Investors are starting to see some worrying signs that user growth – often seen as a predictor of future profitability – at some of the world's biggest technology firms is starting to hit a wall.
Despite largely meeting or beating analyst expectations in most key financial metrics, Twitter Inc. saw its share price drop sharply in after-hours trading on Monday following its third-quarter earnings announcement. For the three months ended Sept. 30, 2014, revenue of $361-million (U.S.) marked a 114-per-cent increase from the same period last year, and beat the average analyst expectation of $351-million. The company's adjusted earnings of $0.01 a share were in line with expectations – as was guidance for the coming quarter.
But Twitter's share price sank more than 10 per cent, as investors appeared especially spooked by the San Francisco-based company's user-growth rates, rather than its financial performance.
The company added another 13 million monthly active users in its most recent quarter, bringing the total to about 284 million. User growth appears to be slowing, however. In the past quarter, the number of monthly active users increased about 23 per cent year over year – a year ago, that growth rate was 30 per cent, and has been in slow decline every quarter since.
"I think in any business where you're selling eyeballs based on impressions, you can't incrementally sell more ads if you don't have more eyeballs," said Neil Bearse, associate director of marketing at Queen's School of Business.
"There's only so many places you can put ads – and frequency with which you can show them – before people start to go elsewhere."
Twitter is among a number of major technology companies that have made it clear the corporate priority for the foreseeable future is, in the words of CEO Dick Costolo, "to build the largest audience in the world." Monetizing that audience comes later.
"We have to continue to grow our monthly active users and make Twitter an increasingly daily use case for them," Mr. Costolo told analysts on a conference call following the earnings announcement.
"I'm happy with the strategy and the quality of the work we're doing, but given our significant aspirations and the breadth of the opportunity in front of us, it's more critical than ever that we increase our overall pace of execution."
Mr. Costolo described Twitter's user base as a number of concentric circles – the core circle being the company's user base of half a billion users. Beyond that, he said, are the hundreds of millions of users who visit Twitter but don't log in to the service. And beyond that, the users who see Twitter content embedded in other media, such as stories on news websites. Before increasing the placement of ads shown to those users, the company appears focused on improving the product experience first.
However, investors and analysts appear to be a little less willing to give Twitter and other major technology companies as much leeway to ignore core financial metrics in pursuit of user growth. Last week, online retailing giant Amazon.com Inc. saw its share price dip after it showed less-than-stellar sales growth. On Tuesday, Facebook Inc. – a company that has already experienced years of massive user growth – is expected to announce its third-quarter results. Investors will be paying close attention to the company's efforts to generate more money from its more than one-billion-strong user base.