Please ensure Javascript is enabled for purposes of website accessibility

Twitter Is Finally Accepting What It Is -- and What It Isn't

By Evan Niu, CFA - Updated Oct 30, 2017 at 3:33PM

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

Costs have come down meaningfully, potentially paving the way to GAAP profitability.

Twitter (TWTR -1.10%) is impressing investors today with its prediction that it could post its first profitable quarter ever in Q4. While the company posted record profitability in the third quarter on a non-GAAP basis, Twitter might just be able to squeeze out some black ink on a GAAP basis in the coming quarter.

Outlook for the fourth quarter calls for adjusted EBITDA in the range of $220 million to $240 million. At the high end of that range, Twitter says it "will likely be GAAP profitable." That's despite a top line that's been shrinking all year. A big part of the company's improving financial condition is due to coming to terms with what Twitter is -- and, more importantly -- what it isn't.

Reception desk at Twitter HQ

Image source: Twitter.

Twitter can survive

Given Twitter's long history of losses, there has been speculation over the years regarding whether or not Twitter can survive as a stand-alone company, which was only stoked by Twitter trying to sell itself last year. I've argued that Twitter can indeed survive, as long as it ramps down growth investments while investors simultaneously lower their own expectations. Twitter has carved out a unique place for itself within social media, and still enjoys solid operating cash flow ($240 million last quarter) with a respectable top line.

The good news for Twitter shareholders is this is precisely what the company is doing. The improvements in non-GAAP profitability are largely thanks to cost discipline. "This profitability reflects our improved prioritization and disciplined execution across all of our strategic priorities," CEO Jack Dorsey said on the earnings call this morning.

Despite the fact that revenue fell 4% to $589.6 million in the third quarter, total costs and expenses fell by 16%. That helped Twitter swing from an operating loss of $78.1 million a year ago to positive operating income of $7.3 million. Twitter's GAAP net loss narrowed from $102.9 million a year ago to $21.1 million. The biggest cost reductions came from R&D and sales and marketing.

Cost Category

Change (YOY)

Cost of revenue

(7%)

R&D

(23%)

Sales and marketing

(23%)

General and administrative

(6%)

Data source: Twitter Q3 shareholder letter. YOY = year over year.

Twitter has been working hard in recent quarters to bring down expenses, but CFO Ned Segal emphasized that Twitter's expenses may still rise going forward as the company continues to invest in specific areas. Future margin expansion will likely come from revenue growth. Segal stated on the call:

We are at the point, though, where after a lot of hard decisions made over the last couple of years, and an expense base that's come down quite a bit, where the expense base will selectively grow as we invest against our priorities. So to the extent you see margin improvement, it's more likely to come from revenue growth than it is from cutting the expense base. As you said, we want to make sure that we're investing appropriately against the opportunities that we see.

The issue is, and has always been, Twitter's ability to monetize strong user engagement. The disconnect between daily active user (DAU) growth and ad revenue growth remains: DAUs jumped 14% in the third quarter while ad revenue fell 8%. Twitter will never be one of the top dogs in online advertising, but that's OK. As long as Twitter accepts that it will always be a relatively smaller player compared to the advertising duopoly of Alphabet subsidiary Google and Facebook -- and sizes its cost structure accordingly -- it can build a sustainable business.

Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Evan Niu, CFA owns shares of FB. The Motley Fool owns shares of and recommends GOOG, GOOGL, FB, and Twitter. The Motley Fool has a disclosure policy.

Invest Smarter with The Motley Fool

Join Over 1 Million Premium Members Receiving…

  • New Stock Picks Each Month
  • Detailed Analysis of Companies
  • Model Portfolios
  • Live Streaming During Market Hours
  • And Much More
Get Started Now

Stocks Mentioned

Twitter, Inc. Stock Quote
Twitter, Inc.
TWTR
$43.94 (-1.10%) $0.49

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

Related Articles

Motley Fool Returns

Motley Fool Stock Advisor

Market-beating stocks from our award-winning analyst team.

Stock Advisor Returns
390%
 
S&P 500 Returns
125%

Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 08/11/2022.

Discounted offers are only available to new members. Stock Advisor list price is $199 per year.

Premium Investing Services

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