Shares of Twitter (NYSE:TWTR) got slammed earlier this week after the company reported disappointing user growth, up just 4.8% sequentially, and 23% year over year. The figure seems to be the most closely watched statistic that comes out of the microblogging site every quarter, but Wall Street is missing the point here.
Despite user growth of just 23%, revenue at Twitter still more than doubled, jumping 114% to $361 million, and with nearly 300 million monthly active users, Twitter doesn't need more users to be relevant, or even profitable. It just needs to monetize the users it has. Let's take a look at three reasons why Wall Street should stop focusing so much on user growth.
1. This is exactly what happened to Facebook
Twitter's slowing user growth shouldn't look that strange to social media followers. Facebook (NASDAQ:FB) followed a similar trajectory. As an eight-year old company, Facebook grew its user base by just 26%, and in its most recent report that growth had slowed to 14%. Despite that slowing user growth, Facebook is still putting up huge increases on top and bottom lines. In the most recent quarter, the social network's revenue jumped 59% while adjusted operating earnings were up 77% and its adjusted operating margin improved from 51% to 57%.
While Twitter will likely never match Facebook in number of users, there's no reason why it can't match its sales and earnings growth trajectory even as its user growth has cooled off. Linkedin (NYSE:LNKD.DL) and Pandora Media (NYSE:P) have also followed a similar path, focusing on user growth and then monetization once user growth slows. This is a natural transition for these businesses as sacrificing profits for user growth up front make sense, but the ultimate test is monetization. For Twitter, 300 million users, roughly the population of the U.S., should be plenty.
2. The business model is still emerging
As an industry, social media is barely 10 years old, and the business model is just beginning to form. Twitter, which essentially invented a new form of communication, is still figuring out its own business model.
Nearly every social media company including Linkedin, Pandora, Yelp, Facebook, and Twitter have sky-high valuations even though all of them, except Facebook, have been unable to put up meaningful profits. These stocks are so dearly priced because investors understand that they have huge potential even though the business model is still developing. And Twitter, whose platform is most similar to Facebook, seems poised to reap similar benefits. In fact, a case study performed by the dating site How About We showed that Twitter ads were 20% more effective at converting subscribers than Facebook and other channels.
3. Monetization still has a long road ahead of it
As Facebook's huge ad growth shows there is an enormous opportunity to monetize Twitter's timeline views, which numbered 181 billion in the last quarter, and the more Facebook can grow, the bigger the market for Twitter will be. In its last quarter, the microblogging site took several steps to build sales, including introducing a promoted video beta, a "Buy" button, and tools to help marketers make ad campaigns more effective. Outside the U.S., the company introduced Twitter ads to 12 new markets in Europe and rolled out an ad platform for small-to-medium-sized businesses in Latin America and Europe.
In addition to making the platform more appealing to advertisers, Twitter is also planning to reach out toward logged-out or casual users, who number one to two times its monthly active user base. Those users enter Twitter through a number of portals including Google searches, profile links, or news reports, but cannot fully use Twitter without logging in. Since there are so many casual users, figuring out how to monetize them would unlock a major revenue stream for the social media site, and essentially nullify the user growth criticism.
Perhaps, one reason for Wall Street's groans about Twitter's user growth is the company's own promises. In the recent earnings report, CEO Dick Costolo said, "I'm confident in our ability to build the largest daily audience in the world, over time, by strengthening the core, reducing barriers to consumption and building new apps and services." On many occasions, Costolo has also said he expects Twitter to "reach everyone on the planet," and thinks it can.
User growth will be helpful to Twitter in reaching its goals, but ultimately monetization will determine the stock's future. Twitter doesn't have to match's Facebook 1.35 billion members to be successful; it just needs to match Facebook's success in leveraging its user base to lift is bottom line.
Jeremy Bowman has no position in any stocks mentioned. The Motley Fool recommends Facebook, LinkedIn, Pandora Media, Twitter, and Yelp. The Motley Fool owns shares of Facebook, LinkedIn, Pandora Media, and Twitter. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.