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Twitter CEO Dick Costolo Flies the Coop; Here's What His Successor Must Do

By Alex Dumortier, CFA – Jun 12, 2015 at 12:14PM

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Twitter CEO Dick Costolo failed to explain the social network's position and strategy

Following three straight winning days, it appears stocks might close out the week on a losing note, with the Dow Jones Industrial Average (^DJI 0.45%) and the broader S&P 500 (^GSPC -0.03%) down 0.83% and 0.69%, respectively, at 12:15 p.m. EDT. One stock bucking the trend in early afternoon trading is that of microblogging platform Twitter (TWTR), following yesterday's after-hours announcement that CEO Dick Costolo will voluntarily step down on July 1. Although the shares are up 1.4%, they remain roughly a fifth below their closing price on their first day of trading in November 2013. While Costolo's parachute jump might have lifted some weight from this bird's back, Twitter needs its next pilot to formulate a clear strategy consistent with its niche position as a social network.

That isn't on the horizon yet. Co-founder and Chairman Jack Dorsey, who will replace Costolo on an interim basis, said yesterday he supported Twitter's current strategy. Costolo was manifestly well liked by employees. One of them captured the standing ovation he received following the announcement of his departure at yesterday's regular company meeting at Twitter headquarters in San Francisco:

Standing ovation for @dickc. Thank you.

— Paul Stamatiou (@Stammy) June 11, 2015

However, Costolo was less well appreciated on Wall Street. One recurring gripe among analysts was Twitter's slowing user growth; however, this criticism stems from an unrealistic comparison with Twitter's much larger competitor Facebook (META -0.74%). In truth, Twitter's management, stuck on the growth-and-hype treadmill, encouraged the comparison with the explicit goal of achieving 1 billion users.

Twitter is no Facebook killer
Last year, The Wall Street Journal reported that, in the wake of Twitter's poorly received first-quarter earnings report, Costolo convened a series of meetings with Twitter managers to reset the company's strategy. The new focus was on courting a broader audience beyond active users. "The goal: to stop the press and investors from comparing Twitter to Facebook, whose social network has five times as many users," according to the Journal.

But Twitter wanted its bird feed and wanted to eat it, too. It didn't want explicit comparisons to Facebook, yet executives continued to foster outlandish growth expectations. Last November, in summing up Twitter's analyst day meeting, Pivotal Research Group senior research analyst Brian Wieser wrote in a client note:

Twitter's aspirations remain as grand as ever. We continue to believe that Twitter's core proposition has niche appeal among consumers, albeit a pretty large niche. But it's not one that will reach the ubiquity the company aspires toward.

The trouble is, those grand aspirations remain to some extent embedded in the shares' valuation. At $36.25, Twitter's shares are valued at a stratospheric 54 times estimated earnings per share for 2016 -- this estimate assumes EPS will double year on year.

Time to face facts and get on with business
Twitter has attracted a passionate – and not inconsiderable – core base of 300 million users, but its cultural visibility is out of proportion with its economic heft and potential. Twitter is a niche service with a very loud echo, but a niche service nonetheless. It will never rival Facebook (which had over 1.4 billion users worldwide by earlier this year) -- its 140-character constraint and its functionality guarantee that. The new CEO needs to understand this, make investors understand it, and get on with the business with developing what is already a very respectable advertising franchise.

Alex Dumortier, CFA has no position in any stocks mentioned. The Motley Fool recommends Facebook and Twitter. The Motley Fool owns shares of Facebook and Twitter. 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.

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Stocks Mentioned

Dow Jones Industrial Average (Price Return) Stock Quote
Dow Jones Industrial Average (Price Return)
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$111.41 (-0.74%) $0.83
Twitter Stock Quote

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