Earnings Miss #2

Twitters earnings release was a mess. The good to come out of it was the 17% year-over-year increase of daily usage to bring us to 145 million mDAU. I just get frustrated that TWTR hasn’t found a way to monetize daily active usage like Facebook or Alphabet. Especially in light of how POTUS uses their platform excessively.

I can also admire that they are proactively identifying abuse and harassment beyond just user reporting. The announcement that they are staying out of the political foray is encouraging, but seems more of a decision around business economics than higher morals. For the nominal revenues brought in from political advertising, the baggage that such a move carries probably doesn’t pass their cost-benefit metrics.

They announced other additions to the platform to make it more deliberate in their focus. From the conference call, “Another example of rethinking the fundamentals is where we have taken on some notable experiments this quarter, which might lead to far greater outcomes. In health, we launched the ability for folks to moderate replies to their tweets by hiding them from the main conversation view, while still allowing moderated tweets to be seen behind the button press.

This is now live in the US, Japan and Canada. Our Global rollout is forthcoming. More broadly, we have evidence to show that people see Twitter as an interest network and spend a bunch of time focused on finding and following accounts that match their interest. From on-boarding to daily use, we have opportunity to make this much easier.

To address this, we went back to a feature only Twitter experts make use of lists. This quarter we made less easier to create, and most importantly, easier to consume. We’ve added the ability to pin lists directly to your home timeline, enabling a fast switch between your home timeline and list of accounts you want to keep on - keep up with, but don't directly follow. Expect lists creation to get more powerful capabilities over time.

We’re also experimenting with following topics right from your timeline. In option to follow a topic will be appended to relevant tweets. A tweet about the Golden State Warriors for instance, would now have a prompt to follow the topic, which allows us to include all relevant tweets matching the topic, without having to follow the various accounts that produce them.

All was good until they dropped the bad news. “In aggregate, issues relating to our revenue products reduced the year-over-year growth by three or more points in Q3. We discovered and took steps to remediate bugs that largely affected our legacy MAP product. These bugs affected our ability to target ads and share data with measurement and add partners. We also discovered that certain personalization and data settings were not operating as expected. These issues were in our control and we will work to do better.”

Add on top a weaker than expected seasonality issues and the stock got crushed.

Bullets from their results

• Revenue totaled $824(1) million, an increase of 9% year-over-year. Performance was impacted by revenue product issues, which we believe reduced year-over-year growth by 3 or more points, along with greater-than-expected seasonality.

• Advertising revenue totaled $702 million, an increase of 8% year-over-year.

• Total ad engagements increased 23% year-over-year.

• Cost per engagement (CPE) decreased 12% year-over-year.

• Data licensing and other revenue totaled $121 million, an increase of 12% year-over-year.

• US revenue totaled $465 million, an increase of 10% year-over-year.

• International revenue totaled $358 million, an increase of 7% year-over-year.

• Costs and expenses totaled $780 million, an increase of 17% year-over-year, resulting in operating income of $44 million and 5% operating margin.

• Net income was $37 million, representing a net margin of 4% and diluted EPS of $0.05. In the same period last year, net income was $789 million, representing a net margin of 104% and diluted EPS of $1.02. Also in the same period last year, excluding the release of deferred tax asset valuation allowances of $683 million, adjusted net income was $106 million, representing an adjusted net margin of 14% and adjusted diluted EPS of $0.14.

Perhaps it’s time for CEO Jack Dorsey to step down and bring in a full time CEO that can address these “bugs” and figure out a way to better monetize the platform. The associated toxicity to the platform I believe is also standing in the way of this company being acquired.

Valuation

With TWTR trading 27x for EPS of $1.08, the stock would appear cheap by historical standards. Long-term EPS growth is expected to compound at an annual rate of 25% providing three-year EPS projections near $2.15. This represents significant upside from these levels but I’m not going to increase my position. There is a failure on the part of management to properly monetize this platform and I’m not sure if this “bug” overstated previous quarters or years numbers.

I did increase my exposure by writing calls against my position and buying at the money calls. If the stock can rally back to $35(ish) by the January expiration, I’ll minimize my losses and move on.

Joseph S. Kalinowski, CFA