Twilio (TWLO) has seen an eventful month of October so far with the company announcing both quarterly results and a big deal in the first half of the month. Both events were welcomed by investors, pushing shares up to a high of $340 per share as it seem very long ago when this was just a $25 stock early in 2018.
While such a move is only in part explained by actual revenue growth, let alone bottom line margins, the reality is that Twilio seems to become a stronger business by the day. While I think that Twilio is a very strong and well-run business, valuations have priced this potential in, and perhaps more.
Twilio has a mission to fuel the future of communications, at least that is how the company describes its long term goal. The company claims that millions of developers use Twilio to unlock communication to improve human experience. The company does this through a range of communication channels including voice, text, chat, video and e-mail. The distinguishing feature is that it does this through APIs which are simple enough for a developer to incorporate, but robust enough to power demanding applications.
With customer expectations on the rise and the cost of human customer service being high, while quality of that not always great, a robust offering here can both save meaningfully on costs while boosts the output for organizations at the same time. The nature of these solutions, with communication shifting from human towards intelligent automation has furthermore seen a boost of course in these times. With Covid-19 resulting in businesses being closed and the e-commerce part of business thriving, it is very obvious that the long term trends and potential has meaningfully accelerated as the result of current events.
Based on the brief description above and the leadership position which Twilio has in this field it is very evident that it operates in a robust market opportunity. The segment is showing solid growth and Twilio is taking the full benefits of this.
The company has seen very steady growth in recent years. From a revenue base of $167 million the company grew sales by 67% in 2016 to a quarter of a billion on which it still reported a GAAP loss of $41 million. Sales rose another 44% to nearly $400 million in 2017, with growth accelerating to 63% in 2018 as revenues topped $650 million. Growth in 2019 was driven by the $2 billion purchase of SendGrid and this boosted the growth number to 79% last year, with revenues coming in at $1.13 billion.
While revenues are up a factor of 6-7 between 2015 and 2019 there is a small caveat to that growth as losses, stock-based compensation and the SendGrid purchase caused quite some dilution. The total share count was up a factor of 2.8 times over this period, implying that revenues per share were up about 2.5 times which is far less than actual revenue growth, although revenues are still up close to 30% per year!
About the losses: the GAAP operating loss of $41 million in 2016 (equal to about 15-20% of sales) has only grown to $370 million in 2019, equal to about a third of sales. While the loss of $2.36 per share based on GAAP accounting was in part driven by amortization charges and acquisition related costs, the company managed to fabricate a $0.16 per share profit on an adjusted basis, although it excluded $1.85 per share in stock-based compensation expense. This is a real expense, as is evident in the discussion above.
Shares started the year around $100 which gave the company a near $15 billion equity valuation. Adjusting for net cash and with the company guiding for 2020 sales around $1.48 billion this year, shares traded at just below 10 times sales.
These multiples look reasonable, especially in comparison to recent technology IPOs having taken place late summer/early autumn, yet this was of course ahead of Covid-19 which has not just provided a boost to the underlying business, it sent the shares a lot higher as well!
Impact Of Covid-19
Early in May the company reported its results for the quarter ending at the end of March, so the operational impact of Covid-19 was yet to be seen. Nonetheless, sales were up 57% to $365 million as the company withdrew the full year guidance as a result of the situation. The company guided for flattish sequential revenues trends (in absolute terms), as that suggested an anticipated slowdown in revenue growth, seen up around 34% on an annual basis.
Early August it was evident that the guidance was far too conservative with sales up 46% to $400 million, as the company again guided for flattish sales on a sequential basis. With shares rising on the back of these numbers, the company tapped the equity markets just a few days later, selling more than 5 million shares at $247 apiece, with shares essentially up 150%since the start of the year.
So what does the situation look like? Truth be told is that the company will probably exceed the full year sales guidance quite easily, although the question is if this is actually the result of Covid-19, or despite Covid-19. The company has been conservative in its guidance, and hence I am not surprised to see revenues trending at an annual rate of $1.6 billion already, yet investors have priced in massive potential gains.
Based on a share count of 142 million by the end of the second quarter, or about 147 million in the aftermath of the August equity issue, shares represent a $48 billion valuation here and now at $326 per share! Even after accounting for net cash balances, this valuation still exceeds $45 billion, which based on the second quarter revenue rate reveals that valuations have jumped from about 10 times forward sales to 28 times annualised sales while growth has not even accelerated! While the company managed to grow adjusted earnings from $5 million to $14 million on a quarterly basis, that number remains highly distorted with stock-based compensation as high as $78 million, still causing large economic losses.
To further bolster its offerings the company announced its largest acquisition to date halfway October, spending $3.2 billion to acquire Segment in an all-stock-deal to take ”advantage” of high valuations. The deal is kind of interesting as Segment allows developers and companies to break down silos of data, to unlock the full potential of that data, information and create optimal solutions for customers. Other than that Twilio is willing to give up a 6% equity stake in exchange for the company, what was pretty much all the information provided in the press release.
The associated conference call revealed a little more information including Segment’s approximately 75% gross margins, revenue growth North of 50% as management basically admitted a roughly 20 times sales multiple was paid. That suggests that the deal even looks cheap, at least on a relative basis and that is what counts if you pay in stock.
With shares up essentially $25 dollar in response to the deal, the increase in the valuation is equal to about the price paid for Segment, marking a clear vote of confidence by the market on this deal.
This comes on the back of the gross margins, growth and valuation multiple dynamics. Moreover, is probably the anticipated widening of the moat, as Twilio no longer is just about communication, but first establishing communication to from thereon expand offerings to drive customer understanding and meaning, making it far more valuable service provider to companies.
Needless to say, I am very reserved for the simple fact that the huge advancement in the share price have exceeded actual growth by a very comfortable margin, which actually is not comfortable for shareholders. At the same time, Covid-19 demonstrated the resilience and acceleration of the business model and offerings. Consequently, I like the (acquisition) strategy to move into adjacent sectors following dominance in the communication market, very much.
With this being a dangerous short or potentially still an M&A target, despite the >$50 billion valuation here, I would not dare to bet against this company easily. This should not be confused with the conclusion that a reasonable risk-reward can be seen here.
If you like to see more ideas, please subscribe to the premium service “Value in Corporate Events” here and try the free trial. In this service we cover major earnings events, M&A, IPOs and other significant corporate events with actionable ideas. Furthermore, we provide coverage of situations and names on request!
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within 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.