Description

Similar in many ways to my 2016 LinkedIn investment, with *much* greater upside potential.  Massively under-monetized and orphaned by both growth and value investors, Twitter is the most powerful media platform in the world with an easily fixed "free rider" problem. Dorsey’s comments in March suggest he realizes this, likely under pressure from the two finest technology activist investors in America: Silver Lake's Egon Durban and Elliott's Jesse Cohn, who in recent weeks have invested roughly $2 billion in the company and joined the Board.  Historically, the stock has been pariah to most investors - that outdated perception is likely to change quickly as the clouds break, setting the path to an $80-100 stock.

Based in San Francisco, California, Twitter, Inc. (“Twitter”) is the ubiquitous social media platform operating in over 40 languages worldwide, with 164 million monetizable daily active users (“mDAU”) and likely over 300 million total users.  Twitter completed its initial public offering in November 2013 at $26 per share, and the shares rose quickly to nearly $70 before weakening user metrics and sharply slowing revenue growth caused management turnover and investor despair, taking the shares down approximately 80% from their highs. 

Following a rollercoaster seven years, and due to an advertising market disruption from coronavirus, the shares again trade around the 2013 IPO price, yet today's Twitter is dramatically improved, extraordinarily powerful and exhibits numerous business and situational dynamics that I believe have potential to lead to a positive outcome for investors:

Quasi-Monopoly, Likely Irreplicable Platform with Very Attractive Business Model.  The network effect that Twitter has developed is an incredible feat.  The company’s platform is essential for those in the media, politics, sports, entertainment and investment industries, and for all who are interested in current events.  There is no other source for truly real-time news and unfiltered, unfettered information.  When world events occur, the news, along with first-hand photographs and videos, inevitably breaks on Twitter, and well in advance of its reporting by traditional news outlets.  Media companies, news agencies, reporters, celebrities, executives, experts and self-styled “influencers” all rely heavily on the platform for both the sourcing and dissemination of content, and their ability to drive traffic to their own sites is reliant on links in their tweets.  From a business model perspective, Twitter has three of the most attractive possible attributes:

• Powerful network effects, as user growth begets user growth;
• All content is user-generated – “UGC” in Silicon Valley parlance – the dynamic that has driven the massive success of platforms such as YouTube, Facebook and Instagram, costing the company nothing; and
• Frictionless, self-service sign-up, where new users can download the app and be learning/reading/tweeting in seconds. 

As Bill Gurley, legendary Benchmark venture capitalist, said in a 2019 University of Texas lecture, “Twitter is the most amazing learning network ever built.”

Activist Investments.  Historically, a primary investor criticism of Twitter has been that it has a politically active, slow moving and inattentive management team led by founder/CEO Jack Dorsey, a visionary programmer who is simultaneously the founder/CEO of payments company Square.  Dorsey, who owns 18 million shares of Twitter worth approximately $0.5 billion, also owns 59 million shares of Square worth nearly $3.5 billion (including his newly formed donor-advised fund), setting up a dynamic where his economic interests seem to favor the latter.  In November 2019, Dorsey tweeted that he was planning to move to Africa in 2020, calling into serious question his commitment and how he would manage these companies from a far-removed location.  This was particularly shocking as Twitter shares had recently fallen from over $45 in September 2019 to below $30.

With shares having partially recovered to the mid-to-high $30s in February, on February 28th reports began to emerge that activist investor Elliott Management had built a substantial stake in Twitter, and was seeking Dorsey’s ouster.  Elliott, founded by Paul Singer, is known for “a uniquely adversarial, and immensely profitable, way of doing business” according to The New Yorker.  Less than a week later, on March 5th, Dorsey spoke at a Morgan Stanley conference and said he was reconsidering his Africa plans given “everything else going on.”  Nine days later, the company announced that it had reached an agreement with Elliott and Silver Lake Partners, arguably the world’s leading technology private equity investor, whereby:

• Dorsey would remain CEO (at least in the near-term, as in the April 15th proxy, there is a new line stating “In 2020, our management structure committee will also evaluate the Chief Executive Offer succession plan…”);
• Silver Lake would invest $1 billion via a 0.375% 5-year convertible note with a conversion price of $41.50;
• Silver Lake’s Co-Chief Executive Officer Egon Durban, whose past high profile successes include the purchase, turnaround and massively profitable sale of Skype and embattled take-private of Dell, and Elliott’s Head of U.S. Equity Activism Jesse Cohn, who has a reputation as a ruthless value creator as detailed in this Air Mail article and evidenced by his successes including AT&T and eBay, both joined Twitter’s board;
• Announced an initial goal of growing monetizable daily active users (“mDAU”) by 20%+ going forward; and
• A new share repurchase authorization of $2 billion to be funded by the Silver Lake investment and pre-existing cash.  Depending on the price, this could represent roughly 10% of shares outstanding and 15% of enterprise value.

