- 2Q16 ≠ SANDBAG: We were expecting upside to 2Q Ad revenue since mgmt’s guidance implied either a y/y decline in its Legacy Owned-&-Operated (O&O) Ad business, or no sequential growth in either Non-O&O or Auto-Play. We had a hard time believing either scenario was possible, but we actually got a combination of both. The Non-O&O business sequentially declined into a seasonally stronger 2Q, and we estimate that Legacy O&O declined y/y in the mid-single digit range. Auto-Play was the sole bright spot, producing an estimated 80% of its total Ad revenue growth in 2Q. The 3Q guide was pretty dreadful; TWTR’s total revenue guidance was actually below what consensus was assuming for just the Advertising segment. The 3Q guide is effectively calling for Ad revenue growth somewhere in the single-digit range depending on mgmt's assumptions for its Data segment. The knee-jerk reaction is to assume 3Q was sandbagged, but the 2Q guide presented the same way.
- AUTO-PLAY = LEGACY SIPHON: It’s becoming clearer that Auto-Play is not a stand-alone growth driver, but is rather pulling engagements/budget away from its Legacy O&O ads. This mix-shift dynamic will likely continue given the lower Auto-Play engagement threshold; especially since the more Auto-Play ads that TWTR introduces into a user’s feed, the less likely they are to directly engage with its Legacy CPC ads, which require user interaction to produce revenue. So even if advertisers are still allocating and/or increasing budget to Legacy O&O, it doesn’t mean those budgets will actually be fulfilled; especially if TWTR continues to struggle to produce user growth. Further, as we move through the NTM when TWTR has Auto-Play fully baked into its comps, it's possible that Total Ad revenues decline in the NTM since Auto-Play engagement growth will now be driven almost exclusively by ad load, which could exacerbate the legacy-siphon dynamic further.
- WHERE'S THE BOTTOM? It may sound crazy to think that Total Ad revenues may starting declining in the NTM, but the thought of its Legacy O&O business declining sounded crazy before its 2Q results. For context, the 2Q pressure in Legacy O&O Ad revenue happened before TWTR fully comped past its Auto-Play launch. We estimate that Auto-Play represents less than 20% of its total O&O Ad revenues, so there is a lot of Legacy O&O budget at risk just from user ad fatigue alone (Point 2). Further, the sequential decline in Non-O&O points to another potential source of declining revenue against peak comps over the next 2 quarters. We’re lucky TWTR isn’t down near LNKD-4Q15 levels off this print, especially considering TWTR's +30% rally since the LNKD-MSFT deal. So we may get another shot at the short, which we had covered prematurely thinking TWTR may have bottomed out. But considering that there isn't any clear way to fix TWTR's model, it may just mean there isn't a bottom in sight outside potential take-out value, which we doubt would be anywhere near its $10B EV when both its revenues and users are trending toward decline.
Let us know if you have any questions, or would like to discuss further.