Twitter (TWTR) recently reported much better than expected first-quarter earnings. Not only did it produce revenue about 10% above the analysts' consensus estimate for the quarter, it posted its second straight quarter of GAAP profitability. That profit wasn't something I was expecting until the back half of the year, as revenues climbed.
Despite the strong first-quarter results, investors punished Twitter stock for an unclear reason. My best guess is management reiterating its expectations for sequential revenue growth similar to 2016, which would produce slower year-over-year revenue growth in the back half of the year compared to this quarter. Still, it would produce about $2.8 billion in revenue for the full year, which is well above analysts' current expectations, and management already told investors about those expectations back in February.
Without further diving into the rationalization of the market for sending shares of Twitter stock lower, I'm still not sure Twitter is a buy. Here's why.
Monthly user growth is still disappointing
Twitter has effectively shifted the conversation from its monthly users to daily users. It highlights that daily active users (DAUs) grew 10% year over year in the first quarter, marking the sixth consecutive quarter of double-digit DAU growth.
Monthly active users (MAUs) grew significantly more slowly. The 336 million MAUs on Twitter in the first quarter were up less than 3%. The 6 million sequential net additions in the first quarter was actually lower than the 9 million MAUs Twitter added last year. What's more, Twitter actually lost MAUs in the U.S. during the first quarter.
Twitter is extremely opaque with regard to its DAU count. But it's a certainty that the growth is unsustainable without faster MAU growth. Twitter's inability to add new users puts a hard cap on how many of its users it can get to come back on a daily basis.
It's gotta spend money to make money
As mentioned, Twitter provided guidance to use its 2016 sequential revenue growth as a model for the rest of 2018's revenue. Twitter produced sequential growth of 1%, 2%, and 16% in the second, third, and fourth quarters of 2016, respectively. Based on the $665 million of revenue Twitter generated in the first quarter, that all adds up to about $2.8 billion in revenue for the full year.
That's a nice 15% increase in revenue from last year, and it comes after a 3% decrease last year. Still, that revenue growth is only in line with the growth the company exhibited in 2016, and management's commentary indicates that it doesn't expect any faster growth in the years ahead. It's also worth noting that Twitter likely saw a significant positive impact on revenue growth from favorable foreign exchange rates, as nearly all of its revenue growth came from international markets.
And while Twitter is growing (albeit slowly), management has noted it will see increased costs going forward. After a year-plus of slashing expenses, management has noted there's no more room to cut costs. With its first-quarter release, management said it plans to increase headcount by 10% to 15%.
The increased spending is necessary to support further revenue growth. But with relatively slow growth on its top line already, the margin expansion will be fairly limited.
Inferior return on investment for marketers
Management said a big part of its new pitch to marketers is the improved return on investment of its ads. That is to say, marketers are generating more revenue for their clients per ad dollar spent on Twitter today than they were a year ago.
And that's great in a vacuum.
But Twitter doesn't operate in a vacuum. It has to compete against Facebook (META 2.48%) and Alphabet's (GOOG -1.22%) (GOOGL -0.95%) Google. Those two companies already produce the best return on investment for most marketers despite their relatively high ad prices. They also happen to have a ton of ad inventory available.
Unfortunately for Twitter, marketers don't have unlimited advertising budgets. And while digital ad spend is growing, marketers, in general, will start with advertisements that produce the highest return on investment before moving to ads with lower ROI. Twitter is near the bottom of the list for those ad dollars.
So, management can talk about its improving ROI for advertisers all it wants, but until it shows an ability to really close the gap between its ads and Facebook and Google's ads, it won't grab much, if any, market share.
Twitter's first-quarter results were certainly encouraging for investors, and it's a bit confounding why the market reacted negatively. Still, I don't think the stock is worth buying while trading at a valuation that implies strong growth for years to come. The company just has to show me a lot more before I believe the type of results it saw last quarter are sustainable.