Elon Musk’s $44 Billion takeover of Twitter will be another radical shift for the software industry. In many way what has transpired in the past week reminds me of Private Equity Tech M&A in the early 2000s. There are some very important differences however. Will the X super app be the long term savior of Twitter and another huge notch in Elon’s belt?
In this article we will discuss:
- Private Equity Tech M&A In 2003
- In 2022, Twitter was Struggling, but Not Distressed
- Musk’s Deal and the Challenges He Faces
- Musk’s Potential 7-Step Plan
- 1. There’s a New Sheriff in Town
- 2. Decapitate the Old Culture
- 3. Send in the Shock Troops
- 4. Challenge Sacred Cows
- 5. Experiment with New Revenue Streams
- 6. Restructure Operating Expenses
- 7. Eliminate Stock Buybacks
Private Equity Tech M&A In 2003
After the DotCom Crash of 2000, private equity stepped into the tech M&A game in a big way. PE firms would find underperforming assets, acquire them with a combination of debt & equity, restructure the, then sell them for a profit a few years later. The debt service requirements often required that the acquired company had to quickly reduce operating expenses and meet draconian EBITDA and cash flow targets. The restructurings were often harsh with over 25% to 40% of the employees being laid off. For most software companies, employee labor costs make up a significant portion of their operating expenses. The only way to quickly improve profitability is to dramatically reduce headcount.
In 2003 I joined Inovis, the former Supply Chain Execution business Unit of Peregrine Systems. It was divested in 2002 to Golden Gate Capital for $35 million. At Peregrine, it had been doing about $85 million a year. Peregrine had been in trouble and needed to raise cash fast, Golden Gate accommodated them. A large part of the consideration paid was debt. Within six months of closing 25% of the headcount was eliminated and EBITDA was raised to 35%.
Golden Gate Capital was the quintessential PE buyer of underperforming enterprise software companies in this time frame. In total, Infor has acquired over 50 companies, including ERP stalwarts Mapics, GEAC, and SSA Global. Their playbook was simple: Use debt to finance, reduce headcount, consolidate common business functions, and leverage the scale of an ever-growing empire. In 2010, Charles Phillips the former co-president of Oracle joined Infor as its CEO. He then led the transition of Infor from an on-premise to a cloud provider of ERP solutions. Infor is now the third-largest ERP provider in the world.
The PE playbook was pretty simple. Use debt to fund acquisitions, restructure to high EBITDA/cash flow by reducing headcount and non-value added expenses, cancel unprofitable product lines, bring in new management to inculcate staff with a new business philosophy, invest new profitable growth initiatives, then exit at a premium. In a nutshell, that is what Elon Musk is going to do with Twitter.
In 2022, Twitter was Struggling, but Not Distressed
In 2022 Twitter was in the Late Majority stage of the Technology Adoption Life Cycle. By then, Twitter was 16 years old. It had annual revenues of $5.23 Billion, a loss of $113 million, $6.12 Billion in cash, and $6.72 Billion in debt. Revenue had declined 1.2% year over year. Twitter was valued at 7.97x Enterprise Value/Revenue (ttm) – the median EV/Revenue multiple for SaaS companies in the communications and collaboration segment was 4.6x in Q3 2022.
90% of Twitters revenue comes from advertising. Apple’s change to iOS ad tracking certainly impacted Twitter, but they were taking steps to mitigate it. When you are doing $5 Billion in revenue in a mature market, you run into what is called the Big Number Revenue Growth problem. For Twitter to grow 20% a year it would have to add $1 Billion in new revenue a year. That’s a pretty tall order. Twitter’s growth had plateaued.
In a mature business like Twitter, operating expenses can become huge. Twitter had over 7,500 employees pre-Musk. They were well compensated. A story came out last week about a viral TikTok that describes one employee’s day at Twitter:
Between the iced macha to start the day to the gourmet food in the cafeteria to the yoga and meditation room to the on tap red wine at the end of the day, you gt the impression that there are some significant costs that can be eliminated from Twitter’s P&L.
