Source: Twitter
At the Twitter(TWTR +0.00%) analyst day in November, CFO Anthony Noto outlined a few long-term goals for the company. He detailed the opportunities Twitter has to grow revenue, including increased ad load, active users, advertising partners, and its monetization of logged-out visitors and syndicated viewers. Additionally, he outlined how he expects the company to scale, leveraging its expenses in research and development, sales and marketing, and other line items.
Let's take a look at where Twitter currently stands compared to where it plans to be, and we will see if Twitter can ever turn a real profit.
The long-term model
|
Line Item |
Long-Term |
Non-GAAP |
GAAP |
|---|---|---|---|
|
Cost of Revenue |
20% to 22% |
28% |
32% |
|
Research & Development |
15% to 17% |
24% |
49% |
|
Sales & Marketing |
22% to 24% |
33% |
44% |
|
General & Administrative |
8% to 9% |
9% |
14% |
*Does not include stock-based compensation
As you can see, Twitter still sees a fair amount of leverage in its model for cost of revenue, research and development, and sales and marketing. In total, the model expects to add 22 to 29 percentage points in operating margin on a non-GAAP basis. Last year, Twitter reported an operating margin of just 7%.
Comparatively, Facebook (FB +0.12%)reported a non-GAAP operating margin of 58%, while LinkedIn (LNKD +0.00%)enjoyed an operating margin of 18%.
Stock-based compensation is the real killer
The biggest impact may be seen in the amount of stock-based compensation Twitter doles out going forward. As you can see, Twitter currently uses a large percentage of its revenue for stock-based compensation, which has dramatically affected expenses. In total, Twitter compensated employees with $631.6 million worth of stock in 2014 -- 45% of revenue.
But that is a dramatic improvement over stock-based compensation in 2013. That year, the company paid out over $600 million in stock, accounting for 90% of revenue. A lot of that, however, was tied to its acquisition of MoPub at the end of the year.
Facebook and LinkedIn, on the other hand, spent just 18% and 14% of revenue, respectively, on stock-based compensation in 2014. The numbers for Facebook include stock used to purchase WhatsApp for $21.8 billion (after the appreciation of its stock). If Twitter can match those levels in the long run, it will start to turn a profit.
This year, Twitter guided for 66% revenue growth, and analysts are forecasting nearly 70%. If stock-based compensation remains flat -- an unlikely scenario -- it would still account for about 27% of 2015 revenue. Of course, stock-based compensation will likely continue to grow considering the number of medium-sized acquisitions Twitter has made in the early part of the year.
Still, if stock-based compensation increases moderately (6% to 8% annually) over the next few years, it is reasonable to expect the number to decline below 20% of revenue by 2016. If Twitter can find 14% of leverage in its operating expenses in that time -- and its long-term model suggests it can -- it could break even next year.
Is it worth the wait?
There is still a lot of potential growth ahead for Twitter, so investors should be buying or selling the stock based on progress (or lack thereof) toward that potential.
In November, Mr. Noto outlined how he believes Twitter has the potential opportunity to capture $11.4 billion in annual revenue based on the monetization results of users during the third quarter of last year. There is additional leverage in the business to increase its ability to monetize users (like increasing average ad prices) that is not factored into that model, which makes the opportunity even bigger. On top of that, Twitter has additional revenue growth opportunities in its data licensing business, other platforms (Vine and Periscope), and its syndicated tweets.
As long as it continues making progress toward these opportunities, Twitter should turn a profit for its shareholders fairly soon. While it might not be as lucrative as Facebook, the potential revenue and earnings growth at this point account for the high valuation. At the same time, the uncertainty surrounding the execution of these initiatives will also result in significant volatility.
