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Takeaway: We remain Long Twitter (TWTR) in the Hedgeye Communications Position Monitor.

Below is a complimentary research note written by Communications analyst Andrew Freedman. For access to more of his research, check out Communications Pro.

Twitter | Never Easy... - cell phone 1245663 1920

overview

If we ever needed a reminder of the work Twitter (TWTR) has ahead of them with revenue products and the importance of getting direct response off the ground - we got it with this earnings report.

Advertising revenue grew 32% YoY (30% constant currency = +11% ad engagement and +19% cost-per-engagement), showing little acceleration from the 4Q20 revenue growth rate of 31% YoY.

We expected growth to clock in closer to 40%, driven by a combination of easier comparisons due to COVID (0.4% YoY 1Q20) and a rebound in brand advertising.

In the investor letter, management cited strong brand advertising trends in March, but it wasn't enough to offset the softness coming out of the insurrection earlier in the year. As a result, U.S. advertising growth declined by -28% QoQ (vs. Q1 average decline '15-19 of -16%) and growth slowed to +22% YoY 1Q21 (vs. +27% 4Q20).

By comparison, international growth was stronger, declining -14% QoQ (vs. Q1 average decline '15-19 of -15%) with growth accelerating to 45% YoY in 1Q21 (vs. 36% in 4Q20).

If we assume U.S. advertising revenue declined consistent with typical seasonality holding international constant, then total advertising revenue growth would have come in at 43% in 1Q21 (...but it didn't).

Managing our own expectations...

To be fair, the quarter itself wasn't bad - expectations (including our own) got ahead of themselves following the strong Q4 and investor day in February 2021.

Consolidated revenue growth of 28% YoY came in at the high-end of management's guidance range of 16-29% YoY (consensus 26% and HRM of 35%). Adjusted EBITDA of $294M beat the consensus estimate of $265M, with margins expanding 220bps YoY. Twitter's reach expanded to ~200M average mDAUs (162M Intl. / 38M U.S.) in 1Q21, adding 7M users QoQ or growth of 20% YoY - right in line with the guidance management laid out in February 2021.

Meanwhile, their outlook for mDAU growth calls for a deceleration to "low double-digits" on a YoY basis in Q2, Q3, and Q4, "with the low point in terms of growth likely in Q2." This guidance is consistent with consensus growth estimates of +11%, +13% and +14% for Q2/Q3/Q4, respectively. Overall, user trends are fairing well, and came in better than feared after Pinterest (PINS) provided disappointing user growth guidance earlier in the week.

Management noted that the "direct response side was strong all quarter", citing the acceleration in MAP growth compared to the 50% growth rate in 4Q20. However, with only 15% of revenue coming from performance, it wasn't enough to offset the sequential slowdown in aggregate.

Management has set a goal of reaching a 50/50 mix of performance/brand at some point in the future (they won't commit to timing) and moving further down the funnel to the point of transaction.

This mix would put Twitter in line with social peers, accelerate growth and reduce volatility in results.

The disparity in the revenue performance of TWTR and FB/SNAP/PINS in Q1 highlights how important direct response is for Twitter to meet its $7.5B or more revenue target by 2023.

Framing the Q2 guidance...

What surprised us the most was the revenue guidance for 2Q21 of $980-$1,080M. The mid-point of $1,030M is flat compared to Q1, with the low-end -5% and high-end +4%. It would be seasonally unusual for revenue to be flat-to-down QoQ with the average increase in advertising spend +7% Q2/Q1 2015-2019 absent an economic recovery that should drive faster growth.

Updating the model before the earnings call, we had a really hard time getting below the high-end of the guidance range without having to assume share loss of brand budgets to other channels/formats or some one-off execution-related issue (e.g., MAP getting turned off for a period of time).

On the call, management noted that the high-end of the guidance range assumes a continuation in the strength in brand advertising they saw in March into 2Q21. 

When contemplating Twitter's Q1 results and Q2 guide, it is important to remember that less than 15% of Twitter's revenue comes from SMBs. Large brands and agencies represent most of Twitter's advertising revenue, and this group tends to see greater seasonal/quarterly swings in overall spending (especially in brand).

We spoke with a large U.S. advertising agency that manages $1B in digital spending earlier in the month.

While spending in Q1 was down 20-30% off a very strong Q4, they noted that Q2 was expected to be up 40-50% sequentially, versus the normal 20-30% QoQ increase.

Driving the strength in Q2 (the two quotes below are from our Agency Field Notes):

Advertising Agency Field Notes

"Brand advertising is coming back, travel coming back, there is a lot of optimism. I am seeing money that didn't exist previously, so our budgets are growing."

"We are seeing brands spend on messaging encouraging people to get a vaccine or do the right thing because we are almost there; brand-led optimism campaigns."

This commentary is consistent with management's commentary on the earnings call:

Twitter's CFO, 1Q21 Earnings Call

"And so we often see a catch-up. So if we look at the beginning of this year and how things got off to a slower start, that doesn't give us pause about the opportunity for the rest of the year. We look at March and we see how things can play out as economies are opening up when brands have decided how they want to show up from a brand advertising perspective and we see lots of positive momentum."

We are not suggesting that Twitter's revenue growth is going to increase by 40-50% QoQ, but it does make the guidance appear conservative and has us thinking the upside we thought we see in Q1 may show up in Q2 instead.

Meanwhile, for the year, management reiterated they expect revenue growth to outpace total expense growth of at least 25% in 2021.

What to do with the stock from here?

Good quarter or bad quarter - investor expectations got ahead of themselves and have to reset. The guidance still looks conservative, but that matters less after not beating by a larger magnitude in 1Q21.

Meanwhile, the mid-point of management's guide fell below the consensus estimate for 2Q21.

We understand why the stock is down, and it is probably going to have a hard time getting positive momentum back until they report Q2 earnings in July 2021. That said, really not much has changed.

Management continues to execute against the strategic plan they laid out at their investor day in February 2021.

We would like to see further traction in monetizing new direct-response ad-formats outside of MAP before the year is out (...hopefully in beta by Q4). 

If we are to believe management's 2023 revenue and margin guidance (which we do), then at $7.5B in revenue at a 42.5% normalized EBITDA margin and 23x multiple gets us to a $90 stock. We would be looking to get more aggressive on the long side $50-55/share.

other takeaways

  • Updated ad formats, improved measurement and new brand safety controls, contributing to 32% YoY in ad revenue in 1Q21
  • Management wouldn't provide any color on engagement with Fleets or Spaces
  • Brand budgets typically reset at the beginning of the year, and the insurrection delayed decision making
  • More than 7,000 topics available across nine languages; Launched more than 700 new international topics in Q1
  • Expanded Spaces to Android, and began shipping weekly iOS updates to give hosts more control and moderation tools, content discovery and reliability.
  • Launched Curate Categories - an engaging, brand-safe way to match advertisers with thematic premium video content
  • Launched improved pre-roll ads across Twitter Amplify; Prominently feature the advertiser's brand logo throughout the duration of the ad and offering
  • Integration with SKAdNetwork allows Twitter to reach a new audience, increasing the total number of iOS devices to which they can advertise with MAP ads by 30% while maintaining cost-per-install performance
  • Repurchased $162M of stock in Q1, bringing total repurchases to $412M year-to-date

Editor's Note: This is a complimentary research note written by Communications analyst Andrew Freedman. For access to more of his research, check out Communications Pro.