What Does the Shakeup at Twitter Inc. Mean For Investors?

Dick Costolo isn't your typical household name, and he's definitely no Mark Zuckerberg. Yet the world is a-tweet with the news that Costolo has relinquished his post, as Twitter's (TWTR) user base has grown stagnant.

With numbers being compared to Facebook (META -4.13%) by the hour, Twitter attempts to climb out of Facebook's shadow to create its own niche. Now that Google (GOOG -1.10%) (GOOGL -1.23%) will soon be offering tweets with each click of the search button, how will users -- and shareholders -- view this new-found instant access? Will they be bogged down with pointless search results, or will they be drawn into the Twitter turnstile that keeps churning users in and out of its platform like a revolving door?

A full transcript follows the video.

 

Sean O'Reilly: This tech edition of Industry Focus is filmed in front of a live studio audience.

[INTRO]

Greetings, Fools! I am Sean O'Reilly, joining you here from Fool headquarters in super-warm, and hot, and sunny Alexandria, Va. To my left is the incomparable Dylan Lewis. How are you today, sir?

Dylan Lewis: Doing all right, Sean. Super warm and muggy.

O'Reilly: I have no intention of stepping outside of our building today.

Lewis: No. Glad I brought lunch.

O'Reilly: If you're just joining us, that is not a joke. We are actually filmed in front of a live studio audience today. We're joined by Motley Fool intern Jake. How are you? Give us a wave. How you doing, man?

Lewis: We can't hear him.

O'Reilly: Well, yeah.

Lewis: He's behind the sound.

O'Reilly: Yeah. We couldn't.

Lewis: Anyway.

O'Reilly: We swear, he waved. He'll be editing articles and learning all about Foolishness here for the next couple of months.

Lewis: Probably joining us in the podcast as some point.

O'Reilly: Yeah, we hope. Maybe next week, Jake? Thumbs up. Good stuff? Awesome.

Lewis: Great.

O'Reilly: Now go get me Starbucks (SBUX 0.53%). I'm kidding. I'm not that mean. I'm watching Jake drink his Starbucks right now. Big news out of Twitter, Dylan.

Lewis: Yeah. Yesterday Dick Costolo, Twitter's embattled CEO, announced he was stepping down.

O'Reilly: I actually read about that via Twitter, by the way. Fun fact. Was this necessary, do you think?

Lewis: I don't know if it was necessary. It wasn't surprising. I think there was some writing on the wall for a while. You look at the public communication that Twitter has given out since the announcement, and it seems like Dick Costolo's departure was not tied to any external event, and it was something that he'd approached them about some time ago. Maybe late last year.

O'Reilly: Leaving for personal reasons.

Lewis: Yeah. That's what was announced. I don't know. You look at some of the stuff going on at Twitter. I was surprised. He had an 88% approval rating on Glassdoor. I know in the market's eye he's not exactly the greatest CEO.

O'Reilly: Yeah, I just pulled up the stock chart. It's vacillated between the low $30s and $50. Now it's at $36. Obviously Twitter is trying to find its way. Do we know anything about what they're talking about for the CEO replacement at all?

Lewis: Yeah. It continues to be planned right now. Jack Dorsey, who's the co-founder of the company -- a chairman currently -- is going to serve as the interim CEO. They're going to have a board search for a permanent successor. Just some background on Dorsey: He was previously the CEO and was forced out and replaced by the other co-founder, Edwin Williams, in 2008.

O'Reilly: We should draw a chart of all this.

Lewis: Then Costolo came on and became CEO, and Dorsey was executive chairman.

O'Reilly: Fantastic. So, the rumor is Adam Bain, the company's president of revenue and partnerships, has been mentioned as a possible successor. We'll see. Do we know anything about Costolo's golden parachute? Are they just going to give him $100 million to go away?

Lewis: Nothing announced yet, and nothing in the financial disclosures that were related to the announcement.

O'Reilly: Before we came down to the studio here, I hopped on S&P Capital IQ and looked at the cash-flow statements of both Twitter and Facebook. They could give this guy $50 million in stock, and it wouldn't be a problem as a golden parachute, because these companies spend billions of dollars -- hundreds of millions of dollars -- on stock-based compensation. It's not an actual cash cost immediately, but it's an economic cost, and it eventually happens to shareholders. We shall see.

Lewis: Yeah, I think that's something that warrants an entire show at some point.

O'Reilly: Yeah. "Guess what your company is spending on stock-based compensation."

Lewis: If we ever hit a week that tech decides to not have anything huge happen, we'll get to that.

O'Reilly: Right. If nothing crazy happens.

