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Is Twitter Finally Singing the Song Wall Street Wants to Hear?

In this segment from the Market Foolery podcast, host Chris Hill and David Kretzmann of Motley Fool Rule Breakers and SuperNova take a close look at Twitter (NYSE: TWTR), which posted higher than expected revenue and raised guidance.

Sales were still down, but the pace of the slowdown is slowing. And they're close to GAAP profitability. Was the day's optimism a case of genuine positivity, or a matter of beating low expectations? And what's next?

A full transcript follows the video.

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This video was recorded on Oct. 26, 2017.

Chris Hill: Shares of Twitter are up 15% this morning. The third-quarter revenue came in higher than expected. They raised guidance for the fourth quarter. This has been a long time coming. If you're a Twitter shareholder, you're having a good day, and it's been a long time since you've had a day like this.

David Kretzmann: Yeah. Honestly, I think part of it, going back to our IBM conversation last week, it really helps when expectations are low. You have a low bar to jump over. I think that's part of what Twitter is dealing with. Their sales were still down 4% this quarter, so they are still shrinking, but the pace of sales declines is slowing. So that's a plus. Last quarter was down 5%. That's improving. They're also really improving their expense management. Their GAAP expenses were down 16%. It's nice when you can cut costs more than your sales are dropping. They're getting closer and closer to GAAP profitability. They're still not quite there, but they think within the next couple of quarters they could hit that mark.

In general, a lot of things moving in the right direction for Twitter, although there's still a lot of room for improvement. But their daily active users are up 14%, so they're just finding ways to increase engagement on that platform, which is obviously what they need right now.

Hill: It absolutely is. When you think about what's driving the revenue, when you think about advertising, I think part of what helps them, part of why I think there's some optimism about the next six months, particularly if they get the profitability next quarter or the one after that, is, one of the things a quarter like this does is it makes people whose job it is to control large advertising budgets, it makes them think twice about skipping Twitter. There was a good stretch of time where Twitter was, if not outright ignored by a lot of ad companies and ad firms and major brands, that sort of thing, this keeps them in the conversation, particularly, as you mentioned, the growth users. When you can add a few million users, that makes it more likely that advertisers are going to come your way.

Kretzmann: Yeah, and ad engagement on the platform almost doubled this quarter. The cost per engagement was down about 50%. But still, in general, moving the right direction. The volume of engagement, people are seeing more ads, which is obviously the direction it needs to go. They are pushing more and more into live video. This past quarter, they streamed 830 events. For the life of me, I don't know where to go on Twitter to find the live video. And I feel like I'm a semi-smart guy. I can use Snapchat, which is supposed to be the most complicated social-media app out there. But Twitter, for the life of me, I can't figure out where they host the live video on their platform. And even people who are die-hard Twitter users, like Jay-Mo here at Fool HQ, even he has a hard time finding it. It's like, guys, discovering live video shouldn't be this hard on your platform when that's supposed to be a key tenet of your strategy.

Hill: Absolutely. I can't remember if it was on Market Foolery or Motley Fool Money, Jason has mentioned that recently, and it's absolutely true. And I am, in fact, reminded of the lack of visibility on their video strategy every time I open up Twitter on the desktop, because when I go to Twitter, it automatically opens up a video screen on the right-hand side of the page. And so, whatever is the thing you mentioned -- how many?

Kretzmann: 830.

Hill: 830, OK. So when I open up Twitter on desktop, whatever is the one live video that they're promoting at that moment -- sometimes it's financial news; sometimes it's a sporting event if it's the evening -- if it's got my attention, I'll start watching it. But every single time, whether I watch it or not, I'm reminded of the fact that, there's still no central section for video where I can click through and say, I know you're streaming other stuff live; where can I find it?

Kretzmann: It seems like a no-brainer. They are testing other ways to increase user engagement, test different things around. They're testing longer character limits. It took them 11 years to figure out that people actually max out their 140 characters in Twitter when they have all sorts of numbers and symbols trying to squeeze as much as possible into 140 characters. So they're at least starting to test rolling out longer character limits, going up to 280 characters, essentially doubling the number of characters you can put in your quality Twitter posts.

In general, this is the most optimistic I've been about Twitter in a while. For a long time, this has been an easy company to hate on, but they are controlling their stock-based compensation, their other expenses, bringing their expenses in general into a better position, better contained. They have $2.5 billion of net cash on the balance sheet. They are more and more free cash flow positive, and that's not just due to stock-based compensation. And they are getting closer to GAAP profitability. So in general, I think the company is in a stronger position today, even though sales are still dropping. But I think there are better days ahead.

Hill: I'm glad you mentioned the compensation, because that was one pretty significant reason why, a year ago, two years ago, plenty of smart people looked at Twitter and thought that company is going to be bought, because they can't maintain the path they're on right now. And a big part of that was the stock-based compensation.

Kretzmann: And it's still high. Last year, it was about 25% of total sales that was made up of stock-based compensation, which is very high. Alphabet, for comparison, was 7%-8%. Facebook was 15%. I'm not sure where Facebook is at this year. But now, Twitter has gotten that number down to 17%. So it's still on the high end of the spectrum. The diluted share count is still almost growing 1% each quarter, but that number has, bit by bit, decelerated. So, moving in the right direction but still some work to do.

Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Chris Hill has no position in any of the stocks mentioned. David Kretzmann owns shares of Alphabet (C shares), Facebook, and Twitter. The Motley Fool owns shares of and recommends Alphabet (A shares), Alphabet (C shares), Facebook, and Twitter. The Motley Fool has a disclosure policy.