Twitter plays a vital role in public discourse; however, the company is worth $30bn—20x less than Facebook. There’s a fundamental mismatch between the value of Twitter as a platform and as a business. If eliminated, this value gap will unlock a huge upside for investors.
If you had bought $100 of TWTR in 2013, you would now have $90. Twitter’s stock reflects the company’s mediocre financial performance—a small revenue base of $3.5bn in 2019—due to a combination of lukewarm monetization and user growth; however, that’s about to change.
Silver Lake and Elliot Management, activist investors, entered the scene. They spotted Jack Dorsey, CEO, harrowing Twitter’s poor shareholders for he dedicates half his time to Square (his other part-time CEO job).
Jack was put on probation. In May, he cut a deal. The activists gained two board seats, and Twitter agreed to buy back $2bn of its stock and set a higher standard for user growth—20% per year vs. 8% over the last five years.
Incentives have changed. Management was too comfortable, the board was complacent. Now, Twitter will strive for greater monetization, faster user growth, and better capital allocation. There’s some low-hanging fruit to achieve that, given the value of the platform and the many opportunities that lie ahead of the company.
Jack will deliver, or Twitter will give Jack the bird. Either way, shareholders will be better off.
Twitter > the News
Twitter is the best social network for keeping yourself informed and taking part in the public debate. I don’t read the news and I don’t watch TV. I only access Twitter.
People use Twitter for things like:
Knowing what someone—celebrities, CEOs, politicians, scientists, scholars, newsletter writers—is thinking, reading, listening, writing, doing.
Grabbing first-seats to interactions between those people.
Accessing information before it reaches big media (if it ever does) through first-hand accounts or alternative sources.
Commenting on sports, stocks, COVID-19, TV shows, concerts, elections, etc.
Twitter’s importance as a curation tool can’t be overstated. I often get unique insights and change my views on topics—such as stocks or public policy—after reading tweets from different people.
For example, if you followed the right accounts on Twitter, you could have realized the risks of COVID-19 and figured out what would be the best approach for dealing with it earlier than most people. Traditional media was way behind in their reporting.
The growing value of Twitter
Twitter is making improvements to its platform. These improvements try to: (1) facilitate interest-based (follow subjects) as opposed to account-based (follow accounts) access to information, (2) expand the way people use the platform, and (3) foster healthier conversation.
For example, Twitter is expanding features such as topics (+4,500 themes available) and lists (groups of Twitter accounts on a given topic), and introducing features such as audio tweets and Fleets (like Instagram stories, but for tweets). The platform is also creating more tools so users can control replies to their tweets, among other things.
With the traditional media decay and constant platform innovation, Twitter’s value to users tends to increase over time.
The soviet
Recently, Twitter has taken controversial measures for “combatting misinformation” by fact-checking tweets, including those from Donald Trump. This prompted a fast reaction by Trump, who issued an Executive Order for preventing online censorship.
If Twitter will start checking the content of tweets, Trump argues that the company becomes a publisher, like a newspaper; therefore, it should be liable for the content posted on its platform.
I won’t get into legal meandering. I think this post does a nice job summarizing it. While the Executive Order may have no immediate impact on Twitter, it does indicate that regulation changes are probably coming for platforms such as Facebook, Google, and Twitter. This is an investment risk weighing on the outlook of all large tech companies. The outcome is uncertain.
My personal view is that “fact-checking” is too much about checking, not so much about facts, and that “misleading information” is a discretionary umbrella concept. I wouldn’t trust a committee of Twitter’s employees (literally a soviet) for telling me what’s misleading information and what’s a fact.
Foremost, I’m wary of things like this:
Later in the quarter, as part of our response to COVID-19, we broadened our definition of harm to address content that goes directly against guidance from authoritative sources of global and local public health information. - Q1/20 Letter to Shareholders
This discussion deserves an essay on its own, but keep one thing in mind: there are no authoritative sources in science. If you think there are, you need to go back to the concept of science and reflect on how human knowledge is built. Until a while ago, authoritative sources told us that we shouldn’t wear masks and that you should eat margarine instead of butter.
The platform argument for “combatting misinformation” is to enhance the user experience by getting rid of trolls, bots, and “fake news”; the business argument is to increase advertising revenue, as companies and brands wouldn’t want to associate themselves with Twitter because of its “toxic” content.
