I am, I guess, a Wall Street insider by definition. I spent most of my working life in dealing rooms around the world and now contribute daily to Nasdaq.com. My current role, however, removes me from the physical environment of traders and allows for some detachment from the groupthink that occasionally takes over in markets. Yesterday, that groupthink was on full display.
I found myself wanting to scream at my TV and computer screens as I saw and heard story after story previewing Twitter (TWTR)’s earnings release scheduled for after yesterday’s close. They all repeated the conventional wisdom: the most important metric to look for in that release was user growth. If user growth disappointed, the story went, then look out below. If, on the other hand, Twitter increased their popularity, then the stock would look like a bargain around $40. The same thought went through my mind each time I heard that... “Show me the money!”
When the company reported yesterday, the stock tanked as the active user number came in at 255 million people, short of consensus estimates of 257 million. As I write, TWTR is trading over 12% lower than yesterday’s close in Wednesday’s pre-market. Understandably given the pre-release stories, disappointing user growth is the most common explanation for the big drop. There is one obvious question if you detach yourself from the hype, though. Why does a 1% miss on that one metric merit a 12% price drop?
In short the answer is that it doesn’t, but that doesn’t mean that the drop isn’t warranted. If you think this is an overreaction and are tempted to buy TWTR on that basis, think again. I have been bearish on TWTR for a while and have said so publicly, including this April 1st Market Musings piece. As I pointed out there and elsewhere, the reason not to buy the stock is simple; a valuation of over $20 billion is just too high for a company struggling to make any money.
Looked at in that way, yesterday’s results could be seen as a positive for the stock; Twitter may have missed on user growth, but they delivered a fairly significant beat on what really counts, the bottom line. Expectations were for EPS of -$0.03, but the company managed to break even on the quarter. Let’s not kid ourselves, breaking even still doesn’t justify a $20 billion valuation, but at least it’s an improvement.
If, like me, you believe that Wall Street’s focus on the popularity of social media companies, rather than their profitability, is a sign that the insiders have lost their collective mind, then you may be tempted to see that bottom line improvement as a reason to buy TWTR on this drop. Resist that temptation. There is another, underlying problem that I believe explains the drastic fall and leaves me, if anything, more bearish than before.
Twitter’s first quarter revenue of $250 million beat expectations, but the bad news lies underneath that number. The advertising revenue that Twitter realized per 1,000 timeline views actually fell, from $1.49 in the previous quarter to $1.44 this time. In other words, disappointment in the popularity stakes aside, Twitter is actually getting worse at what I regard as the most important task they have... monetization.
Monetizing popularity is possible for social media companies; both Facebook (FB) and LinkedIn (LNKD) are profitable. Indeed, if there is significant carryover from the sell off of Twitter and either or both of these stocks falls significantly over the next couple of days they could both be of interest to me, FB around $55 and LNKD should it drop to around $120.
In both cases, high multiples can be offset by improvements in monetization and taking a chance on that could be justified. In Twitter’s case, however, that all important metric is actually moving in the wrong direction. That, not the current popularity contest, is what you should focus on. If the company devises more effective ways of making money from advertisers, then it can survive and prosper, even as user growth inevitably slows. If it cannot, then the future is bleak.