Investment thesis

Despite COVID-19, Twilio (TWLO) has been on a rip, almost tripled in market valuation from March. Its products keep communications between companies and their customers flowing during social distancing. During the peak of the crisis, it has increased customers’ accounts by 24% YoY to 200 thousand, solidified as a leading customer engagement platform.

However, Q2 results have shown some yellow flags, forming a more apparent trend that in the short run as unemployment rises, Twilio’s growth faces the inevitable downward slide.

Nevertheless, the long-term direction of the business remains strong. We see a business that has many avenues for growth and rapidly expanding economies of scale; the company will be posting positive cash flow very soon. The company also benefits from a strong market tailwind as the recent accelerated trend of communication migration to online is not temporary but likely permanent.

Together, Twilio is an excellent buy on dips.

Solid Q2 results

Twilio reported Q2-2020 results on August 5, 2020. The key takeaways below show a rapidly growing business driven by durable product offering that customers are willing to pay more for value-added/adjacent products and services each year.

  • Total Revenue of $400.8 million, up 46% YoY, Q3 revenue is forecasted to be $403 million, a 37% YoY increase.
  • Total Revenue Dollar-Based Net Expansion Rate of 132%, compared to 141% for the second quarter of 2019.
  • More than 200,000 Active Customer Accounts as of June 30, 2020, up 24% year-over-year.
  • Recognized as one of the 100 Best Workplaces for Innovators in Fast Company magazine.

However, Q2 also shows that it was the 4th consecutive quarter of declining growth rate, dropping to 46% from 86% YoY.

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Waning growth

With Q3 forecasted to grow at 37%, the declining trend is concerning.

Additionally, the recent earnings of SAAS & work-from-home related companies have shown growth can fall abruptly, e.g., Alteryx (AYX), Datadog (DDOG), Fastly (FSLY), and The Trade Desk (TTD). Thus, being able to guide 37% growth going forward shows Twilio is incredibly resilient and that its stock price isn’t out of touch.

Lastly, the sizable dilution since IPO is worth monitoring. Q3 outstanding shares are expected to be 145 million, up from 59 million in 2013. Twilio can be forgiven given the company has grown 30x in the same period. However, at this stage of waning growth and under break-even point, investors should keep a tap on this.

While the concerns are reasonable, the upside for what is to come is too large to ignore.

Strong financials

  • Top-line growth is stable at around 40%, driven by steady growth in active customer accounts (up 24%) and top-notched dollar-based net expansion rate (132%). The latter is hugely important as it shows, netting out churn rates, Twilio upsells and cross-sells successfully to existing customers.
  • The gross margin remains high and stable at 52%. Meanwhile, the operating margin has shrunk to -27% from -54%. Break-even is close as the free cash flow margin also improved to -2.5% from -52%.

The two bullet points above show two key takeaways.

First, top-line growth is robust. Netting off SendGrid’s growth disclosed between Q1 and Q4 2019, Twilio’s organic growth is highly likely to be better than the 37% YoY reported. Next, revenue growth is backed up by attractive product value propositions as the dollar-based net expansion rate remains exceptionally high.

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Second, economies of scale are evident and are rapidly improving the bottom-line. Notably, SG&A halved to 48% since 2013. We believe as the company matures, the bottom-line can improve up to another 15% just from SG&A alone.

Additionally, Twilio has a long runway to execute its plan as its cash balance is high at $1,843 million cash and bears $450 million in long-term debt.

Long-term market tailwinds

Twilio is already a leading player in the enterprise communication sector. It is poised to keep winning as the market expands. In the word of CEO and founder Jeff Lawson, things are evolving very quickly and favorably for the company.

[…] in a recent Twilio global survey of more than 2,500 enterprise decision-makers, 97% believe COVID-19 has accelerated their company’s digital transformation efforts. We also found the company’s digital communication strategies were accelerated by an average of six years, barriers like lack of clear strategy or getting executive approval or reluctance to replace legacy software and lack of time have broken down and budgets are increasing as companies are seeing new ways of engaging customers.

COVID-19 has nearly every industry to discover new ways to communicate with their customers and stakeholders, from patients to students to shoppers and even employees virtually overnight.

The upside is massive as customers now see Twilio’s product applicable to more markets and use cases. For example, the company is already seeing additional traction in healthcare, education, financial services, retail contactless delivery, and e-commerce. The transformation is likely long-lasting.

[…] companies must prepare for customer service agents to work from home rather than a crowded call center. Retailers who rely on the expertise of their in-store sales associates will need to create workflows where those employees can still advise customers digitally. Banks will need to replace their traditional in-person branch processes to online services, and the tools and services that keep these agile workforces up and running like Twilio will continue to see demand increase.

To cap it off, Jeff Lawson confidently put:

We are just scratching the surface of this huge opportunity, and we believe the solutions being built today using our customer engagement platform will be the standard for digital engagement in the future

Summary

Twilio is trading at a premium to other SAAS players. However, with vast potential and steady rise to the top, this is well-deserved. Notably, the total addressable market is expanding faster than imagined due to COVID-19.

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Fundamentally, the company continues to provide value-added services to existing customers successfully and, at the same time, attracting many new ones from varied categories.

At 28x P/S and a 5-10 year runway of near 40% growth, we don’t find the stock overvalued. Investors would do well in the long-run investing at the current range.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in TWLO over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.



Via SeekingAlpha.com