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

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

Stock market value: $10.94 billion ($60.08 per share)

Ownership percentage: 1.81%

Average cost: n/a

Comment from activists: 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 the firm really found its activist stride in 2020 with its investment in Olin. Ferguson took a seat on Olin’s board of directors – the first public company board seat he’s had in a non-group investment – ​​and created tremendous value there. Most recently, after appointing a majority slate of directors, Sachem Head secured three seats on US Foods’ board of directors. Taking a seat on the board of directors means both commitment and contribution, and this philosophy and style is really paying off for Sachem Head.

Twilio is made up of two main business units: Communications, which represents approximately 90% of revenues, and Segments, which represents 10% of revenues. The company is considered the industry gold standard for communications infrastructure and provides messaging, voice and email solutions to its customers. Twilio went public in June 2016 with $65 million in sales and a stock price of $15. Over the next five years, it was a hypergrowth stock in a market that rewarded growth stocks more than any other market in history. It was growing 50%+ every year until 2021, when it reported revenue of $2.8 billion and its stock price closed at $443.49. After 2021, revenue growth began to slow: today it is 8.5% and is estimated to be between 5% and 10% in the coming years. As much as a growth market rewards hypergrowth stocks, it punishes those companies when revenue growth slows. So, with $4.2 billion in revenue today, the company’s stock price fell to $60.08 per share, as of Friday’s close.

But the problem isn’t just a lack of growth: Twilio is still growing at 8.5% annually. A bigger problem is that despite the revenue level, even at $4.2 billion, the company has never even come close to profitability. This is good for a hyper-growth company. But companies with normal growth must show profitability to attract investors. Part of this problem is the excessive amount of stock compensation Twilio pays: $676 million in 2023 (leading to an operating loss of $877 million). This was partly 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 is moving in the right direction even before Sachem Head’s appointment to the board of directors. Stock-based compensation declined in 2023 by 15.4% from $1.2 billion in 2022. Twilio has substantially reduced its headcount, cutting employees 18% in the past year, from 8,156 in 2022 to 5,867 in 2023. Additionally, co-founder and former CEO Jeff Lawson resigned in January 2024 and was replaced by former CFO and COO, Khozema Shipchandler. This is not to denigrate Lawson: he is truly a visionary entrepreneur and technologist who has 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 conscious operating executive to continue to rein in expenses and drive it to profitability. Finally, in March 2024, shortly after the CEO transition, Twilio announced an additional $2 billion stock repurchase authorization that it intends to complete during fiscal 2024. It also announced the completion of an operational review of its underperforming business segment where management has worked to reduce costs and replace that unit’s president.

The main value creator here will be margin improvement. The company’s publicly traded closer, Sinch, a smaller, lower-quality company built through mergers and acquisitions of even smaller Twilio competitors, has generated positive operating profits and net earnings for several years with negligible stock compensation or nothing. Twilio should be able to do even better. While the company has demonstrated good intentions and is already doing many of the right things, 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 the management are like-minded, which led to a quick and quiet solution rather than a public proxy fight. On March 30, Sachem Head received a seat on the board of directors for Andy J. Stafman, partner of Sachem Head, and agreed to withdraw the notice of shareholder proposals and nomination of candidates for election to the board of directors at the 2024 annual meeting. It’s always a great activism effort when the activist comes onto the board to help management execute a plan that everyone agrees on, instead of convincing management that the activist’s plan is improve. We believe Stafman will be a valuable asset to Twilio in overseeing margin expansion and other plans, but we also expect him to hold management accountable if he fails to do so. Furthermore, we believe there is a strong possibility that Twilio will also increase its revenue growth. Gartner and IDC, providers of market data and information, still predict a medium to high growth rate for the sector. As a market leader, Twilio should be placed 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 investments at Legion Partners, in October 2023) both have activist campaigns here. Both funds have requested the sale of the segment. On March 5, Twilio announced that it had completed an operational review of its business in the segment and had decided not to divest it. Additionally, in connection with this development, Twilio has appointed Thomas Wyatt as segment president, where he previously 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 13D activist investments. Twilio is owned by the fund.