Twitter's news for investors is exactly what they didn't want to hear
“...less overall advertiser demand than expected.”
That is the takeaway from Twitter's second-quarter earnings report, the 5,000+ word letter to shareholders boiled down to its core six words, the tldr for anyone who wondered why the stock fell as much as 12 percent last night. It is really not very good news for Twitter right now. It is exactly the news Twitter investors really didn't need right now.
Twitter has been battling sluggish user growth for some time. That wearying battle continues, with monthly active users up 3 percent to 313 million from a year ago. Because that was 1 million better than the 312 million analysts had expected, some outlets tried to paint this figure as good news for Twitter. But like a margin of error, such a barely better-than-forecast beat is meaningful only in a technical and questionable way.
Twitter had trouble matching other forecasts, namely the financial ones its investors care about. Revenue last quarter rose 20 percent to $602 million. Wall Street forecast (i.e., demanded) $607 million. Twitter reported 13 cents in earnings per share. Wall Street wanted 9 cents. Whatever Wall Street wants from a publicly traded company, Wall Street gets. Else Wall Street takes from market value.
Last night, Wall Street took $1.5 billion from Twitter's market value.
And in contrast to the recent past, this quarterly ritual of cutting strips out of Twitter's financial flesh didn't have so much to do with slow user growth. In the past, the flat-ish user growth was contained by a silver lining of ad-revenue growth. Advertisers took to Twitter to build their brands. Twitter tried to siphon off more of their ad dollars by introducing targeted ads, which promise higher engagement because they rely on the behavioral footprints users left behind. You know, like Facebook.
Like Facebook, Twitter needed some time to figure this puzzle out. How do you insert ads into a mobile stream of content without driving users away? Even better, how do you get them to see the ads as a kind of clickable content? But Twitter hasn't figured it out. So advertisers seem to be opting instead for companies that have figured it out. You know, like Facebook.
“There is increased competition for social marketing budgets, which requires us to continuously raise the quality bar on the advertising solutions we bring to market, “the shareholder letter read. “We're still priced at a premium CPE [cost per engagement] relative to others. This has proven to be a headwind in growing Twitter’s share of overall social budgets.”
From an investor-relations standpoint, this part of the shareholder letter was worded really well. It made it sound like Twitter was hacking its way through the business-as-usual jungle of social-media advertising. But it's also not entirely clear what it means. I read it as an admission that Facebook is persuading advertisers that it offers a better value proposition than Twitter when it comes to targeted ads. That is, in the jungle of digital ads, Twitter isn't prey, it's a small, furry, jittery mammal, further down the food chain than it aspires to be.
A side rant, if I may. That word “headwinds” Twitter used is investor codeword for “it's not our fault!” Companies with bad news routinely point to headwinds such as the strong dollar, a global slowdown, low oil prices, high oil prices, Brexit, etc., for their ills, while successful companies make a point of pride to not mention them. “Headwinds” signifies something management considers beyond its control, an act of God in an age of the godless. Often, these acts are unpredictable, but just as often the word embraces, in retrospect, stuff that someone probably should have foreseen. A smart pilot checks the weather forecast.
Twitter's headwinds fall into the latter camp. It opted to improve ad engagement through auto-load videos, which most regular users turned off in their account settings within ten minutes of encountering. But enough others clearly did not turn them off. And so Twitter can boast about how “total ad engagements grew 226 percent year-over-year, driven by the adoption of auto-play videos,” and yet regret that “the average cost per engagement fell 64 percent year-over-year, again primarily due to the shift to auto-play video.”
Fly by the headwind, crash by the headwind.
Twitter's revenue growth was not only lower than expected, it tracks a slowing growth rate that marks an early entry into maturity. (A maturity, by the way, that is spending $170 million a quarter on the adolescent practice of stock-based compensation.) A year ago, Twitter's revenue was growing at a 61 percent rate. Two years ago, by a 124 percent growth rate.
A 20 percent growth rate isn't bad – hey, it's better than Alphabet has been showing – but for the current quarter, Twitter's guidance calls for a midpoint target of $600 million, which represents a 5 percent growth rate from the year-ago figure of $569 million. If Twitter isn't being unrealistically pessimistic, let alone being optimistic, Twitter will not really be much of a growth company come October. And it will still be losing money.
Wall Street doesn't like this. For starters, it was expecting $681 million in revenue. Investors extend a new CEO a grace period to effect a turnaround, and then.... well, just ask Marissa Mayer. Twitter's part-time CEO Jack Dorsey must already be hearing an invisible clock ticking as he tries to fall asleep, the tick's volume growing with each passing night.
It's far from new to suggest that Twitter is following in Yahoo's footsteps – Sarah Lacy made an explicit argument early this year – but the parallels are growing eerily familiar, like a poorly plotted sequel to a horror movie. A troubled digital pioneer? Check. CEO hailed for her/his mystical understanding of the realm? Check. Early promises to re-invent said aging pioneer? Check. Lack of originality to the plans for a turnaround? Check. Heavy stock-compensation expenses to hire engineers? Check. Quarter after quarter of earnings revealing said turnaround isn't happening? Check. Rationalizations that buy more time for a turnaround? Check.
We know what comes next. It's hard to break free this far into the well-worn narrative. A moment is coming. It's the moment Jack Dorsey proves himself as a cunning, if half-time CEO. Or it's the moment he decides Square is better if he focuses his full attention there. It's one or the other. It's up to you, Jack. This is your moment.