At the beginning of June, after six months of bearish comments about Twitter (TWTR), I wrote an article explaining why I had changed my mind and defending my right to do so. If you will forgive the smug, self-satisfied tone (I am English after all, and a trader by training, so that comes quite naturally to me) I would point out that yesterday’s Q2 earnings report, or rather the reaction to it, proved my point.
On the day that piece was written and published Twitter closed at $33.33 and has never been lower since. If you took my advice then and bought, you are, based on the trading in the pre-market this morning, looking at a profit of around 50 percent, not too shabby over a two month time period. You are probably also wondering if you should take that profit and run.
The answer to that question is, annoyingly enough, a resounding maybe. The point is that the earnings report and subsequent comments from management have caused a pop in the stock, but have they really given clarity about Twitter’s profitability or just raised more questions? I am more inclined toward the latter conclusion, but until those questions are answered I would rather adopt an unbiased position management strategy based on technical factors than make any assumptions about Twitter’s future revenues or profits.
The initial reaction of the market certainly looks like an overreaction. The company actually declared a profit for the first time ever which is, of course, welcome news to somebody like me who spent six months complaining that basing high valuations on popularity, not profitability, was crazy. That $0.02 per share profit, however, was on a non-GAAP basis. Once generally accepted accounting principles are used and the diluting effects of share based compensation are figured in, Twitter lost money again last quarter. I am sure that using equity compensation on such a scale is not done for the express purpose of engineering a profit, but some will no doubt say that it is and, as I have said many times, perception matters.
The raging bulls will no doubt point to beats in other areas to indicate that these earnings were, as one analyst maintained on CNBC’s Squawk Box this morning, “spectacular.” Monthly active users (the much revered MAUs) jumped 24 percent year on year (YoY) to 271 million, beating the 267 million consensus estimate.
Despite my distrust of valuations based on popularity it is true that the number of users is a key factor in determining the price of a social media company; the assumption is that they will work out the minor details such as how to monetize that popularity at some point. Revenues showing a 129 percent YoY increase, with 81 percent of advertising revenue from mobile, would suggest that, as I suggested in June, Twitter is very close to that point as well, though.
Still, questions remain. That jump in MAUs is presumably, at least in part, down to the effect of the World Cup. To an Englishman like me the fact that Wall Street analysts underestimated the potential effects of that event comes as no surprise. Even when the numbers are freely available, Americans just cannot grasp the popularity of soccer and of the World Cup in particular. My much loved adopted home country has little history of international sporting competition and prefers home-grown games where the best domestic team can be hailed as “world champions."
That beat in user growth, then, is more likely to be an underestimation by Wall Street of the World Cup effect than any real achievement on Twitter’s part. In fact, without those estimates and given that the largest sporting and therefore smack talking event in the world took place last quarter, I would regard a 24 percent increase in users as somewhat disappointing in the still fast growing world of social media.
The increase in ad revenues, particularly mobile, is much more impressive, but at around these levels, much of that is well and truly priced in. As this Seeking Alpha article by Charles Lewis Sizemore points out, Twitter is trading at around 24x 2014 projected sales. For comparison, their competitor in the ad business, Google (GOOG) trades at around 6x sales. Do you really believe that Twitter has four times the growth potential of Google?
As to whether you should book a profit or not if you went into yesterday’s numbers long of TWTR, then I would say “not yet.”
The stock has already lost about 6 percent following last night’s knee-jerk jump up over $50, which is to be expected, but as upward revisions of revenue and profit estimates come over the next few weeks we could well see further strength in the stock. I would suggest waiting for that scenario to unfold, but keeping a stop loss to ensure a decent profit regardless, say at around $42.
In the long term, I still think Twitter is vulnerable. The demographic they appeal to is in some ways great; young people are beloved by advertisers, but modern 15-25 year olds are not known for their consistency. The current growth in users and revenue is also great, but I cannot escape the feeling that it could all turn around in a heartbeat.
With that in mind, I regard Twitter as a trade rather than as a long term investment. That attitude has served me well, with recommendations to short it in the $60s and then turn around and go long in the low $30s. From here, I would be looking for a run back up toward $60 as analysts make their adjustments, but, as I said, would leave a stop loss in place, just in case. Whatever happens though, don’t wait too long. I suspect that the World Cup bump that Twitter received may be bigger than most believe and the company’s likely inability to match the resultant raised expectations will make a sale before the next quarterly earnings prudent.