Sachem Head’s Andy Stafman joins Twilio’s board. Here’s how he may help grow margins

Business: Twilio is a software and communications solutions company. It operates a cloud communications platform that enables developers to build, scale and handle customer engagement within software applications.

Stock Market Value: $10.94B ($60.08 per share)

Activist Commentary: Sachem Head was founded in 2013 by Scott Ferguson. He was the first investment professional hired at Pershing Square, where he worked for nine years. Sachem Head has a history of solid value investing, but we believe that the firm really found its activist stride in 2020 with its investment in Olin. Ferguson took a board seat at Olin — the first public company board seat he took in an investment that was not part of a group — and created tremendous value there. More recently, after nominating a majority director slate, Sachem Head settled for three board seats at US Foods. Taking board seats signifies both commitment and contribution, and this philosophy and style is really paying off for Sachem Head.

Twilio is comprised of two main business units: Communications, which accounts for approximately 90% of revenue, and Segment, which accounts for 10% of revenue. The company is considered to be the industry gold standard for communications infrastructure, providing messaging, voice and email solutions to their customers. Twilio went public in June 2016 with $65 million of sales and a $15 share price. Over the next five years, it was a hyper-growth stock in a market that put a premium on growth names more than any other market possibly in history. It was growing at 50%+ annually through 2021 when it had revenue of $2.8 billion and its stock price closed as high as $443.49. After 2021, the revenue growth started slowing: It’s 8.5% today, and it’s estimated to be 5% to 10% in the coming years. As much as a growth market rewards hyper-growth stocks, it punishes those companies when revenue growth slows. So, with $4.2 billion of revenue today, the company’s stock price is down to $60.08 per share, as of Friday’s close.

But the problem is not solely lack of growth – Twilio is still growing at 8.5% per year. A bigger problem is that despite the level of revenue, even at $4.2 billion, the company has never even come close to being profitable. That is OK for a hyper-growth company. But companies with normal growth must show profitability to attract investors. Part of this problem is the inordinate amount of stock-based compensation Twilio pays: $676 million in 2023 (leading to an operating loss of $877 million). This has partly been the cause of the company’s share count doubling since 2017 from approximately 90 million shares to 180 million shares. But there are several signs that the company has been heading in the right direction even prior to Sachem Head’s appointment to the board. Stock-based compensation has declined in 2023 by 15.4% from $1.2 billion in 2022. Twilio has substantially reduced its headcount, cutting employees by 18% in the past year from 8,156 in 2022 to 5,867 in 2023. Moreover, Twilio’s co-founder and former CEO Jeff Lawson resigned in January 2024 and was replaced by former CFO and COO, Khozema Shipchandler. This is not meant to denigrate Lawson: He is truly a visionary entrepreneur and technologist who created an incredible product and company, but he is not the best person to be CEO at this juncture. What the company needs – and has gotten – is a more financially minded operating executive to continue to rein in expenses and bring it to profitability. Finally, in March 2024, shortly after the CEO transition, Twilio announced an additional $2 billion share repurchase authorization that it is targeting to complete during fiscal year 2024. It also announced the completion of an operational review of its underperforming Segment business in which management committed to right-size costs and replaced the president of that unit.

The primary value creator here will be margin improvement. The company’s nearest publicly traded peer Sinch, a smaller and lower quality business built through M&A of even smaller Twilio competitors, has generated positive operating profits and net income for several years with negligible to no stock-based compensation. Twilio should be able to do even better. While the company has demonstrated good intent and is doing a lot of the right things already, there is still plenty of upside potential on further margin expansion and reduction in stock-based compensation. This is a situation where the activist and management are like-minded, which led to a quick and quiet settlement rather than a public proxy fight. On March 30, Sachem Head received a board seat for Andy J. Stafman, partner at Sachem Head, and agreed to withdraw its notice of shareholder proposals and nomination of candidates for election to the board at the 2024 annual meeting. It is always a great activism engagement when the activist goes on the board to help management execute on a plan they all agree on, as opposed to convincing management that the activist’s plan is better. We believe Stafman will be a valuable asset to Twilio in overseeing its margin expansion and other plans, but we also expect that he will hold management accountable if they fail to do so. Additionally, we think there is a strong possibility that Twilio gets its top-line growth up as well. Market intelligence and data providers Gartner and IDC still project an industry growth rate in the mid- to high-teens. As the market leader, Twilio should be at the high end of the range.

Finally, Sachem Head is not the only activist actively engaged with Twilio. Legion Partners and Anson Funds (which hired Sagar Gupta, former senior analyst and head of technology, media, and telecom  investing at Legion Partners, in October 2023) both have activist campaigns here. Both funds have been calling for the divestiture of Segment. On March 5, Twilio announced that it concluded an operational review of its Segment business and has decided not to divest it. Further, in connection to that development, Twilio appointed Thomas Wyatt as president of Segment, where he formerly served as chief product and strategy officer.

Ken Squire is the founder and president of 13D Monitor, an institutional research service on shareholder activism, and the founder and portfolio manager of the 13D Activist Fund, a mutual fund that invests in a portfolio of activist 13D investments. Twilio is owned in the fund.