Why Twitter's Moat Eroded

Ali Mogharabi: At the beginning of March, we downgraded our moat rating for Twitter from narrow to none. Twitter's slowdown in user growth remains a concern, and as the company continues to invest in product enhancement and video content, the lack of a turnaround in user growth has made user monetization an increasingly difficult task. For this reason, we have less confidence in Twitter's ability to generate consistent excess returns in the long run.

Twitter is not benefiting from increased spending on mobile and online advertising as much as its peers, as the firm's user base and its growth lag other social networks such as Facebook, Facebook's Instagram, and Snap's Snapchat. Twitter's increasing user engagement, driven by some product enhancements, more content, and some large events, has reaffirmed part of our initial thesis, which supported a narrow moat rating. However, the firm's lower than expected user growth and user monetization are indicative of a weaker network effect and the value of user data.

While user monetization is expected to grow at a slow rate due to only a modest growth in Twitter's user base, revenue growth is assumed to still create some operating leverage as sales and marketing, along with G&A expenses, will grow at a lower rate than the top line starting in 2018. We still expect Twitter to reverse its losses and break even in 2019, followed by some margin expansion through 2026.

We also lowered our fair value estimate for Twitter to $17 per share from $18, based on our downgrade of the firm's moat rating. While Twitter shares are trading at a discount to our fair value estimate, we recommend a wider margin of safety before investing in this no-moat and very high uncertainty name.