It's not going to be pretty.
Not that long ago, Twitter’s share price was soaring, based on repeated rumors that everyone from Google to Disney might be interested in acquiring it. But the stock has come back to earth with a thud—falling by 30% in the past week—as potential bidders have disappeared.
Although the New York Times reports Twitter is still in talks with enterprise-software giant Salesforce.com about a potential deal, at least one financial analyst believes there is a far more likely buyer.
John Hempton, who runs an Australian hedge fund called Bronte Capital, says a private-equity buyer is much more likely than a tech or media acquisition. He also believes that once the deal is done, CEO Jack Dorsey will be fired, along with hundreds or possibly thousands of other staff.
Although he is not a household name by any means, Hempton has a track record of successful calls on stocks such as Valeant Pharmaceuticals and HerbaLife. He is a former Australian tax official who went on to work for Platinum Asset Management, and then launched his own fund.
Hempton laid out his analysis of what is likely to happen to Twitter TWTR in a blog post on Tuesday. Although he is mostly known for short-selling stocks, he says he is “long” Twitter (meaning he owns the shares) because he is expecting a takeover bid.
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In a nutshell, Hempton argues that Twitter’s business, while attractive to users, is financially unsustainable. The company has significant revenue with sales of $2 billion last year, but he notes that it also has sky-high costs. Last year, Twitter lost over half a billion dollars.
The vast majority of that loss was produced because of equity grants to employees, which don’t actually involve cash but are still an expense—and become even more of a problem when the share price nose-dives the way Twitter’s has.
“If costs were rising that fast and the service were noticeably improving and engagement growing, then you could be tolerant,” Hempton says. “Making money is far less important in a growing tech company than increasing your relevance and the moat that surrounds your business.”
At Twitter, however, neither of these things is the case. The service is barely growing at all when it comes to the number of active users, and its revenue growth rate is continuing to shrink.
“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,” says the fund manager. However, Hempton believes Twitter has an underlying business that “should be salvageable.”
The problem, he argues, is that strategic buyers like Google GOOG and Disney DIS and even Salesforce CRM aren’t looking for a massive turnaround that they need to focus a lot of time and resources on fixing. That is only likely to appeal to a financial buyer, who can do the extreme cost cutting required.
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“Somewhere near half a billion dollars of costs need to be taken out almost immediately. And that involves firing people,” Hempton says. “It’s inevitable anyway—because Jack Dorsey burning half a billion dollar per year isn’t a sustainable business.”
The answer, the fund manager says, is a “Wall Street bastard” who can make the cuts that are required to return Twitter to some form of profitability.
Hempton argues that in the right hands, Twitter could theoretically have an operating profit margin of as much as 40%. But it would mean firing a lot of people, he says—including CEO Jack Dorsey, who recently sent staff a memo in an attempt to boost morale, after reports of potential bidders losing interest.
“If you can’t make this have a 40% operating margin then—frankly you are inadequately brutal,” Hempton says. “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.”
There have been whispers for some time that Silicon Valley investor Marc Andreessen might be interested in making a bid for Twitter. But if Hempton is right about what a private-equity buyer would have to do, even Andreessen may not be the friendly savior for which some Twitter staffers have been hoping.