Twitter, Inc. (TWTR) stock is up 330% in the last 5 years, but its revenue growth has been lackluster over this period. Since 2011, the company has only turned a profit in two fiscal years, which highlights the obstacles the company faces in monetizing its userbase.
The number of monetizable daily active users on the platform has grown from 109 million in 2017 to 192 million by the end of 2020, but this strong growth has not translated to a comparable increase in revenue and earnings. This is one of the primary reasons that has kept Wall Street analysts from assigning Twitter above-average valuation multiples.
Twitter CEO Jack Dorsey unveiled a new strategic initiative on Feb. 25 to tackle this problem, sending shares to a new 52-week high of just over $80.
The New Revenue Strategy
Twitter has ambitious plans for the future. According to its latest announcement, Twitter seeks to increase its daily active userbase to 315 million from 192 million, and the company expects to double revenue from $3.7 billion in 2020 to $7.5 billion in 2023. To achieve this objective, the company intends to increase the contribution from direct response advertisements, which is one of the fastest-growing ad categories in the world today.
According to industry experts, direct response marketing allows companies to generate a higher return on investment than traditional online advertisements, while creating a platform for marketers to interact with their target customers directly. Twitter, therefore, seems to be heading in the right direction on this front.
The company is also exploring a new subscription model based on delivering premium, exclusive content to paying members. Twitter has named this innovative model “Super Followers”, as users with a large following will be provided the opportunity to charge a subscription fee from followers who wish to gain access to exclusive content not available to the public.
Margins Will Remain Under Pressure
Despite the market cheering Twitter’s new revenue strategy, the company will find it difficult to expand operating margins. Significant additional investments would be needed in order to increase Twitter’s appeal as a go-to advertising platform to target consumers. Capital expenditures have increased from $161 million in 2017 to $873 million in 2020, and this trend is expected to continue as the company embarks on its mission to monetize its userbase.
The competitive landscape is also challenging. Facebook, Inc. (FB) continues to dominate the social media industry, and Twitter has historically found it difficult to thwart its threat. To do so in the future, Twitter will need to use pricing techniques to attract more advertisers to its platform, which can only be done at the expense of profitability. Even if the new strategies lead to an increase in revenue and earnings, the lack of clear competitive advantages will prevent investors from pushing the stock to above-average valuation multiples, and this remains a risk to a continued bull run in the market.
In comparison, Facebook has developed a very valuable economic moat over the last decade, and both consumers and advertisers tend to prefer Facebook over any other social media platform because of its massive reach.
What Wall Street Is Saying About TWTR’s Valuation
Following the release of Q4 earnings on Feb. 9, Piper Sandler analyst Thomas Champion raised his price target for TWTR to $71 from $61. Baird analyst Colin Sebastian and KeyBanc analyst Justin Patterson followed up with two separate price target hikes as well.
Consensus among analysts on Wall Street is a Moderate Buy based on 13 Buys, 19 Holds and 2 Sells. The stock continues to trade above the average analyst price target of $70.50, implying that the stock is around 9% overvalued at the current market price. (See TWTR stock analysis on TipRanks)
Twitter is on the right path to monetize its userbase, but the road ahead will be bumpy as the company will have to sacrifice current period earnings to secure the sustainability of future earnings. Analysts seem to agree that the recent run-up of the stock price has pushed the market value of the company to an overvalued level.
The rising yield environment also poses a threat to the continued outperformance of tech stocks, and it might be prudent for investors to wait for a better opportunity to invest in Twitter despite the recent positive developments.
Disclosure: Dilantha De Silva was long Facebook shares at the time of publication.
Disclaimer: The information contained herein is for informational purposes only. Nothing in this article should be taken as a solicitation to purchase or sell securities.