Twitter: A Bottom Fisher's Perspective

"A-Well-A Everybody's Heard About The Bird." - The Trashmen signing 'Surfin' Bird' circa 1963.

The Twitter (TWTR) logo is one of the most recognized icons of the past few years. It permeates the media landscape on The Internet, and on broadcast television. Go to ESPN, Reality TV Programs, Game Shows, Talk Shows, or your local and national newscasts, and attempt to avoid it. It can't be done. It's everywhere.

Although Twitter is an integral part of contemporary culture, all that free publicity hasn't added up to a very profitable company, or, total world domination like its contemporary Facebook (FB). Facebook has over a billion Monthly Active Users while Twitter languishes at over 300 million. Why? Twitter is more difficult to use. Twitter isn't a plug-and-play application on the desktop computer, or, on your smartphone the way that Mr. Zuckerberg's products are. Quite the opposite. You must have some computer knowledge, or at least have the technological intuition to begin building a timeline on Twitter.

During the 2015 Q1 Conference Call, former CEO Dick Costolo (who still has a relationship with the company although co-founder Jack Dorsey is back at the helm as interim CEO) stated: "After five consecutive quarters of more than 97% year-over-year revenue growth, we under performed against our expectations. We anticipate the factors that affected our first quarter results will also affect our 2015 guidance.". This translates into a potentially rough six months for the company. Wall Street took notice and the stock got hammered, dropping from close to its 52 week high of $55/share to the mid $30 range where it currently trades. It got as high as $75 in late 2013.

Twitter makes most of its sales from advertising, and revenue growth decreased to 74% for the quarter. It's commonly known that there's been a big migration of advertising dollars from traditional media such as newspapers, magazines and television to the Internet. There's also the current movement from personal computers to mobile devices. Advertising budgets follow the eyeballs, and the big players in both the desktop and mobile arena are Facebook and Google (GOOG). A December 2014 eMarketer article breaks down and projects the domestic mobile advertising market to 2016.

As is presented, Twitter only maintains a three plus percent share of the American mobile marketplace through 2016. The United States is where they do the bulk of their business. However, they do have an international presence, and are working on improving the existing product. If you go by the chart, Twitter isn't picking up too much market share. During the last conference call, former CEO Costolo notes that there is a company-wide three prong approach to building the consumer base to increase those eyeballs and click throughs for the advertisers:

• Strengthen Twitter's core. (Make it easier for novice users to create timelines, and engage in activity. Easier said than done. Once you lose a customer, it is difficult to get them back.)
• Remove barriers to consumption. (Increase the monthly active users. Besides the 300 million monthly active users, an additional half billion people monthly visit Twitter, but don't utilize the service to its fullest potential.)
• Build new applications and services.(For example, the relatively new service Periscope which enables end users to create video vérité on their smartphones, and share it with the Twitter's minions.)

Despite the game of musical chairs in the executive suite, Wall Street bulls point to Twitter's potential. The current company game plan requires an enormous cash outlay to build infrastructure, and increase selling, general and administrative expenses. Last quarter, Twitter took in $436 million, but spent $389 million in non-GAAP expenses. As a result, Q1 GAAP EPS was reported at ($0.25) and non-GAAP EPS of $0.07.

Bottom line is that Twitter isn't making much money, but neither are Amazon (AMZN) and Netflix (NFLX), two other companies that dominate the decade, but that hasn't stopped their shares from moving to all time highs. Twitter, on the other hand, is getting close to its all time low. Granted, all three companies have different business models, but Twitter is the one based on advertising sales. Advertising budgets are usually set on an annual basis, and those advertising dollars may not be allocated to Twitter until the end of the year.

Full disclosure, I'm one of the 300 million monthly active users on Twitter and am a big fan of the company, but not the stock because of lofty valuations. For instance, for full year 2015, the company estimates sales to be between $2.12 billion to $2.27 billion. That's with Twitter's current market cap of $24 billion. Very expensive.

Because Twitter lacks substantial earnings, you really can't value it on a P/E, or PEG basis. My personal preference for technology companies is the price-to-earnings divided by growth calculation. Not going to work for this one, which further solidifies my belief that it should never have gone public. Twitter could have raised needed capital via private equity the way that Uber and Airbnb do.

