Twitter's (TWTR) - Get Report Q1 2020 results showed the strength of its platform, as its user base spiked. On the other hand, the advertising sector has slumped, which had a pronounced effect on Twitter's revenue growth rates.
Investors' appetite for Twitter is the lowest it has been over the past three years, with investors unwilling to pay more than 6.8 times its trailing sales. If the advertising sector improves towards the second half of 2020 and into 2021, Twitter's valuation right now is a bargain investment opportunity.
Users Growth Was Very Strong
Twitter reports that its monetizable Daily Active Users (mDAU) was up 24% to 166 million, mostly driven by conversation about COVID-19.
Having said that, Twitter's mDAU has been consistently increasing over the past several quarters. Indeed, Twitter has been reporting yearly increases to its mDAU numbers ranging from 9% to as high as 21% over the past six quarters -- not including this latest quarter.
Put another way, even before the COVID-19 conversation, Twitter had put in motion plenty of work towards successfully increasing its platform’s strength and bringing new users onto the network.
Twitter’s Main Problem: Stable Revenues
Starting with the second half of 2018, Twitter’s revenue growth rate has been decelerating.
Specifically, for 2018, Twitter’s revenue growth rate was 25%, only to drop and finish 2019 with revenue growth rates of 14%. For its recent quarter, Twitter’s management admits that Twitter’s revenues only got hit hard in the second half of March.
Thus, Twitter had two full months and the start of March, before COVID-19 hit its stride. Nonetheless, Twitter states that its quarter was performing in line, while its second half of March was down 27% year-over-year, ultimately finishing Q1 2020 with just 3% year-over-year growth.
Understandably, given all the uncertainty, Twitter has pulled its Q2 2020 guidance. However, Twitter’s CFO Ned Segal did offer qualitative comments that April was continuing to progress largely in line with the second half of March, meaning that Twitter's revenues would be down approximately 25% year-over-year in April.
How Quickly Can Twitter Bounce Back?
The question that ultimately matters is just how long will the advertising industry remain in a slump? Many analysts are expecting the advertising sector to return to strength, once the economy starts to reopen up and pick up momentum once again.
Twitter believes it can use this sudden influx of new users coming onto its platform for COVID-19 related information and rapidly surface other topics these users are interested in, and keeping users engaged for longer -- on the surface, this sounds promising.
On the other hand, Twitter is dramatically taking down its expense growth for the remainder of the year, and into the mid-teens, compared with the more than 20% increase in expenses Twitter had originally planned for at the start of the year.
Areas that Twitter will not hold back on hiring include Engineering, Product, Design, Research, and Trust & Safety -- while keeping steady other areas that Twitter, for now, deems less critical, at least over the near-term.
Hence, Twitter’s actions to be prudent for the remainder of the year doesn’t particularly set a bullish tone of Twitter’s near-term. Thus, herein lies the quandary -- are investors already pricing in this negativity?
Cheaply Valued Opportunity
Twitter’s balance sheet carries some debt, but it still holds a net cash position of $4.3 billion. Given that Twitter’s market cap is approximately $23 billion, this means that nearly 19% of Twitter’s market cap is made up of its net cash position.
Moreover, for 2020, Twitter is still highly likely to generate free cash flow. Indeed, looking at Twitter’s Q1 2020 results, Twitter’s free cash flow reached $126 million. Although its current quarter is largely uncertain, there’s the expectation that Twitter will be able to generate free cash flow for the remainder of the year.
Therefore, if even during this most challenging period, Twitter’s 2020 is still able to be free cash flow positive, this would imply that next year, Twitter will have a larger engaged user audience, and a stronger advertising sector to operate in.
Presently, Twitter’s P/Sales ratio is approximately 6.8 times, and lower than the past three years, when Twitter was being priced at a P/Sales ratio of approximately 7.5 times.
The Bottom Line
If the advertising market suddenly strengthens, Twitter's recent work to rebuild its ad serving will allow Twitter to innovate faster, and launch more products that will resonate with Twitter's larger and more engaged audience.
For now, investors are not willing to give Twitter the benefit of the doubt, pricing its stock with its lowest P/Sales over the past three years, reflecting a promising opportunity for contrarian bargain hunters.