Twitter Inc: Investor Discussion

Publicly Traded Companies Mentioned Herein: Citrix Systems Inc (CTXS), Dell Technologies Inc (DELL), GlaxoSmithKline PLC (GSK), Meta Platforms Inc (FB), Pinterest Inc (PINS), salesforce.com Inc (CRM), Twitter Inc (TWTR)

DeMatteo Research hosted a discussion on Twitter (TWTR) with three investors. The following is a compilation of their thoughts and ideas from the discussion:

Highlights

One investor with a positive/long bias on Twitter (TWTR) noted that since Jack Dorsey returned as CEO in 2017, the company has spent a good deal of time and resources rebuilding the ad tech stack (an ad server rebuild in 2020 and fixing a direct response ad solution that broke down in 2019). But really, the company has done very little on the product side during that time frame other than the switch to a “recommended” timeline vs. chronological. That one move did fuel a good deal of new engagement.

Now, several product improvements are rolling out on the consumer side including Spaces, Communities, and a revamped TweetDeck. Communities should help provide ad signal in a way that Twitter has never had before. Also, Business Profiles should be a big help to SMBs, which have historically been poorly served by Twitter as far as tools and ad capabilities. 

On the advertising side, Twitter never had a robust, server-based API to do measurement and attribution for direct response advertising. It’s still quite basic today compared to competitor capabilities, but Twitter is making steady, modest improvements on that front each quarter. The company operates and moves slowly, as another investor points out.

On a corporate governance/shareholder side, some investors believe that Twitter’s recently installed CEO, Parag Agrawal, has a couple of years’ time ahead of him to execute on initiatives in preparation for a potential sale of the company. This belief is based largely on the presence of Elliott Management and Silver Lake Partners, as both firms have taken sizable positions and active roles in Twitter in the last three years.

There’s been a notable recent trend and success of PE funds in raising $15B - $50B in dedicated LBO capital to buy out firms such as Citrix, EMC, Dell, and, more recently, the expected purchase of GlaxoSmithKline PLC’s consumer unit. These deals speak to a potential outcome here for Twitter, with one investor thinking a takeout price could be as high as $50 per share.

Another investor has also, historically, been long Twitter. Much like another investor, he owned the stock up until the Analyst Day (Feb. 25, 2021), then sold the position entirely. One of these investors recently bought the stock again, while the other remains on the sidelines. 

The investor who remains on the sidelines hasn’t bought the stock again yet because, despite all the new product announcements, there’s been no inflection point in engagement to the platform from any of the new initiatives. To get reinvolved, this investor would like to see the company prove out the more attractive part of the ad thesis, Direct Response. And secondly, he would like to see an inflection point on user engagement (both user growth and usage of the platform).

A third investor has what he describes as a love-hate relationship with Twitter. He is a big fan of Twitter’s Chairman, Bret Taylor, who is co-CEO of Salesforce (CRM) and has served on the Twitter board since 2016. He has owned the stock for several years and remains a holder. Given the 50%+ decline in the stock price since the 2021 Analyst Day, this investor is contemplating doubling down on his position but hasn’t found the right entry point. He points out that Twitter’s monetizable daily active users (mDAUs) are poorly monetized. One example is the fact that any person can use Twitter every day on their Web browser without being forced to register or log in. The registration wall page is not great as users can easily work around having to sign in. Despite such shortcomings, he views Twitter as one of the most critical information platforms in the world and believes it is only a matter of time before many of these easy fixes and under-investments are adequately addressed. 

The investors were not in agreement on the new CEO. In speaking to those who’ve worked with new CEO Parag Agrawal in the past, one investor finds him to be a disappointing choice—underwhelming as a leader. Another investor has a more positive view on Agrawal. Based on this presenter’s checks, he believes Agrawal is well respected within Twitter, and that he understands both the product and the tech stack extremely well. If someone had been hired from the outside, that CEO might have demanded an unrealistic pace of execution given the many legacy tech issues the company still faces.

All investors are keeping a close eye on upcoming 2022 earnings comps vs. last year and how the Street will digest those comps. Twitter is expected to report Q4 earnings on 02/10/2022 before the market open.

