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Commentary

Twitter Shares Overvalued, Despite Increase in Fair Value

We’re more optimistic about Twitter’s ability to become a mass-market advertising platform, but shares are overvalued at today’s levels, says Morningstar’s Rick Summer.

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 Twitter's (TWTR) second-quarter results came in above our near-term forecast across three metrics: revenue, users, and revenue per user. The robust user growth numbers coupled with continued strength in advertising revenue have a meaningful impact on our near-term forecast and also provide us with more optimism that Twitter can come closer to approaching a mass-market advertising platform alongside competitors like  Google (GOOG) and  Facebook (FB). As a result, we are increasing our fair value estimate more than 25%; we are also reiterating our narrow moat rating. However, we believe the current stock market euphoria may prove overly optimistic, and the shares are unlikely to earn appropriate returns.

Quarterly revenue grew 124% versus 2013 to $312 million, led by advertising revenue (89% of the total) posting 129% annual growth. Monthly active users also grew a healthy 24%, leading us to increase our expectations for MAUs to approximately 300 million by the end of 2014. Additionally, we have increased our revenue forecast to account for the company's success in rolling out new ad formats, increasing ad revenue per user 84% to $1.02 for the quarter. The disparity between U.S. and non-U.S. markets remains wide (roughly 5 times higher as measured by revenue per timeline view), although management said it expects this gap to converge as smartphone penetration continues to grow outside the more developed markets. We agree with this assertion, and we are becoming more positive (although not certain) that Twitter will become an effective mass-market advertising platform. We are increasing our base-case and bull-case forecasts to reflect this increased likelihood.

Rick Summer does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.