Twitter (TWTR) has had a problem with fake accounts for a very long time. But when earlier this year, The New York Times dropped a bombshell report that chronicled the cottage industry dedicated to creating and selling fake automated accounts (bots) on the site, the scale of the problem shocked most industry observers.
Twitter is finally addressing this problem by purging approximately 70 million fake accounts, according to a Washington Post report (subscription required). Wall Street harshly punished Twitter stock when the news broke, with a big sell-off before cooler heads prevailed. Here's why Twitter's move is a poor reason to sell shares.
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A fake account is not a user
The Washington Post's headline did Twitter no favors: "Twitter is sweeping out fake accounts like never before, putting user growth at risk (emphasis mine)." The wording is justifiable as the misunderstanding is a problem of Twitter's own making: A fake account isn't a user and should have never been labeled as such. Twitter's true customers -- the brands paying the company for marketing -- do so with the expectation that the accounts engaging with their brands belong to real humans, who will perhaps buy a product or service.
Instead, these automated accounts often share promoted links, creating the effect of advertising engagement where there is none and stealing from ad budgets. Additionally, malicious bots (trolls) often enable the proliferation of fake news, gaming algorithms to strengthen disinformation campaigns or targeted-harassment offensives.
Recently, advertising juggernaut Procter and Gamble cut $200 million from its digital-advertising budget, calling much of it "waste," and noting "ad fraud" and "brand safety issues" as some of the reasons for the ad-spend shift. Twitter is making a smart decision by taking more aggressive action to eliminate bots and trolls from its site.
Marketers never believed Twitter's user numbers
A quick look at Twitter's financial statements shows that advertisers have long doubted the numbers provided by the company. While Facebook has increased the cost of its ads, Twitter has done the exact opposite: In fiscal 2017, the cost per engagement fell 52%, and that's on top of a 55% decrease in the year before.
Advertisers already know a significant portion of Twitter's audience is fake and have adjusted their marketing spend on the site accordingly. In the end, marketers are going to judge the company by their internal metrics, like return on investment, more than the figures Twitter provides. So in this regard, it doesn't matter how many fake accounts Twitter purges.
Twitter's recent rally is missing one final catalyst
Twitter's stock has never fully reflected the value it provides users. The service drives news cycles and is now considered the U.S. president's bully pulpit. Unfortunately, for the reasons mentioned, the service has never been similarly valuable to advertisers.
Twitter's stock is finally rallying: In the last year, shares of the company have advanced by approximately 150%, driven by improving financial metrics, including in the fourth quarter, when the company finally attained GAAP profitability. While there are concerns the stock has gotten ahead of itself, the company's taking action to improve its user base is a poor reason to sell shares.
Twitter's last big challenge is to reverse cost-per-engagement declines. Being more aggressive with bots and trolls is one way to improve its standing with advertisers to do so.