Lewis: Looking at some of the other reasons and some of the pressure involved with the decision, I think Costolo's this embattled CEO and he's been struggling. He talked a bit about financial metrics -- he alluded to it -- but I think the biggest thing he was being hassled for was the struggling user growth. You look back to Q4 2014, they had year-over-year growth of about 30% for comps, and Q1 2015 has been 19, and that's been precipitously falling. You can see where that's going. Obviously, as your denominator gets larger ...

O'Reilly: It gets harder to grow.

Lewis: It gets harder to grow, but that's an easier thing to say when you're at Facebook levels of 1.4 billion. When you're at 300 million, it's a little different.

O'Reilly: We'll get to this in a minute -- Twitter's financial metrics compared to the white elephant in the room, which is Facebook. Do you think that if active user growth was continuing at 25%, 30%, but they weren't making the money yet, he would be having to leave?

Lewis: I think the Street's opinion of the company would be dramatically different.

O'Reilly: OK.

Lewis: I don't know if it's an indictment on Costolo, necessarily. I think we know Wall Street is very willing to accept less glamorous financials if they see these very safe growth rates.

O'Reilly: Hence why Snapchat's valued at $15 billion and it makes $0.

Lewis: User growth, user growth, user growth. Don't worry about how to monetize it.

O'Reilly: "We'll figure it out later."

Lewis: Yeah. They've been public for a decent amount of time now and you're starting to see user growth taper off. That's a point where Wall Street says ...

O'Reilly: "OK, show us the money."

Lewis: "Where's the money?" They stick their hand out. I think that definitely has a big part of it.

O'Reilly: Yeah. It's kind of interesting to me also; according to what you've got here, monthly active users re just over 300 million -- and that's globally, as I understand. It's only about 50 or 60 here in the United States.

Lewis: Yeah. I think the U.S. is about one-fifth of that.

O'Reilly: Yeah. Facebook is 1.3 billion?

Lewis: Yeah. 1.3, 1.4.

O'Reilly: Why are they already slowing down? Shouldn't everybody on the planet have a Twitter just to follow Taylor Swift, and whatever? That's why I joined. I don't know about you.

Lewis: Yeah. I think that question gets to a lot of the issues currently with Twitter. Jake did an awesome job briefing us before this. Chris Sacca, who was an early investor in Twitter and one of its current, biggest investors, wrote this 8,000-word opus that was outlining some of the issues.

O'Reilly: He couldn't tweet it, obviously.

Lewis: No. Although he could direct-message it. We're finding that out now.

O'Reilly: Yeah. That did just come out.

Lewis: They took the cap off that. Basically he was talking about how it was this disjointed platform, something that's really targeted toward the super users, and the people that have a lot of clout, and a lot of followers, and it isn't as tailored for the every user. It's this alienating experience right now. So, on the UE side, that's what's going on.

From the business perspective -- and what they're communicating to Wall Street -- it's all over the place. There isn't a clear, confident vision, and that's obviously going to scare people.

O'Reilly: Yeah. I pulled up Twitter and Facebook just to give everybody some perspective. Their free cash flow GAAP earnings and active users -- if you're listening on the podcast, I apologize. I'm just going to talk slowly and give the numbers and everything. Twitter's free cash flow in 2012 was minus-$78.5 million; 2013 was minus-$74; and then last year -- technically they were bringing in more revenue, but last year, 2014, minus-$119.8 million in free cash flow. GAAP earnings were even worse. Last year they lost, on a GAAP basis, $577 million. That's that stock-based compensation we were talking about. The whole time they're losing more money, but their active users in 2012 were 185 million.

Now we're at 300. So their active users have doubled, but not making any more -- in fact, we're losing more. I looked at their capital expenditures, and it's mostly just more data centers. They're building data centers to support all these users, but they're not making any money. Compare that to Facebook. Good Lord. Free cash flow in 2012 was $377 million; last year, $3.62 billion.

GAAP earnings last year were $2.94 billion, up from -- this has a bunch of charges that were weird -- but $53 million in 2012, and $1.5 billion in 2013. Active users in 2012, just over a billion; last year, 1.39 billion. This gets back to what we talked about in a previous show where I said, "Facebook knows everything about us. Of course they can sell better ads."

Lewis: Yeah.

O'Reilly: Twitter's just a new service right now.

Lewis: It's a new service, but I think there's enough data there to make things happen.

O'Reilly: So they know that I live D.C., they know ...

Lewis: You talk about the classic Facebook example of ...

O'Reilly: The T-shirt?

Lewis: Former Ohio resident lives in Virginia.

O'Reilly: It was staggering. They had the Ohio state flag in the shape of Virginia. It was like, "Oh, this is too much."

Lewis: That market is 150 people, and they found you. I don't know if it's going to get that granular with what you can target on Twitter, but you look at the sources that people follow, and that's -- when you talk about what marketers build on a profile basis, that's it. They would love to have that kind of data for TV shows and stuff. I think to be able to have it and have customers explicitly telling you what they're interested in ...

