2023-07-25 00:36:26 ET
Summary
- Shares of communications platform-as-a-service company Twilio have gained just over 20% year to date, lagging behind other software peers and down more than 85% versus 2021-era highs.
- Despite revenue growth deceleration, Twilio continues to be a category leader in communications APIs, with a diverse customer base, including Uber, Lyft, The Red Cross Organization, Dell, VMware, and Stripe.
- The company is focused on building a business that can deliver profit in any macro environment.
- FY23 pro forma operating income is expected to come in at $275-$350 million versus an FY22 loss.
- Valuation is cheap at <2x forward revenue.
Though most tech stocks are rallying driven by the AI boom, there have been a couple of notable holdouts this year that are citing severe macro headwinds and not seeing as generous of a bump in return. Twilio ( TWLO ) is one of the key examples here, as the communications platform-as-a-service (CPaaS) company has seen a painful shift from hyper-growth stock to the penalty box.
Year to date, shares of Twilio have gained just over 20%, which roughly matches the performance of the S&P 500. Still, Twilio's gains lag substantially behind other software peers, and the stock also remains down more than 85% versus 2021-era highs above $400. Now, I think it'll be a long time before Twilio reclaims those levels again - pandemic-era all-time highs were a function of the bloated market at the time, not of Twilio's business - but I think there's a lot of under-recognized potential here.
I remain bullish on Twilio (a slight downgrade from a prior very bullish view). I don't disagree that the company's revenue growth deceleration is somewhat concerning, and the multi-quarter trend in softening net expansion rates, which is the heart of Twilio's land-and-expand business strategy, merits some attention. At the same time, however, Twilio continues to be a category leader in communications APIs, and remains the foundation that many consumers' favorite applications are built upon. The only real threat to Twilio is if more companies decide to build its functions in-house - but today, when customers as big/notable/diverse as Uber ( UBER ) and Lyft ( LYFT ), The Red Cross Organization, Dell, VMware ( VMW ), and Stripe all use Twilio, it's clear that a "best-in-class" IT strategy leaving CPaaS to specialists is widely accepted.
Here is my full long-term bull case for Twilio:
- Universal, horizontal software platform that has limitless opportunities for expansion. Many kinds of applications require the ability to connect with their customers through talk and text, and as more and more of our lives go digital, Twilio's potential base of customers will continue to widen. Twilio has also been adept at expanding its core product set, adding call-center software capabilities as well as email marketing tools through its acquisition of SendGrid. A recently added product called Twilio Live also introduces live-streaming capabilities for Twilio clients.
- Land and expand; growth alongside the customer base. Twilio is one of the best examples of a "land and expand" software company. Because it prices its services by usage (for example, per messages sent), its revenue grows when the underlying apps it powers do. This gives Twilio a powerful, built-in growth engine.
- Customer diversification. Twilio used to be heavily reliant on large accounts; now, the company's top 10 customers represent only 13% of revenue, and the company has over 280k total customers.
- Path to profitability. Driven by expanding gross profit dollars per message sent, as well as economies of scale on opex as Twilio continues its organic growth path, the company has already crossed into profitability from a pro forma perspective and expects GAAP profitability by FY27.
Let's not ignore the elephant in the room here: investors have soured on Twilio after the company released Q2 guidance that called for just 4-5% y/y revenue growth.
We should note, however, that this deceleration (from 14% y/y growth in Q1) reflects the divestiture of Twilio's IoT unit to KORE . We should focus on the fact that on an organic basis, Twilio expects 15-25% y/y annual growth through the "medium term" through 2027. This indicates Twilio's core belief that a lot of the current growth slowdown is macro-driven.
Valuation check
With weakened sentiment on Twilio, its stock has also fallen into a fairly attractive valuation position. At current share prices just shy of $62, Twilio trades at a market cap of $11.33 billion. After we net off the $3.95 billion of cash and $987.8 million of debt on Twilio's most recent balance sheet, the company's resulting enterprise value is $8.37 billion.
For FY24, meanwhile, Wall Street analysts are expecting Twilio to generate $4.57 billion in revenue, representing 12% y/y growth. This puts Twilio's valuation at just 1.8x EV/FY24 revenue - needless to say, that's a cheap multiple for a company that is still claiming mid-teens organic revenue growth amid climbing operating profits. This is a valuation multiple, in my view, that provides ample safety cover for Twilio's fundamental risks.
Q1 shows deceleration, but underlying profit gains are solid
We should not, of course, ignore the fact that macro conditions have pushed down Twilio's growth picture. Take a look at the company's latest Q1 results below:
Revenue grew 14% y/y to $1.01 billion, essentially in-line with Wall Street's expectations of $1.00 billion. The concerning portion here, however, is continued deceleration - from 22% y/y in Q4, and 33% y/y in Q3:
This was driven, in large part, by a decay in dollar-based net expansion trends, which fell to 106% in the most recent quarter, down from 110% in Q4 and the ~120s throughout most of early 2022.
As a reminder, unlike most other subscription software companies, Twilio charges based on usage. When a user sends a message (a text to an Uber driver, for example), Twilio charges Uber per message sent.
Now, rideshare companies are unfortunately a much smaller portion of Twilio's overall business than in the past, so boosts in delivery and ride-based activity were insufficient to offset global slowdowns in e-commerce and other internet services.
Here are some remarks from CFO Aidan Viggiano during the Q&A portion of the Q1 earnings call, discussing the impacts of macro conditions on Twilio's usage rates:
Yes, I'll start with a bit on the second quarter and then -- this is Aidan, by the way, and then go a little bit into some of the traction for the year. So, it's largely macro as we think about the second quarter. So the market continues to be pretty dynamic, and we're feeling the impacts of a broader slowdown. And so you see that reflected in our guide.
I think the other thing that's important to remember is that, the majority of our revenue comes from our communications business, about 85% of our revenue. As Khozema just said, that's a consumption model tied to consumer activity. So in that business, we are dealing with a combination of macro, as well as the tough comparisons that we just talked about on crypto. And so again, that's creating a headwind year-over-year as it relates to the second quarter growth rate.
On the data and application side, Elena has talked about it as well, but we are rebuilding -- Elena talked about our efforts there to ramp up the sales force and really enabled the team further. And we're also doing that in a tougher macro cycle. So, I'd say on the communications side, it's a combination of macro, some tough comparisons on the software side, it's a mix of our efforts to rebuild plus the macro, and we factored all of this into our guide. So, I'd say some choppiness on growth in the short term, but despite that, we're focused on what we can control, which is delivering profit in any environment ."
It's important to emphasize the last portion (bolded above): Twilio's goal is not to try to subvert macro conditions as soon as possible, but instead to continue building a scalable business that can succeed in any climate. To that end, notice below that pro forma operating margins have expanded sharply to 10%, up from 1% in the year-ago period:
Nominally, Twilio is also guiding to $275-$350 million in pro forma operating profits in FY23, versus a loss of -$4.5 million in FY22. Especially in this more risk averse market climate, I'd say that's a bona fide business improvement to celebrate - despite the stock sitting broadly down from 2022 levels.
Key takeaways
In my view, Twilio is focused on building a scalable business that can continue to deliver both mid-teens organic growth plus margin gains once we exit a recession most now believe to be short and shallow. Stay long here and increase your exposure while the stock is still cheap.
For further details see:
Twilio: Invest In The Downturn