Trailing twelve month price/sales is 14.5. Ken Fisher, who developed the metric back in the early 1990's, believes it may not be as accurate a barometer as it once was, but it's still useful nonetheless when you've got nothing else to go on. Even if you double sales the next twelve months, the price/sales ratio would still be humongous based on Mr. Fisher's teachings.

Based on consensus analyst expectations, Yahoo! Finance reports better numbers going forward for Twitter. The problem with utilizing average analyst expectations, is that they vary to a great degree. It's like Donald Trump claiming he's worth 10 billion dollars, then Forbes refuting that and saying it's more like four billion. However, it's what we have to go by because it's a relatively new public company.

EPS for full year 2015 is $.34, with the lion's share coming in the December quarter. For 2016, this number almost doubles to $.67 for the full year. Impressive growth, but what if they continue to spend money for expenses at unreasonable levels, and gain market share at a snail's pace?

There's not a big short float on the stock, just 4.6%, so the Wall Street believes Twitter may be reasonably valued. Twitter's IPO price was $26, but it opened at $46 on the first day of trading. From my perspective, the investment bankers got the valuation correctly, and the stock may get back to a more reasonable level after the next conference call on July 28th.

At this juncture in time, I wouldn't pay any more than $25/share for Twitter. I'm not going to chase it, especially when we are so close to the next earnings release. Although I believe the equity should be given a premium because of its unique communications platform (it really has no peer except Facebook, and that's not an apple to apple comparison), I'm betting that it may go lower based on valuation, the nature of the advertising business, and the upheaval at the helm.

It Was a Very Good Year

In 2013, the S&P 500 was up 32.39% when you include dividends. Individuals in S&P 500 Index Funds such as the Vanguard S&P 500 ETF (VOO), iShares Core S&P 500 (IVV) or the more renown SPRD S&P 500 (SPY), did a land office business. Hedge funds didn't fare so well according to Bloomberg Business, "Hedge funds returned an average of 7.4 percent in 2013, after a gain of less than 0.1 percent in December...Funds lagged behind the S&P 500 by 23 percentage points.".

Fast forward to 2014, and again, the S&P 500 index was up a compelling 13.69% including dividends. BarclayHedge (no affiliation with Barclay's Bank) research shows that Hedge Funds also lagged the S&P 500 in 2014 with only a 2.88% gain. That's not to say all Hedge Funds did poorly, just on the aggregate, the average Hedge Fund under performed passive investing by a long shot. I think it should be stated that by nature Hedge Funds are "hedged" to protect the investor when the market depreciates, so you wouldn't expect some of them to have banner years in an uptrend in the markets.

Nevertheless, statistics show since the crash of 2008-2009, index investing has handily beaten their more expensive competitors, the Hedge Fund. It is also common knowledge in investing circles that over the long term, actively managed mutual funds tend to lag the primary American benchmark, the S&P 500, the majority of the time. There are instances when various sector mutual funds and ETFs outperform the S&P 500. As an example, for the past three years, biotechnology funds and ETFs have been very good to investors. iShares Nasdaq Biotechnology ETF (IBB) gained 177% in the past three years, and is up almost 30% year-to-date in a flat year for the S&P 500.

However, hot sectors like biotechnology tend to be outliers. There's also the dilemma of when to get in and when to get out. Market and sector timing is an inexact science for the novice and professional alike. It's because most actively managed portfolios tend to lag the market, I liquidated all if my individual equity positions at the end of 2013 after a less than stellar performance, and have gone into well diversified index ETFs. In 2013, I didn't do as poorly as the hedge funds, but I left more money on the table than I wanted to in a concentrated portfolio of primarily small to mid cap securities.

Small to mid cap stocks tend to be very volatile. You must have a cast iron stomach to roll with the punches in a high beta tape. I bought Facebook (FB) after it got cut in half at $18, and this resulted in a four bagger in a little less than two years. Somewhat lucky, but a good call nonetheless. However, there were too many others that didn't fare so well, primarily in the smartphone infrastructure and component arena. Although this is a very exciting time in which we live in regards to technology companies, the game changing science in many of these equities becomes obsolete in a matter of months.

