After Twitterâs stock performance (TWTR) in the past few monthsâit has fallen by more than 40% since Mayâyou might think all the bad news was priced into the shares. But you would be wrong.
The companyâs latest financial report took the stock down another 10% or so, which means that Twitter has lost close to $15 billion in market value in the last six months. Itâs not that the company isnât making money: It pulled in $569 million worth of revenue in the most recent quarter. Thatâs almost 60% higher than its revenue in the same quarter of last year, and higher than analysts expected.
If Twitter just made that same amount of revenue every quarter, it would have annual sales of $2.3 billion. Thatâs nothing to sneeze at. So then why did the stock fall off a cliff? Because the company said it will only have $700 million in sales this quarter, much lower than consensus estimates. And subscriber growth was beyond anemic: Twitterâs user base grew by just 1.3% in the quarter, which might as well be zero.
The problem isnât Twitterâs revenues, or its user baseâwhich is around 300 millionâor even its profitability. Itâs that those things arenât growing quickly enough to justify the premium investors are paying. Even at its current depressed level, the share price works out to about eight times revenues, which is a lot to pay for a company that isnât growing very quickly. Twitter hopes new features such as Moments can help boost the user base, but thereâs no sign of that happening.
The big issue is the ad model
In many ways, user growth is just a subset of a larger problem, which is the companyâs ad model. Most of Twitterâs focus has been on brand advertising, the kind where the sales team goes out and lands big-name clients like McDonaldâs. But that kind of advertising requires huge audiences to be cost-effective, and Twitterâs 300 million users pales next to Facebookâs 1.5 billion. Itâs even smaller than the user base at Instagram, which is becoming more of an advertising force.
Twitter has been trying to build a direct-response ad business alongside the brand business, but it has been having mixed success, in part because it doesnât have the behavioral data to convince advertisers that the business is working. It also isnât able to target users in quite the same laser-like manner that Facebook (FB) can. The result has been lower prices, which is putting pressure on advertising revenue growth.
For a time, investors were willing to pay a premium for Twitter because its advertising revenue was growing by double digits every quarter, and the rate of growth was also increasing. But that no longer seems to be the caseâand boosting the amount of ads in the stream could make it worse. As tech analyst Ben Thompson put it in a recent issue of his subscription newsletter Stratechery:
âBrand advertising is the sort of advertising most adversely affected by Twitterâs lack of scale: brand advertisers want to reach the largest possible audience at the lowest possible cost in both dollars and in effort. In other words, given the reality of Twitterâs growth problem, the company has been building the exact wrong sort of advertising business.â
Cost per engagement
Speaking of ads, if you look underneath the hood of the latest financial results, one number jumps out: Twitterâs CPE, or cost per engagement. Thatâs what the company charges advertisers for each click or share or retweet of their message, and it dropped by almost 40% year-over-year. According to analysts, thatâs almost entirely because of auto-play video ads, which are notoriously poor performers, and are priced accordingly.
Twitterâs head of revenue, Adam Bain, says the low CPE for video means a better return on investment for advertisers, which will encourage more to use them. But if they donât, it means Twitter makes a lot less money. And while ad-engagement levels were up sharplyâwhich helps explain why revenue rose even though CPE fellâthe recent shift to auto-playing videos boosted those engagement levels substantially, because each play is considered an engagement.
Whether the combination of auto-play videos and a low CPE pulls in more high-value advertisers remains to be seen, however. And some agencies complain that Twitterâs cost-per-engagement model doesnât actually translate into âconversions,â which is what advertisers want to seeânamely, a user clicking to go to a website (Twitter recently added a new feature that also lets advertisers pay per click).
Hereâs the hypothetical future investors are wrestling with: Twitterâs user growth remains slow to non-existent, which means large brands are likely to be less interested; that in turn means more low-rent, direct-response advertising. Twitter is touting its reach to âlogged outâ users of the service, but they are probably worth even less. All of which leads to the possibility that Twitterâs revenue growth continues to decelerate.
What you have then is a company with an audience of 300 million, and a relatively low-growth and low-value advertising business attached to it (along with maybe a smattering of e-commerce, etc.). Itâs not that this would be a bad thingâit might even be a pretty good business for a small to medium-sized company. But is it worth $20 billion? Probably not.
You can follow Mathew Ingram on Twitter at @mathewi, and read all of his posts here or via his RSS feed. And please subscribe to Data Sheet, Fortuneâs daily newsletter on the business of technology.


