Nothing is Wrong with Twitter Inc. that Price Can't Fix

The difference between a company performance and its stock is no clearer than the action in Twitter following tits IPO. Recently, the company reported that revenue surged over 100% while its stock collapsed 50%. For investors, it should bring to bear that the market routinely disengages from the fundamental analysis and valuation of a company. The company's stock becomes a trading mechanism where traders hope to see the price jump in the next couple of hours or days, regardless of the underlying fundamentals.

Typical with a company's stock that's down 50%, the conversation moves away from the greatness of the company to the weakness of the stock. In reality, Twitter is a great growth story that was out of balance with the stock valuation.

Twitter provides a remarkable experience where a user can engage with a television personality or athlete, compared to an old high school buddy on Facebook . The advantages of Twitter though aren't catching on with the majority of the population, with user growth not matching that of the lofty expectations for the social service. Has the sell off solved the valuation problem?


Huge growth
For the first quarter, Twitter produced revenue of $250 million for an incredible 119% gain over the prior year period. The company generated a small loss and an adjusted EBITDA of $37 million for an EBITDA margin of 15%. The majority of the revenue growth comes from the 96% growth in ad-revenue-per-timeline view. In the case of the first quarter, that metric soared to $1.44 per-thousand-timeline views leading total advertising revenue to surge 125%.

The growth fares well against the roughly 70% revenue growth of fellow social media stocks like Facebook and Yelp . Going forward, analysts only expect yearly growth of around 50% for both Facebook and Yelp that quickly drops toward the 30 to 40% range in 2015. Twitter growth expectations are close to doubling those rates over that time period.

Concerning user metrics
As with any high-growth company, questions exist that could unravel the growth story if it comes to the forefront. In the case of Twitter, the major concern is that users aren't growing fast enough to support the current valuation.

Investors are most concerned about timeline views only growing 15% year over year during the first quarter of 2014 to reach 157 billion. The company claims a change in the software reduced the timeline views in order to improve the quality. The solid 25% increase in monthly active users to reach 255 million partly backs up those claims. So does the increase of advertising revenue per timeline view.

Either way, the difference between user engagement rates and revenue growth should have highlighted reasons to avoid a company that was previously trading at around 20 times next years revenue when its stock reached the highs of around $75.

Facebook faces similar issues with negligible domestic user growth. For the first quarter, daily active users only grew 21% year over year. Even worse, monthly active users only grew 15% over the prior year period. With 1.28 billion users, the social media giant could soon hit a wall with user growth. 

Possibly due to its smaller size, Yelp is still seeing solid growth from a 30% growth in monthly users. More importantly, active business accounts jumped 65% over the prior year. With only 74,000 active business accounts, Yelp still has years of growth ahead to reach the millions of global businesses.

Bottom line
The 50% drop in the stock price of Twitter has solved a lot of the problems that ailed the company's valuation. The fundamental growth story remains intact with revenue surging due to higher monetization of users. The stock now trades at roughly 10 times forward revenue. While shares aren't cheap, the lower valuation does offer a better proposition for investors.

Whether Twitter is a home run from here or never reaches the all-time high again probably depends on the ability to attract users who are active on Facebook that don't use Twitter. Either way, investors need to separate the company's performance from its stock. Twitter continues making strides to becoming the leading platform for public conversation, and investors should consider that when valuing the stock. For those investors that can handle the risk and always liked the story, the stock drop provides a better entry point since the fundamental story hasn't changed.

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The article Nothing is Wrong with Twitter Inc. that Price Can't Fix originally appeared on Fool.com.

Mark Holder and Stone Fox Capital clients own shares of Yelp. The Motley Fool recommends Facebook, Twitter, and Yelp. The Motley Fool owns shares of Facebook. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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