Stockwatch: Time to follow this $1bn investor into Twitter?

With the shares cheap and an activist investor planning to boost earnings, our analyst shares his view. 

How much notice should you take of “activist” investors: can they really get results?

In principle, it is useful given they should have considered the financial benefits as over-riding costs (including their time and potential distraction from better situations) for taking a modest stake and doing work for which other shareholders could benefit. 

Such a “free-rider” dilemma explains why this style tends to be a preserve of well-capitalised hedge funds in the “alternative investing” space – having raised money from institutions needing to see their investments gingered up but lacking the skills set.

Saga being a case study yet to happen

A prime example is New York-based Elliott Management with circa £30 billion equivalent under management. I looked up its track record last July when it took a 5% stake in London-listed Saga (LSE:SAGA) whose stock then was worth around 40p. I found a mixed record, yet enough results to watch where they do get involved, and think for oneself. Can their actions release underlying value where company boards have erred in strategy or its implementation?

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Market speculation last summer was on a potential “sum-of-parts” break-up of Saga’s insurance and cruise-liner operations, to be eventually sold on. Yet the stock’s drift to 31p on fears of a coronavirus pandemic hitting demand for cruises, plus flooding likely to have swelled home insurance claims, shows bigger factors can predominate – at least in the short term. You could say that, at around £350 million currently, Saga is small beer for Elliott, but they still judged it worthwhile.

More pertinent is a 4-5% stake worth over $1 billion (£780 million) in NYSE-listed Twitter (NYSE:TWTR) with an alleged agenda for three or four board seats and big changes – potentially including removal of co-founder Jack Dorsey as chief executive. 

It is claimed Dorsey spends too much time at Square, a fintech company he also co-founded and is CEO - with a 10%-plus stake worth nearly $5 billion versus his 2% stake in Twitter worth around $500 million. He has also declared a 2020 objective to spend at least six months in Africa exploring opportunities in blockchain and digital currencies.  

While this sounds classic maverick behaviour able to create shareholder value, it can also mean disrupted results. UK fashion brand Superdry (LSE:SDRY) has been a good example where a creative founder quite lost the plot in terms of management challenges – or in Twitter’s case perhaps, interest in the relatively boring stuff.

Timing may be astute to target Twitter

Elliott has hinted it will support Dorsey if he drops his other projects, otherwise it will push for a full-time focused CEO. Given Twitter’s recent quarterly results have involved surprises relative to expectations (bad in respect of third quarter 2019, turning better) the sense of a more consistent business is already helping Twitter stock off a recent $32 low to $35.80, although the volatility may chiefly be COVID-19 related swings in big tech.

In the last two years, Twitter has traded in a sideways $28 to $43 range, having floated at $26 in November 2013 and breached $60 amid early euphoria, but which dissipated to a 2017 low below $15. The current level of $35.80 is barely a 50% premium to flotation six years ago compared with Facebook up over 400% since 2012. 

So, Elliott has initially picked its target well for having shareholder frustration on its side. It would be swaggering though to assert control of a six-member board, if the demand for up to four seats is genuine, as a minority investor.

Source: TradingView Past performance is not a guide to future performance

Let’s see proposals by way of a letter to shareholders

There’s also concern about frequent executive turnover in other key positions, as if corporate culture needs to be re-set. But it’s the claim Twitter has potential to deliver much better profits that should guarantee support for Elliott. Its modus operandi is to publish a letter to shareholders outlining issues it has identified and a better way forward, as was sent regarding eBay in January 2019, proposals that the management accepted. Mind how eBay (NASDAQ:EBAY) shares have yet to definitively break out of a sideways-volatile $30 range.

A disciplined investor would first want to see Elliott’s genuine proposals. Have they understood this social media business better than its current board, or are chiefly a gung-ho hedge fund enjoying confrontation and a “noise trade” quite like Carl Icahn talked up Apple then sold?

Logic suggests Elliott has identified drivers for better profit to justify a circa $1.3 billion stake that will be tricky to sell (except at a loss) if its agenda is flawed. 

A potentially promising year ahead for social media

Coincidentally, social media ought to benefit in the months ahead if COVID-19 cuts social interaction, initially as hysteria grows then as public events lock down. This would provide opportunity to substitute Twitter’s goal to capitalise on the Tokyo Olympics, should they be cancelled, and other sporting events. Management sees scope to boost Twitter’s use as an information source for breaking news on which it can graft advertising, so, potentially COVID-19 will offer a lot of potential for this - besides 2020 being a US presidential election year.

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Average “monetisable” daily active users were 145 million in the third quarter of 2019, rising to 152 million in the fourth quarter, representing a 20.6% increase on quarter four 2018. While this is only around 11% of Facebook’s near-1.7 billion daily active users, Facebook’s market cap is 20x Twitter’s – on such a metric Twitter is valued at nearly half that of Facebook (NASDAQ:FB).

Otherwise, Twitter trades on a trailing price/earnings (PE) ratio of around 19x versus over 30x for Facebook, neither paying dividends. An extent of PE gap is logical given scope to leverage profits from Facebook’s wider reach, although both platforms are exposed to shifts in fashion.

A big uncertainty with Elliott weighing into Twitter is will this foster or hinder the right culture for successful innovation and marketing?

Shareholder activism tends to be associated with the brutality of restructurings, whereas a more constructive re-set may be needed here – although the right managerial changes could provide necessary catalyst.

Financial statements reflect revenue/profit disparity

The table of three years of income statements shows revenue rising 24.5% in 2018 and 13.7% in 2019 (15% on a constant currency basis), while cost and expenses rose 19% to $3.1 billion for an 11% operating margin last year. Pre-tax profit fell 8% to $390 million, and there’s the curiosity of how a $1.1 billion tax credit has supported net income – confusing what fair view to take of the PE rating.

My eyebrows rise also at management coolly disclosing in its annual capital expenditure guidance of $775 million to $825 million, stock-based compensation expensed in a $425 million to $475 million range. Superficially, it’s as if the company exists as a means to enrich senior employees, hence it is overdue that a vigorous owner asserts some check.

However, it is not yet clear if Elliott intends to boost profit by an extent of cost-cutting, which could risk muscle and bone than just fat. Twitter’s current objective is to grow staff by at least 20% this year, especially in engineering, product, design and research; hence, it flags a similar rise in costs. Investments are to include a new data centre in support of audience and revenue growth, with capital expenditure weighted towards the second half of the year.

The current board must believe such investment will be value-enhancing in the longer run; yet presumably Elliott reckons on a different game plan if profits are to leverage in the short to medium term. As yet, we don’t know their proposals, and, arguably, the substance won’t truly manifest until any new CEO is installed and has made a review.

A speculative case assumes Elliott has done its homework

Stock price wise, much obviously depends in the short term on US market volatility; we have just seen a big fall and rise on COVID-19 sentiment swings. The appropriate stance is to wait for Elliott to publish detailed proposals but, in the meantime, the stock is likely propped by expectation that a $1 billion-plus stake means no pussy-footing around.  

Though wary of a clash between hedge fund culture and the investment required by tech, I reckon Twitter constitutes a good target for them to work with. Broadly: Buy.

Edmond Jackson is a freelance contributor and not a direct employee of interactive investor.