Twitter is Fairly Valued

Price Target: $48

Twitter has always had a loyal and vocal base. With COVID-19 making people spend more time at home and possibly on their phones, Twitter saw a record jump in monetizable daily active users (mDAUs) in Q2 2020. There were 186mm people globally using Twitter in Q2, representing a 34% YoY increase. Unfortunately, this increase in usage did not translate into an increase in revenue. Q2 revenue was down 19% YoY. This contrasts with Facebook, where Q2 revenue was up 11% YoY. Clearly, Twitter is not the platform of choice for advertisers.

The company is investing in making their ad platform more competitive, and recently completed rebuilding its ad server. However, it’s unclear to me that product improvements will lead to meaningful revenue growth or margin improvement. To me, the fundamental issue is that text as a format, doesn’t lend itself to advertising in the same way that images do. In using Twitter for the past year, I’ve never clicked on a single ad. However on Instagram, I’ve probably clicked on at least one ad each day. This is in spite of spending twice as much time on Twitter as I do on Instagram.

Twitter went public in 2013 - about one and a half years after Facebook. In that last seven years, Twitter has essentially remained the same, with no meaningful product improvements or new business lines. This is in sharp contrast to Facebook which has acquired and integrated Instagram and WhatsApp and become a key player in the digital ads space. As an investor, Twitter’s relatively poor performance over the last seven years, is cause for concern. If you want to bet on social media, I’d put my money on Facebook’s management.

Based on my analysis of Twitter, I believe the stock is worth $48. This is based on somewhat optimistic assumptions where margins gradually improve and revenue growth rebounds in 2021. Read on for more detail.

Revenue Growth

Twitter’s revenue growth has been patchy over the last four years and has averaged 12%. Based on the first three quarters of this year, I assume revenue will grow by 3% in 2020. I expect it grow by 15% in 2021 as ad spending rebounds and the improvements in the platform attract more advertisers. Beyond 2021, I expect revenue growth to decline by one percentage point a year, reaching a growth rate of 6% in 2030. This reflects the maturity of the platform and the competitiveness of the online ad market.

Margins

Twitter had negative operating margins in 2015 and 2016, but margins turned positive over the last three years (averaging 9%). I expect Twitter to make no money in 2020 (it’s entirely possible they will lose money), with margins improving to 11% in 2021 and then increasing by 1%/year till they reach 20% in 2030. This improvement in margins is based on the enhancements I expect they’ll make to the ad platform and cost discipline I expect will occur as activist investors put pressure on management.

Valuation

I assume Twitter will have a terminal value of 22.5x 2030 FCF. This is in line with the multiplier I used in my Facebook valuation and seems realistic for a business that is growing slightly faster than inflation with 20% margins.

Based on these assumptions, I arrive at a per share value of $48 for Twitter.

My model is available here if you’d like to use your own assumptions.

Notes

Interest expense and interest income roughly offset each other in 2019, so I ignore these items going forward for simplicity.

Shares outstanding increased 19% between 2015 and 2019. This reflected Twitters need to keep raising capital, despite its competitors (like FB) not having to do so. Given profitability in the last two years, I assume no meaningful equity will be raised going forward.