Twitter (NYSE:TWTR) disappointed investors when it reported flat monthly active users for the second quarter. In fact, Twitter's U.S. user base declined by 2 million to 68 million, but it was offset by international growth. Nonetheless, Twitter was keen to point to its third straight quarter of double-digit year-over-year daily user growth.
What's gone largely unnoticed is the growth in Twitter's data licensing revenue. The other side of Twitter's business grew 26% year over year to $85 million, an acceleration from last quarter. While data licensing still only made up 15% of Twitter's total revenue, the profit margin on that revenue is significantly higher than its ad revenue. "$1 in data revenue is equal to about $3 to $4 in advertising revenue, given the difference in profitability," CFO Anthony Noto told analysts on the second-quarter earnings call.
Data licensing is the path toward profitability
Twitter made it a goal to become profitable on a GAAP basis by the end of 2017. Focusing on accelerating data licensing is its best path toward that goal considering it produces a higher profit margin than advertising.
Data licensing revenue growth slowed significantly along with the rest of Twitter's business during 2016. Growth fell from 35% in the second quarter last year to just 14% in the fourth quarter.
At the beginning of the year, Twitter refocused its ad products, but it also made some changes to its data licensing business. It created a new tiered-pricing structure, providing two potential areas for growth: onboarding new customers and increasing how much they spend per month. The new changes brought on "a significant number of new enterprise deals" last quarter, according to Twitter's letter to shareholders.
As a result of its efforts to grow its data licensing business, Twitter grew revenue from the business 17% and 26% in the first and second quarters, respectively. It also produced a smaller net loss during the first six months of 2017 compared to last year thanks to higher margin on data licensing and reduced costs across the board. That's despite a slight decline in revenue.
But Twitter still needs user growth
While Twitter's efforts to expand into new channels and make its pricing more flexible have resulted in accelerated growth for its data licensing business, that won't be the case forever. If Twitter wants to keep expanding its data licensing business, it won't get far without more user growth.
Noto even admits that user growth is essential. "It's directly related to the audience growth and engagement on Twitter," he said. "We're taking that data and packaging it for our partners. So, as the audience grows and the engagement grows, the value of the asset will grow."
The problem is Twitter's audience growth has mostly come in fits and starts. Twitter points to the increased engagement with double-digit year-over-year daily user growth, but using year-over-year numbers masks a lot of the ups and downs. Twitter refuses to release actual numbers for its daily users.
What's more, daily user growth is capped by monthly user growth. Noto said the company's daily user to monthly user ratio is about the same as it last reported in 2015: 44%. Noto spun this as a positive, saying it provides plenty of room to grow. But the other way of looking at it is that despite Twitter's focus on growing daily usage, it hasn't made much progress over the last couple years.
If Twitter can't grow the top of the funnel (like last quarter), it spells trouble for the future of the company's data business -- even if it's managing to execute in the short term.