Every industry has a shake-out phase at some point when rising levels of competition begin to saturate the most valuable markets. The torrid pace of technology innovation has made the social media industry a rapidly changing industry. Perhaps sooner than some had expected, the social media industry has recently entered the shakeout phase. This phase of an industry’s evolution is generally bad news for weaker, money losing players who become obsolete and irrelevant via a steadily loss of both consumer market share and stock market capitalization as their share price declines. This would be an appropriate point to reference the stock chart for Twitter (NYSE: TWTR):
Why Twitter Has Not Been Acquired and Why Twitter Will Likely Not Be Acquired (Unless a Takeunder Occurs):
The profitable, but smaller, players in an industry are often bought out during the shake-out phase. Instagram is an excellent example of an industry leader, Facebook (NASDAQ: FB), making a prescient acquisition of an emerging growth entity with brilliant results since the buyout. Conversely, the money losing companies with overvalued market caps in an industry are often left to wither on the vine since successful companies are less inclined to want to acquire them.
Regarding Twitter, what company would want to pay a premium valuation to acquire the money losing problems of a declining growth company that will negatively impact the acquiring company’s bottom line? If for many years the founders of Twitter have been unable to successfully monetize the business model that they created, then why should another company believe their chances for successfully managing Twitter would be any better after an expensive buyout?
If you are a CEO that does not value your job, then go ahead and pay a premium valuation to the current market for an acquisition of a money losing company that forecasts horrible future guidance and has slowing growth. This type of a disastrous acquisition should have shareholders up in arms immediately and the board ousting the CEO with rapidity. This is why Twitter has not been acquired to date, and why the chances for any acquisition disappeared many quarters ago. In layman’s parlance, Twitter’s chances of being bought out are slim to none, and Slim has already taken the outbound train.
Investors should dismiss the prospects of any takeover for Twitter at a premium price. It is possible that a takeunder could occur in which an acquiring company pays a price below the stock’s current market value. Takeunders are rare but they happen. Twitter’s dismal future scenario makes it a candidate for a takeunder at a level somewhere below the current market valuation. But it would be highly unlikely for any company to pay a premium above the current market value for this declining enterprise.
Candidly, even a takeunder is unlikely for Twitter. Let’s be honest: If Twitter were fixable, then it would have been fixed by now. The concept that some other company can magically change the equation at Twitter in the face of newer, more innovative technologies that continue to launch from larger competitors like Facebook, Snap (NYSE:SNAP), Apple (NASDAQ:AAPL), YouTube, Microsoft (NASDAQ:MSFT), etc., is not likely to ever occur. And no investor should ever make an investment decision based upon such unlikely hopes of any company ever paying a premium valuation for a failing company like Twitter.
And The Award For Best Job Putting Lipstick On A Pig Goes To…
Let’s give Twitter’s management credit for finally learning to lower analyst expectations instead of delivering disappointments on almost every quarterly financial report. It was these lowered expectations that set the stage for the Street to be fooled by what appeared to be an upside surprise that has sent the stock about $2 higher since Q117 was announced. In fact, Q117 was a dismal report worthy of sending the stock lower again, not higher. If ever there was a prime example for the cliche of putting lipstick on a pig, then Twitter’s Q117 is that prime example.
Contrary to the smoke and mirrors that Twitter’s management presented to the market via their very adroit manipulation of Wall Street, let’s look beyond the financially engineered headline numbers:
Decreasing Revenues: Twitter suffered its first ever YOY sales decline but successfully managed to take the eyes of investors off of this primary metric. Revenues are a very important measure of any company’s overall health and rate of growth. And in the case of a money losing company such as Twitter, then revenue growth is usually vital for achieving profitability while also supporting a higher stock price. When a money losing company also shows decreasing revenues, then investors must consider the very real possibility of future insolvency under the scenario of decreasing revenues and continued losses. Twitter’s revenues decreased 7.8% YOY to $548.3 million. Guidance for Q217’s revenues are much worse but we will get to the horrible forward guidance shortly. Decreasing revenues combined with horrible forward guidance are not a recipe for a higher stock price.
Continued Losses: This metric may be where the financial engineering (lipstick on a pig) was most evident in Twitter’s Q117. The headline number showed EPS of .11 cents versus estimates of about .02 cents. But the net number showed continued losses of .09 cents per share. Decreasing revenues and continued losses require investors to measure the burn rate of cash against a company’s cash position. Concerns of possible future insolvency are not generally considered a positive for a company’s stock price. Again, guidance for Q217 is horrible in this metric also but we will discuss guidance separately.
Insignificant User Growth: Social media platform competitor Instagram has delivered strong growth of 100 million new users in just the last four months and growth of 200 million new users in the last 10 months. The Q117 report stated that Twitter managed to scratch out meager user growth of less than 20 million over the past 12 months. Still worse, it has come to light that up to 15%, perhaps more, of all Twitter accounts are non-human bots. Is it any wonder that advertisers are leaving this platform and ad pricing has fallen through the floor while ARPU has declined sharply?
