• Brett Schafer

Not So Deep Dive: Twitter Stock



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Show Notes


(Ryan) What they do: I think most of our listeners will know what Twitter is, so I’ll focus for the most part on their actual revenue streams, and how they make money. But in case anyone doesn’t know about Twitter, I’ll give a brief explainer. Twitter is one of the most popular social media platforms in the world, where users can communicate through short messages known as tweets and the platform is particularly well known for how passionate its users are. These are often referred to as power users. Aaron Edelheit described Twitter as “the most powerful news and curation tool in the world.” And according to a 2019 study, Twitter’s are on average wealthier and more educated than other social media sites.


But they make money currently in pretty much two ways. Advertising and Data Licensing.


There are pretty much 4 ways people can advertise on Twitter. 1) Promoted Ads: This is a regular tweet that advertisers can pay to have shared with a broader group. Most users have probably noticed these because of their randomness. 2) Follower Ads: This is where Twitter recommends your account for people to follow based on their interests. 3) Trend takeovers: This puts ads next to the trending topics on Twitter. But these ones can be ultra-expensive. 4) Twitter Amplify: For this one, if there’s a video that’s going viral, advertisers can pay to have a pre-roll advertisement in that video. There are a few other ways to advertise, but those are really the primary ones.


And then there’s the data licensing portion. As of the most recent quarter this part only accounted for 11% of revenue and this part is just Twitter selling subscriptions to companies or developers for public data. Platform trends and stuff like that.


(Ryan) History: Twitter’s got an interesting back story. I haven’t read the book, but I’ve read some founder interviews, and here’s how I understand it.


Noah Glass (yes the current CEO of Olo) came up with this idea for a web-based directory for RSS audio otherwise known as podcasts. The company was called Odeo, it was based in San Fran and like most founding stories it started with a little bit of investor capital and hired a few employees. One of those employees was Jack Dorsey. However, shortly after the founding, Apple came out with its own product, basically killing Odeo. They needed to pivot or close up shop.

So they had a few hackathons trying to come up with new ideas. Dorsey was fascinated with a platform where you could express your status to a bunch of your friends. Glass liked the idea and came up with the name Twttr, but eventually changed to Twitter. Unfortunately, Glass was eventually pushed out by Williams, who had bought shares back from Odeo investors, and Dorsey was elected to be CEO. But after Dorsey’s outside hobbies like drawing, cooking, yoga, and partying took up too much of his time, the board fired him. He was eventually brought back and kept the role until a few weeks ago. He stepped aside, giving the CEO role to Parag Agrawal.


(Brett) Industry/Landscape/Competition:

  • The industry is digital advertising market, which is estimated to have $356 billion in spending in 2020 that will grow to $460 billion by 2024

  • A lot of estimates will have different numbers/projections, but it is clear that this is a large and growing market opportunity

  • Overall, Twitter has a unique industry/competitive landscape, as it isn’t so much competing with others a lot of the time, but with itself to improve its monetization tools

  • Competitors: Facebook, Snap, Instagram, Tik Tok (all the social networks), Clubhouse, Roblox, Substack, essentially anywhere you are finding and reading things on the internet. Twitter is competing for the time spent by users throughout the day.


(Ian) Management and Ownership:

  • Parag Agrawal is the CEO. He was recently made CEO in an announcement from Jack Dorsey.

  • Dorsey is staying on the board through May (the rest of his term) then stepping down. He said that he has been thinking that Parag would succeed him for the last year.

  • Agrawal has been at Twitter for 10 years (first as a software engineer), most recently as CTO since 2017. Was instrumental in building Twitter’s ad platform

  • An interesting transition, different than Bezos holding exec chairman, also hard to argue Dorsey has been nearly as successful as Bezos as a public company CEO at Twitter.

  • Dorsey currently owns about 2% of shares outstanding

  • Parag owns very little stock, about $12mm in market value

  • We do have info on Parag’s comp package, and I don’t think it's crazy

  • $1mm in salary

  • A possible $2.5mm performance bonus

  • $12.5mm is RSUs, would vest over 16 quarterly increments (a little over $3mm per year)

  • I’d expect that number of RSUs to keep rising over the next few years if he is successful in the short term

  • Not a whole lot is known about Parag or his intentions. There are some indications that he is more prone to censorship than Dorsey. He has been focused on ML and AI components of Twitter during his time as CTO

  • Vanguard is the largest holder with about 9% of shares outstanding. Institutions own about 80% of shares so definitely a known entity with significant coverage.


