Regular readers know that we have been positively disposed to Twitter as product, platform, and stock for the better part of its two years as a publicly traded company. We have taken profits in the shares from time time when we thought sentiment was overzealous, and added to our long bias when we were of the mindset that sentiment was too pessimistic. Since the start of the Summer we have been fairly positive on the potential for new management to focus on making the product more understandable and easier to use, thereby growing the audience. But in the near term the challenge in the stock gauging sentiment. Prior to the company’s Q3 results last month we had the following to say (from Oct 27th):
We have been fairly steadfast on our view that despite TWTR’s weak user growth and challenged engagement, it remains a very unique social media property whose $21 billion market cap ($19 billion enterprise value) does NOT reflect its scarcity value, especially when you consider Facebook’s 2014 purchase price of $22 billion for WhatsApp, and the ever-growing private market valuations of so called “unicorns” like SnapChat.
As for expectations, TWTR had a lot of news last month, starting with the Oct 5th resolution to their CEO search where (despite some external concerns) the board agreed to re-tap co-founder Jack Dorsey as CEO while he retains his role as CEO of online payments company Square that is currently preparing for an IPO. The company also announced that former Google exec Omid Kordestani would join as Chairman. Dorsey got to work fairly quickly with a workforce reduction and the launch of Moments, which is a feature that the company hopes will dramatically assists user engagement.
So investor sentiment went from downright disastrous in September to possibly a tad too optimistic for material improvement in the metrics that mean the most to Wall Street. I would say though that if you have been long the stock for most of the year as we have, there should be little by way of disappointment that should not be expected in forward guidance, as it makes perfect sense that the new management team would set expectations that they know they can beat. So unless forward guidance is far worse than the low end of expectations, then I see little reason why investors would hate sell shares on a weak quarter and guidance.
There are a couple things I want to focus on from that excerpt. First, the value relative to private Snapchat. Today, the Financial Times is reporting that Fidelity has marked down their value of their Snapchat private holdings “from $30.72 at the end of June… to $22.91 by the end of September.” Aside from Twitter and SnapChat being mobile messaging apps there are few other similarities. SnapChat recently announced that they have 6 billion daily video views, which is far greater than Twitter Vine views, but Snapchat lacks the ability to monetize those views. Which could be one of the main reasons why Fidelity sees less value in the holding. While Twitter’s revenue model has little to do with monetizing video at the moment, they hope to with Vine and Periscope in the future. And they have proven they can advertise to their 320 monthly active users with an expected $2.2 billion in sales this year, up 58% from last year and expected to grow 42% next.
Lastly I want to focus on the price action since earnings late last month. It was my and many other market participants expectation that the new CEO would guide down forward expectations so that they would be set up to beat. This is New-CEO 101. What I did not expect was investors to hate sell the stock after what was widely expected. So we are two years on from its IPO, and the stock is up 3% from its offering price, down 25% on the year and down 65% from its all time highs made in Dec 2013. The stock is a trainwreck, plain and simple, with little technical support below current.
One thing is clear to me, investors who are crowding into Amazon, Facebook and Google do not see similar attributes in Twitter’s business model, and they are clearly not placing any value in the company as an acquisition target of Facebook or Google. It has long been my belief that TWTR as publicly traded company with $3.5 billion in cash on their balance sheet and a proven and fast growing revenue model should trade at a large premium to Snapchat’s private market value. That said, Fidelity’s 25% markdown in Snapchat value since late June could mark a seachange for private market valuations, which could weigh on the market values of similar public companies.
Twitter’s turnaround as a product, a platform and a company is going to take quarters, if not a couple of years. If investors are not willing to give new management the benefit of the doubt now, I suspect they will be less inclined to do so in what I expect will be a rockier period for growth valuations both private and public in 2016.
In late April prior to Q1 results, I sold my long stock (which I bought lower) at $51 (here). I started buying the stock in the low $40s after that disappointment. In early June I sold in the mid $30s for a loss and replaced with call spreads (here). Following disappointing Q2 results in August I started buying again and watched the stock go all the way to the low $20s in late August before its recent earnings disaster on Oct 27th. At this point I am a bit fed up. I realize it’s gonna take a while for the stock to start to work again, and I’m resigned to the notion that there are better places to invest. But I do want to keep some exposure on the long side as I still think there is a positive turn around in the company’s future.
So What’s The Trade?:
I am selling my long stock (most of it) at $27 and swapping into:
*Trade: TWTR ($27) Buy March 20 – 30/40 Call Spread Risk Reversal for $1
-Sell to open 1 March 20 put at .85
-Buy to open 1 March 30 call for 2.30
-Sell to open 1 March 40 call at .45
Break-Even on March Expiration:
Profits: up to 9 between 31 and 40, with max gain of 9 at 40 or higher.
Losses: up to 1 between 31 and 30, 1 between 30 and 20. At 20 or lower, down 26%, lose the 1 in premium paid for the structure, but I am also put 100 shares of stock at $20 and have losses below.
Rationale: While sentiment is reaching a fairly dire spot, I see few positive catalysts between now and year end. There is a distinct possibility that more negative headlines on private tech market valuations could weigh on TWTR shares and therefore I’d rather position farther down the road and not sit with the stock itself.
This trade structure offers a potentially wide range of profitability, and aside from the 3.5% premium outlay, that breaks-even at level where the stock was trading 10 days ago, the worst case scenario is down 26% at a level where the company’s enterprise value would be below $12 billion.