2023-03-24 10:35:37 ET
Summary
- Twilio Inc.'s business model thrives on low-interest rates. For its sake, let's hope that the Fed cuts interest rates very soon.
- Twilio's business model won't reach GAAP profitability until 2027. Investors are going to have to wait 4 long years for this highly anticipated date.
- A discussion of some of the failings of Twilio's business model.
Investment Thesis
If profits matter, Twilio Inc. (TWLO) is substantially overvalued. If we can pretend that non-GAAP profits have any value to shareholders, this investment may work out.
That said, at this juncture, Twilio appears to be making several critical mistakes on top of a poor capital misallocation. Consequently, I can no longer stay bullish on this stock.
What did "as-a-service" mean in the end?
Twilio was at one point such a high-flying company. It's difficult to imagine how devastating interest rates have been to Twilio's prospects.
Furthermore, post-bubble times, I find it astounding how many SaaS/cPaaS/IaaS businesses were actually just operating under the ''as-a-Service'' label, but deploying usage-based business models.
To drive my point further, see here if you find any similarities?
As I've stated a few times already, the best companies in the world are frequently the ones who go above what is required to give their customers the most value possible. Think of AWS ( AMZN ), Netflix ( NFLX ), Costco ( COST ), or Amazon's retail division. These are businesses that in the first instance consider the customer experience, and are not focused on overcharging their clients.
To echo this perspective, this is what Twilio's co-founder Jeff Lawson stated in the company's prepared remarks :
Our usage-based model is a more immediate reflection of macro-economic factors than traditional bookings-based subscription revenue. Admittedly, that's an accelerated headwind during this part of the economic cycle , but can turn into a more accelerated tailwind when we see economic recovery.
For my part, I don't believe that Twilio's net expansion rates will improve anytime soon.
Here's the core of it: Twilio was able to over-charge customers and drive its revenue higher with this technique. But over time, the graphic above shows its customers figured out how to spend less with Twilio.
Essentially, rather than viewing Twilio as an asset, customers didn't welcome being left with a bill each month for embracing its customer-engagement tools. This aspect is also reflected in Twilio's revenue growth rates.
Revenue Growth Rates Are Fizzling Out
Twilio's business model relies on large acquisitions to grow its operations. The problem here is that with approximately $4.5 billion of run-rate revenues, and only $3.1 billion of net cash on its balance sheet , Twilio's ability to make further meaningful needle-moving acquisitions will be a challenge.
Consequently, what investors are now left with is a business that is likely to be growing at less than 20% CAGR. And in practical terms, Twilio Inc. is a business that is now more mature and isn't growing as rapidly, so investors will be much more acutely concerned about its underlying profitability.
This takes us to our next topic.
Do Profits Still Matter?
Twilio openly declares that it is not expected to reach GAAP profitability until 2027. Even if Twilio ends up reaching GAAP profitability a quarter or two ahead of schedule, investors will have to hang around for a good few years to figure out just how profitable Twilio could be.
Are we talking about 1% GAAP profitability? Maybe 3% GAAP profitability? Maybe even 5% GAAP operating profitability? Either way, it feels like a very long wait for not a lot of profits.
Capital Allocation Priorities
Twilio has signaled to investors that in the coming several months it will use $500 million to buy stock in the company, as they believe the "current share price undervalues [their] position in the market today and the long-term opportunity ahead."
At the same time as buying back 4% of its market, Twilio reduced its workforce by 17%.
Frankly speaking, I simply don't support the Twilio Inc. capital allocation strategy. Twilio needs to put all its effort on the table to stabilize its operations, and figure out how to deliver more value to its customers , rather than deploying cash on these one-off capital allocation decisions.
The Bottom Line
Let's welcome some critical thinking.
Let's assume that from the end of 2022, into 2027, over the next 5 years, Twilio Inc.'s CAGR is 15%. That would put the business at $7.7 billion. And let's assume that Twilio's GAAP operating profits (before taxes) reach 5%. That would put Twilio's operating profits at $390 million. Now, let's be generous and allow for a margin of safety, let's assume that Twilio takes on some debt, and gets its GAAP operating profits by 2027 to report $500 million.
This would leave Twilio Inc. today priced at 23x forward 2027 GAAP profits. For a business that's growing at 15% CAGR. Furthermore, I've assumed no increase in its shares outstanding between now and 2027.
For further details see:
Twilio: A Shadow Of Its Former Self