Musk’s Deal and the Challenges He Faces
Musk paid $44 billion for Twitter. $31 Billion was in cash from Musk and other investors like venture capital firms Sequoia Capital and Andreessen Horowitz. He also raised $13 Billion in debt. As the New York Times pointed out “Last year, Twitter’s interest expense was about $50 million. With the new debt taken on in the deal, that will now balloon to about $1 billion a year. Yet the company’s operations last year generated about $630 million in cash flow to meet its financial obligations.”
Musk will need to find ways to cut expenses, increase cash flow, and grow revenues.
Musk’s Potential 7-Step Plan
As an outsider looking in it is hard to know Musk’s exact plans. Based on the first week of his ownership, seven steps emerge as a potential strategy.
1. There’s a New Sheriff in Town
Musk made it clear on Day One who was in charge. His grand entrance to Twitter headquarters and assuming the label of Chief Twit was just a start.
2. Decapitate the Old Culture
One of Musk’s first acts was to decapitate the old culture. CEO Parag Agrawal, CFO Ned Segal, General Counsel Sean Edgett, and legal affairs and policy chief Vijaya Gadde were fired on Day 1. Supposedly they were terminated for cause to reduce severance payouts, but that has not been confirmed.
Additionally, several other executives have resigned including:
- Sarah Personette, Chief Customer Officer
- Dalana Brand, Chief People and Diversity Officer
- Nick Caldwell, General Manager for Core Technologies
- Leslie Berland, Chief Marketing Officer
- Jay Sullivan, Head of Product
- Jean-Philippe Maheu, Vice President of Global Sales
A key aspect of the PE acquisition playbook is to destroy the old company culture and replace it with the new owner’s culture. The departure of so many policy-making executives is just the first step.
3. Send in the Shock Troops
The next step in the PE playbook is to parachute in leaders and resources from the other part of the acquirer’s empire to assess what is really going on ‘under-the-hood’, lead change, and start to build the new culture. These resources are people that Musk trusts. They have performed in the past and will carry his culture forward.
As noted by CNBC:
“According to internal records viewed by CNBC, employees from Musk’s other companies are now authorized to work at Twitter, including more than 50 from Tesla, two from the Boring Company (which is building underground tunnels) and one from Neuralink (which is developing a brain-computer interface).
Some of Musk’s friends, advisors and backers, including the head of his family office Jared Birchall, angel investor Jason Calacanis, and founding PayPal chief operating officer and venture capitalist David Sacks, are also involved. So are two people who share Musk’s last name, James and Andrew Musk, who have worked at Palantir and Neuralink, respectively.
Among the dozens who Elon Musk enlisted specifically from Tesla are: director of software development Ashok Elluswamy, director of Autopilot and TeslaBot engineering Milan Kovac, senior director of software engineering Maha Virduhagiri; Pete Scheutzow, a senior staff technical program manager, and Jake Nocon, who is part of Tesla’s surveillance unit, as a senior manager of security intelligence.”
4. Challenge Sacred Cows
In the first week, Musk has already started to challenge long held beliefs and practices at Twitter. Some examples include:
Changing the Twitter Home Page
As noted in The Verge:
“Less than 24 hours after completing his $44 billion acquisition of Twitter, Elon Musk decided to change its homepage.
He requested that logged out users visiting Twitter.com be redirected to the Explore page that shows trending tweets and news stories, according to employees familiar with the matter who requested anonymity to speak without the company’s permission. Before, visiting Twitter’s homepage while logged out showed only a sign-up form, encouraging the creation of an account to view tweets. Musk’s directive, which was implemented late Friday, required VP involvement to override a code freeze put in place to prevent rogue staffers from making changes during the takeover process.
Though Musk didn’t widely articulate a reason for the change, to the employees who observed it, the message was clear: no more sacred cows. Inside the old Twitter, such a decision would have been fought over between teams for weeks. But this was the new Twitter. As a former executive told me: “That’s definitely one way to make it clear you’re in charge now.”
$8/month for Twitter Blue
Musk set off a firestorm by announcing that the Twitter Verified program (the infamous blue check mark) would be available to anyone for initially $20/month, later reduced to $8/Month:
Remember, Twitter’s revenues declined 1.7% this year. This is just one of many steps Musk will take to increase the monetization of Twitter.
