Here’s Why We Changed Twitter’s Price Estimate To $49

We recently changed our price estimate for Twitter‘s (NYSE:TWTR) stock from $39.10 to $49.30, reflecting a change of around 25%. The rapid rise in Twitter’s monetization was the key factor responsible for this updated valuation. It has been fueled by an increase in ad load levels, surge in the user base, the  roll-out of better and more targeted ads that derive higher pricing, as well as the monetization opportunity from the passive user base. In addition, we expect significant EBITDA margin expansion over our forecast period, owing to both operating leverage and the growing maturity in the business model. Finally, a decrease in capital expenditure as a percent of revenue in the long-run will lead to strong growth in free cash flows.

Our $49.3 price estimate for Twitter’s stock, represents near-5% upside to the current market price.

See our complete analysis for Twitter

Twitter’s Top-line Could Surge To $9.3 Billion By 2021

We estimate Twitter’s revenue to increase from $1.4 billion in 2014 at a CAGR of over 30% over our forecast horizon to reach $9.3 billion by 2021. The key rationale behind this top-line estimate includes:

• Twitter’s monthly active user base is estimated to rise from 274.5 million (average) in 2014 to 526.3 million by 2021, driven by high growth across international markets. We estimate Twitter’s international users to increase by around 30 million annually over our forecast period.
• Additionally, expansion in ad load levels on the platform will drive increased monetization over our forecast period. At around 1.5%, Twitter’s ad load levels are presently far below the 5% levels for more mature social networks (such as Facebook). The total number of ad engagements rose by 150% and 78% year-over-year in Q3 2014 and Q4 2014 respectively, and we expect this trend to continue in the coming years until ad load levels become optimal on Twitter. Hence, demand rather than supply will be the key factor that will govern the future pace of Twiter’s monetization.
• Cost per ad engagement could also move up in the coming years, as Twitter rolls out more advanced ads (featuring videos), and improves the targetability, measurement and click through rates for advertisements.
• International growth is a key driver for the Twitter’s stock as it is rapidly expanding its sales network as well as the reach of its self-service advertising platform across international markets. Consequently, international ad revenue per 1,000 timeline views could rise from $0.80 in 2014 to over $3.00 in the long-run.
• A significant monetization opportunity also stems from the hundreds of millions of visitors who visit Twitter-owned properties who don’t login, as well as from the over 185 billion tweet impressions that are accessed through syndication across the web quarterly. With Twitter recently partnering with Flipboard and Yahoo Japan to syndicate its ads across its tweet impressions on these web properties, we believe this revenue stream could start generating steam going forward.

Twitter’s EBITDA Margin Could Cross 45% By 2021

We forecast Twitter’s EBITDA margin to increase from 21.4% in 2014 to 48.8% by 2021. We think these bottom-line estimates are achievable — as a benchmark, Facebook’s adjusted EBITDA margin was seen at 66% in 2014, hence there is considerable headway ahead for margin expansion at Twitter. The key factors driving our bottom-line forecasts include:

• Operating leverage owing to faster top-line growth will be the key factor that will cause operating expenses as a percentage of revenue to decrease over the coming years.
• While Twitter is rapidly expanding its sales presence across international markets presently, we expect the company’s business model to become more mature in the future, and this could drive down costs over the long-run.
• Though we expect R&D dollars to rise in absolute terms over coming years, we believe these expenses as a percent of revenue will trend down significantly, due to the uniqueness of Twitter’s platform. While Twitter will continue to invest in areas that bolster user engagement and ad relevance, we believe the company will avoid making the platform too complicated or cluttered with features, which could cap the growth in R&D expenses.
• In their Investors Day conference, Twitters’ management guided long-term costs as a percent of revenue (excluding stock compensation and amortization of intangible assets) as follows: cost of revenue at 20%-22%; R&D expenses at 15%-17%; sales and marketing costs at 22%-24%; general & administrative expenses at 8%-9%; depreciation & amortization at 10%-12%. We think Twitter could easily meet and outpace these targets in the long-run.

In any event, if Twitter’s EBITDA margin increases to 60% by the end of our forecast horizon, then it could be a game changer of TWTR’s stock, taking our price estimate 20% higher to $60.

Capex As A % Of Revenue Could Fall To 7%-8% In The Long-Run

We have forecasted capital expenditure as a percentage of revenue to fall down significantly over our forecast horizon, even though this metric will rise sharply in 2015 owing to investments in data center infrastructure and real estate. This is because Twitter’s business model is not capital intensive.  We have also drawn parallel with Facebook’s business to arrive at these estimates. Our other forecasts include a discount rate at 11% and effective tax rate to stay negligible over the coming years due to significant net operating loss carry-forwards. We’d encourage our readers to tweak our estimates to evaluate the impact on TWTR’s valuation.

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