2023-09-27 14:28:02 ET
Summary
- Twilio's Q2 earnings report shows disappointing results, with a 10% stock price drop and a downward revision in Q3 revenue guidance.
- The company is experiencing a deceleration in revenue growth and struggles to keep up with its previous growth rates.
- Despite challenges, Twilio has a strong balance sheet, potential for future growth, and is trading at historically low valuations.
- We currently rate Twilio as a hold.
Introduction
Today we will be looking at Twilio’s (TWLO) second-quarter earnings report. Twilio, once a high flyer, took a nosedive from its 2021 peak, plummeting by a staggering 91% at one point in 2022. During 2023 the stock has moved fairly sideways, albeit in a wide range.
In this article, we will take a deep dive into Twilio’s latest quarterly results and we will explore where the stock might be heading in the future.
Where We Are
Before we plunge into the most recent earnings, we would like to address that TWLO’s results have been disappointing in Q1 of 2023 and we already saw growth declining in Q4 of last year.
Unfortunately, the second quarter was disappointing again, resulting in a 10% stock price drop. Although TWLO had a beat on both revenue and EPS, they revised Q3 revenue guidance from $1.02B to a range of $980M-$990M. Despite Twilio’s efforts to develop new AI tools, the company is struggling to keep up its revenue growth.
As illustrated in the chart below, TWLO’s growth is showing signs of big deceleration and the company must find a way to reverse this trend. The sooner, the better.
Although revenue continues to rise, there is a noticeable deceleration in this growth. Looking at the trailing-twelve-month ((TTM)) basis, revenue is only up 5.90% year-over-year, indicating that the first two quarters aren’t a good sign for what’s to come.
The reason is probably that Twilio focused on profits, sacrificing growth. In addition, gross profit has risen 6.95% on a TTM basis, an improvement over revenue growth, but still a far cry from the 52% and 30.5% YoY gross profit growth seen in FY 2021 and 2022, respectively.
Furthermore, the gross margin has been declining, although it remains relatively high at 47.41% for the past year However, this is still noticeably lower than the 53.70% the company reported back in 2019. As such, this trend suggests that the company may be experiencing a reduction in its pricing power.
Reasons To Sell
We need to address the concerning decline in Data & Applications revenue. We believe this is a crucial segment for TWLO, as this is the segment with the highest margins. We saw a decline last quarter and unfortunately, this downward trend has persisted.
While the revenue from this segment demonstrated a 19% year-over-year growth in the last quarter, it has since further declined to a mere 12%. This doesn’t really instill confidence when it comes to the prospects of revenue growth in other areas.
The significance of Data & Applications to our investment thesis lies in the fact that, generally speaking, this segment has higher margins. Furthermore, total revenue growth has continued to deteriorate further to just 10% growth year-over-year. It's important to note that TWLO is a growth company. TWLO’s total revenue growth fell below 15% year-over-year last quarter. Unfortunately, the latest results were even worse with revenue growth coming in at just 10% year-over-year in Q2.
Adding to the concern, the company guided for a quite depressing 5% growth rate for Q3. As such, we believe the growth narrative for TWLO is getting even more concerning.
In addition, the company is still far from achieving GAAP profitability. Although the current market conditions have proven to be challenging for companies like TWLO, this isn’t the only company that has suffered. The entire sector has been grappling with difficulties, and multiple are facing similar struggles.
However, we saw one positive this quarter. The company appears to be shifting its focus towards its shareholders. Notably, the Non-GAAP SBC expense is now 15% of the total revenue. While this figure is still relatively high, it marks a significant improvement compared to the 26% recorded in Q2 of last year.
Nonetheless, the company isn’t planning on being GAAP profitable before 2027. Consequently, unless they can reignite their growth, it's likely that the company’s stock will continue to bleed. Jeff Lawson, the CEO of the company, mentioned that he is “confident that revenue growth will reaccelerate over time”.
To be honest, I think this is a pretty blank statement, lacking a specific timeframe regarding when this reacceleration might take place. From our perspective, it seems more like a statement aimed at reassuring shareholders rather than providing concrete guidance.
Cash Flow and DBNER
Not only does the company have a high stock-based compensation as a percentage of revenue, but the company also has a cash flow issue. Twilio had a negative FCF of $288.80M in 2022. But in this quarter, the company turned that around to a positive free cash flow of $72 million.
Furthermore, the company's operating margin presents a considerable concern. We believe that the company should try its best to achieve a positive operating margin in 2023 or at least show substantial progress toward achieving a positive operating margin.
This is also what the management of TWLO indicated they wanted to achieve in Q4 of 2023. While the numbers are improving, it will be rough for the company to achieve this.
Currently, the operating margin sits at negative 18.18% on a trailing-twelve month basis as can be seen in the chart below. Nonetheless, the company has 2 quarters left for achieving this feat.
The company doesn’t have any balance sheet issues, over $675M in cash and cash equivalents and over $3B in short-term investments.
Moving on to the dollar-based net expansion rate, also known as DBNER, this quarter the DBNER came in at 103%. It's worth noting that we expressed concerns about DBNER in the previous quarter when it was at 106%, and unfortunately, this metric has continued its decline, which signals another step in the wrong direction.
Hence, the DBNER has seen a 20% decline compared to Q2 of last year. It is essential to understand that this figure doesn’t take into account all the users who have departed. It means that those who stayed (and only those!) spent a paltry 3% more on the platform than the previous year. Not really a sign of strength. This metric must improve soon, otherwise the company will have a rough time in the quarters to come.
