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Why Shorting Twitter Stock Could Be an Expensive Mistake

By Andrés Cardenal - Sep 7, 2015 at 4:20PM

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There is a lot of bad news already incorporated in Twitter stock, and it offers explosive upside potential if things turn for the better.

Twitter (TWTR 1.65%) stock has been falling from a cliff over the last several months, accumulating a staggering decline of more than 50% from its highs of the last year. The bears are clearly winning the battle against the bulls so far, and Twitter stock has a high short interest ratio -- investors who are betting that the stock will continue declining -- of almost 7% of the shares outstanding.

The company is facing considerable challenges, user growth is quite disappointing, and Twitter has yet to announce a new CEO, so there is plenty of uncertainty surrounding the company right now. However, that doesn't mean shorting Twitter at these prices is a good idea -- to the contrary, it could be a very expensive mistake.

The problem with Twitter
Twitter has delivered disappointing user growth over the last several quarters. Based on data for the second quarter of 2015, Twitter has 304 million monthly active users when excluding SMS Fast Followers (those who access Twitter exclusively via SMS). This represents an increase in users of 12% year over year, and only 2 million new users were gained versus in the first quarter of 2015.

While Twitter is an enormously recognized platform, user growth is downright disappointing, and management is well aware of this. In the words of CFO Anthony Noto:

This low level of penetration implies that we have only reached early adopters and technology enthusiasts and we have not yet reached the next cohort of users known as the mass market. We believe the reason is that we have failed to do two critical things. First, we have not clearly communicated Twitter's unique value, and so that's reflected in everything we do across product, content and marketing, and as a result, non-users can ask, why should I use Twitter?

Additionally, we have not delivered on meeting the new potential user's expectations of Twitter when they try the product. 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.

The positive view
On the other hand, not everything is bad news for Twitter. Even if user growth is below expectations, the company announced a big increase in revenues of 61% year over year last quarter, reaching $502 million during the period. This shows that the company is doing a sound job at increasing monetization levels and generating solid sales growth in spite of uninspiring expansion in the user base.

In addition, the company is implementing multiple initiatives to accelerate user growth. Twitter is simplifying its language and making it easier for users to find relevant content via pages that are specifically created around a specific topic, and it's also exploring content curation to make the experience simpler and easier to enjoy by new users.

Twitter is promoting its new "While You Were Away" feature, which shows popular tweets a user may have missed by not being online at the time of publication. The main idea is that users don't need to be constantly monitoring their Twitter feeds in order to get the best from the platform. In addition, Twitter is betting on video content with applications such as Vine and its Periscope live-streaming service, which have been well received by users.

These are just a few relevant examples of the kinds of moves Twitter can make to attract more users and keep existing ones actively engaged. The company is looking for a new CEO, and a fresh leadership team could mean better ideas and more innovation.

On risk and reward
There is a lot of bad news already incorporated in Twitter's stock price. Things could continue getting worse for the company, particularly if users start declining, but that doesn't seem like the most likely scenario, since Twitter has already gone a long way in establishing its relevance and staying power.

On the contrary, management is testing multiple strategies to accelerate growth and gain traction among a broader public. It wouldn't be a big surprise to see Twitter delivering higher user growth once the company figures out the right way to attract and retain new users. If this happens, the stock could rise explosively from currently depressed levels.

At these prices, Twitter shorts are taking a big risk, especially when analyzing the position from a middle- or long-term perspective.

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