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Should Investors Chase Twitter’s Post-Earnings Rally?

By Leo Sun – Jul 28, 2020 at 1:45AM

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Twitter’s accelerating user growth can’t offset its declining ad revenue and rising expenses yet.

Twitter's (TWTR) stock recently popped after the social media company posted its second-quarter earnings. That reaction might seem surprising, since its top- and bottom-line growth broadly missed expectations.

Twitter's revenue fell 19% annually to $683.4 million, missing estimates by $24.5 million. That trickled down to an adjusted net loss of $126.6 million, or $0.16 per share, versus a profit of $37.1 million a year ago. Analysts had expected roughly break-even earnings per share.

However, Twitter's mDAUs (monetizable daily active users) grew 34% annually to 186 million, beating the consensus forecast by over 13 million mDAUs. That surprising growth in users sparked Twitter's post-earnings rally, but will those gains fade as investors digest its other problems?

Twitter's headquarters in San Francisco.

Image source: Getty Images.

Why is Twitter gaining more mDAUs?

Twitter's mDAUs grew 24% year-over-year to 36 million in the U.S. and rose 36% to 150 million internationally. It attributed that growth to shelter-in-place measures and an "increased global conversation" regarding current events.

During the conference call, CEO Jack Dorsey noted more people were coming to Twitter to "learn about and participate in conversations focused on systemic racism and Black Lives Matter, COVID-19, and the reopening and reclosing of economies all around the world."

Twitter also expanded its number of topics to over 4,100, and over 50 million people now follow specific topics. Dorsey declared those topics, which offer an alternative to following individual accounts, represent the "best way to experience the power of Twitter with very little effort required."

Twitter also attributed its growth to improvements to its Search, Explore, Home, and notification features. It claims its mDAU growth in the second quarter "would still have been strong" without the increased interest in current events, thanks to the "ongoing benefit of these product improvements."

However, Twitter didn't provide any guidance for the third quarter or full year, so it's difficult to tell if its mDAUs will keep rising and beating expectations. During the conference call CFO Ned Segal admitted it was "hard to parse" how much of its mDAU growth came from recent events versus product improvements.

But its advertising revenue is drying up

Twitter's ad revenue, which accounted for 82% of its top line, declined 23% annually due to COVID-19 disruptions.

Its total ad engagements grew 3%, but a 25% decline in its cost per engagement more than wiped out those gains. Therefore, Twitter's audience expanded throughout the recent crises, but it generated significantly less revenue per user as companies purchased fewer ads.

A network of social networking connections.

Image source: Getty Images.

Twitter saw a "gradual, moderate recovery" relative to March throughout most of the second quarter, "with the exception" of late May to mid-June -- when many brands paused their ad spending again in response to the civil unrest across the U.S. Its ad revenue fell 15% annually in the last three weeks of June, with demand for its ads "gradually" improving as the protests subsided.

However, the COVID-19 crisis remains unresolved, and recent protests in Portland and other cities suggests the civil unrest could still escalate again. Therefore, Twitter's ad business could still face significant headwinds over the next few quarters.

Furthermore, Snap (SNAP 2.75%), the parent company of Snapchat, recently posted much stronger growth in its second quarter, as its DAUs and revenue both rose 17% annually. Snap's growth suggests advertisers are sticking with high-growth youth-oriented platforms like Snapchat as they curb their ad spending on mature platforms like Twitter.

Rising expenses will weigh down its bottom line

Twitter's total costs and expenses rose 5% annually to $807 million and wiped out its revenue. It attributed those higher expenses to a higher headcount, increased investments in its products, and the expansion of its audience.

But Segal stated those expenses were "lower than we expected," and still expects Twitter's total costs and expenses to rise at least 10% annually in the third quarter. Twitter will also likely need to ramp up its security spending after dozens of high-profile accounts were recently hacked.

Those higher costs, along with its weak ad revenue growth, could cause another steep earnings drop in the third quarter. That's why analysts expect Twitter's revenue and adjusted earnings to decline 12% and 65%, respectively, in the third quarter. For the full year, they expect Twitter's revenue to dip 5% and for the company to post a net loss.

Too many unpredictable factors

Twitter's mDAU growth was impressive, but its declining ad revenue and rising expenses suggest its growing audience won't meaningfully strengthen its business until the macro headwinds dissipate.

It's too early to tell if the situation will improve next year since we could still face a second wave of COVID-19 infections, higher unemployment rates, and escalating civil unrest ahead of the November elections. In short, investors should stick with more stable social media companies instead of chasing Twitter's post-earnings rally.

Leo Sun owns shares of Snap Inc. The Motley Fool owns shares of and recommends Twitter. The Motley Fool has a disclosure policy.

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