest oddity in today’s release was the massive divergence between the household survey (which drives the Unemployment Rate), which showed net job loss of -732K, and the headline strength in the Establishment survey (which drives the NFP figure) which showed a net gain +204K with a positive two month net revision to Aug/Sept of +60K.
Further, while the Establishment Survey showed accelerating improvement and job gains across all industries except wholesale Trade, the Household survey reflected decelerating payroll growth across all age cohorts, a 720K decline in the total labor force and another new low in labor participation.
What do you do with that? Practically, we’ll probably just have to wait for next month’s data to get a “cleaner”, confirmatory read on Trend.
SHUTDOWN IMPACT: The impact of the government shutdown appears to have shown up primarily in the temporary layoff tally which increased by +435K on the month.
Elsewhere, U-6 Unemployment ticked up to 13.8% from 13.6%, part-time employment continued to decline, state and local government employment growth continued to accelerate, and hourly earnings growth and ave hours were essentially flat sequentially.
Takeaway: Alongside the continued strength in the initial jobless claims data, the BLS employment figures reflect ongoing, albeit moderate, improvement in the domestic labor market. The odds of today’s data shifting the course of policy action in the immediate term seems unlikely. We continue to navigate heightened policy uncertainty, and the resultant market volatility, with our lowest gross and net exposures of the year.
PERSONAL INCOME & SPENDING: TREND IMPROVEMENT
Personal income increased 0.5% MoM in September, outpacing spending growth of +0.2% while the savings rate increased to its highest level since December of 2012 ahead of the government shutdown.
From an intermediate term perspective, the trend improvement in personal income growth remains encouraging for forward consumption. Personal Income & personal disposable income growth are both rising, Per Capita DPI is accelerating and the household savings rate is moving higher.
Notably, the positive improvement in income is occurring despite the discrete drag from government where budget cuts are driving the largest decline in government employment growth in decades and negative income growth for approximately 17% of the workforce.
If negative growth in government employment bases and government sourced personal income growth goes positive alongside some measure of budget resolution (i.e. sequestration alternative), consumption growth could see meaningful support in 2014.
Christian B. Drake
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