Twitter earnings: Can they recover?

Investors punished Twitter as new account growth and user engagement rates disappointed. This was in direct contradiction to other social media companies like Yelp and Facebook that have reported strong revenue growth as well as higher adoption rates. What's going on with Twitter?

First, let's be clear that Twitter's basic model is all about capturing market share. And, after this capture is complete, they hope to monetize their user base through advertising. And what does advertising success mean? It means capturing data from your users and targeting ad dollars in the growing mobile space. If you distill social media down to one basic business premise, that's what these companies are trying to do — capture eyeballs that are sticky and sell stuff to users.

Twitter CEO Dick Costolo at the NYSE for the Twitter IPO launch.
Adam Jeffery | CNBC
Twitter CEO Dick Costolo at the NYSE for the Twitter IPO launch.

This type of strategy is all about growth now and making money later. Even Amazon has adopted this strategy with its massive market share and revenue growth. But investors have become less patient and punished the company for losing money (over $450 million) during its latest quarter. You probably didn't know this, but Amazon currently has a price-to-earnings ratio around 500, which doesn't exactly make it a screaming value play.

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The risks in a strategy based on capturing share and making money later is clearly understood by social-media companies. It's a land grab and investors who take the time to really look at what these companies are all about recognize this is speculation on who will be a winner in the social-media space. Twitter knows — and that's why in their SEC-required IPO prospectus they stated the following:

  • "If we fail to grow our user base, or if user engagement or the number of paid engagements with our pay-for-performance promoted products, which we refer to as ad engagements, on our platform decline, our revenue, business and operating results may be harmed."
  • "We generate the substantial majority of our revenue from advertising, and the loss of advertising revenue could harm our business."
  • "If we are unable to compete effectively for users and advertiser spend, our business and operating results could be harmed."

(See the full prospectus.)

The bottom line is that, when a company fails to grow as expected, like Twitter, it essentially exposes the firm to the risks stated in the prospectus and that's what moves the stock. Of course, most investors on the secondary market never read the prospectus, which is probably not a good thing — given that it outline risks for investors.

Facebook is an example of a company that has done well in monetizing their user base, particularly with the insertion of advertising on their mobile platform. I was skeptical they could make such rapid progress and clearly I was wrong in my perspective. While it remains to be seen if they can continue this trajectory forward, they are off to a good start. Its the model for how capture and monetize should work. And its what Twitter is trying to emulate.

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I see Twitter's path as more difficult towards monetizing their user base. The average time spent on Twitter pales in comparison to the average time users spend on Facebook. Supposedly, a numbers of accounts on Twitter aren't active and an inactive user base is not appealing to advertisers.

But, once again, it is speculation on which social media companies will win the land grab. Companies like LinkedIn and Facebook and Yelp appear to be doing well towards their goal of monetizing users. Twitter, not so much. The nature of the application and its use, in my view, does not suggest that users will be planted on their Twitter accounts — and that's what advertisers are most looking for.

Twitter's prospects to become a huge advertising platform are challenging — to say the least. I do not believe that the nature of the app lends itself to long periods of engagement so coveted by advertisers. And what if Facebook decides to put out a competing application? Suddenly Twitter becomes a feature and less a viable standalone application.

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Investors must always remember that the key to appreciating stock prices are the revenues and profits a company can generate — not whether or not a cool technology sparks users' interests. As Cuba Gooding, Jr., said to Tom Cruise in "Jerry Maguire," "Show. Me. The Money!" That's what investors will demand if stock prices are to go up. That's what Twitter failed to do in their last earnings call and that's why the stock went down.

If Twitter is to succeed, they need to figure out how to engage users for longer periods of time. They need to build their business services unit (just has LinkedIn has) in order to engage companies looking to release information on a real-time basis. And they need to look over their shoulder and watch carefully what Facebook is doing — that's the real competitive threat.

Commentary by Michael A. Yoshikami, the CEO and founder of Destination Wealth Management in Walnut Creek, California. He is also a CNBC contributor.

Disclosure: Michael Yoshikami and Destination Wealth Management have no holding in any of the stocks mentioned in this article.