- THE ISSUE WITH THE MODEL: Monetization has been both TWTR’s largest source of revenue growth, and what we believe will be its biggest challenge moving forward. We estimate that a persistent surge in ad load has been driving monetization, which will be a difficult feat to sustain; at least as it relates to revenue growth expectations through 2016.
- WAS CONSENSUS LISTENING? On the 4Q14 call, TWTR’s CFO quantified the 1H14 benefit from the Olympics, and the much bigger World Cup (non-recurring tailwinds with no comparable event in 2015). That said, consensus estimates suggest that adjusted advertising revenue growth (ex events) will moderately decelerate in 1Q, and then slightly reaccelerate in 2Q15; a tall order for a company struggling to drive ad engagements above user activity.
- ARE ACQUISITIONS ENOUGH?: We believe TWTR needs to acquire growth to hit 2015/2016 consensus estimates, and the company appears to be moving toward another acquisition push in 1Q15 QTD. We doubt the street will accept inorganic upside, but we're not sure when they will recognize it. Further, we don't believe TWTR can sustain this acquisition push, especially as move closer to 2016. We remain short, but this one could go against us until the street realizes TWTR's guided upside isn't organic.
THE ISSUE WITH THE MODEL
TWTR has three core growth drivers:
- User growth (MAUs)
- Engagement (Timeline views/MAU)
- Monetization (Ad revenue/timeline view).
Monetization has been TWTR's chief source of growth over the LTM, but is also where we expect TWTR to see the most pressure through 2016. The reason is ad load, which we estimate has been driving monetization. It’s not that TWTR can’t increase ad load, but we don’t believe it can do so at a rate that can drive the revenue growth the street is expecting (68% and 53% in 2015 and 2016, respectively)
TWTR is well past the 2Q13 Supply Shock, which we believe was a sudden and sustained surge in ad load that drove much of TWTR's revenue growth through 2014 (more detail in our note, and S-1 excerpt below).
TWTR: What the Street is Missing
05/19/14 09:09 AM EDT
TWTR S-1/A MD&A (11/4/2013): “The decreases in cost per ad engagement over these periods [3Q12-3Q13] were primarily due to an increase in supply of advertising inventory available in our auctions, which was partially offset by increased demand for our Promoted Products. Supply of advertising inventory increased as we expanded the distribution of our Promoted Products to our mobile applications and additional markets outside of the United States in 2012. The increase in advertising inventory provided us with additional opportunities to place ads on our platform.”
Now TWTR is at a point where it’s struggling to drive ad engagements above user activity, which means TWTR must find a way to drastically improve its ad targeting ability, or increase ad load at a disproportionately higher rate to achieve comparable ad engagement (TWTR runs a CPC Ad Model).
WAS CONSENSUS LISTENTING?
During the 4Q14 call, TWTR’s CFO (Noto) quantified the 1H14 benefit from the Olympics, and the much bigger World Cup. Both events are non-recurring tailwinds with no comparable event in 2015. The 1H14 benefit was provided in q/q terms, so we translated it to y/y terms for context. These events provided incremental revenue growth of 10% and 20% in 1Q14 and 2Q14, respectively.
We believe the reason why Noto quantified this incremental benefit was to temper 1H14 expectations/estimates, but estimates still rose after the print. Now consensus estimates suggest that adjusted advertising revenue growth will moderately decelerate in 1Q, and then slightly reaccelerate in 2Q15; a tall order for a company struggling to drive ad engagements over user activity. For context, the only time TWTR reported accelerating advertising revenue growth (ex events) was 3Q13: the quarter following the 2Q13 Supply Shock.
ARE ACQUISITIONS ENOUGH?
We believe TWTR needs to acquire growth to hit consensus estimates in 2015/2016. The tea leaves have been pointing toward another acquisition push, similar to 2Q14 & 3Q14 when it spent a combined $165M in acquisitions. So far in 1Q15, TWTR appears to have already spent $160M on acquisitions (based on preliminary data complied by Bloomberg).
We doubt the street will accept inorganic upside, especially if its favors the Data segment (similar setup to 3Q14 when the stock sold off). However, the other questions is when will the the street recognize inorganic upside, which will be harder to isolate since TWTR is not reporting timeline views moving forward.
But the better question may be how long can TWTR sustain its M&A spending spree. TWTR has an inconsistent history of generating cash flow. TWTR currently has roughly $3.6B in cash ($1.8B was raised in 3Q14), and the company had guided to $500M-$650M in 2015 Capex (with no mention of acquisitions in guidance). While it’s possible that TWTR can acquire enough growth to achieve the 68% growth the street is expecting in 2015, the feat will be that much harder in 2016 when TWTR needs to generate another 53% on top of that.
We remain short, but this one could go against us until the street realizes its guided upside isn't organic. Timing that is the challenge.
Let us know if you have any questions, or would like to discuss in more detail.
Hesham Shaaban, CFA