This activist event highlights Twitter’s vulnerability, owing in part to its pre-IPO reorganization through which only one class of stock was issued.  This is a critical difference from most founder-led companies that employ super-voting share classes specifically to prevent such outside activism.

Fortress Balance Sheet and Tax Shield.  Notably, with over $6.6 billion of pre-existing cash, Twitter did not need Silver Lake’s capital infusion.  Pro forma for the Silver Lake investment, Twitter now has approximately $7.6 billion of cash, offset by only $3.8 billion of extremely low-cost debt, with coupons ranging from 0.25% to 3.875% and effective conversion prices of $41.50, $80.20 and $105.28.  In addition, the company will have minimal cash taxes in the near term owing to its $2.3 billion of federal and $1.3 billion of state net operating loss carryforwards.

Substantial Monetization Potential.  In early 2019, Twitter announced it would stop reporting its total user count, as it had taken aggressive action to remove bot and spam accounts, and began reporting mDAU.  Notably, this decision resulted in Twitter swinging from overstating its user base to understating it, as mDAU excludes less active users and an unknown number of power users who use the company’s TweetDeck or third-party platforms through which Twitter does not currently display advertising or charge subscription fees.

Twitter's value proposition is Twitter’s value proposition is essentially infinite under its current, free structure.  I would gladly pay a significant monthly fee to use the platform for the value it provides me.  In fact, with some additional customization features or ad-free options ("Twitter+" or "Twitter Pro" or "Twitter Premium"?), I would surely pay $50+ per month. There are power users and corporations who would have no choice but to subscribe regardless of price, and the platform’s mission-critical nature could ultimately drive subscription fees higher over time.  For example, it could easily be argued that traditional media companies need Twitter much more than Twitter needs them, yet they are essentially free riders on Twitter’s platform. Once a network effect has been established, I believe it begs to be monetized beyond advertising, while continuing to foster the network’s growth.

To that end, consumers have proven their willingness to pay monthly subscription fees for content, and many of these services have successfully implemented price increases in recent years: 

• Network television (e.g. basic cable at $40-50, YouTube TV at $50, Hulu at $12);
• News (e.g. The New York Times at $10-20, The Wall Street Journal at $20, Miami Herald at $16, Los Angeles Times at $16, San Francisco Chronicle at $15);
• Music (e.g. Spotify, Google Play Music, Pandora, Apple Music at $5-10);
• Video (e.g. Netflix, Amazon Prime Video, HBO, YouTube Premium, Disney+, Apple TV+, CBS All Access at $5-$16);
• Dating (e.g. Tinder, Match, eHarmony at $10-30);
• Career networking (e.g. LinkedIn at $10-100); and
• Blogs (e.g. Substack, which takes 10% of monthly subscription fees charged by writers who publish on the platform).

Going forward, Twitter should be able to maintain and grow its network effect dynamic through its standard free, advertising-supported service, while creating a premium option for super-users, verified “blue check mark” accounts, media companies and corporations.  The financial payoff to such a strategy could be large. For perspective, I have considered the following:

• There are approximately 42 million millionaires in the world according to Credit Suisse, excluding China where Twitter is presently blocked;
• Netflix, Spotify Premium, YouTube Premium and The Wall Street Journal have 167 million, 124 million, 20 million and 3 million paying subscribers, respectively;
• LinkedIn, a platform for professionals, has 675 million members (up from 433 million at the time of our 2016 investment), an estimated 310 million monthly active users, $8.4 billion of run-rate revenue (up from $3.7 billion at the time of our 2016 investment), and is growing revenue at 25%+ annually through a combination of subscription price increases and advertising improvement (note that even paying LinkedIn subscribers are served ads on the platform); and
• Twitter has zero paying subscribers and $0 of subscription revenue, save for a small amount of premium data licensing fees.

