Twitter: The Grace Period is Over

In a take-no-prisoners trading culture, there was a mass exodus of investors in Twitter (TWTR) after interim CEO Jack Dorsey and CFO Anthony Noto reported anemic user growth in the Q2 2015 Conference Call. Originally, Wall Street liked the results of the second quarter when the earnings press release first hit the Web. According to the document, sales of $502 million for the quarter, up 61% year-over-year, and above the previously forecast range of $470 million to $485 million. The stock shot up over 7% in after hours trading.

However, the equity did an about face a few minutes into the conference call when the executive team discussed user growth, or lack thereof. The gears of capitalism ground to a halt, and the stock not only lost all after hours gains, but descended to near all time lows the next day of trading. Here are some quotes from members of the C-suite from both the prepared statements and Q&A session that accelerated the selling:

• "Specifically, we do not see organic growth."
• "Simply said, the product remains difficult to use."
• "Our growth rate in users is slowing quite dramatically."
• "We will take the necessary time to build the service people love to use every single day. And we realize it will take some time to show results we all want to see."
• "The DAU (daily active users) to MAU (monthly active users) ratio has gone down...because we’ve grown MAUs faster than DAUs, and we have not historically focused on driving daily active user growth."
• "Our organic growth is going to be very low as it was this quarter, and as I think about Q3, it’s marginally better, but I wouldn’t want you to or anyone else to expect a change in our growth rate relative to what you are seeing in this quarter."
• "We have only reached early adopters and technology enthusiasts, and we have not yet reached the next cohort of users known as the mass market."

That assessment is about as succinct as you'll get from high-tech management, or management in any publicly traded company. My hat's off to Jack Dorsey and Anthony Noto for not sugarcoating prospects going forward. However, it wasn't a bad quarter. Besides beating on the revenue front, Q2 adjusted EBITDA was $120 million, up 122% year-over-year. This is above the previous forecast range of $92 million to $102 million.

I believe a big problem with Twitter is perception. Early investors just got seduced by the Wall Street marketing machine. People thought this global brand on the digital frontier would be an instantaneous profit generator. In reality, it was an unprofitable story stock from the get go. If you bought the hype thinking the share price would be in an automatic upward trajectory, you got dealt a cruel hand. The equity may reach it's previous all time high of $75/share again, but that may take some time the way sentiment is going.

Twitter has some new initiatives going for it, which may be why Twitter bulls cling on to lofty price expectations. Most importantly, the company appears to have a growing relationship with Google (GOOG). Tweets are now integrated in the daily search of Google domestically, but only on the desktop. Mobile is a work in progress. In addition, there are other languages they will be expanding into internationally with Google desktop search, specifically within English-speaking countries.

A partnership with Google's DoubleClick will help improve advertising performance measurement. There's been speculation in the business press that Google would be a good suitor for Twitter, and that may be so, but that's just speculation. With Twitter's market cap of $21 billion, it would be an expensive acquisition for Google. Plus, regulators would have to approve the deal.

The acquisition of TellApart in late April is also discussed in the Q&A session. TellApart will remain a standalone business, although under the Twitter family of companies like Periscope and Vine. The marketing technology company provides retailers and e-commerce advertisers with cross-device retargeting capabilities. At this juncture, Twitter has no plans to monetize TellApart. Twitter paid $533 million for the company, so that just adds to the mounting expenses the corporation has accrued recently, including increased headcount and infrastructure build out. Nevertheless, these expenditures are a necessity to stay current in today's social media environment.

Like all companies, Twitter is in a state of perpetual flux. The partnership with Google, and the acquisition of TellApart, helps monetize the rabid base of over 300 million active monthly users. However, if current management plans come to fruition, Twitter may be taking steps backwards by making the service easier to use. In doing so, you take the chance of alienating the current user base, which may dilute end-user participation. Twitter is not a mass market product like Facebook (FB). It's a niche product.

Going toe-to-toe with Facebook would be a big mistake in my opinion. Facebook has 1.5 billion monthly active users, five times the population of Twitter. You need to invest intellectual capital to become well versed in Twitter. Therefore, you may have a more affluent user base. Facebook is basically plug-and-play. Octogenarians posting pictures of their grandchildren and other family members, to stereotype the process. Both demographics are important to advertisers, but followers on the Twitter communication platform may be more qualified, allowing higher advertising rates. After all, it's the Millennials and Gen-Xers that primarily use the communications service.

It was only a few weeks ago that I wrote my previous article about Twitter. To recap, I thought the equity was expensive, and that I wouldn't pay any more than $25/share for the company. With a trailing twelve month price/sales ratio of roughly 15, and very little earnings visibility, it's still expensive despite the recent selling spree. With a range bound stock market looking to take a breather, I'll wait on Twitter. It was a one-sided love affair on the way up, now a messy divorce on the way down. If I'm patient, I may get my price.