3 Reasons to Buy Twitter

Twitter's big drop in price makes it much more attractive than it was at $75. Twitter will not be the next Facebook, but it is a great niche service.

May 19, 2014 at 5:00PM

After a big price drop for Twitter (NYSE:TWTR) its valuation seems a lot more earthly (and yet still not cheap). The company's lack of user growth has confirmed the hypothesis of many investors and analysts who have previously stated that Twitter will never be Facebook (NASDAQ:FB).

Twitter remains a niche product for certain types of social-media savvy users. It is not mainstream like Facebook is, and it also does not own highly valuable social-media and communications properties like Instagram, WhatsApp, Oculus, etc. The big correction in Twitter's stock price from the mid-70s, coupled with some improving trends in its monetization, could lead to a more realistic investment case for Twitter. 

Robust growth in monetization
Twitter remains an advertising-centered company, just like other social-media names such as Facebook and Yelp. Advertising revenue made up roughly 90% of Twitter's revenue in the last quarter. The company's ad revenue per thousand timeline views grew to $1.44 for a healthy increase of 95% on a year-over-year basis from $0.74. 

Twitter's quarterly average revenue per user, or ARPU, stood at close to $1 per user. Going forward, higher ad loads in its platform will enable the company to ramp up this number a lot. Twitter is adopting Facebook's playbook of focusing on the user experience first and then focusing on ad placements. Facebook has substantially increased the ad load on its platform in the last few quarters, but Twitter still has a very low ad load and can increase the number of ads portrayed on user timelines substantially in the future. 

Rising margins
Twitter anticipates full-year 2014 revenue of $1.20 billion-$1.25 billion, which is a $50 million increase in revenue guidance from the estimate laid out in the prior quarter. It expects adjusted EBITDA in the range of $180 million-$205 million, and stock-based compensation for 2014 of $640 million-$690 million. 

The company's CFO stated on the earnings call that roughly $500 million of the stock compensation was driven by stock grants and a small portion resulted from acquisitions. Twitter had to expense many pre-IPO stock grants to employees in 2013, and this will continue into 2014 and thus create the illusion of low profit margins.

When Facebook went public, the social media company also saw its operating margins compress in the near-term, only to rise back to pre-IPO levels of 43%-44% in the last two quarters. So Twitter should see its margins rise dramatically as the company sees strong revenue growth and its stock compensation plans go back to a more normalized trend. 

Ad placements can increase substantially
In the last quarter, Twitter saw its cost per ad go down 20% from the prior quarter, but a 28% increase in total ad engagements offset this price decrease. The company has improved user targeting, and that should drive demand from advertisers going forward. 

Due to the conversational nature of Twitter, the company's TV product suite could gain a lot of momentum. Twitter allows advertisers to target their ads by using keywords, live events, etc., and this could drive a lot of value for media and broadcast companies across the globe. In addition, higher-quality ads on the platform will enable the company to increase the ad revenue per timeline view.

In addition, Twitter is ramping up its offerings to small and medium-sized businesses, or SMBs, by allowing them to place ads through a self-serve platform. These initiatives will enable the company to not only attract newer ad clients, but also get existing marketers to increase their ad budgets on Twitter. 

Going forward
Even though Twitter saw a decline in user engagement, the total number of views on its platform did see a material increase, and the company's decision to increase its revenue and EBITDA estimates for 2014 remains a strong positive. The company's high-flying stock has rewarded speculative traders who managed to sell their positions at the highs. However, with improving fundamentals and a much more attractive stock price, longer-term investors will start taking more serious looks at Twitter.

Twitter's engagement as measured by retweets and favorites increased 26% in the last quarter, which is a notable positive. If the company can show marketers higher ROIs, newer clients will flock to the company's platform. Improved investor sentiment and monetization will drive upside in Twitter's stock price. 

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Ishfaque Faruk has no position in any stocks mentioned. The Motley Fool recommends Facebook, Twitter, and Yelp. The Motley Fool owns shares of Facebook. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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