Assuming Twitter only grows mDAU by its (likely understated) goal of 20%, it will end 2021 with approximately 220 million mDAU.  If only 5% of these users were to pay $10 per month (half the price of the WSJ despite infinitely more content), the company could generate incremental annual recurring revenue of over $1.3 billion and, assuming an 85% contribution margin, incremental EBITDA and free cash flow of over $1.1 billion.  If Twitter’s 353,000 verified, blue check mark users – who typically depend heavily on the platform to disseminate their messages and view the blue check as a coveted “status symbol” – were charged $30 per month, an incremental $125+ million of revenue and $100+ million of free cash flow could result.  Publicly-traded companies, large private companies and media businesses – which each typically employ numerous Twitter accounts – would be price takers, as it is a mission-critical communication platform. Twitter should also charge a monthly subscription fee for TweetDeck, the platform of choice for all-day desktop users.  Additionally, Twitter has struggled with the roll-out of its Mobile App Promotion product (“MAP”) which allows app advertisers to place “install” buttons directly in promoted tweets, and direct response ads similar to those shown on Instagram – anecdotally, in recent days, such MAP ads have begun to appear in my stream, perhaps signaling the product’s inflection.

There is no question that Silver Lake and Elliott understand the opportunities, and now it appears that Jack Dorsey has felt the pressure to acknowledge them.  On March 5th, he said the following:

“We're completely aware that people are more and more coming to Twitter to figure out what's going on with this crisis.  And we want to balance that responsibility with our business. And I think the company has proven throughout that we have the capability to do that.  But this kind of goes back to the point of our #1 goal on the revenue side is to increase durability, to not be so dependent upon one thing working and being -- and that it being stable.  But we have choices. We have things that may diminish and other things can rise in their place.  So as we look forward 3 to 5 years out, the most important thing for us as a company is to increase that revenue durability.  And that means experimenting with new models that also complement the advertising business.  And I'm proud to say that we're finally at a state as a company, we've done so much work on our foundation as a company. We've done so much work on our foundation from a technology perspective.  So we're finally in a position where we can start experimenting a lot more.  And we can start asking the questions that many of you have probably had in your mind, things like contribution models, tipping models, commerce models, payment models.  These are all things that we just could not prioritize in the past because we had to sequence it behind getting back to usage growth, getting more stability and a clear message around our advertising business and proving it.  And last year was a really big year for us, where everything started to align and compound into the results that we saw all last year and into this year.”

Compared with the company’s $17 billion enterprise value at a $27 share price, and status quo consensus 2021 Adjusted EBITDA of $1.4 billion (before generous stock compensation and other excessive spending, both of which likely will be right-sized under the watch of Elliott/Silver Lake), the financial opportunity appears more than substantial.  Should the company effectively implement a subscription pricing format, Twitter would likely realize the compounded benefit of rising revenues/cash flows and higher valuation multiples.

In sum, I believe Twitter exhibits many of the qualities and situational dynamics that could result in a successful investment for our partnership.  To be clear, the pandemic will weigh severely on the company’s near-term advertising revenue, and near-term earnings reports will not be pretty, and that is the element of the story that is dominating investor focus.  In fact, on March 23rd, Twitter was one of the first companies to pre-announce the negative impact on its business, and that was after only one month of virus impact.  However, the company simultaneously noted that user engagement had accelerated higher, with quarter-to-date mDAUs up 23% year-over-year and 8% sequentially, in this case despite only one month of pandemic benefit.  Because the platform has become quite addictive, new users tend to be sticky, driving a virtuous cycle of growth and increased value for all users.

While sentiment is obviously depressed, as the stock has numerous bearish ratings from sellside analysts and is pariah for buyside investors, I see significant opportunity for both the business and the shares.  By all accounts and evidence, the activists from Silver Lake and Elliott are brilliant, demanding and impatient. In 2016, Disney was reportedly one of several companies that considered acquiring Twitter, only to pull out due to a variety of brand and user behavior issues – since then, platform health has been a primary management focus and has greatly improved.  While I do not specifically predict a strategic sale event, and would rather see the business outperform for a long period of time on a standalone basis, Twitter could be a wonderful fit with a company such as Apple, which would likely love to own the most powerful news and media platform in the world, or Microsoft, which has underutilized search and ad serving expertise via Bing, and previously acquired both LinkedIn and Silver Lake’s Skype.  The strategic potential is clear when considering that at the time of our 2016 LinkedIn purchase, the sellside expected 2019 revenue of roughly $5.5 billion, while under Microsoft’s ownership the actual results achieved were at least 50% higher, creating a likely implied triple for Microsoft shareholders from the deal price. Twitter may have greater potential for improvement.

Disclaimer:  The author of this idea presently has a long position in securities of this issuer and may trade in and out of these positions without notice.  The data contained herein are prepared by the author from publicly available sources and the author's independent research, estimates and opinions.  No representation or warranty is made as to the accuracy of the data or opinions contained herein.  Please do your own research.

Catalyst

Modest execution and incremental improvement in economic outlook

Sentiment shift 

Potential sale to strategic buyer or private equity consortium