TWTR Twitter Inc

By Marc Vartabedian, Yoree Koh and Michael Wursthorn 

Shares of Twitter Inc. and Facebook Inc. endured a surprise rout this week, as investors were rattled by signs that users are souring on the social-media stalwarts.

Twitter said Friday that its number of monthly users dropped in the second quarter and could continue to fall as it purges fake accounts, results that echoed Facebook's bombshell guidance Wednesday that its growth is expected to slow through the end of the year.

Both companies suffered share-price declines of more than 20% after results. Facebook's drop of over 19% on Thursday lopped more than $119 billion from its market value -- the biggest single-day drop in U.S. market history. Twitter lost almost $7 billion.

"We're two for two being down 20%," said Brent Thill, an analyst at Jefferies, adding, "It has not been a great week."

The S&P 500 dropped 1% over the last two trading days of the week, its largest two-day point and percentage decline this month, as the disappointing earnings reports put pressure on the technology sector. The tech-heavy Nasdaq Composite suffered a bigger loss of 2.5% over the same period.

Facebook and Twitter have different business models but each is dependent on grabbing -- and keeping -- people's attention and then showing ads to them. That imperative on occasion has led them to embrace content that is viral or provocative, and now they are trying to find a better balance that will keep users engaged without driving them away. For instance, both are scrambling to clean up their platforms, which were the epicenter of Russian misinformation campaigns around the 2016 U.S. presidential election.

Advertisers have flocked to the platforms in recent years but may pursue other options if user engagement falls in a meaningful way or if the sites get overrun with ugly content. Privacy concerns are also affecting the way users think about social media, particularly Facebook.

This week's results show social media "hitting the pause button" after years of embracing a growth-at-all-costs mentality, said Colin Sebastian, an analyst at Robert W. Baird & Co. The combination of Europe's new privacy law, which went into effect in May, and the investments that Facebook and Twitter are making in security are a short-term drag on growth.

Still, he said, "this is more likely a speed bump than a structural shift in the way people are consuming media online."

Ahead of their earnings reports, Facebook and Twitter shares had risen 23% and 79%, respectively, since the beginning of the year, so the dramatic slumps were at least in part about valuation. But the epic wipeout in shareholder value is forcing investors to rethink the dominance of the so-called FAANG group, which includes Facebook, Amazon.com Inc., Apple Inc., Netflix Inc. and Google parent Alphabet Inc.

The stocks have been among the best performers in the S&P 500 this year, and some investors think of them as a unit rather than individual businesses with unique challenges.

Alphabet and Amazon, for example, both produced strong earnings in the second quarter, in line with what bullish investors have come to count on. The social-media slump, though, will serve as a warning sign for anyone with broad exposure to big tech giants.

"These really high growth rates can't go on forever," said Scott Wren, managing director and senior global equity strategist at Wells Fargo Investment Institute. "So people have to readjust for these lower growth rates by taking some money off the table."

In the new environment, analysts said, the social-media sites will be under more pressure to find fresh sources of growth beyond their core platforms and the U.S. market. Facebook's user growth is more robust in regions such as Asia, compared with the U.S., and further expansion internationally will be closely watched, several investors said.

They will also be scrutinizing the social-networking giant's progress of further monetizing newer features such as Instagram "Stories," which have become increasingly popular among users, said Dan Morgan, a senior portfolio manager with Synovus Trust Co.

Twitter said the second quarter was the first in which revenue from international ads exceeded that from ads in the U.S., a trend it expects to continue in the near term.

But few expect either Facebook or Twitter to deviate from the ad-based business model that has been their foundation, an idea that "would be like saying a chocolate company should seriously think about getting into the salad business," said Brian Wieser, senior research analyst at Pivotal Research.

Twitter attributed its drop in monthly users largely to its efforts at "improving the health of the public conversation" on the platform. It also cited Europe's tough new privacy law, as well as a move away from contracts in some markets where people receive tweets through texts. Combined, the three factors erased more than 3 million monthly users in the quarter.

Chief Executive Jack Dorsey told analysts Twitter is moving faster than expected to clean up the quality of conversation on the platform, and that the efforts will have a positive impact on building engagement.

"We see health as a growth factor for us over the long term," he said. But he likened work cleaning up the platform to dealing with security. "We don't think this work will ever be done -- it doesn't have an endpoint," he said.

Facebook likewise has been plowing money into hiring people to better police activity on the platform, efforts that will ding margins. Until this week's surprise guidance, Facebook had shown few business effects from the negative headlines that have dogged it in recent months. And many analysts touted Thursday's massive drop as a buying opportunity, but that wasn't the consensus: Facebook shares fell slightly on Friday.

Write to Yoree Koh at yoree.koh@wsj.com and Michael Wursthorn at Michael.Wursthorn@wsj.com

(END) Dow Jones Newswires

July 27, 2018 19:34 ET (23:34 GMT)

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