I buy neither of them. Controlling content outside of what’s obviously criminal—such as incentivizing a murder—is a dicey step because much of Twitter’s value lies on it being an open content network. Moreover, I think Twitter’s bad execution is to blame for the company’s poor monetization, not its content.
A clown car with network effects
Twitter is such a mess—it’s as if they drove a clown car into a gold mine and fell in. - Zuckerberg
Twitter is a mess for many reasons. They have poor leadership (part-time CEO) and governance (a board that only says yes). They have safety issues and incredible bugs in their advertisement system. They gave up on Vine for no good reason at all.
Despite all that, Twitter has a solid competitive position as a social platform. That’s because it benefits from network effects.
There are network effects around social products and a finite number of different social mechanics to invent. Once someone wins at a specific mechanic, it’s difficult for others to supplant them without doing something different. - Zuckerberg explaining why he wanted to buy Instagram and was willing to pay $1bn.
Over the last few years, Twitter had problems too numerous to count, but network dynamics are such that the company still succeeded as a platform. Twitter’s relevance grew as the number of users increased. The company invented a social product that is valuable to users and has unique mechanics.
Twitter has a solid competitive moat. Network effects are hard to beat.
Sluggish monetization
Some people argue that Twitter’s ARPU is lower than Facebook’s because they are fundamentally different platforms. For example, when users access Twitter they want to hastily scroll through their feeds and don’t have time to see any ads.
Others argue that ARPU is lower because management failed to execute. Twitter’s code isn’t the best out there. The company had many problems with its advertisement system and it’s still trying to fix those.
I think both arguments have merit. Twitter is a platform that demands a different monetization strategy than Facebook, and management hasn’t executed well over the last few years, recently having to rebuild its ad servers, among other things.
The good news is that both problems are solvable. On one side, being a different platform opens up alternative monetization options; on the other side, the solution to Twitter’s bad management has already arrived in the form of incentives, as many shareholders have lost patience.
Monetization opportunities
Twitter derives revenue from two segments: advertisement (~85% of sales) and data licensing (~15% of sales). Both are linked to Twitter’s ability to understand users and gather insights around their preferences and behavior.
Currently, Twitter sells its users—the company monetizes users’ information and clicks. From a business perspective, that’s an attractive play. Companies like Facebook and Google make a ton of money doing that; however, Twitter has other options to monetize features based on the value of the platform itself.
Facebook is a social media that connects people on a personal level; it’s in the business of connecting people. Twitter is a social media that informs and gives people a voice; it’s in the business of communication. Both are social media, both are platforms, and both benefit from network effects; yet, they have a different purpose, follow different mechanics, and generate a different value to their users.
Because of the high value of Twitter’s platform and the way it is used, the company has alternative monetization options that Facebook doesn’t have.
For example, Twitter may start a subscription service—people could pay for a premium account to have special features, such as verified accounts or a restricted and monetizable list of followers (can you imagine Facebook charging for anything like that?). Other monetization opportunities could be related to video broadcasting (improve periscope!), podcasts, integration with traditional newspapers for breaking news, special features for company accounts, direct monetary contribution to accounts (sort of like a Patreon inside Twitter, and why not buy Patreon?), etc.
Twitter is already moving in that direction
Now that incentives have changed, Twitter is moving into exploring alternative monetization opportunities.
[…] we're in the early stages of exploring other potential revenue opportunities to complement our advertising business - Jack Dorsey, Q2/20 Earning Call
This is a positive sign. I believe Twitter’s ARPU will increase as the company improves its advertisement platform and tap on alternative revenue sources. Getting more creative on the revenue front is central to Twitter’s financial growth.
Valuation
Twitter’s market price reflects assumptions similar to the company’s past performance—that is, the market believes Twitter will continue its trajectory with user growth of ~10% per year, ARPU roughly flat, and steady but slow margin expansion.
However, I think Twitter is on the brink of change; therein lies the upside. The value of Twitter’s platform and the nature of the social media business is such that a slight change in growth leads to an enormous uprise in valuation. A growth leap could easily result in a +4x revaluation of the company.
