What: Global social media network Twitter (NYSE:TWTR) flew in the wrong direction during Thursday's trading session, with shares falling $0.29, or 0.8%, to close at $36.71 according to S&P Capital IQ. The culprit was a downgrade from research firm Evercore ISI.
So what: According to a research note put out before the opening bell on Thursday by Evercore ISI analysts, Twitter was downgraded to "hold" from "buy," and had its price target lowered from $49 to $39, implying just 6% upside from yesterday's closing price.
The thesis behind the downgrade revolves around a breakdown of the core thesis that led Evercore to its original "buy" rating on Twitter. Specifically, while noting positives that include a recent partnership with Google and new content efforts such as the company's Media Forward strategy, Evercore believes these initiatives are in their early stages, which is a concern if "the underlying health of [Twitter's] core user growth and monetization are coming into question." In other words, catalysts for growth are still there long-term, but the rapid growth that Evercore had been expecting may no longer be.
On the flip side, Evercore talked up Facebook (NASDAQ:FB) as the smarter choice for investors among social media networks. Evercore sees Facebook winning the war for content, and highlights its unveiling of Instant Articles, which will keep users on Facebook rather than directing them to a third-party publisher site, as a major growth driver. Evercore is forecasting that Instant Articles could generate $1.5 billion in revenue for Facebook in 2019. In short, Evercore believes that Facebook has the content edge over Twitter in both scale and design.
Now what: The question investors have to ask now is whether Twitter's recent weakness is a valid reason to keep their distance. In other words, should Evercore's downgrade be all the more reason to stay away from Twitter?
On one hand, Twitter obviously has an impressive platform, with 302 million average monthly active users at the end of Q1, and it's a leading content provider for many of its regular users. With a number of new initiatives designed to invigorate growth -- including its Media Forward strategy, which mimics Facebook in terms of allowing Vines to play and photos to appear without the user clicking a link -- Twitter should be able to grow its top-line in excess of 30% at least through 2018.
The other side of this coin shows a company with slowing user growth. Whether that's a reflection of improvements in Facebook's platform, which may be drawing users away from Twitter, remains to be seen, but it is clear that user growth is slowing. In fact, Q4 2014 represented the first quarter when Twitter actually experienced a sequential quarterly decline in monthly active users.
To that end, I don't think it would an awful idea to hang out on the sidelines and see if Twitter can reignite its user growth. We're talking about a long-tail growth story here, so missing out on a few quarters shouldn't mean you'll miss out on all Twitter has to offer in terms of share price advancements. On a forward basis Twitter looks pretty inexpensive at 20 times 2018's EPS forecasts, but I'd still like to see at least one more quarter of improved sequential user growth before giving Twitter a clean bill of health.