This year has not been kind to Twitter's (NYSE:TWTR) stock price, with shares falling 30% since Jan. 1. The downturn accelerated when the microblogging platform reported third-quarter results, which fell short of Wall Street's lofty expectations. Has the drop made Twitter's shares a bargain, or are more declines ahead? Before I answer that question, let's look at some recent events.
In the third quarter, Twitter's revenue surged 114% year over year to $361 million, which exceeded Wall Street's forecast. The company also raised its outlook for full-year revenue and earnings before interest, taxes, depreciation, and amortization, or EBITDA, above analysts' estimates. However, Twitter's guidance for the current quarter came in below consensus expectations.
More troublesome, in the opinion of many Wall Street analysts, are the trends in some of Twitter's most important operational metrics, specifically relating to user growth and engagement. Average monthly active users, or MAUs, rose 23% year over year to 284 million. However, the MAUs rose only 5% sequentially from the second quarter, suggesting decelerating user growth in the quarters ahead.
Worse still, timeline views only climbed 14% to 181 billion. With timeline view growth significantly trailing user growth, we can conclude that either new users are engaging with Twitter's platform far less than existing users, or users are becoming less engaged across the board. Neither situation is good.
These results led to a flurry of downgrades from analysts, with many slashing their price targets for Twitter's stock. The negative reaction likely added to the pressure on Twitter's share price, with the stock closing 10% lower the day after the company released its earnings report.
There were some bright spots during the quarter. Advertising revenue per thousand timeline views jumped 83% year over year to $1.77. The sharp improvement in this key metric shows that Twitter's monetization efforts are beginning to take hold. This tells me Twitter is better targeting its ads and is giving advertisers the right tools to reach its growing user base. In addition, it would appear the ads are resonating with users, and advertisers are seeing solid returns on their marketing investments on Twitter's platform. If this trend can continue, it would be a virtuous cycle for both advertisers and Twitter's shareholders.
Twitter, however, must balance demand from advertisers for more ad inventory with the user experience. Otherwise, user growth could come to a screeching halt if the company were to suddenly bombard its users' feeds with ads. CEO Dick Costolo and his team are well aware of this, and have so far resisted the urge to increase the number of ads too dramatically. In fact, Costolo stated on the second-quarter conference call that Twitter's ad load was "still very low relative to our industry peers and even the best in class." Costolo added that Twitter has "significant upside as it relates to ad load or coverage." That suggests we should continue to see solid improvements in advertising revenue per thousand timeline views as Twitter slowly increases the number of ads it displays in its user feeds, while still protecting the user experience.
Improvements in monetization become even more interesting if we consider Twitter's overall reach, rather than just its user base statistics. Costolo had this to say on the subject,
And beyond our 271 million monthly active users, there are hundreds of millions of additional unique visitors who come to Twitter every month but don't log in. When you consider the combination of monthly active users and unique visitors, the size of our audience on our owned and operated properties is two to three times that of just our monthly active user base.
That's a key point because, unlike Facebook (NASDAQ:FB), which places almost all of its content beyond a registration wall, Twitter makes much of its content available to nonregistered users. If we accept that the size of Twitter's overall audience is actually three times larger than its 284 million-strong user base, that would put Twitter's reach much closer to Facebook's massive 1.3 billion global user base. If Twitter can convince advertisers to pay to reach this wider audience, investors might be drastically underestimating Twitter's future earnings power.
The profit opportunity
With Twitter's stock price now down more than 30% for the year, analysts and investors alike are ratcheting down their growth assumptions for the company. Therein lies our opportunity.
Within Tier 1, the real-money portfolio that I manage for the Fool, I initiated a written put position in Twitter in December 2013. Even with Twitter's stock price down sharply since that time, the hefty premiums I received when I sold the puts have kept the trade in the black for Tier 1. If Twitter's share price remains below the $50 strike price of my written puts at expiration on Jan. 17, 2015, I will be obligated to purchase shares at an adjusted price of $40.31 ($50 minus the $9.69 in premium I received when I wrote the puts). I'd be happy to pay that price for Twitter's shares. I also have the option of rolling the puts down to a lower strike price or out to a further expiration date. And so I'm confident Twitter will ultimately be another profitable position for Tier 1.
More importantly, I believe Twitter remains an attractive candidate for investors wishing to write puts today. And, for nonoptions investors, simply purchasing shares at current prices with the intent of holding them for the long term could be the best strategy of all. That's because, as I wrote in my Twitter trade alert, "I like to invest in companies that lead the world forward. And Twitter, with its mission 'to give everyone the power to create and share ideas and information instantly, without barriers,' is one such company."
That all remains true today. And as Twitter expands its global reach and strengthens its position as the place for real-time news and conversation for hundreds of millions of people around the world, advertisers should continue to flock to its network. With several initiatives under way to boost engagement and drive further increases in monetization, I think there's a strong possibility Twitter could exceed investors' expectations for revenue and earnings in the years ahead. All told, I believe patient investors who buy shares of Twitter today, and who can endure the heightened volatility that comes with an investment in a business so early in its growth cycle, should be rewarded in the years to come.