Please ensure Javascript is enabled for purposes of website accessibility

Are Users Flocking Back to Twitter Inc?

By Motley Fool Staff – Apr 28, 2017 at 2:01PM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

The company’s first-quarter report revealed a rise in monthly active users, and shares have jumped over 13%.

In this Market Foolery segment, Chris Hill is joined by David Kretzmann and Aaron Bush to check in on Twitter (TWTR) in the wake of its first quarter earnings report. Revenue fell, but margins, cash flow, and MAUs were up, leaving followers of the company with some important questions. Among them: Is this a sign the company is putting itself in a better position to compete with other social media platforms? And where is this company ultimately heading?

A full transcript follows the video.

10 stocks we like better than Twitter
When investing geniuses David and Tom Gardner have a stock tip, it can pay to listen. After all, the newsletter they have run for over a decade, Motley Fool Stock Advisor, has tripled the market.*

David and Tom just revealed what they believe are the 10 best stocks for investors to buy right now... and Twitter wasn't one of them! That's right -- they think these 10 stocks are even better buys.

Click here to learn about these picks!

*Stock Advisor returns as of April 3, 2017

This video was recorded on April 26, 2017.

Chris Hill: Let's start with signs of life -- I can't believe I'm saying this -- signs of life from Twitter. Shares are up 11% this morning after a first quarter report that included, Aaron, a rise in monthly active users. The revenue fell, for those of you who actually pay attention to money. The revenue fell, but that seems to matter less than the fact that monthly active users are on the rise.

Aaron Bush: Yeah, I think the 10% pop in the stock today is a little misplaced, in my opinion. I don't really think it was that great of a quarter, to be honest with you, Chris. I think you could say it was a mixed bag. Revenue was down, margins and cash flow were up, users were up. But ultimately, I do think, when you piece it all together, the news is more bad than it is good.

Hill: Wow, really?

Bush: I think so. On one hand, it's clear that Twitter is slowly making changes. They're slow, they're ungodly slow when it comes to handling user issues like abuse and improving the actual timeline. But they are improving their cost, free cash flow is growing, the user base is growing, daily active users was up 14% year over year, which is actually pretty great. And I do think that's because of some of these efforts they put in place from the product perspective.

That said, revenue, you can't just ignore that. That's huge. It's down 8% over the last year, and this is the 11th quarter in a row of a deceleration. The first quarter that it's down. That's pretty bad. I think the moral of the story here is pretty simple. Twitter's ads are currently not competitive with Facebook and Google, not even close. And it's a huge undertaking for them to become competitive. So, you can celebrate all these other wins, but at the end of the day, this is the business. Turning the ship around is still a multi-year process, and the slower they move, the higher the odds of them getting whacked.

Hill: So, the people who are on Twitter itself, but also reporting in the media, etc, who are saying, among other things that CEO Jack Dorsey has bought himself some time, this was a good quarter, let's quiet down the drumbeat of, he needs to choose between being CEO of Twitter and being the CEO of Square. You're saying "No".

Bush: I think this is beyond him. This is beyond what any one person can change at this point. I do think a lot of the changes that he has put into place have been positive, but revenue, you can't overlook that.

David Kretzmann: Yeah, Aaron mentioned the competition from Google and Facebook. As far as digital sales go, those are definitely the big giants in the room. But then, as Twitter is doubling down on its live video strategy, they're starting to compete more with Snap, which has a very engaged user base. The growth there has slowed a little bit, it'll be interesting to see what Snap's metrics look like, and how those compare to Twitter, as far as ad engagement and user growth. But, yeah, it's not a good combination when you have users going up, but ad revenue going down. And Twitter said they expect that disconnect to continue for the rest of the year. This probably won't be the last quarter that revenue goes down.

In the meantime, their pace of stock-based compensation has receded a little bit, but their diluted share count increased over 1% just from the last quarter. So, in the process, as revenue has completely decelerated and now is declining, their share count has climbed up. So I went back and looked, if Twitter wanted to bring its share count back to the same level it was in 2014, a few months after it went public, they would have to spend $1.9 billion just to get back to that break even level with the share count. What that shows is, the bar that they have to cross at some point to reward shareholders is perpetually getting higher as they continue to dilute shareholders. So, that's not a good trend to have when your revenue is dropping.

Hill: And share-based compensation, that's one of those things that, if you're the average investor, it's understandable if your eyes gloss over, and it's easy to dismiss it and focus on the more headline-oriented things like revenue and monthly active users. But when we talk about some of these tech companies potentially putting themselves up for sale, you need to recognize that share based compensation is a huge factor in that, the fact that they're going out and hiring people and convincing them to stay on board and not jump ship, a lot of that has to do with, "Look, we're going to give you more shares." Go back and look at LinkedIn being acquired by Microsoft. As much as anything, it was the share-based compensation within LinkedIn that made the leaders of that company go, "We have to figure something out quick."

Kretzmann: Yeah, because that's one of the main currencies they have for paying their employees. And competition between employers in Silicon Valley is not going to disappear. I think that's a dangerous thing for Twitter shareholders and something to watch. At first glance, on the balance sheet, it does look pretty strong. We have net cash of $2.2 billion, as Aaron mentioned, you have free cash flow, which is going up, but stock based compensation is still a huge component for that positive cash flow production. So, the balance sheet, to me, is not as strong as it looks on the surface, because $1.9 billion just to break even with your share count two years ago, that takes up most of their net cash today. The investments that they've been making up to this point are not paying off. At some point, that trend has to reverse for shareholders to be rewarded.

Bush: One other thing that David and I were talking about earlier today is how slow they move, and what that really means when you look long term. I think it's easy to look at these incremental changes and think about where things should go. But the pace that they move, these larger tech companies like Facebook and Google, they could do it at the snap of a finger, what these guys take six months to do.

Hill: I was going to ask you about that. It's, in some ways, an unfair question because unless you're spying on headquarters at Twitter, there's no way for you to have the information to answer this question, but I'm going to ask it anyway. Why do you think that is? I've seen you write about this, I've seen other people touch on it. The popular image that we have of Silicon Valley is, among other things, it's a fast culture, it's a nimble culture. The way things move at Twitter, they might as well be the U.S. Department of whatever. When you think of bureaucracy, you think of Washington D.C. When you think of fast and nimble and cutting-edge, you think of Silicon Valley. Twitter's lack of speed is really astonishing.

Bush: I do think I know one big reason behind it. I think a lot of it stems from the very early days of the company. They never had to struggle to reach product/market fit. So, never in their journey to figure out how to improve what they're doing, they never had an issue. They just threw something out there and it worked. So then, they just kept on capitalizing on what worked, but never really changed the product itself. Now that they're up competing against these companies that have been changing their platform at pretty innovative speeds for years now, they're finding that gap so much larger that it's just, in comparison, it takes so much more time to get out of.

Kretzmann: Yeah, it seems like Twitter just doesn't have near the focus on the actual product. What is their platform, fundamentally, compared to Snap or Facebook, where you have leaders that are so product-driven, and it drives everything they do. From there, you find the business model that fits. But with Twitter, it seems like they're very scattered trying to figure out the direction of the company and what their actual product is.

Teresa Kersten is an employee of LinkedIn and is a member of The Motley Fool's board of directors. LinkedIn is owned by Microsoft. Aaron Bush owns shares of Facebook and Twitter. Chris Hill has no position in any stocks mentioned. David Kretzmann owns shares of Facebook and Twitter. The Motley Fool owns shares of and recommends Facebook and Twitter. The Motley Fool has a disclosure policy.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.