Hey Twitter Longs, "Enough Is Enough"

Nomura's bullish call moved Twitter higher by 10% on Wednesday, but until the fundamental problem of user engagement and growth is corrected, investors should be careful in thinking that Twitter can't go lower.

Jun 2, 2014 at 4:10PM

Twitter (NYSE:TWTR) shares soared 10% last Wednesday behind an upgrade from Nomura. The "buy" rating came with seemingly frustrated notes, reasoning with investors that "enough is enough" in regards to its 50% stock losses in 2014. Nonetheless, Nomura took a rather bullish stance, expecting Twitter to follow Facebook's (NASDAQ:FB) path, which appears to be following Google (NASDAQ:GOOG) (NASDAQ:GOOGL). But the big question is whether Nomura's call is logical.

Straight to the point
After Twitter's 10% gain, the stock is just shy of $34 and still a long way off from Nomura's $43 price target. So, how does Twitter get to $43? According to Nomura, Twitter gets to $43 -- despite slowing user growth -- by monetizing users at a faster pace than any of its peers. In that regard, Nomura believes that Twitter can earn $5.97 per user in 2015, on par with Facebook in 2013. It also believes Twitter can eventually be on par with Facebook.

So, despite Twitter's slowing quarter-over-quarter user growth and a widespread belief that its days of rapid user growth are behind it, let's assume Twitter gets to 350 million users in 2015. If so, Twitter could generate nearly $2.1 billion in revenue, according to Nomura's figures.

Enough is enough 
Naturally, there are a lot of people who like and use Twitter, especially investors, as it's a great tool for obtaining information. But, there are a lot of problems with assuming it can match the revenue per user of Facebook so soon.

The most obvious problem is that to attract advertisers on a large scale, a social media platform must have good engagement, not just users. Specifically, a BI Intelligence  research report recently found that the average Facebook user spent 50.7 minutes per day on the site, ranking number one among social media sites. For Twitter, it ranked third at just 7.4 minutes, far from Facebook, and also behind Instagram at 13.5 minutes. Therefore, perhaps most damning to Nomura's analysis is that it doesn't account for engagement, but rather users only.

Moreover, you can also read What User Engagement Tells Us About the Big 3 Social Media Companies to get a more visual analysis of how Twitter lags Facebook in communicating with other users. With that said, it's a tough sell to assume that a low engaged Twitter with limited 6% quarter-over-quarter user growth is worth the same to advertisers as Facebook, who if you multiply users times engagement is light years ahead of Twitter. Even in 2013 Facebook had 1.2 billion users, far more users than Twitter is expected to have in 2015.

Facebook is the real value
Albeit, Facebook has the largest platform in the world, which conveniently has the highest level of engagement. Yet, Nomura is right about one thing: There is a huge gap in advertising dollars.

Specifically, Google has an average revenue per user of $45, which has grown at an 8% year-over-year rate. Recently, Google has invested in other technologies such as hardware to drive future growth, thus implying that $45 might be near its max limit. Facebook, with the largest platform, is earning just $7.24 with 57% year-over-year growth. Due to this disconnect, investors have to like Facebook's opportunity to grow its revenue per user over the next few years, and looking at Google, we have to assume its upside is limited.

Already, Facebook is rolling out new services, including video advertising, to better monetize its 1.3 billion users. If Facebook can get to $24 per user with little resistance, by implementing Google-like tools, its annual revenue can triple from its current level, and with operating margins of 40%, Facebook is a company that has significant upside to gain.

Final Thoughts
Nomura said, with a quarter billion users, it's hard to imagine a valuation that is a lot lower than where it is today .

Yet, at $20 billion, you're paying $80 per user in a company that earns just $3.55. Hence, Twitter is not undervalued, but rather already priced for growth. Therefore, explosive revenue-per-user growth is not an unaccounted for luxury, but rather a necessity to protect the valuation of the company.

Hence, enough is enough, until Twitter proves it can grow users and improve engagement, it's tough to imagine a stock price much higher than where it is today.

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Brian Nichols has no position in any stocks mentioned. The Motley Fool recommends Facebook, Google (A shares), Google (C shares), and Twitter. The Motley Fool owns shares of Facebook, Google (A shares), and Google (C shares). 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.

4 in 5 Americans Are Ignoring Buffett's Warning

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Jun 12, 2015 at 5:01PM

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