(Brett) Valuation:

  • Market cap of $35 billion, ticker TWTR

  • Enterprise value is closer to $33 billion with a large amount of cash on its balance sheet

  • EV/s of 6.8 (72x sales at IPO)

  • EV/GP of ~11

  • EV/FCF of 101 (they actually have sizable CAPEX spend)

  • 147 million dilutive securities (warrants, convertible notes, stock options, RSUs) outstanding vs. 798 million shares outstanding. Expect a share count headwind

  • They are buying back stock which could neutralize this


(Ryan) Earnings: A few TTM numbers for a holistic view, then I’ll get into the recent Q3

  • TTM revenue is $4.8B, up about 40%

  • Last 12-month gross margin has been 64%

  • They’ve generated just under $1.5B in OCF, which puts them at an OCF margin of 31%

  • But they spend a shockingly high amount on CAPEX, so FCF margin over the last 12 months has been about 7%

Q3:

  • Revenue grew 37% YoY

  • Average mDAUs were 211M, up 13% YoY

  • Had $743M operating loss in the quarter due to a big one-time litigation settlement (it was a shareholder lawsuit alleging that in 2014 Twitter misled investors about how much its user base was growing)


(Ian) Balance sheet and liquidity:

  • $7.4B in cash

  • About $5.5B in debt

  • $3.6B in convertibles

  • 0% 2026 convertibles

  • Conversion price is $130.03, about a 3x from here

  • .25% 2024 $57.14 conversion price

  • .375% 2025 $41.50 conversion price

  • $700mm in 2027 senior notes

  • 3.875% interest

  • The rest in leases


(Ad)


Anecdotal Evidence: What do you use Twitter for most?

  • (Ryan) I spend a ton of time on there. I probably use it primarily for news + new investment ideas. Honestly, I use it a lot for learning. I find a ton of interesting articles through there.

  • (Brett) Finding things to save and read later, current market news, researching a company. Interacting with fintwit. From our CCM account perspective, it is a lot more limited than it should be. Why can’t we easily sell things on it? Why can’t people listen to our podcast on it? Why is the newsletter product a tenth as good as Substack? The app is also consistently slow for me.

  • (Ian) The only social media that I have been addicted to at times in my life. One thing that I have been noticing recently is that the algorithm seems to be limiting what I see more often. I’ll think to myself that someone has been tweeting much recently and then check their profile to discover that they are tweeting every day which is a little annoying.


Future growth opportunities:

  • (Ryan) News bundle. Like what Apple tried to do with Apple news. So many people use Twitter as their news source and I know I use it as my sort of personal dashboard as sad as that is to say. So if I could pair a WSJ subscription, with Financial Times, and maybe the Verge or Stratechery. Idk, the specifics could vary, but if Twitter were able to offer some sort of a bundle I think that could help monetize those power users.

  • (Brett) So many things that they seemingly are unwilling to do. One they are trying now that feels promising is shopping, which allows people to plug stuff into their profiles as they have on YouTube now. The problem is, they aren’t just doing Shopify/Wix/Amazon plug-ins (I think). That would have been simple, and super easy to scale for all users, but they have decided to take the complicated route.

  • (Ian) I would say improving their ad platform. Out of all the social media ads, it feels like theirs are the worst. I rarely see anything applicable to me, and many times it is comical. It is also kind of funny because the same AI technology that is showing trends is probably used for ads (Now trending in sports: The science of hitting tweeted “I’m looking for singles, doubles, triples, and home runs.”


Highlights and lowlights:

  • (Ryan) Highlights: It’s got unlimited lives. They can just try different monetization strategies and if it doesn’t work then who cares, they still have 200 million DAUs. Lowlights: It might not be monetizable. The platform simply isn’t built for performance advertising. They’ve tried over and over.

  • (Brett) Highlights: Strong moat, no realistic direct competitors for their core product offering (breaking news and discussion for finance, tech, sports, politics), good unit economics, and Dorsey’s out. Lowlights: management, SBC, and history of terrible product roll-outs (clown car that fell into the gold mine).

  • (Ian) Highlights: Awesome platform. Modern-day newspaper. Well-poised for the rising creator economy in my opinion. Lots of cash to do something with. Generating a decent amount of cash flow, even after SBC, so the debt is not concerning. Lowlights: Unfortunately, no recent history of adding valuable products for the user or the company. Maybe twitter spaces, but twitter blue, super follow, fleets, tipping, even revue seems subpar.



Bull case:

  • (Ryan) It’s pretty obvious. They have to find a way to juice more money out of their users. They’ve got 200 million-plus people spending hours of their day on there. They could easily double, triple, quintuple their ARPU, I don’t know how but they could. If they find a way to really induce spending, and I think it has to be through subscriptions of some sort, this will be a good investment.

  • (Brett) A lot of ways to get there, but I think you have to see a path to $10 billion in revenue through either improvement in advertising or ancillary services like shopping, subscriptions, etc. Margins should get to 40% as Facebook’s did at a certain scale.

  • (Ian) 15% revenue growth and 30% EBITDA margins should get them to market-beating returns if they can sustain it for 3+ years, but they have been unable to do this as a public company since 2015. Even that would be only 12%ish returns assuming a 20x EBITDA multiple.


Bear case:

  • (Ryan) Also once again the bear case is really simple. If they can’t find a better way to monetize their existing users, it’s not gonna be a great investment. They don’t even have to grow users.

  • (Brett) Management continues floundering around releasing half-baked products with minimal ad improvements.

  • (Ian) Twitter has passed its peak of innovation without ever reaching its mature cash-generating potential. It focuses too much on controlling the conversation and not enough on creating great products. The platform experiences a slow decline as users start migrating to more innovative platforms.


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Disclosure: The author and podcast guests are not your financial advisors. Ryan Henderson and Brett Schafer are general partners and portfolio managers at Arch Capital. Clients of Arch Capital may hold securities discussed on this show.

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