Equity research note on Twitter performance and outlook (April 2017)

Twitter (Underperform, $14.50) Stock view: Engagement could be improving, but still trailing peers On positive note, DAU growth, tweet impressions, and time spent growth have all been accelerating, and we won't be surprised if most metrics show stable growth in 1Q17 given event activity (political, sports, awards shows) in 1Q. However, the NFL season is over, the election surprise is slowing fading, competitive pressure is rising (particularly Instagram), and new monetization initiatives will take time, so we are more cautious on 2Q. The high level of executive churn also raises an element of strategic uncertainty that could continue to weigh on sentiment. While it’s possible Twitter could see moderate residual benefit from recent YouTube/Google Display Network boycotts, we continue to believe MAU growth acceleration is key to improving sentiment, and we continue to expect other platforms to grow much faster. The biggest upside driver for 1Q could be conservative guidance, which implied revenues would be down 17% y/y at the midpoint in 1Q. Longer-term, our primary concerns are user growth, rising competition in video, and lack of positive advertiser feedback. Despite execution on the live streaming initiative in 2016, MAU impact was underwhelming and we see risk of rising costs and/or content loss in 2017. At this point, it’s unclear how aggressively management will push live streaming in 2017, and early exploration of potential subscription revenue streams (enhanced Tweetdeck offering beta) could suggest potential strategic shifts. On the advertiser side, we are still hearing limited traction with Twitter’s ad platform changes and ROI measurement, and it seems experimental dollars are being moved to Snap. The biggest risk to our Underperform rating, in our view, is the underlying value of the Twitter platform for users and potential Artificial Intelligence (Al} signals. We remain on the sideline for now, with ever-present M&A potential providing some element of a floor to the stock. We think 3x 2017 revenues plus cash ($12/share in total) is a valuation an acquirer could see as very reasonable given stabilizing DAU trends and value of Twitter data. Key theme/metric(s) for 1Q: Mgmt focus on engagement, investors on users MAU growth likely remains the primary focus in terms of metrics investors consider. While DAU growth could continue to growth at high single digits, we do not see much upside potential to low single digit MAU growth (we model 322mn, 4% y/y), which lags in comparison to Facebook’s recent17% y/y growth. We expect engagement metrics in general (tweet impressions, DAU growth, time spent) to be solid, though it’s possible lack of NFL and fading US election catalysts could have some negative effect. In terms of monetization, our ARPU estimate for $1.67 implies a 14% y/y decline, which reflects both weaker Twitter pricing trends and potential competitive pricing pressures. Biggest 1Q issues/risks: ¢ MAU growth could slip: We model 4% y/y MAU growth to 322mn, but fading NFL and election tailwinds could lead to weaker user growth trends in 2Q. ¢ Competition could impact pricing: Management noted elevated competition in mid-January (shortly after Snap’s ad API update}, which may have continued throughout the quarter and impacted pricing more than anticipated. - Live streaming pipeline in question: Amazon recently announced a deal with the NFL to steam game content, replacing Twitter. ¢ Ad product wind-down could impact revenue: Management indicated that it is reevaluating lower return ad formats, and a decision to wind down certain formats (like direct response, promoted tweets) could further impact 2Q guidance. Bankof America Merrill Lynch Internet/e-Commerce | 06 April2017 43 HOUSE_OVERSIGHT_014929