Twitter (NYSE:TWTR) stock is down by more than 45% over the past year. Investors seem concerned about the company's lack of profitability and unconvincing strategic direction. Is this a buying opportunity in Twitter stock, or is the worst yet to come for investors in the company?
Twitter is really falling out of favor among investors and Wall Street analysts. Growth is showing some deceleration, and the company is losing money on an operating-income level. Perhaps even worse, CEO Dick Costolo is under heavy criticism, as many believe that Twitter lacks a proven strategy to improve financial performance and accelerate growth.
As of the third quarter of 2014 Twitter had 284 million monthly active users. That's quite an impressive platform, even if Twitter is still considerably smaller than Facebook (NASDAQ:FB) and its massive 1.35 billion monthly active accounts.
While scale does not seem to be much of a problem for investors in Twitter stock, there are some worrisome trends to watch. The company increased the number of active users by 23% year-over-year during the third quarter, but timeline views grew only 14%. The fact that timeline views are increasing at a slower rate than users could indicate that users are losing their interest and engagement is declining.
Also, sequential growth does not look very exciting. Both monthly active users and timeline views grew less than 5% versus the second quarter in 2014, so there could be some kind of slowdown in the horizon.
Sales grew at an impressive rate of 114% year-over-year to more than $361 million in the third quarter, according to S&P Capital IQ data. However, expenses are outgrowing sales due to heavy investments in growth, and Twitter is still in negative territory at the operating level.
Making things worse, Costolo has been selling considerable amounts of Twitter stock lately. This has raised a lot of eyebrows among both investors and analysts, and it's not a very reassuring move when it comes to evaluating management's level of confidence and long-term commitment to the company.
Is Twitter the next Facebook?
Twitter and Facebook are different companies with their own weaknesses and strengths. But it may be interesting to keep in mind that Facebook also went through a very challenging period after its IPO, so maybe there are some valuable lessons to consider.
From an initial closing price of $38.23 in May of 2012, the social network founded by Mark Zuckerberg fell to approximately $18 per share by August of that year. Lack of a visible strategy to monetize Facebook's mobile users was a big concern back them.
However, Facebook made an extraordinary comeback, proving to investors that it has what it takes to deliver explosive financial performance without alienating users with too much advertising. Sales were up by 59% to $3.2 billion during the third quarter, and mobile advertising represented a big 66% of advertising revenues during the period. Facebook stock is currently trading around $77 per share.
Many users find Twitter much harder to use than Facebook, and that's a limitation when it comes growth. The company acknowledges the problem, and management is actively working on making the experience more simple and enjoyable. For example, Twitter is working on a new web on-boarding flow that simplifies the sign-up process and automatically creates a timeline based on the user's choices of topics and browsing history.
However, Even if Twitter makes big progress in this area, it makes sense to assume that it will probably mature with a smaller user base than the massively popular Facebook. But Twitter has some big positives too.
The short-message format is particularly comfortable to use in smartphones and other devices with small screens. Twitter is designed to thrive under the mobile paradigm, and this is reflected in the fact that more than 80% of monthly active accounts access the platform via mobile devices.
Being a real-time communications platform, Twitter offers many exciting possibilities for advertisers, especially because traffic tends to increase exponentially during big events such as the Super Bowl or the Oscars. Needless to say, these kinds of events are especially coveted by major advertisers.
Also, it's relatively easy to track users by their interests based on the accounts they follow and their interactions. Segmentation provides opportunities to improve targeting and increase the efficiency of ads over time.
Although progress is currently slower than expected, key metrics such as advertising revenues per thousand timeline views are moving in the right direction, with a big increase of 83% year-over-year and 11% sequentially during the last quarter.
Reinvestment needs should slow down as the business matures over time, so it makes sense to assume that profit margins will be on the rise in the coming years.
None of these guarantees that Twitter will necessarily find a sustainable strategy to accelerate growth and improve financial performance in the middle term, and the stock could remain volatile until that happens.
However, the company has an enormously valuable asset in its platform. Even if it requires a new strategy, or perhaps big changes in the top management team, chances are Twitter will find multiple ways to generate shareholder value from its platform in a sustainable way.
At current prices, and for investors with a long-term horizon, upside potential seems to outweigh the risk in Twitter stock.
Andrés Cardenal has no position in any stocks mentioned. The Motley Fool recommends Facebook and Twitter. The Motley Fool owns shares of Facebook 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.