2023-05-24 09:30:00 ET
Summary
- Two weeks ago, Twilio released its Q1 2023 earnings results. The stock dove by about 15%.
- We look at the underlying trends and what management had to say on the conference call.
- Fundamentally, Twilio is a sell, but there could be reasons to see it as a hold as well.
- What I will do with my position and what I think you should do with yours.
Introduction
I'm an investor and for me, investing is inherently for the long term. I always buy with the intention of holding forever. But to paraphrase Warren Buffett, this period shows who has been swimming naked. Therefore, the cream rises to the top.
Mind you, I will never judge on price action and not even just on revenue results. But there must be signs that the company I hold shares of still does well for long-term returns.
Twilio (TWLO) is one of my long-term holdings. With a cost basis of $138.73, I'm down 57%. I think it is important to show that as well. Losers will always be a part of investing. Even the very best usually just have a hit rate of 55% to 65%. It's now how many losers you have that count, but the size of your winners.
But let's get back to Twilio. There are reasons to sell my position, but there are also reasons not to sell.
Reasons To Sell
Let's break things down a bit. This is from the earnings presentation .
I have highlighted Data & Applications revenue. This includes Segment and Engage revenue. The fact that this only grows by 19% is not really encouraging. It had already trended down in the previous quarter, but it was still up 25%.
To me, Data & Applications was the lynchpin of my investment thesis. After all, this is the part of the revenue that has much higher margins. But it's still less than 12% of the total revenue.
Another part of the bull thesis was Twilio's Internet of Things division. Communication between IoT devices and control them. But Twilio sold this division to Kore, for about $10 million and not even in cash but in shares. It got 11% of a microcap of $95 million. Not a great look, either.
Revenue growth has dropped off a cliff.
Twilio's Q1 2023 earnings presentation
Now, of course, this is not the only company in which the revenue has gone down so much. Many other companies now focus on profitability. Twilio is also trying to become profitable, but it will need time. It was the first quarter of positive non-GAAP income from operations, but that's still a far cry from GAAP net income.
The company projects GAAP profitability only in 2027. In this quarter, the GAAP loss from operations was $264.1 million, even worse than last year's Q1 operational loss of $217.8 million. But, to be clear, there were quite a few one-time expenses. There was $121.9 million in severance and other lay-off expenses and $21.8 million in lease impairment caused by office closures. This all resulted in a GAAP EPS of -$1.84.
Besides the one-time expenses, one of the main reasons for the big GAAP loss is the high stock-based compensation. Jeff Lawson explained on the previous earnings call that it takes 4 to 5 years before the signed contracts expire.
But if you look at this graph, you see that management's compensation went up enormously in 2022.
Twilio's 2022 10-K, emojis and text by From Growth To Value
( from the company's 10-K)
Together, that's $140 million in stock-based compensation, up from $69.5 million in 2021.
If you look at gross profit margins, you also see a very unfavorable trend.
This shows that Twilio doesn't show any operating leverage. Operating leverage means that you can make costs go down with more revenue coming in. As you see, revenue was up 15%, gross profits just 14%. Not what you want to see.
A particular lowlight for me was the DBNER or dollar-based net expansion rate. It came in at just 106%, compared to 127% in the same quarter last year.
Mind you, this is not dollar-based net retention rate; it's net expansion . Net retention means you take all churn into account. Net expansion means that you don't take into account all the users that left.
An example to make this clearer. Suppose you have 1,000 users, all spending $1,000 per year in year 1. That means you have $1 million in revenue. In year two, 100 customers leave, but those that stay, spend 6% more than the previous year. That means 900 customers spending $1,060 or $954,000. The dollar-based net retention rate will be 95.4%, but the dollar net expansion rate will still be 106%. And that's the number Twilio reports. Very clear: dollar-based net expansion of 106% is just really weak.
So, up to now, you have only gotten reasons to sell. Let's look at a few reasons not to sell.
Reasons Not To Sell
The first reason not to sell is that Twilio is not a dying business. The company could add 12% extra customers year-over-year, which is still pretty good in this tough environment and at that scale.
It is also financially strong. Let's take a look at the balance sheet.
Seeking Alpha
As you can see, the company has nearly $4 billion in cash, equivalents and short-term investments. It also has $575 million in receivables. I don't consider long-term assets because these are not liquid, and there's also a big sum in goodwill from the acquisitions Twilio has done.
If you look at the other side of the balance, you see this:
Seeking Alpha
So, that's $4.521B in liquid assets and $1.98 billion in total liabilities. That means the company has a net liquid asset position of $2.5 billion. With -$93 million in negative free cash flow, it means the company could not improve anything and could still go on for 27 quarters, or almost 7 years. Financially, Twilio is still rock-steady.
In February, Twilio announced a share repurchase program of $1 billion . It now announced that it has already bought back $250 million in shares. The company also said it would buy $500 million in the first six months of the program, meaning from February until August. That could support Twilio's stock price. Another reason not to sell.
Also, if you look at the valuation, you see that Twilio raked in $1 billion in this quarter and you extrapolate that to the year, it means that Twilio now trades at just two times sales. If you subtract the $2.5 billion net cash, it's just even 1.5 times sales. If you look at enterprise value, it trades at about 4 times gross profit, which is cheap.
