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Here Are The Gloomy Remarks That Sent Twitter Tumbling After Earnings

By Evan Niu, CFA - Jul 30, 2015 at 8:20AM

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Twitter's figures didn't come in half bad, but then executives started openly criticizing the business and the product. That's good news and bad.

On paper, Twitter's ( TWTR 5.71% ) earnings report was just fine.

In fact, shares jumped 12% immediately after the release. Revenue was up 61% to $502 million, topping both the high end of guidance ($485 million) and analyst estimates ($481.3 million). If it weren't for the tough foreign exchange environment, revenue would have been up 68%. Adjusted net income more than tripled to $48.5 million, or $0.07 per share; the bottom line beat expectations as well.

User growth was somewhat encouraging with monthly active users increasing 15% to 316 million, although this figure includes SMS fast followers, or users that access the service exclusively via SMS text messages. Excluding SMS fast followers, total MAUs was 304 million. Twitter is also getting better at monetization.

And then the conference call started.

Sticks and stones can break my bones, but words sent shares tumbling
Twitter co-founder and interm CEO Jack Dorsey held back nothing on the conference call, bluntly addressing some of Twitter's weaknesses. CFO Anthony Noto also had some gloomy remarks to share about the business. These comments were largely why shares quickly turned around and went the other way; shares were down 13% by the time after hours trading was done. Let's take a look at what the execs had to say.

Twitter doesn't convey its value proposition to consumers effectively. Here's Dorsey:

We have unbelievably high brand awareness globally. People all over the world know of the power of Twitter, but it's not clear why they should harness it themselves. An answer to "why Twitter" must be articulated clearly and felt everywhere throughout the service. We are advancing this marketing communications work as fast as possible and ensuring it's coordinated with the simplification of our service.

Noto elaborated on why Twitter only has less than 30% penetration in many markets:

Simply said, the product remains too difficult to use. As Jack mentioned, we need to simplify the product so everyone gets value from Twitter faster. In short, we have not communicated why people should use Twitter, nor made it easy for them to understand how to use Twitter. This is both a product issue and a marketing issue.

In the long-term, Noto wanted to reassure investors that Twitter can grow its MAU base:

To be clear, however, we do not expect to see sustained meaningful growth in MAUs until we start to reach the mass market. We expect that will take a considerable period of time. What I can tell you today, though, is we will be bolder, move faster, and raise the bar in everything we do to unlock value for shareholders by ensuring disciplined execution.

Both executives also acknowledged that Twitter has not been executing well with its "total audience" strategy.

The first step is admitting you've got a problem
There's good news and bad news here. The good news is that Twitter is keenly aware of the challenges that it's facing, and acknowledging those problems is the first step to fixing them. Companies that remain in denial about how they're doing are unlikely to improve. Analysts actually also found this blunt honesty rather refreshing. The bad news is that the service itself has some serious fundamental problems.

Specifically, what if Twitter never becomes mainstream? That's a distinct possibility, and a troubling reality for Twitter investors to confront right about now. Hence, the sell-off. Compared to larger rival Facebook (NASDAQ: FB), Twitter has a relatively steeper learning curve and isn't nearly as simple or intuitive.

We're talking about a stock that's trading at 14 times sales, which suggests that the market is still pricing in significant growth in the years ahead. If Twitter remains unable to convince the mass market to sign up and start tweeting, then even more pain is in store for the long-term.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis – even one of our own – helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

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