$TWTR Q2 Earnings Preview

by Enis July 28, 2014 3:17 pm • Commentary

Event:  TWTR reports its Q2 earnings tomorrow after the close (Tuesday July 29th).  The options market is implying about a 11.5% one day move, which is below the 2 quarter average of 16.25%. (TWTR has only reported twice as a public company).

Sentiment:  Wall Street analysts are mixed on TWTR, with only 12 buys, 19 holds and 6 sells, and an average 12 month price target of around $43.  Despite the stock’s nearly 30% rally from $30 in early May, TWTR is still down 40% year-to-date.  Short interest has declined in TWTR from a peak in the spring (as many traders anticipated the selloff at the end of the lockup period):

TWTR Short Interest, Courtesy of Bloomberg
TWTR Short Interest, Courtesy of Bloomberg

Options Open Interest:  Even though TWTR has declined substantially over the past 6 months, total open interest in TWTR is skewed towards calls over puts by a ratio of around 1.35 to 1.  The average volumes over the past month have been skewed towards calls as well, by a ratio of 1.55 to 1.

For the Aug1st expiry, the weekly 35 strike put and the weekly 40 strike call are the only two strikes with over 6k of open interest.  For Aug16th expiry, the open interest is concentrated in 41, 42, 43, and 45 strike calls, which all have over 10k outstanding.  The strike in play with the most open interest of any expiration is the Sept 50 call, which has over 40k of open interest.

Price Action/Technicals:  TWTR has been in a steady downtrend since late December.  In fact, while the stock has bounced in the past couple of months, it was unable to make a new high on the recent move higher:

TWTR daily chart, 50 day ma in pink, 100 day ma in green, Courtesy of Bloomberg
TWTR daily chart, 50 day ma in pink, 100 day ma in green, Courtesy of Bloomberg

One positive is that the 50 day moving average is finally upward sloping for the first time since February.  It is now around $36.60, and an important level to watch.  On the upside, the 100 day moving average is still declining, and was not breached on the strength in early July.  The 100 day ma is currently around $40.30.

Zooming in to the price action since April 1st, there are a couple technical areas that stand out:

TWTR daily chart, Courtesy of Bloomberg
TWTR daily chart, Courtesy of Bloomberg

The pre-earnings close on April 29th was $42.62, which acted as resistance in early July.  The lockup expiration day’s open of $35.61 on May 6th has acted as support over the past couple of months.  A break of either of those levels would be significant after earnings.

Fundamentals/Valuation:  Perhaps the most important development for TWTR stock over the past couple of months has been the shifts in the executive office.  Twitter’s management is trying change the perception of slowing user growth.  The Wall Street Journal had the details in a story 10 days ago:

When it reports second-quarter earnings on July 29, the San Francisco company is expected to unveil as many as four new metrics that it hopes will illustrate its reach beyond the 255 million users that log in at least once a month, according to people familiar with the matter. The aim: to show Twitter isn’t just a diminutive Facebook Inc.

The new metrics will measure the breadth of the audience that is exposed to Twitter’s content but not logged in, the people said

To help sell the new metrics, Mr. Costolo earlier this month recruited Anthony Noto,a former Goldman Sachs Group Inc. banker, to succeed Mike Gupta as chief financial officer. Together Messrs. Noto and Gupta steered Twitter through its IPO just eight months ago.

They crafted much of Twitter’s IPO documents, devising which metrics to present to potential investors, according to people familiar with Twitter’s IPO process. Mr. Costolo hopes Mr. Noto will be more adept at communicating Twitter’s business to his former peers than Mr. Gupta. Mr. Noto’s appointment is the latest in a flurry of changes to Twitter’s executive lineup. Since April, Twitter has hired a new product chief, replaced its heads of engineering and finance and divvied up the duties of its former operating chief, Ali Rowghani. Mr. Gupta is now in charge of overseeing a new team investing in startups.

The real question is whether the management changes and re-emphasis of metrics will have a meaningful impact on advertisers’ perception of the quality of Twitter as a platform for promoting brands and products. TWTR’s value all along has been its enviable position in the fight for mobile screen time, and mobile advertising is continuing to grow as demonstrated by the GOOG and FB results.  But with annual sales growth of 50-75% expected over the next 2 years, the company is scrambling to maintain momentum in terms of both user growth and advertiser interest.

Interestingly, the stagnant user growth figures contrast with continued strength in the company’s financial metrics, as outlined by Goldman Sachs research:

While third-party data has suggested downside risk in MAU’s and engagement, our checks with advertisers continue to show strong momentum. While forecasts over the next 12-18 months depend more on monetization than MAU growth, TWTR’s multiple will depend on the restructured management team’s ability to grow engagement and users.

With uncertainty over metrics, management, financials, and the multiple, it’s no surprise that TWTR has been a volatile stock over the past 9 months.

Volatility:  Implied volatility in TWTR is lower than it was prior to the past 2 earnings reports:

30 day implied volatility in TWTR, Courtesy of Bloomberg
30 day implied volatility in TWTR, Courtesy of Bloomberg

The low level of implied volatility is due to decline in realized volatility in TWTR, as the stock has only averaged a 2.25% move over the past 30 trading days.  TWTR’s 30 day implied volatility is likely to fall back to the low 40’s after the earnings event.

Our View:  Back in late May, following TWTR’s fairly dramatic decline following their Q1 results and the onslaught of selling from the IPO lock-up we took a fairly constructive view on the shares just above $30 (May23rd, 2014: TWTR: Catching a Failing Whale) as we felt the sentiment got way too poor in a very short period of time.  Since then the stock had more than a 40% rally before settling back in the high 30s and it feels now that sentiment has reached a sort of equilibrium. The one worry we would have at current levels is that the company’s recent addition and changes to senior management and the intro of new metrics to explain engagement and user growth (or lack thereof) makes us wonder if management could kitchen sink forward guidance in order to set up for a series of beats afterwards.

After exiting our prior bullish bets on the stock we are now fairly neutral with the stock up here and we think it would take an outlier qtr/guidance higher or lower for the stock to outperform the one day implied earnings move of almost $4.5.

We will be sure to take a closer look at possible trades prior to tomorrow’s close.