Twilio by most accounts would be considered a startup success story. But after peaking at $400 a share in September 2021, when everyone was riding fantasy valuations, the company has experienced a long plunge to around $66 a share. That kind of performance tends to get the attention of activist investors, so perhaps it’s no surprise that Anson Funds and Legion Partners are reportedly turning the screws on the company.
The communications API company appeared to be reacting to that pressure by cutting costs, which in corporate speak translates into laying off another 5% of its workforce Monday morning. As the stock price has fallen, so has the number of employees; the announcement comes a little over a year after the company cut 11% of the workforce in September 2022 and 17% in February 2023.
But this round seems more like Twilio is throwing the activist dogs a bone by showing it could get even leaner still. Laying people off during the holidays isn’t a great look, but with investors breathing down its neck, perhaps the executive team felt it had little choice.
At the height of its valuation, Twilio made some big moves. In 2018, it purchased SendGrid for $2 billion, and in 2021 it bought customer data platform Segment for $3.2 billion. Both moves were designed to combine customer data with the communications data the company was collecting via its core communications APIs.
Whether that worked is still open to debate, but with the stock price in the $60s, it feels extravagant in retrospect. At the time with so much value, it was worth trying to expand the company’s capabilities. Today, not so much.
With two activists putting on the pressure, and the stock price plunging, it leaves the company in a vulnerable position. This fight feels more like Zendesk’s, which ended up being sold off to private equity, than Salesforce’s, where it ultimately fended off its activists.
The big question here is whether the dramatically lower stock price, the questionable acquisitions and other bad financial data points mean this is a case where the activists have a point. And if they do, what does it mean for Twilio?
Activists mixing it up
Any way you look at it, the company has faced great instability of late. CEO Jeff Lawson announced in February that he was splitting the company into two units. He named Elena Donio to run the data and apps side of the house, which includes Segment. She announced that she would be stepping down later this month during the company’s Q3 2023 earnings call.
Patrick Gadson, a partner at the law firm Vinson & Elkins, wonders whether the activists were at least partly responsible for her departure.
“I don’t know why you would name someone to be the head of one of two major business segments where you have this big restructuring announcement in February, and then in December announce that she’s resigning and the CEO was going to be the interim head of data and applications,” Gadson told TechCrunch+. “That to me is very unusual, and is consistent with the sorts of things that happen once an activist starts agitating for change in the background, and makes certain suggestions, quote, unquote, slash threats.”
Meanwhile, CFO Aidan Viggiano, speaking at the UBS Global Technology Conference last month, very bluntly stated that the core communications business is worth about 90% of the company’s revenue, while the apps and data business is good for just 12%.
Gadson thinks that kind of candor might have been deliberate. “If I were dead set on not selling the data and applications business, and there had been agitating by the [activist firms] to sell it, I probably wouldn’t be stating publicly, ‘Hey, it’s not even that much of our revenue, guys.’”
Do the activists have a point?
When we have seen software companies wind up under the hammer of activist intervention, a few commonalities emerge.
First, slowing revenue growth. Second, a cost base that external parties consider excessive. And, perhaps, a loss of focus.
Twilio’s current status and activist interest thereof hits all three notes at once: The company’s growth has slowed to a crawl, it has clearly had excess costs baked into its results historically, and, given that the folks beating on Twilio’s door want it to dispose of certain assets, it could focus more.
A very simple, commonsense reading of the situation is that the activists have a point. However, Twilio is not quite the underperformer that the situation makes it out to be. Let’s run through the activist perspective, and then mount a defense of what Twilio is trying to do next.
The activist case
Starting with growth, Twilio’s revenue growth has all but halted. What follows is a chart from Twilio’s Q3 2023 earnings, showing its total revenues back through Q3 of 2021:
The chart details two core issues: Twilio has grown very modestly since the end of 2022, and its growth rate — the gray line that points toward the basement — has slipped in every quarter in recent memory. Slow growth that is also decelerating is a hard thing to explain away for a public company.
Doubly so when folks think that the company in question was overspending for underperformance. To achieve its revenue growth deceleration, Twilio has consistently reduced its costs. That’s to say that it was likely spending far too much when times were good and is now dealing with that expense base since growth is harder to achieve. Again, not a great look for a management team.
On the cost point, even after massive cost reductions in the form of laid-off staff, Twilio is still unprofitable today. In Q3 2023, the company lost $108.9 million on an operating basis and $141.7 million on a net basis.
Twilio has lots of adjusted profit to report, as is often the case among tech companies. But given its value decline in recent years, it doesn’t appear that a good chunk of adjusted operating income is really making investors happy: To reach that figure, Twilio has to strip out $185 million worth of share-based compensation it doled out in its most recent quarter.
