Twilio: Where to from here?

A lot of chatter around Twilio as it has continued to underperform in this mess of a tape in SaaS. Naturally, a good deal of focus on the upcoming quarter and whether they miss guide or cut long-term guide. I’m not exactly in that camp, and think this name is really more at a narrative crossroads. To get this you need to take a trip down memory lane….

Phase 1: Hot Web 2.0 Infrastructure IPO

Twilio IPO’d in June of 2016 and like many IPO’s took off out of the gate on the back of hot WEB2 customers like WhatsApp and Uber. The stock promptly tripled by September of that year before quickly deflating by nearly half ahead of lockup expirations and natural subsiding IPO enthusiasm around the model. Like most new issues the stock was interesting to some folks but there was not exactly a growth cult yet around with respect to devops and cpaas and Jeff Lawson.

Phase 2: UBER Pokes Holes In The IPO Narrative

2017 was your standard competitive concerns around the entire Twilio biz model. Early in the year, Twilio disclosed that Uber would be reducing their usage of the platform and the stock dropped 30%. Customer concentration across Web 2.0 darlings now became more of a long-term concern versus a reason to be bullish. Bears subsequently started speculating around would WhatsApp be next as well as what potential competition from Amazon and others might mean for the business model.

Phase 3: Twilio The API First Devops Focused CPAAS Platform Company Is Born

Twilio base and variable revenue growth accelerated notably in 2018 and the stock took off. Shares nearly quadrupled as investors left the Uber concerns in the dust and started focusing on it being The API first platform infrastructure software company. The CEO took advantage of this by the end of year and acquired Sendgrid to broaden their platform comms offering. This momentum continued throughout the first half of 2019 as SaaS mania and FLEX enthusiasm really got going before hitting a speed bump in the back half of the year as some of the air came out of the sector and Twilio organic growth concerns started to surface.

Phase 4: Covid Turbo Charges The Narrative

I remember this phase well as I entered Twilio on the long side at the end of 2019 thinking that we would start to get a good look at FLEX momentum in 2020 and on a general belief that organic growth concerns were overblown. I figured the valuation entry was a decent starting point for a name I’d heard plenty about and that as Flex and Sendgrid became a greater part of the mix the entire financial operating model would start to look a lot better. Then along came Covid which basically turbocharged the entire CPAAS space. Shares tripled in the first six months of the pandemic, and Twilio used this an opportunity to make another big acquisition. As someone who exited very early on due to the fact the stock got to where I thought it would be in 3 years in 4 months, I really didn’t get to evaluate whether or not the thesis I had was right. By the end of the year, Twilio was a retail favorite and Jeff Lawson was pretty much viewed as a financial genius who was leveraging low margin messaging revenue to build the marketing cloud of tomorrow.

Phase 5: Covid Blues

Twilio spent most of 2021 melting with other Covid winners despite the overall narrative excitement shift at the end of 2020. I’d say for the first 9 months of the year little attention was paid to this melt as most just attributed to a somewhat healthy cool off, but that has obviously changed over the past few months. It’s no secret I shorted Twilio into the Q3 print based on Covid headwind thesis and relative valuation compared to the likes of Zoom. The name had looked relatively weak and the late October rally provided kind of an easy set up into the quarter. Not that they reported anything too shocking, but organic growth did tick down notably as I had expected. Since then the name the name has gotten a lot more controversial, and the narrative has started to falter. George Hu leaving was one part of this, but their messaging around G2M with respect to Twilio Engage hasn't been encouraging. There are investors clearly starting to wonder whether a developer focused company that has excelled selling a messaging API can transform itself into the marketing cloud of the future.

So, how should one think about Twilio at this point?

Twilio peaked out during Covid at just under $100bl market company. Not unprecedented in this market, but still kind of remarkable for a company that has generated like $50ml in aggregate operating cashflow since it’s been public and doubled its share count over the past several years to fund $7bl+ in acquisitions. Thus, it’s no surprise that some folks are having a hard time shedding the “It’s a $100bl platform company narrative,” at current levels and banking on earnings to put an end to the underperformance. I think this is a mistake and that any investor here needs to set the narrative aside and be objective about what they own today. What’s the $35bl EV Twilio of today actually worth if you consider all your alternatives in SaaS?

This is a breakdown of what Twilio looked like after last quarter on a rev/gp basis:.

As you can see, 81.5% of revenue is clocking in at a 47.1% gross margin. If you buy into the 30% organic growth narrative here in core CPAAS what do you pay for this? 18-20x annualized gross profit? You could have bought ServiceNow at that in the past week with 30% growth and robust FCF margins. Let’s say you are willing to pay 15x GP for this biz, that’s a $17bl EV company. Are Segment and Sendgrid worth $18bl? I’m willing to guess that if Sendgrid was standalone in this tape it would be trading around 12x annualized revenue or about $4bl. That leaves Segment at $13bl or 4x what Twilio paid for it 15 months ago. I’d call that just a bit of a stretch at this point. If the business 10x’s in next four years that would look like a decent deal, but like if it just 5x’s it looks pretty mediocre if not disappointing. So, maybe it’s worth $6bl if you are a bull right now, that still leaves you $8bl short of the current price.

What about a more bearish take on valuation?

10x GP for Twilio core, 8x sales for Sendgrid, and 20X ARR for Segment.

That’s a 17bl EV biz. Note the sensitivity on Twilio at this point really revolves around the core biz valuation. Twilio has made some seemingly big splash acquisitions and you can essentially pay the richer multiples for them, but the days of valuing the core like it’s wonderful software business just so it can fund the acquisitions of businesses with actual software economics appear numbered.

What about a bubble pop take on valuation?

Assume the core CPAAS/Email has a 15-20% Ebitda margin and trades at 20x that implied profitability. That's a 10-12bl EV. Now assume Segment/Flex/Engage etc are impairing that vs being viewed positively by the market. Where does the stock land? 8bl ev? maybe lower?

So, having read some recent sell-side commentary on the name, I don’t think the big problem here is concern about Sinch A2P growth at 10% or a notable deceleration at Syniverse. I think the issue here is some folks woke up and realized they aren’t a marketing cloud yet and even making some decent progress in that direction doesn’t make the stock attractive. You need step function progress here. The conversation shouldn’t be about whether they can hit 30% topline but rather when will the entire operating model start improving. Like Twilio is at a $3bl run rate already, the issue isn’t revenue. When is it going to start throwing off some meaningful cash? Or is the CPAAS platform just meant to run breakeven to fund M&A? If that’s the case they better start breaking out the software margin level businesses and offering far more detailed metrics for investors to track. When I got long the name end of 2019 I thought we’d be focusing on Flex revenue on the calls by April of 2020 and instead they just kind of pivoted to marketing cloud of the future. Might not seem like a big thing to focus on, but when you actually remember what you were thinking about as a long it’s easy to comeback to it. The irony here is Twilio’s current reporting structure has kind of been key to the model as investors just focus on revenue topline and Twilio leverages that to fund acquisitions. I can see them being reluctant to change that as the message has been this is a weaved together infrastructure platform biz, but at this point it might be beneficial to steer investors away from the core if you actually have something superior to show them. You can’t just count on Byron Deeter throwing you in with Adobe/Msft/Salesforce/AWS basket when your overall economics look nothing like those businesses. Anyway, I’m curious to see how they handle things from here as there is a point where optionality comes into play for the future, but I doubt they want to rock the boat right now.