I prefer to buy and hold my investments to minimize trading costs and capital gains taxes. Investing in some of the smaller entities that power our iPhones and Android devices seemed like a prudent idea for a small period of time, but didn't pan out the way that I planned. I had to trade too much to keep up with the ever changing computer science. This, coupled with the undeniable statistics that passive investing in a well diversified index fund or ETF is better for your bottom line, caused me to alter my investment thesis.

Back in the late 1990's, I read "Winning the Loser's Game" by Charles Ellis, which is considered the bible for index investors. At that juncture, I was on a hot streak in NASDAQ stocks like Cisco (CSCO) which needs no introduction if you were investing at that time. I fully understood and appreciated the concept Mr. Ellis discussed in the book, but my personal preference was with Robert Hagstrom and his best seller "The Warren Buffett Way". Hagstrom's contention that a concentrated portfolio is the optimal way to invest if you follow the wisdom of The Oracle of Omaha. I followed the advice of Mr. Buffett, and did well.

Times have changed. With the advent of High Frequency Trading, and computerized Web bots that scour the Internet at warp speed assimilating information, the teachings of Benjamin Graham and David Dodd seem outdated in today's world. Although I believe the concepts of "Security Analysis" are still intact, Warren Buffett, the most famous pupil of Value Investing, suggests that individuals use a plain old vanilla index fund. That's a good enough endorsement for me.

So where does that leave this blog? After a sixteen month hiatus, I have decided to continue writing articles about ETFs and individual securities. Although 95% of my equity investment allocation is in either S&P 500 index ETFs, and to a lesser degree the Vanguard FTSE Europe ETF (VGK), I'm still sitting on a small cash position. There are always alpha opportunities to be had in sector ETFs like The Pure Cyber Security ETF (HACK), which has outperformed the market this year, and individual stocks like Netflix (NFLX) and Apple (AAPL) which have also done well. I am not planning on buying or writing about any of these at this point, but they are examples of what is to come going forward.

Rocket Fuel's Fall From Grace May Be Temporary

"I expect programmatic to slow down in the same way people stopped trading on exchanges and went back to handing pieces of paper back and forth for selling stocks. The Pandora’s box is open..." - Rocket Fuel CFO Peter Barwick in an interview on AdExchager

Wall Street can be a fickle place. Two short months ago programmatic advertising company Rocket Fuel (FUEL) hit an all time intraday high of $72. This was on the heels of an IPO of $29/share in late September of last year. On the same day shares hit their apex, the company announced a five million share stock offering ahead of its March 19th lockup expiration. Traders didn't like the news, and the price has spiraled downward to roughly $46, a decrease of $36% in sixty days. Although it's hemorrhaging cash, Rocket Fuel is still growing close to 80% on a revenue basis, and may present long term investors a decent entry point at the current valuation.

Programmatic Advertising - A Secular Growth Story

Artificial Intelligence. Big Data. Machine Learning. Distributed Systems. Combine these ingredients, and you get a high octane recipe for an advertising platform know as programmatic (which includes real time bidding). Rather than focusing on data analysis by humans, it's a business practice that autonomously adapts and learns while solving multiple problems. In lay terms, it's where and when to feed that advertisement. John Henry versus the steam shovel - you know who won that battle.

Consider this:

eMarketer projects Real Time Bidding digital display ad spending in the US will account for 29.0% of total US digital display ad spending by 2017, or $9.03 billion. In 2013, it accounted for 19.0%, or $3.37 billion.

(Chart Source: eMarketer)

That eMarket extrapolation may prove to be conservative. It also doesn't take into consideration international sales, so the potential for profits increases. Although Rocket Fuel is primarily a domestic company, it's entrenched in Europe with regional offices in the United Kingdom, France, Germany and the Netherlands. It's also making a push into Japan. The company is one of the kingpins and a pioneer of programmatic advertising. It should benefit from the secular growth story of a market in its infancy.

