A hedge fund manager explains why Twitter is a perfect target for an old-school private equity takeover

Twitter’s Jack Dorsey. (Photo by Kimberly White/Getty Images for Vanity Fair)

Twitter is wildly addictive. This is well known and there are people who check Twitter more obsessively than anyone checked email.

Twitter is also a chaotic world full of trolls, useless information, porn-spam and videos of kittens.

It is also – as anyone cares to notice – for sale.

The gossip – and I have no reason to doubt this – is that there are on the Twitter board two factions: the CEO Jack Dorsey who wants to run the company and the board who – sick of pointless losses and running out of money – wants to sell it.

This leads to probably the most leaky sales process I can ever remember – with almost daily rumours about who is interested and who is not interested. The current rumour mill says all the “strategic buyers” are not interested.

In this blog post though I just run through the numbers and try to delineate what as a regular user (but an outsider) should be done. But I will cut to the chase now. This company should be and probably will be bought by an aggressive financial buyer. And Jack will be fired. (And – I think – the world will be a better place for that.)

Just the numbers

You can find time series quarterly P&Ls (standardised by Thomson Reuters) here. An annual series is below.

Here is what to notice. Revenue has gone up very nicely – from $664 million to $2.2 billion and is still increasing. And costs have gone up commensurately. Losses seem stubbornly stuck at half a billion per annum. That is real money – just burnt – and burnt by a business that is already established.

In other words costs have gone up by $1.5 billion give or take something. That is billion with a b.

Now if costs were rising that fast and the service were noticeably improving and engagemet growing then you could be tolerant. Making money is far less important in a growing tech company than increasing your relevance and the moat that surrounds your business. (Amazon is the leading example of a company which increases the moat every day.) The short-hand for that thinking is that revenue follows relevance.

But – as a pretty dedicated tweeter (with almost 20 thousand followers) – I have noticed almost no changes in twitter that improve my user experience. It is almost impossible to find out what they spend that $1.5 billion extra per annum on. I gather there are some improvements in the monetisation side but this is just a website – and it does roughly what it did in 2012 – and but spends well over a billion dollars more to do the same thing. [From my perspective the marginal improvement is that I am seeing fewer failed-to-load pages… but that is it.]

Twitter has become a parody of bad Silicon Valley management – the sort of management that existed in the dot-com boom where quite literally burning shareholder funds was considered a mark of innovation.

The main difference between this and (say) Pets.Com is that underneath is a business that should be salvageable – and should make pot-loads of money. After all if they raised costs by $1.5 billion per annum without achieving jack-shit then costs should be able to be controlled. And if that is possible then Twitter as an LBO works on the back of an envelope at these prices.

Why a financial buyer not a “strategic buyer”

The news of the day is that almost all of the strategic buyers (other big tech companies) have pulled out of the bidding process. There is good reason why that should be the case.

If you run Salesforce.com for instance your main agenda should be on growing your business in a disciplined fashion. They are still in the stage of building relevance. And that requires friendly well directed management willing to let staff have their little well-directed flights of fancy (rewarding of course those fancies that grow the business).

But Twitter is past that. Somewhere near half a billion dollars of costs need to be taken out almost immediately. And that involves firing people and being a general tough-bastard. It’s inevitable anyway – because Jack Dorsey burning half a billion dollar per year isn’t a sustainable business. The cash eventually runs out.

The problem is if you mix this with a Salesforce.com or similar company it will be really hard to take costs out in a disciplined fashion without upsetting the culture of the home company. Instead this should be fixed (with extreme prejudice by a disinterested outsider) before it is sold again to a strategic buyer.

Or – in summary: the best bastards are from Wall Street. And this needs a Wall Street bastard.

Carl Icahn – Twitter needs you.

That said – there are things that need to be done that are not being done under the (seemingly incompetent and fashion obsessed) Jack Dorsey.

First troll detection has to be done much better. There degree of incompetence in troll-hunting beggars belief. For example I have stereotypically attractive 20 year olds in bikinis who just want to do wicked things to me (and I am not even Donald Trump). I block them all and report them – but somehow Twitter has not managed to stop filling my time-line with porn spam. Blocking this is the sort of pattern recognition that computers should do – and if your spam-to-content ratio gets to high you eventually lose real users.

Also there is a lot of semi-commercial (even scam) spam here. Have a look at this twitter stream: https://twitter.com/doxitehydyla.

There are almost 10 thousand tweets – and they are all penny stock promotion mostly for the same penny stock. I think it is Russian but the location says Manchester. (Many scam promotion schemes look the same – and I do not think the penny stock promoters all live in Manchester.) The Tweets include a reference to some hot stock or controversial stock (Apple, Herbalife etc) and then links to a penny stock page. It is really obviously spam. But it has been around for months.

It also has 800 followers and not a single overlap with my followers. In other words almost all the other followers are spam bots too (because I seem to have overlap in followers with all serious financial tweeters.

I could block five of these a day and there is still an endless supply. It makes searching for news about a stock almost pointless because the ratio of spam to real news is not good.

I suspect the management incompetence goes further. If they actually fix the spam-bot problem then the truth about the active users numbers will out. It is weak (precisely for the reason above). But weak numbers mean they are all going to need to be fired.

But let’s play the numbers

Twitter revenue is still rising and is running about $2.5 billion per annum. It is a website that once ran extremely well on less than $250 million in costs. (No I am not joking.)

If you can’t make this have a 40 percent operating margin then – frankly you are inadequately brutal. Personally I think 50 percent is possible.

At this market cap that works extremely well for a financial buyer. Its a no-brainer even.

So expect it to be bought. By some Wall Street bastard armed with a lot of debt.

And that bastard will fire a lot of people.

If I worked at Twitter I would be preparing my resume and providing a list of really quick things that can be done to improve the user experience – with the code all mapped out. That largely involves getting rid of spam bots and the like. But unless it radically improves the user experience or monetisation and you can convince the new owners you can implement then you are out.

And the fashion-obsessed philosopher king. He is out too whether there is a buyer or not. That is necessary to save the company.


PS. Long for the takeout which I see as inevitable.

John Hempton runs the Sydney-based hedge fund Bronte Capital. This post first appeared at the Bronte Capital blog. Republished with permission.

Business Insider Emails & Alerts

Site highlights each day to your inbox.

Follow Business Insider Australia on Facebook, Twitter, LinkedIn, and Instagram.