By Gerry Shih
SAN FRANCISCO (Reuters) - Twitter, whose shares had soared more than 150 percent since their November debut on Wall Street, stunned investors this week with a one-two punch of bad news: near-flat user growth and a drop in engagement among its 241 million members.
To assuage fears that the company's growth is plateauing, and to justify its rich valuation - still at $28 billion even after a 24 percent drop on Thursday - Chief Executive Dick Costolo must now convince investors that he can quickly make the right moves to broaden Twitter's appeal.
"The fact that we've seen timeline views per user go down two quarters in a row suggests that it's more than just a design problem, that they may be hitting a ceiling for their current iteration," said Nate Elliot, an analyst at Forrester Research. "Clearly we've seen that other social sites, even ones that are much bigger, have kept growing by adding new features and new functionality."
So far, Costolo has asked for time to implement a series of changes that, while not directly lifting Twitter's user growth, will help the service gain traction over several quarters.
Costolo told analysts on a conference call Wednesday that tweaks such as directly displaying pictures and videos in the timeline, or stringing conversations into a thread, have raised user engagement metrics by 35 percent and that the company must continue its course.
"We don't think we need to change anything about the characteristics of our platform, we simply need to make Twitter a better Twitter," the CEO said.
But Wall Street's lingering concerns point to a central dilemma about Twitter's evolution. In the past six years, the service has spread precisely because of its spare, lightweight format, which has fueled everything from mass protests in the Arab world to Hollywood celebrity spitting matches.
Yet critics say Twitter has failed to innovate quickly, especially compared to Facebook Inc , which famously lives by Chief Executive Mark Zuckerberg's mantra: "Move fast and break things." Twitter's overseas rivals, such as Sina Weibo , also often copy each others' features and overhaul their own offerings with ruthless efficiency.
Brian Blau, an analyst at Gartner, said Twitter's relatively slow evolution was part of the company's cautious culture, which has been highly methodical in testing how to deploy advertisements or how to venture into a new line of business.
For instance, speculation has mounted for years that Twitter would introduce real-time commerce to its platform, but executives have only begun to openly address the subject in recent months and staff up its e-commerce team.
In comparison, Facebook in 2006 introduced the "news feed," which completely changed the feel of the service but has since become its most central element. By 2010, its sixth year, the world's largest social media site was still gaining users at a rate of more than 10 percent quarter over quarter, and had topped 600 million members by the end of that year.
In the most recent quarter, Facebook delivered its strongest revenue growth in two years, beating Wall Street targets, and said it now has 1.23 billion monthly users.
Twitter reported higher-than-expected fourth-quarter revenue, but investors focused on user growth of just 3.8 percent, the lowest rate of quarter-on-quarter growth since Twitter began disclosing user figures.
"The challenges around user metrics in the fourth quarter are likely to raise more questions around whether Twitter can become a truly mainstream product," JP Morgan analyst Doug Anmuth said in a research note.
BIGGER CHANGES IN STORE?
Some of the tweaks Costolo spoke of were cosmetic, such as helping new users find their friends more easily so they won't abandon Twitter within the first hours or days. But the CEO also hinted that Twitter might make more drastic changes, including introducing an alternative to the chronological timeline, which until now has underpinned the user experience.
"We want to do a better job organizing content for our users along topical lines rather than just chronological," Costolo said on the conference call. "Topic-based discovery on our platform will make Twitter easier to understand and use for everyone."
Under Costolo's stewardship, Twitter has been credited with conceiving the advertising model of injecting ads directly into the timeline, now the de facto business model for social media in the mobile era. But it also came under pressure for not moving quickly enough in 2010 and 2011, when it was quietly perfecting that advertising product with experiments.
Costolo on Wednesday repeatedly stressed that the company conducts extensive research into user behavior before making moves to juice up user growth. An uptick in traction may only take effect slowly through 2014, he warned.
Blau said he agreed with Costolo's belief that Twitter possessed a basic appeal to people around the world, but he said the management needs to move faster.
"It's basic human behavior that people want to have open public discourse," Blau said. "It may be a matter of changing Twitter's interface to make that smoother. They need time to figure it out, but time right now is a luxury."
(Editing by Bernard Orr)