Managers Should Code
Musk has launched a comprehensive set of code reviews. One of his tenets is that managers should be able to code:
5. Experiment with New Revenue Streams
The core challenge Musk faces is that Twitter’s revenue growth has stalled:
To achieve long term success, Musk must find ways to restart revenue growth. $8/monthis one way. Relaunching the abandoned short form video service Vine is another. As noted by Axios “Elon Musk has instructed Twitter engineers to work on a Vine reboot that could be ready by year end, multiple sources tell Axios.”
As reported by Forbes earlier this year, Musk’s long term strategy for Twitter maybe the superapp ‘X’:
When Tesla CEO Elon Musk revived his deal to buy Twitter for $44 billion this week, he called it on Tuesday “an acceleration to creating X, the everything app”—and while the billionaire has not offered many details on his ideas for the application, previous comments suggest he wants to integrate many more services into Twitter and turn it into a “super app.”
Musk has previously spoken of his goal to create a super app, which aims to provide users with a wide range of products and services, many of which are unrelated, in one single interface.
The term “super app” was first used to describe WeChat, owned by Chinese tech giant Tencent, which has a variety of uses, making it widely popular across China. WeChat and other affiliated mini-apps “connect every facet of life in China” from “hailing a cab, buying groceries, booking a doctor’s appointment, purchasing insurance,” according to an earlier Forbes story.
In a town hall with Twitter employees earlier this year, Musk suggested he wanted Twitter to follow in WeChat’s footsteps, saying “There’s no WeChat equivalent out of China,” and claiming, “There’s a real opportunity to create that.”
6. Restructure Operating Expenses
A classic play in the PE playbook is to restructure operating expenses, including reducing headcount. Twitter’s operating expenses look like this:
|6 Months Ending Jun. 30, 2022||% of total|
|Costs and expenses|
|Cost of revenue||1,048,126||36.79%|
|Research and development||826,554||29.01%|
|Sales and marketing||608,110||21.34%|
|General and administrative||366,449||12.86%|
|Total costs and expenses||2,849,239||100.00%|
|Income (loss) from operations||(471,595)|
Twitte’s headcount looks like this:
As a veteran of over 15 corporate restructurings due to acquisition, I can tell you there are always opportunities to reduce headcount. The ‘Day in the Life’ TikTok shows some obvious areas to cut costs.
The Washington Post reported that Musk was considering laying off 75% of Twitter’s workforce. To achieve breakeven operating profitability, however, Musk would probably only need to eliminate 25% of Twitter’s current payroll expense. It is extremely common to reduce headcount in non-strategic/non value-added areas and invest in new growth initiatives.
7. Eliminate Stock Buybacks
In the near term, however, the scale of reducing staff to improve cash flow to meet the new annual debt service requirement of $1 Billion. Like many mature public companies, Twitter has been repurchasing its stock to boost its EPS. In the first six months of this year, Twitter spent $2,077,759 buying back its stock. From the second quarter 10-Q:
“In the six months ended June 30, 2022, the Company repurchased 1.9 million shares for an aggregate amount of $71.5 million under the 2020 Repurchase Program. In connection with the ASR Agreements, the Company made a prepayment of $2.0 billion and received an initial delivery of approximately 37.8 million shares of its common stock. The repurchased shares were immediately retired upon settlement and treated as a repurchase of common stock for purposes of calculating earnings per share. $600.0 million of the prepayment was evaluated as an unsettled forward contract, classified within stockholders’ equity. Under the terms of the ASR Agreements, the remaining shares are expected to be delivered in the third quarter of 2022. The number of shares that the Company will ultimately repurchase will be determined based on the volume-weighted average price of the Company’s common stock over the term of the ASR Agreements, less an agreed upon discount.”
Eliminating planned stock buybacks will give Twitter some cash flow flexibility to deal with debt service requirements.
Musk’s takeover of Twitter will be fodder for thousands of stories of how he will never succeed. Can he manage the concerns of employees, advertisers, government regulators, and users? Musk is the definition of unconventional in both his professional and personal lives. He has a track record of doing incredible things. Who would have thought a private company could have built a reusable rocket and dominate the space launch industry? Who would have thought he could build an electric car company that is now worth more than GM, Ford, and Chrysler put together? The X super app will probably come to be and transform Twitter. He will certainly make mistakes along the way, but in the end he will win.
Also published on Medium.