the earnings announcement

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Why Twitter's 38 Million Zombies Could Impact Ad Revenue

Twitter CEO Dick Costolo. (NYSE:TWTR) announced Q2 earnings over a week ago and it was the talk of the Street. The company exceeded expectations on revenue growth and key metrics for monthly active user ("MAU"), timeline views and timeline views per MAU. Leading up the earnings announcement I predicted it would be DDay for Twitter, and that the company would announce deteriorating operating metrics and flat revenue quarteroverquarter. The Wall Street Journal reported that 14% of MAUs up from 7% a year ago never interacted with Twitter or saw an ad. Such "Zombies" connected through hundreds of thousands of thirdparty applications they have given permission to link to Twitter and were growing faster than the company's active users.

Of the 271 million people counted in Twitter's latest tally, 14% or 37.9 million, never log in directly to Twitter's website or mobile app, the only places where Twitter serves ads. Instead, they connect through hundreds of thousands of thirdparty applications that the users have given permission to link to Twitter. These are the users who, for example, read tweets on digitalnews app Flipboard, share photos on Twitter from Instagram, blast their location from Foursquare, or tweet stories from news sites.

The following chart illustrates the quarterly change in MAUs, broken down between active and inactive users.

Impact of Twitter ZombiesZombies Can Keep Active Twitter Users Engaged Or Spur Page Views

Though Zombies never log into Twitter's site or see ads, they do have a presence. According the Wall Street Journal, they read tweets on digitalnews app Flipboard, share photos on Twitter via Instagram, tweet stories from news sites or blast their location from Foursquare. In some ways, Zombies help Twitter's active users stay engaged or spur their page views. Whenever LeBron James posts a picture to Twitter via Instagram, thousands react to the picture. Many would not have known about the picture had they not seen it on Twitter. In a similar vein, many people read my Seeking Alpha articles after I post them to Twitter. They do not necessarily go to Seeking Alpha looking for my articles; they simply search my Twitter page. In fact, some people read the articles and then tweet about them, keeping them more engaged.

Presence Of Zombies Mutes Advertisers' Reach

In Q2 2014, Twitter had 271 million users of which 38 million were Zombies. That means only 233 million were active or actually saw an ad on Twitter. In Q1 2013 of the 218 million MAUs, 203 million were active and 15 million (7%) were Zombies. In effect, advertisers were marketing to 38 million fewer users than anticipated in Q1 2014. Going forward, that could reduce the amount of ads they show on Twitter or force them to negotiate lower advertising rates.

Active Users Growing Less, More Engaged www.valentinoshoessale.co.uk Than Once Thought

The following chart attempts to bifurcate Zombies and active users. The attempt may have backfired, however, placing emphasis on the inefficiency of clients' ad spend on the service. The company is currently trying to wring more dollars from Zombies by placing ads on thirdparty sites that pull stories from Twitter. Such thirdparty revenue may be on the come, but the reduction in ad spend on Zombies may occur in realtime.

ConclusionThe revelation that 14% of Twitter's MAUs never log into the service and never see an ad is damaging to Twitter's growth story. Zombies who post stories, articles or updates onto Twitter may keep the company's active users more engaged or spur more timeline views. However, given that the company's growth and advertising reach are less than once thought, I expect advertising rates, ad placement and advertising revenue to decline. At a $26 billion market capitalization based on Friday's close, Twitter trades at about 23x runrate revenue of $1.12 billion. That said, Twitter is a sell.