Explosive Growth Since Launching

Most notable in the latest 10-K, released February 28th, is the 126% compound annual sales growth from 2011-1013. In the last earnings report, Rocket Fuel guided for full year 2014 of revenues between $420-$435 million. If we split the difference, that would give us approximate sales growth of 80% for this year. Yes, revenue growth is slowing, but still advancing at a compelling clip.

Drilling down with some specifics:

Rocket Fuel statistics	2011	2012	2013
Revenues in millions:	$44.7	$106.6	$240.6
Net Loss in millions:	$(4.3)	$(10.3)	$(20.9)
Active Customers:	266	536	1,224
R&D in millions:	$1.5	$4.9	$17.7

We're in a new paradigm shift where technology is concerned, and many young companies are coming public before profitability. That's certainly the case for Rocket Fuel, and may continue for the foreseeable future. If you want to invest in some of the exiting new tech pure-plays, you may have to forego earnings to get hyper-growth. Taking that into consideration with your risk/reward tolerance, the losses may be overlooked for awhile.

To accentuate the positive on Rocket Fuel, look no further than its impressive client base which doubled last year to 1,224. This includes 70 of the Advertising Age top 100 advertisers and over 50 of the Fortune 100. It has significant mindshare in an industry in its early innings. Take a look at some of the heavyweights Rocket Fuel services, a who's who in corporate culture:

(Chart Source: Rocket Fuel)

What bothered me most about the financial filings was the R&D expenditures. With only eleven patents, and $17.7 million being poured back into R&D, the company should be doing more to widen the moat, if indeed it does have one. Criteo (CRTO), Tremor Video (TRMR), and YuMe (YUME) are other digital advertising companies that have recently gone public, and will attempt to take market share from Rocket Fuel.

The Move Into Mobile

As smartphones, tablets, laptops, desktops and televisions become interconnected with the advent of technological advances such as seamless video streaming, advertisers want to reach as many devices as possible in one fell swoop. Rocket Fuel got ahead of the curve by launching a next generation mobile advertising suite in February. The suite integrates with 27 mobile ecosystem partners which includes Flurry, Factual, BlueKai, MoPub (TWTR), and Celtra. According to the company:

Mobile Real Time Bidding suppliers connect with Rocket Fuel's proprietary bid infrastructure to provide the broadest mobile reach across tablets and smartphones on all operating systems, and utilize all possible anonymous identification protocols, including cookies, device IDs, and statistical matching.

I believe one formidable opponent going forward is Millennial Media (MM), a small cap company with a mobile advertising exchange. Millennial Media is moving into programmatic with a recent acquisition of JumpTap. Although the two companies compete in the programmatic arena, they are entering the multi-channel universe from two different directions. Millennial Media is going from mobile to desktop, and Rocket Fuel is going from desktop to mobile.

Full disclosure, I own shares of both Millennial Media and Rocket Fuel. Why own shares of both companies? I really don't know which organization will prevail, and because both are relatively inexpensive on a Price/Sales metric, I've got two horses in the race, at least for the next few quarters. However, Millennial Media is a turnaround play, and potential investors should be aware of this. For more information on Millennial Media, my recent article can give you the low down.

Some Rocket Fuel Valuations

Rocket Fuel is currently unprofitable because it's increasing headcount, and acquiring data centers to increase product improvement. As demonstrated earlier, sales are increasing at an impressive clip with mobile comprising 19% of revenues for Q4 2013. As supplied by Yahoo Finance and the annual report:

• Total Debt - $26.8 million as of December 31st
• Cash and cash equivalents - As of December 31, 2013 were $113.9 million. Rocket Fuel received net proceeds from its IPO of $103.3 million during 2013. Subsequently in February 2014, Rocket Fuel received net proceeds from its follow-on offering of $116.5 million.
• Price/Sales (trailing twelve months) - 6.86
• Market Cap - $1.59 billion
• Price/Book (most recent quarter) - 10.8

At roughly 5X 2014 sales, and a significant total addressable market, I took a flier on Rocket Fuel at $46. Eighty percent revenue growth is an opportunity that doesn't come up too often. You're never sure if you've reached the bottom of a sell-off in an equity, but if Rocket Fuel can continue to execute, it should be able to outpace the overall market in the next year.