Lower ARPU: Regarding the decline in average revenue per user the YOY decline from $1.93 down to $1.69 is disastrous. When you combine decreasing ARPU with stagnant user growth, excluding non-human bots, then you have the definition of a broken business model. Twitter has been trying their very best to fix the problems associated with their business model for years. The verdict is now clear: Twitter’s business model is broken and it cannot be fixed.
Sharply Lower Ad Pricing Power: CFO Anthony Noto admitted during the conference call that forward guidance is weak “due to a couple of reasons”: A) “… the company is phasing out less effective ad formats.” Translation: Twitter’s business model still doesn’t work, advertisers are leaving, and we still can’t figure out how to monetize this sinking ship; B) He also said,
“Revenue in this past quarter was from ad deals made 6 to 12 months ago, and since then the cost per engagement for advertisers has decreased.“
Translation: Revenues are drying up as advertisers migrate to the rising competition with hotter, more innovative platform features. This migration away from Twitter will continue and it has knocked the bottom out of Twitter’s ability to price the ads that they need to sell to customers. Twitter simply can’t sell their ads at a price high enough to make their failing business model work. And competition is rising as the SM market has become saturated in the world’s most profitable markets. In fact, ad pricing is under sharp pressure industry wide. This literally are nails in the coffin kind of stuff for Twitter’s future prospects as an ongoing concern.
Twitter’s business model was failing prior to the advent of SM industry saturation, decreasing ARPUs, and sharply lower ad pricing. Now in the face of superior competition, an industry shakeout, and these nails in the coffin of Twitter’s business model could deliver a sharp decline in the market valuation for Twitter shares sooner than expected. But wait, there’s more bad news:
Declining Ad Revenue: Revenues from Twitter’s ad sales plunged 11% down to $474 million in Q117 according to FactSet StreetAccount. In the most favorable market, the United States, Twitter’s ad revenue decline was steeper at 17 percent. This is terrible. The stock should have traded down $2 on these type of metrics, not up $2. Investors would be wise to take their profits off of the table while they still can.
Horrible Guidance: With all of the bad news in the Q117 metrics, amazingly Twitter is also guiding for Q217 to disappoint significantly. Expect a decline in both EBITDA and EBITDA margin. Management is guiding for a horrible EBITDA between only $95 million to $115 million on margins of only 21% to 21.5%. This guidance is a huge drop down from the $170 million EBITDA and 31% margin it posted for Q117 during this week’s quarterly report. And YOY the drop is still worse from the $175 million EBITDA and 29% margin achieved in Q216. This guidance is horrific and indicative of a failed business model that is being forced towards insolvency by strengthening competition in the SM industry. There is no reason to believe that the remainder of this year in Q317 or Q417 will improve.
Let’s be honest regarding Twitter’s problems and acknowledge that the company could not fix itself when they had some control over the key metrics that determined their ability to generate revenue and become profitable. But now the rapidly changing SM industry has removed most key metrics beyond the control of Twitter’s management. In the past it was a matter of whether Twitter’s management could make the adjustments to figure out the formula for profitable monetization. None of the brain trust at Twitter were ever able to successfully monetize their platform in the past.
Recently, the window of opportunity for Twitter to be able to successfully monetize their platform may have closed forever. The advent of saturation in the best global markets by stronger competition has caught up with Twitter. The shakeout in the SM industry has begun. Key metrics like ARPU and ad pricing are under sharp pressure that is likely to continue as competition is certain to increase in the SM industry going forward. Even the emergence of smaller startups like Mastodon.social that is a rapidly growing, open-source Twitter competitor raise questions regarding the validity of any defensible technology moat at the company. However, the moat point may be a moot point since innovations at other SM platforms may be making Twitter’s platform obsolete.
The bottom line is that Twitter’s future has long ago slipped from its own control while competition and market forces are now ravaging what is left of a once hopeful company. Simply put, as the shakeout phase progresses in the SM industry the weaker players will be finished. It has been very clear for some time that the larger players in SM are taking competition and innovation to a higher level and that Twitter will not be able to compete in R&D or marketing. SM has already progressed to the next level and Twitter has not been a part of this conversation for some time. Twitter has become the BlackBerry of social media.
The long-term stock chart has been telling the truth on this company for several years now. There will be other minor trading blips like this current price spike on the chart and it might be prudent to avoid the temptation to go long these short-term price spikes. The possibility of a takeover at these prices is not going to happen. Perhaps a takeunder could happen at lower prices but who wants a money-losing problem like Twitter that the founders could not even figure out how to monetize? The company’s inability to innovate competitively of late is another sign of resignation by management at the company. Late to market and copied features by Twitter will not shift the momentum of users and advertisers that are migrating to the next generation social media features at competing platforms.
So long Twitter, it seems like we hardly knew ya.
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Disclosure: I am/we are short TWTR.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.