May 4, 2015

Twitter future possibilities according to Doug Kass

Twitter's price weakness after Tuesday's lower guidance offered an opportunity to add to my holdings in the social media company, and I paid $41.30 a share, on average, in pre-market trading on Wednesday.

Twitter faces a long runway of sales, profit and user-growth opportunities, and the company represents an important and valuable strategic asset to a buyer who seeks a foothold in social media.

I believe there are three potential outcomes that will influence Twitter's share price. Given my three scenarios and the probability distributions (below), I calculate Twitter's shares to be fairly valued at about $49.75 a share, or 18% above yesterday's close of $42 a share. Here is my calculus:

    Scenario 1: Twitter continues across its present course. Share price value of between $38 and $46, a midpoint value of $42 a share. (Probability 50%)
    Scenario 2: Disappointed in the recent lack of operational progress, the Board of Directors at Twitter replaces current management. Share price value of $48 to $52, midpoint value of $50 a share. (Probability 20%)
    Scenario 3: Disappointed in the recent lack of operational progress, Twitter puts itself up for sale. Share price value of between $60 to $65, midpoint value of $62.50 a share. (Probability 30%)

While the company's execution has been poor recently, Twitter's move into real time video and Periscope are the future of social media and an important potential catalyst for the company's sales and profit growth over the next few years. The rollout of a quality scoring system will improve direct responses from advertisers over time -- as advertisers pay for better quality leads rather than the quantity of leads.

I originally purchased Twitter in early December at $37 a share and I sold 50% of my holdings at $53 a share in early April.

What's gone wrong for the company is that first-quarter sales fell short and user growth was off to a slow start in the current quarter. Ad click rates (CTRs) declined from the fourth quarter of 2014 to the first quarter of 2015 in a mix shift towards formats with lower CTRs. Ad load was unchanged and app install ads underperformed.

In other words, despite the introduction of real-time video and Periscope, management's execution was poor

What's going right is that Twitter is partnering with Google's  (GOOG) DoubleClick unit. (Twitter is getting closer to Google as this partnership follows Google's adding of Tweets into its search functionality.) DoubleClick, a dominant factor in the display ad space, competes directly with Facebook's Atlas Ad Server/Measurement Platform. It will allow advertisers on Twitter to "measure when conversions result from views and other actions on Twitter."

A new attribution model will give advertisers on Twitter a better sense of tracking and will allow for better conversions as well as make Twitter ad inventory available through DoubleClick Bid Manager (a widely used ad-buying platform that supports many online ad exchanges).

The adoption of Periscope's live streaming app has, as I expected, been exceptional, with more than 1 million signups in the first 10 days. The company is now working with Apple (AAPL) on a Spotlight search integration deal. Twitter plans to begin counting users of its SMS follow service as monthly average users -- a figure currently at about 6 million. 

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