With Twilio under activist pressure, Segment could be put up for sale

Twilio’s foray into the customer data (CDP) business could be heading for an early conclusion. The former startup offers communications software services via APIs, and in recent years expanded its product footprint through the acquisition of companies like Segment, which added CDP capabilities to its larger portfolio.

Now, in the wake of the company’s growth slowing to a near halt in late 2023 and the exit of its founding CEO Jeff Lawson, Twilio is executing “an extensive operational review” of the asset, according to its recent earnings call. Asked by an analyst if the review could result in a sale, the company stressed that Segment has strategic value, but that it is approaching its review of the business “with an open mind.” That doesn’t necessarily bode well for Segment to remain part of the company much longer.

During the last quarters of Lawson’s tenure atop the company, Twilio came under pressure from activist investors Anson Funds and Legion Capital to divest assets to bolster shareholder value. Twilio’s own share price soared to more than $400 per share in 2021 before falling to $72.27 Wednesday before the company shared its fourth-quarter performance. The stock price was off another 15% on Thursday to $61.15 per share, suggesting that investors weren’t thrilled with the report.

Whether Twilio will actually sell Segment is an open question right now, but if it does, activists are betting that it will increase the value of the parent company by focusing on its core communications business.

Twilio’s history with Segment

When activist investors start circling a company, one CEO who went through the experience said that the first thing to do is to figure out if maybe they’re right, or at least partly right, in their assessment. That takes an ability to step back and see what they’re complaining about.

In this case, it’s about a big acquisition and whether it was the best place to put resources. Ah, but hindsight is always 20/20, isn’t it, especially in this case. Think back to October 2020 when we were at the height of the pandemic, and Twilio was flush with a healthy market cap of over $40 billion. With all that value and an eye toward expanding its market, Twilio went out and spent $3.2 billion to acquire Segment.

Segment was a high-flying startup that raised over $283 million. Its last round in 2019, a year before the acquisition, was a $175 million Series D at a $1.5 billion post-money valuation, per PitchBook. It was also a time where companies were really beginning to understand the value of customer data by bringing it into a single view, and Segment was one of the top startups going after large incumbents like Salesforce and Adobe.

But it was fair to ask, even at the time, where Segment would fit inside a company where the core business was building communications APIs. The consensus was that Twilio wanted to help customers build data-fueled customer-centric applications to take advantage of the data stored in the Segment CDP to provide a new growth path for the company.

It felt like that growth path was in reach, a way to expand the company’s markets beyond the communications APIs business. It actually made sense until the market shifted pretty dramatically post-pandemic and Twilio’s stock price plunged.

With its market cap dropping, Twilio was left with an asset that wasn’t really pulling its weight, making it vulnerable to activist investor complaints about where it fits in the business. The question is whether activists are putting the company in an impossible position.

What is Segment worth?

In its most recent earnings report, Twilio moved its “Flex and Marketing Campaigns products” to its Communications line of business, leaving its former Data and Applications unit much slimmed and now operating under the Segment name. It also includes some non-Segment efforts, like the company’s Engage products.

According to Twilio, its Segment unit generated $75 million worth of revenue in Q4 2023, up 4% from a $73 million result in the year-ago quarter. Its gross margin slipped 80 basis points to 74.4%, posted a non-GAAP operating margin of –24.6% and saw its dollar-based net expansion rate improve by 2% to 96% compared to its Q4 2022 metrics.

In simpler terms, Segment is not growing much, is seeing its revenue quality decline slightly, and is still seeing spend from existing customers contract. (Twilio took a charge relating to Segment in its most recent quarter: $286 million regarding “developed technology and customer relationship intangible assets,” which it added did not include any of Segment’s “reporting unit goodwill.”)

Given Segment’s known underperformance — in its earnings call, Twilio’s new CEO Khozema Shipchandler said that Segment is “not performing at the level it needs to,” adding later that its main priority is “mitigating churn and contraction” — and a more conservative market for tech valuations at present compared to late 2020, it’s doubtful that Twilio could hope to get the $3.2 billion it spent on the company back in a sale. This perspective has been floating around since even before the company better-surfaced Segment’s metrics. Now with more data, we can be more precise.

Segment’s business unit at Twilio generated $295 million worth of revenue in 2023, up 7% year-over-year. If we anticipate that Segment will manage the same growth this year, the business unit would close 2024 with about $316 million in revenue.

With that growth rate in hand, Segment would likely be valued similarly to other, slowly growing software businesses. Market data analyzed by Altimeter’s Jamin Ball indicates that software companies that are growing at 15% or less per year are worth about 4.4x their next 12 months’ revenue. At that multiple, Segment is worth about $1.4 billion.

You could argue that even that figure is a bit rich, given that Segment has stiffly negative operating margins, even on an adjusted basis. Some companies in its growth bucket have better profitability ratios, so we might expect Segment to earn a multiple in a sale that was slightly lower than the median figure that Ball calculated.

At the same time, the value of Segment won’t necessarily be measured directly from its potential public-market worth. If a buyer can be found that has a particular need or use for what Segment offers, Twilio might be able to juice a light premium. But no matter whether you adjust up or down, Segment’s growth rate and revenue base give it a light-unicorn value by current metrics, and nothing close to what it sold for.

It was easier to value software businesses at higher levels when growth was faster and money cheaper. Indeed, when the deal was covered by TechCrunch, we noted that by then-current norms it didn’t seem too expensive. Segment was also growing at more than 50% at the time, a figure that has dramatically come down in the intervening years. No matter, it’s hard to buy a company when software revenue multiples are in the high teens, see it decelerate, and then try to get your money back when single-digit multiples are the norm.

Apart from valuation dickering, another $1.4 billion in cash might not really change the game for Twilio. The company is worth around $11 billion today, has more than $4 billion in cash and equivalents, and under $1 billion worth of debt. So with more cash, it could extinguish debt and bolster its share buyback program, but the money doesn’t seem transformative for the parent org, given that it is cash-rich and debt-light.

This is the conundrum: Investors want action and news that could bolster Twilio’s share price. They have lobbied for Segment to be sold off to help improve the value of their holdings. But Segment is only so valuable today, and the company is stuck deciding between potential strategic gains from keeping one foot in the realm of CDP and divesting an asset at a loss that would see its revenue base erode. That’s a tough spot to be in.