Drew Angerer
Investment Thesis
There’s the realization that Twilio’s (NYSE:TWLO) days as a growth business are now in the rear-view mirror. A lot of people reached out to me that I called Twilio wrongly. This is true. Absolutely and undeniably so.
What a lot of people appear to get confused with, is that in this game, you are going to be wrong 50% of the time. Or perhaps, better put, I’m wrong 50% of the time.
I recognize that this is a game of probabilities. And it’s important to understand that there’s no such thing as a risk-free return.
It’s all about looking at the company, striving to make assumptions about its future prospects, and pricing in those prospects relative to what the market is expecting.
As you’ll see, the company is growing significantly slower than I previously expected. Therefore, I am not going to remain bullish on this stock, but I will move to the sidelines. With no emotions and no qualms about having called this stock wrong in the past.
Rapid Recap,
In my previous analysis, back in January, I went bullish on Twilio, saying
[…] As we look ahead to 2024 and beyond, there’s ample evidence that this once high-flying business is about to regain favor with investors.
Here I contend that not only are Twilio’s underlying growth rates pointing to a turnaround in its growth trajectory, but also, it’s going to increase its revenue growth rates while at the same time increasing its profitability, and this combo is something that investors will be very inclined to pay a premium for.
Author’s work on TWLO
In hindsight, this was a horrible call. Rather than doubling down on my mistake, I’m now going to move back to the sidelines on Twilio where I should have stayed. There’s no point looking back to what should have happened. The game now is to look ahead. And on that basis, I’m sticking to the sidelines on this stock.
Twilio’s Near-Term Prospects
Twilio is a communication services platform that enables businesses to seamlessly integrate messaging, voice, and video features into their applications. This facilitates communication with customers through various channels such as text messages and phone calls, enhancing businesses’ ability to interact with users in a customized manner.
In the near term, under the leadership of its new CEO, Khozema Shipchandler, Twilio is determined to turn around its prospects. With nearly $1.1 billion in revenue and a strategic focus on customer engagement, Twilio aims to leverage the synergies between communications, data, and artificial intelligence to enhance personalized interactions.
Furthermore, Twilio’s Communications business, contributing 93% of its revenue in 2023, demonstrated strength, showcasing the potential for further momentum in 2024.
However, Twilio faces headwinds in its Segment business. Despite some improvement in sequential bookings, this growth trajectory has fallen short of expectations, prompting a comprehensive operational review led by the new CEO.
With challenges in accelerating growth and meeting performance expectations, Twilio acknowledges the requirement for enhanced execution and intends to provide a detailed report on the Segment business in March.
Additionally, external factors, such as headwinds from customers in the crypto industry, have impacted the revenue growth rate, and this challenge is expected to persist into Q1 2024. Furthermore, the decision to wind down certain products within Twilio’s portfolio, including the deprecation of its video product of the Zipwhip business, adds complexity to its short-term outlook.
Given this context, let’s now appraise its fundamentals.
Growth Rates Go Ex-Growth, Meaning Sub 15% CAGR
In my previous analysis, I said,
I put an estimated 10% CAGR for 2024. My assumptions here are as follows. If we consider that as Twilio comes to compare against 2023, it is doing so against a much lower base this immediately allows Twilio to deliver an improvement in its growth rates relative to 2023.
I was working off the assumption that 10% CAGR could be on the cards for Twilio in 2024. But this was including a wide margin of safety.
TWLO revenue growth rates
Next, Twilio guided for Q1 it guided for 5% to 6% y/y revenue growth rates. To that figure, I’ve presumed that Twilio is lowballing its estimates and added a further 200 basis points.
One way or another, Twilio is delivering single-digit growth rates. Even if I take on board that Twilio’s Q1 is the toughest comparable period of the year, I have to come to terms that Twilio, as a business, that was previously delivering +30% of consistent revenue growth rate is now in the rear-view mirror, and a forgotten memory.
And the problem with investing with tech companies is that you are either growing and taking market share, in which case you are rewarded with a high multiple on your stock. Or, conversely, you are decelerating and getting disrupted, and your multiple will compress. Given this context, let’s now discuss its valuation.
TWLO Stock Valuation — 16x Forward non-GAAP Operating Profits
Twilio’s underlying profitability is increasing at a rapid rate. I estimate that Q1 will increase approximately 40% y/y compared with Q1 of the prior year, to approximately $145 million.
This implies that by the time Twilio ends 2024, it will deliver approximately $700 million of non-GAAP operating profits. This is about a 30% increase in profits relative to 2023.
And herein lies the second problem. Twilio will have no difficulty in improving its underlying profitability in 2024, as it cuts back on expenses. But how sustainable is this increase in profitability beyond 2024?
On the other hand, the stock is priced at 16x forward non-GAAP operating profits. Few investors would declare that this is particularly expensive. But at the same time, it’s only cheap and attractive, if Twilio is able to resume its growth rates.
Because tech businesses that suddenly become ex-growth, meaning delivering sub 15% CAGR on the topline, need to dramatically increase their profitability, without significant adjustments to its expenses, to entice value investors into its stock.
Presently, Twilio finds itself in no-man’s land. Too slow for tech growth investors and with too many adjustments to its profitability for value investors.
The Bottom Line
In summary, my investment thesis on Twilio has evolved due to the company’s slower growth rates and challenges in the Segment business.
Recognizing the inherent uncertainties in investing, especially in the tech sector, where growth is pivotal, the current state of Twilio presents a conundrum.
Despite its improving profitability, the stock’s valuation at 16x forward non-GAAP operating profits raises concerns about its appeal to both growth and value investors. In this delicate balance, Twilio appears to be in a challenging position, requiring a careful reassessment of its trajectory. As an investor, the odds seem less favorable at the moment, leaving me on the sidelines on Twilio.
