Pando

Who had Twitter as the safe haven of choice during a tech selloff?

By Kevin Kelleher , written on February 12, 2018

From The Earnings Desk

Twitter's stock has nearly doubled in the last six months, against a 11% rise in the Nasdaq Composite.

So far in February, while the Nasdaq lost as much as 10% of its value during last week's selloff, the stock traded up 22%. The mighty FAANG were tumbling alongside nearly everyone else, but Twitter held its head above the fray to reach its highest point in two and a half years.

What did Twitter do to win the favor of investors during a market slump? Why, it posted a profit! Net income in the fourth quarter swung to profit of $91 million from a loss of $167 million a year earlier. For all of 2017, Twitter's net loss shrank to $108 million from $457 million in 2016. If you've been following Twitter for the past few years, you recognize this as good news.

There are some qualifications. The profit had little to do with revenue growth. Twitter's ad revenue actually fell 6% to $2.1 billion last year, although ad revenue did eke out 1% growth in the fourth quarter, the only quarter of revenue growth in 2017. Instead, Twitter became profitable by cutting its operating costs: Research and development spending fell by a third, while sales and marketing costs declined by 27%. Twitter has also been spending less on infrastructure as it tightens its belt.

Like Snap, Twitter's post-earnings rally had something to do low expectations. But Snap's financial statement is sort of the inverse of Twitter's: Revenue surging by 72% but still posting a nine-digit net loss. While Snap has further to go, it's probably the more compelling turnaround case right now: Snap is launching an aggressive redesign of its app, while Twitter keeps tinkering with a platform ever vulnerable to abuse.

Back in 2015, the last time Twitter's stock traded above $35 a share, the company was struggling to make its service more accessible to mainstream users. That effort has been, at best, mixed. Internationally, the company is seeing strong growth, with revenue up 17 percent last quarter. US revenue is a different story – falling 8 percent.

Lost in the Twitter stock rally is that the company's core market is weak to deteriorating. Monthly active users in the U.S. totaled 68 million in the fourth quarter of 2017, up a million from a year earlier, down a million from a quarter earlier. In fact, this up and down has been Twitter's story for the past three years. Between 2015 and 2017, the number of US monthly users has vacillated between 65 million and 68 million.

And somehow, Twitter's ability to monetize that stagnant US user base is worsening, because revenue fell 8% year over year. The real growth is coming overseas, where monthly active users rose 4% to 262 million and where revenue grew by 17% to $325 million. International revenue went from 39% of total revenue a year ago to 44% last quarter. At this rate, overseas revenue will overtake the more lucrative US market later this year or early next year.

Put another way, only one in five Twitter users are in the US, where the average revenue per user ($5.97) is well above the international figure ($1.24). Twitter is growing fastest in markets where it makes about one fourth of the money it makes in the US.

Most of the international growth is coming in Asia, particularly Japan, where revenue grew 34% to $106 million. The growth in Asia was tied to Chinese companies trying to expand their brands in other Asian markets, CFO Ned Segal said in a conference call discussing earnings.

“On the revenue side, we saw strength in all of our geographies this past quarter, so we were about flat in the United States and we grew in every other region,” Segal said. Note that Twitter considers flatness in its biggest market to be a strength. Which is true in a relative sense, since US revenue fell by 13% in early 2017.

Again, the great quarter Twitter enjoyed was all relative. Growth is flat in the US, but hey, at least it's growth! User growth is stagnant overall, but hey, at least it's growing in markets where we see less revenue per user! We cut spending on R&D and marketing, but hey, we finally posted a GAAP net profit, right?

Financially, this can be acceptable on Wall Street. But as been pointed out time and again, Twitter's value is less as a financial investment and more as a force of influence in society. And it's here that Twitter has continued to serve its dual role as a venue for discussing what's happening in the world (its stated purpose according to Jack Dorsey) and as a steady stream of toxins spewed by extremists, abusers and troll bots.

Twitter's endless tweaks to its service are having some success. Ad engagement is deepening, while coverage of live events is crawling towards its potential. And yet the days surrounding the company's supposedly blowout quarter were filled with disconcerting news about its effects on the world it purports to reveal.

A Russian-bot campaign distorted the conversation ahead of the release by Rep. Devin Nunes of a controversial memo critical of the FBI. Meanwhile, scammers are using celebrity accounts to dupe people into bitcoin scams. Twitter looked askance at a cottage industry churning out fake followers, just as it did the hundreds of Russian propaganda videos it kept up - until reporters asked about them. It stalled the Senate on information about Russian influence distributed through its service. When Donald Trump violated Twitter's ToS, including amplifying Russian propaganda, Twitter declared it would not block world leaders in order to “advance the global, public conversation.”

This is all fine, though, because Twitter finally has a profit!

Facebook is facing a similar crisis, with Mark Zuckerberg doing what he can to fight the public abuse of his platform. Not enough, maybe, but at least he's trying. Jack Dorsey has responded to this crisis exactly the way you'd expect a part-time CEO to: Cut costs to push the company into the black and keep up the endless promises to make things better. Dorsey has vowed time and again to improve Twitter. Meanwhile, the controversies keep coming.

And the stock keeps rallying. Should it, though? Twitter's pointing to its international growth is like someone waving away the fire department because, yes, the house may be on fire, but the in-law unit is perfectly fine. Maybe Japan is doing well because it's relatively insulated from bots and trolls. Or maybe because Chinese companies are making so much money they don't mind spending a bit on Twitter ads.

But Mr. Dorsey. Your house is burning. The fire may not have torched your financials yet, but it's kept your users stagnant for years and is hurting revenue in your core, most lucrative, market. What happens once your overseas markets mature enough for the trolls and the bots to feel at home there?