After a 24 slump are Twitter shares still a buy

One thing is for certain. The way the markets reacted to Twitter’s first-ever earnings report as a public company couldn’t have been more of a wake-up call about what to expect when you disappoint investors.

The market’s reaction was aggressive and, in my opinion, harsh. But that’s the reality of many IPOs where volatility follows stocks higher and lower.

Upon market opening, Twitter shares fell a whopping 24% – from $66 to a low of $50. This is the lowest level at which Twitter shares have traded since 10th December last year.

So why did investors sell Twitter shares?

Twitter reported its fourth quarter and full-year 2013 earnings to the market. Here’s a snapshot of what they reported:

• Q4 revenue rose 116% to $243m
• Q4 net loss of $511mn vs $9m loss a year ago
• Full-year revenues rose 110% to $665m
• Full-year net loss of $645mn vs $79m a year ago
• Average active monthly users +30% year-on-year to 241m

We need to delve deeper past the headline numbers to understand why this was a disappointment.

To date, Twitter has never made a profit. Now whilst that sounds shocking, particularly for a company valued at $27.8bn, and whose share price has, at least before this earnings report hit a high of $74.73, it’s a common feature for start-up ventures.

In all honesty, this isn’t a massive concern for investors right now. It will become more of an issue if losses continue to widen with volatility. Indeed, the revenue increase for the fourth quarter was actually better than expected.

Slow user growth and engagement

On the outset, a 30% year-on-year increase in average monthly users is a fairly positive number and result but that’s looking quite far back in time. Remember that investors always look ahead. They want to predict or estimate how the company might perform in six, 12 and 24 months’ time. That’s why they buy the stock.

On a quarterly basis, users grew 3.8% in the final quarter, marking a slowdown in active user growth and its slowest quarter-on-quarter user growth. That number included an even faster slowdown in the US, where growth fell to 3%.

Along the same lines, engagement in the social networking site is also a huge concern now. There was a 7% decline in quarterly timeline views – the amount of times users refresh their feeds.

That was a stark shock: not only are Twitter attracting less users but their 241 million user base used the site less in the last quarter. Compare that to Facebook, who just reported their strongest revenue growth in two years, with 1.23bn monthly users.

That’s why the stock tanked. It paints a picture that the pace at which it is attracting new users is slowing and current users are using the site less, which for a growth start up reliant on advertising revenues, is a big warning sign.

Remember, investors buy stocks on their prospects six months to two years in the future. Those selling Twitter shares did so because they heralded this warning sign and hit the brakes.

Is now the time to buy Twitter shares?

I think investors will look at Twitter’s 24% decline as a buying opportunity once the noise has dampened somewhat and the results digested.

When it comes down to it, there will be ups and downs as Twitter evolves itself and the optimist in me sees their first earnings report and the market’s reaction as a trigger of enlightenment within the firm that they need to move fast to evolve. It needs to be the wake up call it needs.

Not only did the firm remain somewhat positive in its outlook, they also confirmed their belief that 2014 would be the year that generates more than $1bn in sales, with a forecast of $1.15bn to $1.20bn. Optimistic? Yes. Achievable? Yes.

A 24% decline is, by any stock standards, an absolute nightmare.

Given the fact that Twitter shares a somewhat celebrity status, this can make the wins huge and losses monumental.

What’s been troublesome is that many investors have been buying Twitter shares on blind faith that it’s is the next Facebook, the next Google, the next big thing. As soon as the data starts to send warning signals, like it did last week, they run for the hills. But I still feel that was a knee jerk reaction of a mixture of locking in profits from the IPO launch and fears that maybe the stock has risen too far, too quickly and too soon.

When any stock declines by double digit percentages, there will be the inevitable bargain hunters looking to scalp the share price if it retraces higher. That appears to have already happened.

But I think it’s a danger to buy Twitter shares to make the most of any retracement higher just on hopes of a dead cat bounce. If you want to buy Twitter shares, you need to believe in them, not scalp them.

Remember when everyone called the beginning of the end of Facebook? Their shares plummeted from their IPO launch to a low of $17.55 and it took the best part of a year to trade above their IPO launch price. Since then, share prices have doubled and are right now trading at record levels of $64.50.

Can Twitter become a Facebook?

I am not sure on that one but I certainly see the revenue potential in Twitter as long as they can evolve the product in a timely and relevant fashion.

75% of revenue for Twitter came from the mobile sector whilst the problems at Facebook to make more money from mobile advertising have been there for all to see.

Facebook’s average revenue per user is $8.33 whilst Twitter’s is just $3.61, although Twitter’s revenue growth by user did increase by over half in the last year.

Twitter’s CEO, Dick Costolo, said he was ‘doubling down’ on accelerating Twitter’s user growth.

There remains many more potential active users out there who have Facebook on their desktop or mobiles but not Twitter. Perhaps what we are seeing is more of an age adjustment thing.

After all, how many mums and dads now use Facebook compared to five or six years ago? Perhaps that same adjustment will happen to Twitter in the next few years but they will need to evolve their product to facilitate that adjustment.

At the same time they need to keep engagement high. They also need to do more to earn revenues outside of the US.

There is a disproportion between the money they make globally and their global user base. These are the challenges they face. I, for one, still think they can deliver.