And unlike its growth rate, the direction of the fraction of revenue that Twilio spends on paying its staff in shares that dilute its common equity holders is not heading down and to the right. Again, from its Q3 2023 deck:
Don’t all tech companies that are not nation-state size like to strip out their share-based comp costs? Sure, but that doesn’t mean that investors like it, as they are being told that the costs that impact them directly — through dilution — don’t count. So when a tech company turns around and says, “Hey, we’re going to rebuy a bunch of our stock,” all it’s saying is that it will work to undo a portion of the damage it already did to the stakes its backers have held. Not that enticing anymore, right?
Then there’s the question of focus. Twilio’s Segment purchase that we mentioned is part of the company’s data and applications (TD&A) revenue bucket. Driving around one in every eight dollars of Twilio revenue today, TD&A grew at a 9% rate in the third quarter. That’s better than the 5% that Twilio’s much larger communications business managed but is hardly enough to blow the doors off the company’s barn. You can see why investors might want that to get spun out or sold to generate some potential returns for their own holdings.
That said, is it worth the trouble?
In Twilio’s defense
Twilio’s core business has seen its growth slow, but not due to its products suddenly not being an attractive offering to potential customers. Read the following riff from Khozema Shipchandler, the leader of the Twilio communications business, in the company’s last earnings call:
Our Q3 dollar-based net expansion rate for communications was 101%, and 104% excluding crypto customers. Similar to last quarter, new customers are driving a greater portion of the overall growth, while crypto and social and messaging headwinds mask the success we are seeing with our cross-sell and expansion opportunities. Churn continues to remain relatively stable, and we are seeing year-over-year volume growth across many industries.
Recall that Twilio was an early leader in on-demand pricing, which means that the more its customers use its product, the more money it makes. As noted, Twilio is adding new customers but seeing weakness from prior accounts, which pushes it closer and closer to flat growth. The economy is not great in every sector; a company of Twilio’s scale is going to see uneven results from different customer segments.
The same folks who loved Twilio’s model when it was putting up astounding results are now somewhat sour on it. The counterargument here is that as Twilio expands its customer base, it is setting itself up for very tidy growth down the road.
And with a smaller cost base to boot. Twilio is now smaller than it was. In Q3 2023, its spend on R&D, G&A and S&M were lower than year-prior totals. If customer demand picks up, not only is Twilio in a great place to grow with a larger number of customers — 306,000 active accounts in Q3 2023 vs. 280,000 in Q3 2022 — but it will also enjoy those gains with greater profitability leverage, given its smaller cost basis.
Bullish, right? It’s not a hard case to make. But all the work we’ve done arguing in favor of Twilio thus far doesn’t include the real elephant in the room: Segment.
What to make of that purchase, and its less-than-anticipated impact on Twilio’s growth? A few things come to mind. First, Twilio’s overall growth rate would be lower without it, which means it is helping its parent company maintain growth to a modest degree. That matters.
Second, Segment is probably only worth so much in the event of a sale. The entire TD&A group at Twilio did $127 million in revenue in the third quarter, putting it on a run rate of just over a half-billion dollars per year. Growing at 9%, it’s worth around three or four times that figure. If Twilio sold it at that price, or spun it out at a similar equity valuation, it would unlock about one-eighth of the company’s current market cap in the process. That’s enough cash to extend Twilio’s share repurchasing campaign, certainly, but is that enough to make up for the revenue loss and growth deceleration? It sounds like a lot of bother for little victory, frankly.
And there’s the chance that Twilio’s leadership is right and that keeping Segment will unlock a lot of future growth. The company recently announced something called CustomerAI, which it described to investors as a “set of predictive and generative capabilities that pairs customer data with large language models to give companies AI that truly knows their customers.” We care about that when it comes to Segment because Twilio’s CEO thinks that “Segment’s capabilities are foundational to CustomerAI.” And given that AI requires good data, and CDPs are all about collecting large amounts of valuable data, it’s reasonable to assume this could generate more revenue down the road for Segment.
If Twilio were to go through the work of ripping Segment from its business, the financial gains are only so big with uncertain financial downside to its continued operations. Even more, Twilio could be left with less of an AI future in early 2024. That sounds like a very risky proposition.
All Twilio needs to get pesky investors to hush and go away is stronger customer spend from its ever-larger customer base. And some evidence that CustomerAI, leaning on Segment, is driving real growth for its business. It may simply need a few more quarters to show both. In the meantime, we are sympathetic with investors impatient for a return to boom-era Twilio share prices, but the plan they are pushing doesn’t seem accretive and comes with enough risk to be a bit silly in total.
Not that we want to defend multi-billion-dollar businesses, as they rarely need any sort of external boosterism. But in our analysis of this deal from a numbers perspective, Twilio is probably an inverse Brexit. It really is better together.
Update: This story has been updated to reflect the correct timing of the announcement of Elena Donio’s exit from the company, and to correct the number of Twilio active customers accounts from 360,000 to 306,000 as of the end of Q3 2023.
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