Could This Activist Investor Shape How Twitter Does Business?

Twitter's (TWTR +0.00%) stock recently popped after hedge fund Elliott Management took an activist stake of roughly $1 billion in the social media company, according to The Wall Street Journal. Elliott nominated four directors to Twitter's eight-person board and wants the company to hire a full-time CEO to replace Jack Dorsey, who leads both Twitter and online payments company Square (SQ +2.43%).

Elliott Management founder Paul Singer also expressed concerns about Dorsey's plans to move to Africa for three to six months per year to explore cryptocurrency opportunities. However, critics pointed out that Singer is a major Republican donor and could seek to address accusations of liberal bias on the platform.

Will Singer change how Twitter does business? Or will Dorsey weather the storm and fend off the activist investor, who previously pushed eBay (EBAY 5.32%) and AT&T (T 1.54%) to make major changes?

Image source: Getty Images.

Is Elliott right about Dorsey?

Dorsey, who co-founded Twitter with Noah Glass, Biz Stone, and Evan Williams in 2006, was initially the company's CEO prior to its IPO. However, Dorsey was ousted in 2008 due to complaints about poor leadership skills and a tendency to leave work early to pursue other hobbies.

Dorsey returned as Twitter's full-time CEO on Oct. 5, 2015, after his predecessor Dick Costolo struggled to grow the platform's user base and ad revenue. However, Dorsey was already serving as the CEO of Square, which he co-founded in 2009.

Under Dorsey, Twitter's annual revenue rose from $2.5 billion in 2016 to $3.5 billion in 2019, and it generated GAAP profits over the past two years. Most of that growth came from new ad products, overseas growth, and cost-cutting measures.

However, Twitter's stock barely advanced since Dorsey replaced Costolo as the company's interim CEO on July 1, 2015. Square, which went public four months later, generated a near nine-bagger return for its initial investors.

Source: YCharts

Dorsey tightened up Twitter's business, but it's been a bumpy ride. Twitter explored a sale in late 2016, but its suitors reportedly walked away due to concerns about the platform's controversial content. Several of Twitter's top executives, including COO Adam Bain and CTO Adam Messinger, also left the company.

Last year, Twitter replaced its standard MAU (monthly active user) count with a proprietary metric, mDAUs (monetizable daily active users), to eliminate logged out users, spam, and bot accounts. The move gave investors a clearer look at the platform's core growth, but it also masked its stagnant MAU growth.

Twitter was also repeatedly caught in the political crossfire as politicians weaponized the platform. Liberals were upset that Twitter didn't block President Trump's tweets, while conservatives claimed that it actively censored right-leaning accounts.

Dorsey's own eccentric behavior -- which included odd diets, daily routines, and overseas retreats -- also sparked concerns about his abilities to lead both Twitter and Square. Therefore, Elliott's concerns about Dorsey's plans to live in Africa to research cryptocurrencies -- which would benefit Square's Cash App more than Twitter -- are valid.

But does Twitter need a big shakeup?

Dorsey is a controversial CEO, but Twitter's growth in revenue and mDAUs has remained consistent over the past year.

YOY = Year-over-year. Source: Twitter quarterly reports.

However, Twitter's adjusted net margin, which excludes tax benefits, fell from 12% in 2018 to 7% in 2019. It expects its margins to continue declining in 2020 as it increases its headcount by about 20% to focus on new engineering, product design, and research projects.

That's why analysts expect Twitter's earnings to dip 62% this year as its revenue rises roughly 16%. That earnings decline isn't ideal, but it also indicates that Dorsey isn't letting the platform stagnate. An abrupt disruption of Twitter's board and the hiring of a new CEO could interfere with those plans and cause new problems.

Singer has been a vocal critic of President Trump, but his support for Republican causes suggests that he could push Twitter to review accusations of anti-conservative bias or open the floodgates to political ads again. Those actions could drag Twitter deeper into a political quagmire and force it to rely more heavily on overseas markets, which accounted for 80% of its mDAUs but only generated 41% of its revenue last quarter.

The road ahead

Elliott's stake is only equivalent to about 4% of Twitter's shares, so it could be tough to replace half of Twitter's board and oust its CEO. I doubt that Elliott's push will succeed, since Dorsey is widely credited for stabilizing the company after Costolo's messy tenure, but it could force Dorsey to lay out clearer long-term strategies and succession plans for both Twitter and Square.