Twitter (NYSE:TWTR) recently hit a 52-week low after warning that its sluggish user growth wouldn't bounce back anytime soon. After that post-earnings plunge, value-seeking investors might be tempted to buy a few shares. However, I doubt that Twitter will recover anytime soon, for three simple reasons.
1. Abysmal user growth
During its second quarter, Twitter's monthly active users, or MAUs, rose 15% annually to 316 million -- its slowest growth since going public in late 2013. It's also a far cry from the 400 million MAUs which former CEO Dick Costolo claimed Twitter would have by the end of 2013.
Average revenue per user, or ARPU, came out to $1.59, up from $1.44 in the first quarter. However, that was notably lower than its ARPU of $1.66 in the fourth quarter of 2014. Interim CEO Jack Dorsey admitted during the conference call that new features -- like like Instant Timelines, logged-out experiences, group chats, and video editing tools -- didn't have a "meaningful impact on growing our audience or participation."
In the past, Twitter relied heavily on boosting ARPU with new services to offset disappointing MAU growth. But if MAU growth slows to a crawl and ARPU growth peaks, then sales growth will also hit a plateau. During the conference call, CFO Anthony Noto admitted that Twitter did "not expect to see sustained, meaningful growth in MAUs until we start to reach the mass market," and that the effort would "take a considerable period of time."
2. New strategies don't make any sense
Last year, Twitter switched to a system that let advertisers only pay for the clicks that they wanted -- like conversions to a website, collecting email addresses, or gaining new followers. Twitter thought that this pick-and-choose "direct response" model would attract smaller businesses. But instead of bringing in more customers, the model encouraged existing advertisers to pay Twitter less money for fewer clicks. As a result, Twitter now expects its full-year revenue to only rise about 60% this year -- down from 111% growth last year.
After Dorsey replaced Costolo in June, I expected Twitter to rethink that business model. Instead, it introduced two new advertising options for app developers -- optimized action bidding and cost-per-install bidding. Optimized action bidding lets advertisers bid for ad space by stating how much they would pay per installation. Cost-per-install budding lets them pay only after a user installs an app, instead of paying for each ad click. Both strategies merely extended Costolo's doomed direct response model to app installs.
Looking ahead, Twitter plans to emphasize new experiences like "while you were away" and Project Lightning. "While you were away" only displays missed tweets with the highest engagement rates, instead of the entire timeline in reverse chronological order. Project Lightning will let users curate event-based content with tweeted photos and videos, creating "stories" that can be embedded across third-party apps and sites. Twitter thinks that these new features will appeal to new users, but I doubt that they'll solve its core problems of slumping MAU and ARPU growth.
3. Stock-based compensation
Twitter paid out $175 million (35% of its revenue) to employees as stock-based compensation last quarter, which contributed to the company's net loss of $137 million. The percentage was a slight decrease from Twitter's first quarter, when it paid out 42%, but it's still a whopping amount for an unprofitable company. By comparison, Facebook (NASDAQ:FB), a profitable company, only paid out 19% of its revenue as stock-based compensation last quarter.
Many tech companies pay a significant portion of their employees' salaries in stock when they don't have enough cash on hand. They also do so to retain top talent. But with Twitter's growth rates plunging and its new initiatives flopping, it might be time to reduce bonuses and slash jobs. Otherwise, Twitter looks like it's enriching its employees and the expense of its investors.
Storm clouds and silver linings
Despite those negative factors, investors shouldn't overlook Twitter's positive qualities. The company's revenue soared 61% annually last quarter, topping its own estimates. Revenue at its data licensing business, where it sells a "firehose" of data to companies, rose 44% and accounted for 10% of its top line. More users also finish watching an entire video on Twitter than on Facebook, according to research firm iProspect, indicating that it has room to grow in video ads.
But until Twitter addresses its biggest issues -- sluggish user growth, peaking ARPU, a lack of clear "mass market" strategies, and oversized stock-based compensation -- it's doubtful that its stock will bounce back anytime soon.
Leo Sun owns shares of Facebook. 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.