O'Reilly: What? So, they know ...?

Lewis: There's still value there. I don't know if it's as good as what you're getting on Facebook.

O'Reilly: So you're saying that Twitter knows that I follow Forbes, and The Motley Fool, and Taylor Swift.

Lewis: Yeah. So, Taylor Swift's eminent financial advice site -- you'd be the customer.

O'Reilly: "What Taylor Swift has in her 401(k)."

Lewis: Precisely. One of the things that I was most surprised about reading Chris Sacca's opus was that there are almost 1 billion users that have tried Twitter and left it.

O'Reilly: That's staggering.

Lewis: Yeah. So, you look at ...

O'Reilly: Where are all these people?

Lewis: It's a huge issue. The big things for them, looking at the user side of the issue, is getting people to stay in the platform once they're on the platform and figuring out a way to monetize the logged-out users that are visiting the site right now. Some of the stuff that was outlined in that paper looking at building engagement was prompting people a bit more, in getting them to interact with the platform more.

Chris Sacca had outlined some ideas like "nudges," or "what do you think about this kind of thing" -- getting people to interact with trending articles and things like that. Building up a conversation. Making it more of a public-square kind of thing. I think there's a lot of "there" there. That's the best way to get people onto a platform and keep them there, is to get them engaged and interacting with it.

O'Reilly: Can I ask how and when you became a Twitter user?

Lewis: I became a Twitter user three years ago. I think I've been in and out of it here and there. Obviously, working in media more recently I've been more active on it.

O'Reilly: That's how -- I joined six months ago, and I got it for work so I could follow the articles that our writers are putting out; Forbes, to know what's going on in the world. I don't know that I would have joined had I not come onboard the Fool about a year and a half ago. That compares with Facebook. They got me -- I was part of that second-wave rollout in the movie The Social Network, when they break out of the IVs. I was part of the second wave.

Lewis: That was -- what did they call it? The Little Bighorn approach?

O'Reilly: Yeah. Facebook had this huge organic growth, and now I use it to follow the people I went to college with, and now my parents, to look at photos of my son, they've kind of got me. It's almost like Twitter needs to get some organic hook. Like getting all silicon -- I don't know. Something more organic than "Oh, I want to follow Kim Kardashian."

Lewis: Yeah. I guess that's what a lot of these initiatives that have been laid out are getting at.

O'Reilly: Do you have an idea of what the next CEO's going to try to do?

Lewis: I don't know. I think it's hard to tell. The end user is obviously going to be the focus. It's just going to be a matter of how they choose to address them. I think Chris Sacca's paper here is an excellent blueprint for them to follow. Looking at some other things that might help down the line, obviously the Google deal they setup recently is going to hopefully be big. Earlier this year ...

O'Reilly: Putting tweets in searches?

Lewis: Yeah. Earlier, in the first half of this year, tweets are going to start being visible in Google search results as soon as they're posted. Google's going to have access to ...

O'Reilly: I somehow feel this is going to ruin my Google searches.

Lewis: Yeah. It's interesting. Something that's going to be interesting to check out is how loaded with populated content Google searches are going to be. They currently pull in Wikipedia auto-answers if they can. How much are they going to load up before they get to that first search result? That will be something to check out down the road.

O'Reilly: Yeah. What's up with Periscope here?

Lewis: It's hard to know exactly where they're at in terms of adoption. Back in April, Twitter announced that the app had 1 million downloads in the first 10 days -- which is obviously very encouraging. There haven't been any updates that I've seen on user count yet, but they've been pretty aggressive with rolling out updates. I know one of the big things they did in late May was making an Android version available.

Which, obviously, opens them up to a much larger user base globally. That'll be interesting to see how that plays out. Early June, I think, they rolled out World Map, featuring all these specific hubs and allowing users to tap into live feeds from those locations. You're leveraging the cool factor of live-streaming things out. I hate to relate it to something that we just criticized with Twitter, but this plays so well into the breaking-news side of the platform.

O'Reilly: Yeah. Very good. So, what are your final thoughts if I'm a shareholder? What should I be thinking? I'm not loving these cash-flow numbers.

Lewis: I'm not a Twitter shareholder, personally. I'm a Twitter user, and I love it. I think the Chris Sacca letter really serves as a great blueprint for them to follow, moving forward. I'm not overjoyed by Dick Costolo's leaving, as the market might have been. You look at the reaction; it was up 5% after hours yesterday. It's something to watch. I think the big thing they're going to have to do is continue to grow their user base for me to be confident with them, because right now you're seeing them stall there. It gives me concerns, because the monetization efforts just haven't worked out.

O'Reilly: Very good. Well, thank you for your thoughts.

Lewis: Yep. Always, Sean.

O'Reilly: Have a good one.

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