Short-form social media company Twitter (NYSE: TWTR) is currently embroiled in a bitter dispute with Elon Musk, the innovating billionaire and head of electric vehicle maker Tesla. Musk offered to buy Twitter for $54.20 per share back in April, but he has since tried to pull out of the deal citing a lack of transparency and concerns about its user base.
The parties are fighting it out in court, but back at Twitter HQ, management faces perhaps a more pressing challenge: The company is experiencing a slowdown. Consumers and businesses are grappling with high inflation and rising interest rates, which means there’s far less advertising spending happening, and that’s the main driver of Twitter’s revenue.
Setting aside the Musk controversy, here’s what Twitter’s recent second-quarter financial results suggest about the economy, and why investors might want to avoid owning the company’s stock.
Twitter is adding users, but revenue is stagnant
Twitter is still growing as a platform, which means consumers still find it useful and entertaining, so the company is winning half the battle. The other half is monetizing those users, and unfortunately, that’s proving to be a challenge.
This isn’t unique to Twitter, though. Snap Inc (NYSE: SNAP), the parent company of social media platform SnapChat, is experiencing a similar phenomenon. Both companies are generating modest user growth while at the same time watching quarterly revenue plateau after dropping heavily from late-2021 levels. That means there’s an underlying trend across companies that rely on advertising for revenue.
Twitter didn’t host a conference call after its recent Q2 2022 earnings report because of its pending transaction with Musk, but Snap did, and that company discussed an across-the-board drop in demand for advertising spots from businesses. It cited higher inflation, which was hitting the bottom line of the corporate sector, compelling them to cut back on spending.
Also, when businesses feel consumer spending is likely to slow down, they tend to invest less money in marketing because their return on those dollars will inevitably be far lower than usual. Therefore, Twitter’s weak revenue numbers in 2022 are likely a sign of broader economic weakness.
Twitter won’t meet its 2023 projections
In February 2021, Twitter outlined operating targets it expected to achieve by the end of 2023. It told investors it wanted to reach 315 million monetizable daily active users and $7.5 billion in full-year revenue, but in light of its recent results, it’s almost certain to miss on both metrics.
It will have to grow its user base by 4.8% sequentially every quarter for the next six quarters to accrue 315 million users by the end of 2023. Since Q1 2021, Twitter’s user growth rate has averaged just 3.1% per quarter. Unless there’s a significant acceleration from here, it will fall several million users short of its target.
On the revenue front, analysts expect Twitter’s 2022 full-year revenue to come in at $5.8 billion, followed by $6.9 billion in 2023. That’s about $600 million short of its $7.5 billion goal. In the face of falling advertising demand and economic weakness, analysts’ estimates will likely only be revised lower in the coming months, placing Twitter’s target further out of reach.
Musk might be Twitter’s best shot at delivering value
But not necessarily from an operational standpoint. Twitter’s stock currently trades at $39 which is 27% below Musk’s $54.20 per share offer. In light of Twitter’s slowing financial results and the potential for further economic challenges, it’s unlikely the company’s stock will recover far beyond its current price without Musk completing this deal.
Twitter’s next two quarters are crucial because if its revenue comes in at the same level as its Q1 and Q2 results, the company will be facing a year-over-year contraction rather than growth. That means Twitter would effectively be a shrinking business, at least in the short term, and that’s a recipe for share-price depreciation.
High-profile Wall Street banks like Goldman Sachs and Bank of America think the U.S. has a 35% to 50% chance of falling into a recession within the next two years. If those predictions come true, Twitter (along with other social media companies) could experience a prolonged deterioration in its business.
The silver lining is that Twitter’s platform is still growing, so when the economy eventually bounces back, the company will have a much larger monetizable user base whether the Musk deal goes through or not.
Bank of America is an advertising partner of The Ascent, a Motley Fool company. Anthony Di Pizio has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Goldman Sachs, Tesla, and Twitter. The Motley Fool has a disclosure policy.