AI could also mean a boost for Twilio. As founder and CEO Jeff Lawson said during the conference call:
The AI platform shift is upon us. Like the PC to web transition, the web to mobile, this is the next major technology shift in our society. Working with customers, we see many ways to activate customer data in segment across the whole customer life cycle using artificial intelligence.
Knowing Twilio's business, I think this is true and could boost the Data & Applications revenue in the next few years. After all, Segment has a lot of first-party data and AI could unleash its power on those data.
As I have written before, Data & Applications, now headed by Elena Donio, is the most interesting part of Twilio, both because of the future and because of the higher margins this division generates.
Elena Donio also gave an example already about how Twilio's customers can unleash the power of their own data:
This was a highly competitive deal that we ultimately won by showcasing that by using Engage Premier paired with Segment CDP, Cricket Wireless could activate customer insights from their data warehouse without developer support and get a complete view of the user, reduce churn by precisely identifying where customers fell off during the onboarding journey, and drive growth through personalized campaigns with customized offers.
Donio also talked about Segment Unify, which was launched during Q1 and could become very important in the future. In the prepared remarks, she wrote :
During Q1, we also launched Segment Unify, a real-time identity resolution solution that allows businesses to merge the complete history of each customer into a single profile and freely sync it to and from their data warehouse using reverse extract, transform and load ("ETL"). Sanofi, one of the world's largest healthcare companies, is using Segment Unify to provide better treatment options for patients. Before using Unify, it took three-plus days to activate customer data; now it takes under three hours.
A second product launch was Flex Unify. Donio again explains what this is and does:
Flex Unify natively brings Segment's rich customer profile data and identity resolution capabilities into the agent experience, which enables them to offer end customers a more personalized interaction. One of the largest nonprofit health insurers in the U.S. is now using this connector to immediately deploy a robust contact center and engagement solution that improves productivity by 250% across 3,500 agents.
These and other big customer wins are another reason why I think the bull case for Twilio is not completely busted. Management also said that, despite the macro headwinds, they are excited about the second half of the year. The company has been reorganized, sales teams were rearranged and rewards reworked, there was a sales kickoff and management believes this will increase sales in the second half of this year. In other words, Q2 could be the revenue growth bottom. But no guidance was given for the remainder of the year, because of the uncertainty that the macro situation brings.
Next to the macro, Twilio Communications President Khozema Shipchandler also pointed out that Twilio was impacted by the crypto implosion, both in revenue and comparable numbers.
The company's Q2 guidance was also impacted by the sale of the IoT sale I already wrote about earlier in this article. That caused an impact of "mid to high single-digit millions."
Twilio shared that it could sign several big customers. It mentioned MongoDB ( MDB ) and Sanofi ( SNY ), for example. And it stressed several times during the earnings call that it doesn't see elevated churn, just customers tightening their belts. That's a positive sign.
Overall, we have seen that consumption-based models are much more impacted as companies scrutinize their spending. They will also have more upside if the macro headwinds become tailwinds.
This may be totally different for you, dear reader, but another reason for me not to sell for me is Jeff Lawson. I have listened to many CEOs over the years, and no matter how much heat Jeff Lawson now gets for his generous stock-based compensation, I still see him as a good leader.
Definitely, he has drunk too much of the honey in stock-based compensation and probably spent too much on acquisitions. He may be even lean a bit too much to the woke side, but I still believe he is a good leader. I don't let any political views interfere with my investing, so please refrain from commenting on that. But if I'm right, a big IF, Jeff Lawson now has to stand up to prove he is a great leader. Because it's in the most dire times that true leaders stand up. Can Lawson do it? We'll have to see.
Buy-Hold-Sell Scale
For my Potential Multibagger subscribers, I give an Overall Quality Score. The highest score is 98, while Twilio only gets to 50. I also issue a Buy-Hold-Sell Scale. It's a spectrum more than a label, to add more nuance. This is it for Twilio.
Twilio is not a strong sell, because it still has positive elements, as I showed. But it's showing no improvement either. That makes it a weak hold in my opinion.
What I Will Do With My Twilio Position
Twilio accounts for just 0.79% of my portfolio, so it's not a big position.
The macroeconomic headwinds clearly impact Twilio, and it proves the stock will be quite cyclical, not something I had anticipated to that extent. I thought communication was more essential to companies, and I was wrong. It seems companies can cut their communication budgets much more and much easier than I thought.
Conclusion
There are clear fundamental reasons to sell your Twilio position. It will probably be a big loser for many, just as it is for me. If you add the money to one of the stocks of companies still executing even during these tough times, you might win it back faster than staying in Twilio.
But there are also reasons to believe that Q2, the current quarter and the next to be released, might be the bottom. If that is correct, Twilio can grow again after that. AI could be a boost and Twilio promised to release more news in August when they have their yearly Signal conference.
As always, dear reader, I encourage you to think for yourself. Your analysis might give you a completely different and maybe clearer insight. Make sure you have looked at all information, and then make your own decision.
If Twilio is a big loser, don't kick yourself. Circumstances can change fast and you can't avoid losers in investing. It will always hurt, but it's part of investing.
In the meantime, keep growing!
For further details see:
Is Twilio Stock A Good Long-Term Investment?