2023-10-20 12:21:14 ET
Summary
- Twilio is a concealed value play with a strong margin of safety, offering an attractive option for value-focused investors.
- Twilio has access to a wealth of unique product usage and user data. This synergy between data, communications, and AI presents significant growth potential.
- With impressive cash-to-debt ratios, robust revenue growth, and cost management, I believe Twilio presents a secure long-term investment.
- Twilio's valuation is appealing compared to peers, and a DCF analysis suggests significant undervaluation.
In the world of stock investments, there's an ongoing quest for underappreciated opportunities, where low risk meets high potential reward. Twilio (TWLO), a cloud communications platform, fits the profile as a substantial hidden value prospect. So why does Twilio stand out as a value-driven option? It's a combination of various factors that align with the attributes of a deep-value stock, a relatively rare find in today's market.
In the post-pandemic era, stocks experienced an overselling phase, distinct from the earlier euphoria surrounding the pandemic's impact. Twilio, like many others, encountered this situation, leading to a relatively modest valuation, despite its strong financial base. Alongside its attractively priced stock, Twilio maintains robust financial stability, featuring minimal debt and a significant cash reserve.
Most importantly though, Twilio's strategic acquisition of Segment, a popular customer data platform, has equipped it with a valuable data-driven advantage, where the synergy between product usage data and communications AI opportunities presents an often overlooked advantage that is quite unique for the industry.
In this article, we'll explore how these factors, coupled with bearish market sentiment and ongoing revenue growth, position Twilio as a concealed value opportunity with the potential for long-term gains.
Unlocking Twilio's hidden value: The synergy of pure data and AI
In today's rapidly evolving landscape, the widespread adoption of artificial intelligence is transforming numerous sectors, driving tangible gains in productivity and efficiency. However, the effectiveness of AI critically depends on the availability of substantial data. In this context, Twilio enjoys a distinct advantage. Through its acquisition of Segment, the company has access to a wealth of unique product usage and user data.
Segment is a platform that helps businesses collect, clean, and manage their customer data. It also allows companies to unify their customer data from various sources, such as websites, mobile apps, and other software, into a single comprehensive view. To simplify, every time you open an application or a website for a particular service and interact with it by clicking on something, this action can be recorded in Segment, along with your user attributes. These recorded data points can then be utilized by the service in the future.
In the realm of data tracking, Segment has established itself as an industry standard, underpinning countless businesses' efforts to gain deeper insights into their customers' behaviors and preferences. Drawing from my nearly seven years of experience in data analytics, most startup- to scaleup-stage companies use segment to track user actions and product events within their apps.
In turn, CDP software industry is expected to reach $7.3 billion by 2027, as reported by IDC. This growth serves as an additional catalyst for Twilio, considering its strong market presence. To put this into perspective, Twilio's Data & Application revenue for Q2 2023 amounted to just $125 million, which means there is a significant room for growth in the coming years.
As Twilio delves further into integrating AI into its communication products with its CustomerAI, the synergy with Segment takes on an even greater significance. This powerful combination is poised to be a game-changer for Twilio, allowing the company to harness the full potential of AI-driven communication solutions and deliver more personalized and effective services to its clients.
To draw an analogy, when it comes to gathering insights into app user behavior, Twilio holds a unique vantage point that sets it apart from other communication companies, such as Salesforce ( CRM ). While Salesforce excels in building CRM journeys, its information is largely confined to communication data. Twilio, on the other hand, brings a wealth of app usage data into the equation, offering a more comprehensive view of user interactions. This expanded perspective allows Twilio to provide insights and solutions that go beyond traditional communication data, offering a richer and more holistic understanding of customer engagement.
Twilio's financial strength makes it a safer long-term investment
Revenue growth
Further bolstering the case for Twilio as a hidden value play is its robust financial foundation. The company's revenue growth has consistently been in the double digits, significantly outperforming the broader tech market. What makes this growth even more promising is the hidden synergy Twilio possesses between data, communications, and AI, which could potentially accelerate its growth trajectory.
A noteworthy aspect of Twilio's financial health is the revenue growth in the Data & Applications segment, as sales there increased by 16% year-over-year in the first six months of 2023. Over time, this growth has the potential to compound, further solidifying Twilio's position as a promising value investment.
Balance sheet
Beyond revenue growth, the company's financial safety nets are particularly impressive and are among the best across the peers . Twilio boasts an outstanding cash to debt ratio, with about $3.7 billion in cash and short term investments and about $988 million in long-term debt, providing a solid cushion for economic uncertainties. Its high quick and current ratios also underscore its financial stability, which is a crucial consideration for investors seeking a margin of safety in their investments.
Costs and profitability
On the cost front, Twilio exhibits stable R&D expenses, indicating a commitment to innovation and product development. Simultaneously, the company is efficiently reducing its SG&A costs. This combination of controlled spending and focused investment is a positive signal for investors.