Consider that Twitter has publicly disclosed its target of +20% annual growth in daily active users. If achieved, this growth would be enough to justify a value of 30% to 50% higher than Twitter’s current market price.
And while the upside is enormous, I see limited downside due to a strong competitive moat (network effects), the asset-light nature of the social media business, and a net cash position of +$5/share (+$4bn).
Here’s what drives my valuation:
Daily Active Users (DAU): Strong growth in 2020 is guaranteed. In Q2/20, Twitter achieved 186mm DAUs, up 34% from the year prior—that’s the strongest growth rate Twitter has ever reported. This increase was supported by the conversation around COVID-19 and other spectacular and extraordinaire events, such as the stock market crash and subsequent recovery, political tensions between the US and China, and the US election.
While a +30% annual growth isn’t sustainable, I think Twitter’s DAU will continue to grow double digits as the platform improves and management remains focused on achieving its target of +20% annual growth. I forecast a 20% growth in 2021, and an annual growth rate trending down to 8% in a 10-year period (8% is what the company has achieved, on average, over the last years). By then, Twitter would have close to 600mm DAUs—which is 60% less than what Facebook has today—still leaving a largely untapped addressable market.
Average Revenue per User (ARPU): Over the last three years, Twitter’s ARPU remained roughly flat around $23. I think this number will increase as Twitter explores different monetization opportunities and improves its advertisement platform. In Q2/20, the company completed its ad server rebuild, began the implementation of a new Mobile Application Promotion (MAP), and completed the acquisition of a performance advertisement start-up.
With increased pressure from shareholders, management will double its efforts to expand Twitter’s ARPU, increasing the chances that the company will finally grow as expected.
I assume a 15% drop in ARPU in 2020, due to COVID-19, and a recovery to 2019 levels in 2021. From then on, I assume Twitter’s ARPU can grow double digits for a couple of years, trending towards 3% annual growth in a 10-year period. By then, Twitter would have an ARPU slightly below what Facebook has today.
Operating Margin: This is where Twitter has the most room for improvement. The company reported an EBIT margin of 11% in 2019, which is disappointing for a software-based, asset-light company. Consider that companies such as Facebook, Google, Apple, Microsoft, or Tencent report EBIT margins of +20%. Of note, Facebook has EBIT margins of +40%.
Twitter’s revenue base is much lower, but as the company grows sales, it will benefit from scale advantages and margin will expand. The company is hiring and expanding its team, which weighs on operating expenses; however, I don’t view expenses surpassing revenue growth. Management is aware of the need to control costs.
To put it simply, for Twitter, margin expansion will likely flow as a consequence of revenue growth—assuming revenue growth indeed occurs. I assume it will. As such, I forecast margins gradually trending towards +20% in a 10-year period.
I arrive at a fair value estimate of $45.50/share for my base case scenario. I think this scenario uses assumptions that, if not conservative, are reasonable on condition that Jack gets squared. At the current price of $36/share, that’s not a very large margin of safety according to my standards.
What attracts me to Twitter, though, is the huge upside that is close at hand coupled with a very limited downside. That’s a powerful combination. In a bull case scenario with assumptions that aren’t far-fetched, I figure Twitter is worth +$150/share.
In this instance, I have decided to initiate a position in the company.
Risks
Twitter’s major risk is regulation. This is something out of the company’s control and which impacts the whole tech sector, especially social media companies and very large, monopolistic companies such as Facebook, Google, Apple, Microsoft, and Amazon.
Other risks include increased competition for ads, Twitter’s management, the activist investors which may end up not helping the company, etc.
Conclusion
I like Twitter because it has:
A powerful platform that has gained importance over the last years.
A defensible product owing to network effects.
A long runway for growth due to a still relatively small user base.
Alternative monetization opportunities outside of advertisement.
Plenty of room to improve advertisement revenues.
With incentives recently changing for management, and the strong DAU growth in the first half of this year—which still have not shown in the financials because revenue decreased—I think a step function growth on Twitter’s value may soon happen.
If you have good arguments for a Twitter bear case, please leave me your comment. I’d love to read it.
Next Steps
I’ll monitor my investment by keeping an eye on the following:
DAU, ARPU, and operating margin evolution
Introduction of new features, improvements to the platform
Exploration of new monetization opportunities
Jack’s status as CEO
Social media regulation talks