Twilio Inc. (NYSE:TWLO) is an $11-billion market cap firm that offers software and communication solutions, running a cloud communications platform allowing developers to create, expand, and manage customer engagement in their applications. This platform includes tools like APIs for integrating voice, messaging, and email interactions into customer-facing apps.
As of June 30, 2023, TWLO had 2 segments:
Twilio Communications [~88% of total sales]: offers APIs and software solutions to enhance communication between Twilio customers and their users. Key revenue sources are Messaging, Voice, and Email.
Twilio Data & Applications [12%]: provides software products that help businesses improve customer engagement, enabling personalized relationships. Key revenue sources include Segment, Engage, Flex, and Marketing Campaigns.
In Q2 FY2023, Twilio’s Data & Applications segment generated $125 million in revenue, a 12% increase YoY, with a non-GAAP gross margin of 81.7%. This growth was driven by investments in AI-powered products, partnerships, and expanded pipeline development, the CFO commented during the latest earnings call.
Twilio Communications, on the other hand, recorded $913 million in revenue, a 10% YoY rise, with a non-GAAP gross margin of 48.2%.
In total, TWLO’s revenue rose by 10% YoY, and most of the increase was organic.
The company’s gross profit increased 12.7% year-over-year, which looks good. However, the Dollar-based net expansion rate (DBNER) – a financial metric that measures the growth of a company’s revenue from its existing customer base – continued to decline in the second quarter, raising concerns about the sustainability of future business growth.
However, it is clear that the company is moving very quickly towards the break-even point: the operating loss in the second quarter of last year was more than double that of the current year.
This improvement enabled the company to beat analysts’ forecasts for the last reporting quarter by a comfortable margin. However, due to problems with the company’s expansion in its market (slowdown in organic sales growth), management decided to give a more modest guidance, which lowered the stock after the report:
In the cash flow statement, I see another half-year of increasing receivables. By itself, the increase in this item says little, but when I think about the continued decline in the revenue growth rate, it becomes clearer to me personally. The company is probably granting more generous credit terms to attract customers. But for some reason, that’s not working for TWLO’s topline expansion.
Cash on the company’s balance sheet increased only due to the sale of marketable securities for over $1 billion in the first half of FY2023. Therefore, cash flow from investing activities shows a positive amount. By the way, the company invests little in its growth as far as I see it: What do $28 million in capitalized software development costs and asset purchases mean for a half-year of a multi-billion-dollar SaaS company? I don’t think these costs are sufficient to resume the topline appreciation TWLO once had.
Twilio’s addressable markets are expected to grow at least double digits over the next few years, while Twilio’s revenue will soon likely slip into the single digits. In this particular case, it no longer matters how quickly the company becomes profitable.
The only thing that matters is that as the company loses revenue growth, it also loses its market share, and given the technological developments of the last few years, I think it will be difficult to regain it.
In my opinion, analysts are too optimistic about uninterrupted earnings per share growth over the next 10 years: according to consensus data, TWLO’s EPS will grow at a CAGR of ~22.3%:
However, a resumption of downward earnings revisions seems more likely to me, as the lack of sales growth is going to put pressure on EPS growth.
Seeking Alpha Quant Rating gives TWLO stock a strong “B” Valuation grade as its revenue-based multiples are 20-30% lower than those of the IT sector.
Jim Kelleher, CFA of Argus Research also notes that TWLO appears to be undervalued. But if we look at the last pages of his research, we’ll clearly see that TWLO’s multiples are higher than even Google’s (GOOG) (GOOGL), while TWLO’s growth rates are lower than the sample analyzed.
The entire valuation of the company rests on the assumption that the operating loss will soon be behind us and we are waiting for the 22% CAGR of earnings growth [demonstrated above]. The reality, however, is that this is unlikely to happen without sufficient revenue growth, in my opinion.
So Twilio stock may become much cheaper from where we stand now.
The Bottom Line
I love the stories about trying to get out of the red – many companies sinned with their reckless spending on customer acquisition in 2020-2021, for which they paid a heavy price in 2022. TWLO is definitely making progress with its cost management today, and it should be given credit for that. That’s why I’m not rating the stock as a “Sell” this time around.
What TWLO can’t be credited for is losing control of revenue growth. The unit-economic metrics leave a lot to be desired. I was also confused by some aspects of working capital management, especially in relation to receivables. Wall Street analysts’ forecasts paint a very nice, positive picture that seems to me to be far from reality. I hope TWLO proves me wrong, but at this point, I’m not ready to recommend Twilio for purchase.
Thanks for reading!