Reasons Not To Sell
As we mentioned earlier in the article, it is evident that Twilio’s growth has decelerated. Nevertheless, the company is still growing, and we believe Twilio possesses the potential to reaccelerate its growth when the overall market conditions become more favorable for growth companies.
Moreover, the company has been able to grow its revenue at a CAGR of 42.55% from 2018 to 2022. This is very impressive now that the company managed to generate FCF, TWLO could transform into a cash-generating machine in the future.
Furthermore, the company has $3.68 billion in cash & short-term investments, as of the latest report versus $1.93B in total liabilities. As such, the company has a strong balance sheet and will not have any liquidity issues, signaling that TWLO is able to pay off its debt easily even if these rough macro conditions last longer than one might initially expect.
Furthermore, TWLO initiated a $1B share repurchase program in February of this year. The company completed the first $500M of new repurchases in early July, per the most recent earnings transcript .
Additionally, we like the shift in Twilio’s strategy amidst these challenging market conditions. For example, CFO Aidan Viggiano mentioned the following:
While we feel confident about the strength of our competitive positioning and market opportunity, we’re continuing to plan and run the business prudently given the dynamic external environment.
Obviously, it is important that they find a way to reaccelerate growth. Nonetheless, it is good to see that the company is choosing share buybacks over expensive acquisitions.
Another interesting comment during the earnings call was the following:
We expect Q3 non-GAAP income from operations of $75 million to $85 million. This takes into account approximately $10 million of expenses for our SIGNAL Conference, which will take place this month. Given our strong first half performance, we're raising our full-year non-GAAP income from operations guidance to $350 million to $400 million.
We’ve made meaningful progress over the first half of the year, but there is still more work to be done. I’m confident that we are taking the right set of actions that will enable us to continue to drive focused execution and deliver increased value to our shareholders in the quarters to come.
Once more, we firmly believe the company should prioritize achieving positive FCF and reigniting its growth. While this won’t be a straightforward task, we believe the company could be able to turn its business around. Furthermore, the current AI tailwinds could be in Twilio’s favor in the upcoming years.
When looking further at some financial metrics, it is worth noting that TWLO is trading at historically low valuations. For instance, when examining the price-to-sales ratio, the current 2.766 is much lower than historical averages.
Ycharts
In addition, the EV to revenue ratio is showing a similar trend, the stock was only cheaper at the end of 2022 and in May of 2023, when the stock took a serious plunge.
Ycharts
As mentioned earlier, TWLO could be a big beneficiary of generative AI. CEO Jeff Lawson mentioned the following regarding this transformation process:
A business transformation as big as what Twilio is taking on takes time. It requires tactical focus in the short term and a bold vision for what's possible in the long term. Twilio's Act 1, Communications, has been a success in terms of scale and efficiency. Our Communications business continues to deliver against the objectives we've set, driving efficient growth, while we target ongoing operating leverage in the coming years.
And we're now building Act 2 based on our belief that Twilio's data asset, when combined with the power and reach of our Communications platform and accelerated by AI, can unlock value for businesses that we are uniquely positioned to deliver through our innovative combination of product offerings.
While I don't expect the road ahead to be linear, we've embarked on a massive market opportunity, one that has the ability to transform the status quo for customer engagement.
Technical Analysis
If we look at the technicals for TWLO, it is clear that the company had a rough 2 years, with the company being down close to 91% at one point in time.
The company is currently trading in the golden triangle as can be seen in the chart below. We believe a breakout above or below this triangle could initiate a swift move either higher or lower. If the company is able to break above the trendline, the first resistance we should be looking at is the $80 resistance.
On the downside, we should be looking at the $43 support in case of more downward price action. This would be challenging for investors who have confidence in the stock's stability.
Looking at the EMAs, the stock is trading below all of its EMAs on both a daily and weekly basis. This shows the immense bearish pressure currently put on the stock.
For the stock to find a significant upside, it would have to break through all EMAs on a daily basis and, with the 200 EMA aligning perfectly with the golden trendline resistance.
Unfortunately, we do not see any signs of a significant move to the upside for TWLO on a technical level in the short to medium term. As such, we expect TWLO to trade within the triangle until we see a significant catalyst.
Conclusion
In this article, we've looked closely at Twilio, a company that's been on a rollercoaster ride since its 2021 peak. Or maybe a plunge is a better word.
2022 was rough, and 2023 hasn't been a total rebound, but there's hope. The latest earnings weren't stellar, with a downward revision in Q3 revenue guidance. Revenue growth is slowing, especially in the Data & Applications segment. TWLO isn't on track for GAAP profitability anytime soon, and stocks of companies that cannot show that are not particularly loved by the market.
Cash flow is a concern, but TWLO's got a solid cash reserve. Share buybacks and a prudent approach are positives. Despite the hurdles, TWLO's long-term growth story isn't dead yet. It's trading at historic lows and could ride the AI wave.
So, it's a mixed bag. TWLO has work to do, but it's not out of the game. Or at least, not yet.
As such, we believe TWLO can currently be rated as a hold. Mostly due to the already significant decline the company had and they might be able to reach a positive operating margin by the end of 2023.
Thank you all for reading!
For further details see:
Twilio: A Mixed Bag, But Long-Term Growth Story Isn't Dead Yet