September 20, 2016

Twitter’s Business Tailwinds Indicate An Overly Bearish Market


Summary:

  • Twitter, Inc. is expected to see a declining Adjusted ROA, but management’s confidence in audience growth, business momentum, and success related to content deals indicate that this is unwarranted.
  • Moreover, TWTR’s ROAs have actually been positive since 2012, indicating that investors may have been wrongly viewing TWTR all along.
  • TWTR is trading at a 22.0x Value-to-Earnings ratio (V/E’), near historical lows.
  • At these prices, the market is pricing in overly pessimistic expectations for the firm, especially considering Twitter management’s confidence in their business.

twtr

TWTR has seen volatile Adjusted ROA levels ever since the firm became profitable in 2012. Adjusted ROA levels then dramatically rose from -4% in 2011 to 23% in 2013, only to drop to 11% in 2014, where it held steady in 2015. Meanwhile, Adjusted Asset growth has declined from 251% in 2012 to a still robust 37% in 2015.

Performance Drivers – Sales, Margins, and Turns

It can be helpful to break down Adjusted ROA into its DuPont formula parts, Earnings’ Margin and Asset’ Turns, which are the cleaned up margins and turns metrics used to calculate our Adjusted ROA metric. The chart below details both Earnings’ Margin and Asset’ Turns historically, to help us better understand the drivers of TWTR‘s profitability and performance.

twtr-1

Valuation Matrix – ROA’ and Asset’ Growth as Drivers of Valuation

When valuing a company, it is important to consider more than a singular target price, and instead the potential value of a firm at various levels of performance. The below matrix highlights potential prices for TWTR at various levels of profitability (in terms of ROA’) and growth (Asset’ growth.) Prices that are in excess of 10% equity upside are highlighted in black, and prices representing an excess of 10% equity downside are highlighted in red.

twtr-2


Click here to read the article in its entirety at Seeking Alpha.