Seeking Alpha; notes by the author
One more remarkable aspect is how close Twilio is to achieving GAAP profitability. Notably, the recent quarter was positive for Twilio in terms of operating cash flow, as the company accrues significant stock-based compensation expenses.
Twilio has a relatively low valuation and a significant margin of safety
Twilio's valuation metrics further support its status as a hidden value opportunity in the tech sector. When compared to some of its peers, Twilio's valuation multiples appear notably lower, signaling a potential undervaluation. The company's low price-to-earnings growth ((PEG)) ratio of 1 is particularly eye-catching, as it indicates that investors are not overpaying for the company's growth potential. Additionally, Twilio's low price-to-sales ratio of 2.5, coupled with a forward price-to-sales ratio of 2.3, suggests that the stock may be trading at a discount relative to its sales performance.
DCF analysis shows a significant undervaluation
To strengthen the analysis, I use discount cash flow model to value the company.
My analysis is based on the following key assumptions:
1. The average annual revenue growth over the horizon period of five years is estimated to be around 14%, with a 6% increase in 2023 and 9-20% growth between 2024 and 2027, mostly based on analysts' earnings estimates . I hold a more optimistic outlook for the revenue growth in 2026 and 2027, factoring in Twilio's data and AI initiatives.
2. I use an adjusted EBITDA view, adding back the stock-based compensation expense. From there, I assume a 5% yearly EBITDA margin expansion, which would result in 26.5% margin by 2027, which is the average EBITDA margin between peers like Akamai Technologies ( AKAM ) and Salesforce.
To compensate, a dilution of shares outstanding by about 20% is assumed, based on the current difference between stock-based compensation expense and TWLO's repurchase of common stock.
3. Then goes the WACC.
The after-tax cost of debt is 3.1%, based on TWLO's debt structure. The cost of equity capital (16.8%) is calculated using CAPM, with 1.32 beta, 4.9% risk-free rate, which is the current U.S. 10-year bond yield, and 9% market premium. The WACC is, therefore, estimated to be around 15.6%.
4. EV/EBITDA multiple will be around 11-13 after the 5-year forecast period, which is the current average forward EV/EBITDA of peers like Salesforce, Akamai, and 8x8 ( EGHT ).
Here is the operating and balance sheet data used in the modeling:
As a result of these calculations, TWLO's fair price range is approximately $91-96.6 , which is about 70% higher than the current stock price.
Now, this scenario does assume a bullish EBITDA margin expansion of 5% per year in the next years. But even if we take a more conservative approach with a 3% margin increase per year, we still get a fair price range of $68.4-72.3 . Therefore, the stock's margin of safety appears substantial.
Notably, Seeking Alpha's quant system gives TWLO a Strong Buy recommendation, with top-notch valuation and growth grades. TWLO is also among the companies that currently receive Buy ratings and higher from Seeking Alpha analysts, Wall Street analysts, and Seeking Alpha's quant rating, which is a rare consensus for the technology sector.
Risks
It is worth outlining the risks that can impact TWLO's performance in the near- to medium-term future.
While Twilio's revenue growth has been impressive, it's worth noting that the pace of growth has significantly slowed down recently. After several years of double-digit revenue expansion, the company is now projecting only 1% revenue growth in Q3 2023. The company's Dollar-Based Net Expansion Rate has also decreased significantly over the years, from 123% in Q2 2022 to just 103% in Q2 2023. For Twilio to truly succeed, it will need to reaccelerate this growth, as slower expansion could potentially disappoint investors who have grown accustomed to its previous performance.
Additionally, Twilio needs to focus on expanding its margins and maintaining the positive cash flows it achieved in the recent quarter. As the tech industry is highly competitive, increasing profitability is a crucial factor for long-term success. Any challenges in achieving these goals could pose risks to the stock's performance.
Another risk factor lies in the general economic environment. Economic instability can lead to reduced spending on B2B software and services, as companies may become more cautious with their budgets. A decrease in demand for such services could negatively impact Twilio's revenue and growth prospects, making it essential for the company to adapt to changing market conditions.
Key takeaways
To sum up, TWLO stands out as a promising value investment:
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Synergy of data, AI, and communication products: Twilio's strategic acquisition of Segment, a leading customer data platform, places it in a unique position. The synergy between product usage data and AI opportunities presents a transformative advantage. As Twilio further integrates AI into its communication products, this synergy can revolutionize client services.
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Financial strength and promising growth: Twilio's financial position is robust, with double-digit revenue growth and strong revenue projections, especially in the Data+Applications segment. The post-pandemic overselling phase led to a modest valuation, despite the company's strong financial foundation, marked by minimal debt and a significant cash reserve.
- Margin of safety with hidden potential: The company's relatively low valuation metrics further underscore its potential as a hidden value opportunity with a significant margin of safety. A DCF analysis reveals the stock is undervalued by at least 27% under conservative assumptions and potentially by up to 70% in a bullish scenario.
As a result, Twilio is an appealing target for value-driven investors, offering a solid risk-reward opportunity.
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Twilio: An Underappreciated Value Opportunity