Trade Update – Replacing Long Stock in $TWTR

by Dan April 28, 2015 2:47 pm • Commentary

On Friday afternoon I gave some thoughts about my current long position in Twitter (TWTR) and the fact that I was considering replacing my stock with a defined risk options structure into tonight’s potentially volatile earnings event (read here).

I think there is a some likelihood that the stock could move about $5.25, which is what is implied by the options market. With the stock just above $51, the May 1st weekly 51 straddle (the call premium plus the put premium) is offered at about $5.25, if you bought that you would need a move above $56.25 or below $45.75 by Friday’s close to make money)

On a percentage basis would be below the average move over the five quarters of about 16% since the company went public, and just a tad above the two smallest moves of 9.8% and 8.5% in October 2014 and April 2014 respectively. However, the stock has consolidated recently around the $50 level, and it wouldn;t be out of the question for it to continue to consolidate is the results are inline with expectations.

As for expectations tonight, writer Kathleen Chaykowski had a succinct rundown of what to watch for in the quarter:

User base growth: Twitter’s user base grew by only 4 million in Q4, down from 14 million in Q1 a year ago, 16 million in Q2 and 13 million in Q3. Twitter management has suggested that today’s metric will be closer to last year’s first three quarters, and iOS 8 integration issues contributed to the low Q4 figure.

Revenue: Twitter management offered guidance that Q1 revenue growth is expected to be about 80%. Analysts’ consensus estimates on the Street expect the company to post adjusted earnings per share of 4 cents on revenues of $456.2 million. It wouldn’t be surprising for Twitter to beat its previous guidance because of solid, continued growth in mobile and international advertising. Twitter’s ad products, such as promoted photo tweets, website cards, mobile app downloads and promoted videos continue to rise in popularity. Twitter has also been expanding its sales presence and ad products in international markets. During Q4, international ad revenue grew by 141% annually, compared to a 78% rise in U.S. ad revenue.

Updates on partnership deals: Twitter entered into partnerships with Flipboard and Yahoo Japan in February to syndicate ads across their respective web properties. Twitter also signed a deal with Google GOOGL -0.05% to include tweets in Google search results. Financial updates could offer a better sense of how these deals affect data licensing revenue.

Product updates: Since last quarter, Twitter has released a number of new features including logged-out homepages, instant timelines, and new features in private messaging and video sharing. Twitter also acquired a new video live-streaming app, Periscope, in March. It will be interesting to see how these features and tools affect engagement and user growth.

I would also add that Suntrust Analyst Bob Peck who I like a lot downgraded the stock the other day to a Hold, and gave the following reasons:

SENTIMENT ON Q1 IS DIVIDED. We think sentiment heading into Tuesday’s 1Q ’15 earnings report is equally divided, with Bulls excited about recent product improvements and MAU net add growth, while Bears are more concerned on 2Q guidance for users and monetization. We note the stock has climbed ~23% since the last earnings report (+29% over 3 months vs. S&P +3%). While we are big believers in the long-term opportunity in front of Twitter and believe the company will report a strong Q1, we are lowering our rating to Neutral as we think the negative risks create enough concern and likely result in a range-bound stock in the near term. We lower our target to $50 from $58.

THE POSITIVES. Bullish investors have 4 main points that we have been hearing: 1) The company is likely to have a strong Q1 report and is iterating fast on new products and innovation; 2) The opportunity to convert non-logged in users is large; 3) The Google (GOOGL, $573.66, Buy) deal should drive more exposure and usage; and 4) There are multiple avenues and opportunities for new monetization. We agree with the points.

THE NEGATIVES. Bearish investors have 4 main points that we have been hearing: 1) MAU net add guidance for 2Q may decelerate; 2) Monetization levels are closer to Facebook (FB, $81.53, Buy) than most realize; 3) Engagement (Tweets per day) is declining and investors may not have other metrics; 4) Non-Compliant Terms of Service users being monetized may suppress advertiser growth in the short and mid term.

So what to do?

I like the idea of defining my risk into the event. I’ve been riding the stock higher on and off for some time and I still think the stock should work higher as the company is able to increase their user engagement/base and increasingly monetize that base.  Prior to Q4 results I bought the stock in the high $30s and rode it up to the high $40s.   Now with the stock just above $50 I think the risk/reward feels fairly even.  My bullish view on the company has a lot to do with its scarcity value and that a large web/media property will be able to get far more leverage. But that is not what the stock is going to trade on after tonight’s results, which could disappoint high expectations.

Therefore I’m selling my shares here at a profit and replacing them with this bullish but defined risk trade:

TRADE – Bought to open the TWTR ($51.00) May 50/60/70 call fly for 2.50

– Buy 1 May 50 call for 3.60

– Sell 2 May 60 calls at .60 each (1.20 total)

– Buy 1 May 70 call for .10

Break-evens on May expiration:

-Losses of up to 2.50 between 50 and 52.50 & between 67.50 and 70 with max loss of 2.50 below $50 and above $70.

-Gains of up to 7.50 between 52.50 and 67.50 with max gain of 7.50 at  $60.

Rationale – This defines the risk of the long to 2.50 and allows for a lot of room to the upside to the $60 level where profits will be similar (but a little less) than long stock. Profits do trail off above that level but that’s unlikely from a probability perspective.