Twitter’s whole ethos has been to refrain from being at all aggressive toward users the way peers have been in building the active (registered) user base. There was agreement among all investors that this must change and that perhaps the pace of change will quicken under Agrawal and given the involvement of activist investors on the board now.

A key question is what incentives Agrawal will put in place for both GMs: Kayvon Beykpour, Product Lead, and Bruce Falck, Revenue Product Lead. It is possible that we will see Agrawal put more accountability on both of them going forward. 

The investors want to better understand why Twitter has such a small base of mDAUs in the US relative to other social platforms. Twitter’s US MAUs are about 80MM, according to third-party data. There was agreement that mDAU isn’t a good reflection of how people engage with the platform and that the company may be shooting itself in the foot by reporting it. They add that if a new user registers, the onboarding process is quite poor in terms of data gathering relative to other platforms.

On the other hand, once a user finally becomes registered, the frequency of use of the platform is quite high relative to other platforms, and Twitter does a good job of retaining users. The platform saw big bumps in users gained after certain Black Lives Matter events of 2020 and the Capitol riots of 2021. Of course, some of those users were going to churn off the platform and did, but Twitter has held on to a lot of them. App Annie is reporting a positive inflection for the first time since those events ended.

On valuation, all agreed the stock is cheap but acknowledge that we’ve entered uncharted territory on valuation reset. The current 4.1x sales seems like an incredible value but at the same time, who’s to say whether the stock holds up when 4Q earnings are reported Feb. 10 against a difficult comp? When you go back to the COVID total panic mode of early 2020, TWTR troughed at 4x sales. If that's the fundamental floor, the stock is right back there today.

Another view expressed was that looking at price to sales isn’t all that meaningful when the stock isn’t owned by value investors. It’s owned by growth investors and therefore it’s plausible that Twitter’s price to sales can decline below 4x.

Regarding the upcoming earnings this week, if Twitter misses on expected user gains and revenue (against a tough comp) fails to measure up to Street expectations, the stock could decline another 15% - 20%.

Another way to look for a valuation floor is to compare today to 2016. During the worst of the turmoil in the company with management overhaul, declining users, declining revenue, and the viability of the platform in question, the stock traded at roughly 3.5x revenues for most of that period. That’s about $30/share today, and on that basis, we’re close to the floor. On an EV/sales basis, the EV compresses rapidly because of the net cash balance of roughly 25% of the market cap. This investor believes the stock is an obvious buy. He’s just not sure whether the best entry point is today or after this week’s earnings.

One investor wanted to discuss Pinterest (PINS) vs. Twitter, arguing that it feels like there are more investors with keen interest in PINS because of the belief that there was a potential acquisition offer at roughly 3x the current price. However, like Twitter, he feels it’s plausible that PINS could decline another 15% from here. And again, this investor is looking for an inflection point. In PINS’s case, that means on shopping or users not bleeding.

It isn’t a perfect fit to compare an ad-driven internet model to SaaS, but it’s worth noting that for the average SaaS business, if you can buy one for less than 4x revenues, that’s almost always the floor. That’s the point at which the company gets taken out because the NPV math works extremely well at that point. In other words, it is typically easy to generate/demonstrate a 40% EBITDA margin from that basis.

Some of the same logic applies to Twitter. This is implicitly a 60% EBITDA margin business at the current revenue scale. That may be what Silver Lake or another levered takeout player appreciates about Twitter at current levels. 

Twitter has more employees than Facebook had at the same revenue level in 2012, and has a high average salary. For the most part, TWTR does not offshore technology spend. Thus, there are many ways that a takeout investor could find improvements that significantly boost cash flow. 

The Street is at roughly $1.5B for 2022 EBITDA. The investors agree that is a reasonable/achievable earnings number if the company rolls forward the opex growth that management has guided toward. They also agreed that focusing on the advertising revenue line is more important than total revenue. One investor expects total revenue to come in a touch lighter than estimates when the company reports this week.

Another added that there’s a pattern for Twitter of guiding big and missing on earnings in the first half of the year. The company issues stock grants in May, creating a big incentive to “sandbag” earnings to some degree in Q1.