Twilio: Blown Away, But Still Don't Chase

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About: Twilio (TWLO), Includes: SEND
by: Stone Fox Capital

Summary

Twilio reported another blowout quarter.

The deal value for SendGrid is further questioned based on the surging stock.

The combined entity will see massive revenue deceleration in 2019 and 2020 eventually hitting the stock.

After reporting blowout Q3 results, my mind is blown that Twilio (TWLO) agreed to purchase SendGrid (SEND) in an all-stock deal prior to releasing these numbers. The cloud communications company continues to generate accelerating growth rates with no signs of needing an email provider to effectively compete in the communications sector questioning the rich valuation. Don't chase the stock at $100 as my previous research still questions the value in the stock after the deal.

Image Source: Twilio presentation

Ramping Growth

Due to a massive Q3 revenue beat of ~$17 million or over 10% above estimates, Twilio surged to nearly $100 following the release of earnings. The stock surged beyond previous highs in the process and repaired all the damage done with the SendGrid buyout.

In the process, the cloud communications company reached revenue growth of 68.0%. Incredibly, Twilio topped growth in its first quarterly report as a public company back in Q3'16 where growth was only 61.6%. Though, the odd part is the purchase of SendGrid with only 31.4% revenue growth and decelerating.

Chart TWLO Revenue (Quarterly YoY Growth) data by YCharts

In the quarter, Twilio had an incredible net expansion rate of 145%. At this rate, the company doesn't even need to add new customers for substantial growth. The cloud communications company has a massive total addressable market in the $55 billion range now before adding Email while the revenue runrate is only in the $700 million range. Twilio has over 200% growth ahead before even capturing 5% of the market.

The Q4 guidance is incredible. At a revenue target of $184 million, Twilio would grow at a 60% rate. The company has regularly beat estimates by $10+ million per quarter suggesting the actual results approach 70% growth.

Source: Twilio Q3'18 earnings release

Back To SendGrid

The deal to acquire SendGrid was announced on October 15. The timing is very interesting considering the all-stock deal while Twilio should've known the blow away results and likely outcome being a much higher stock price. Instead, the company was willing to pay a similar forward P/S multiple to acquire SendGrid that is growing at about half the growth rate of Twilio. The deal now has a value of over 12x forward revenue estimates.

Chart TWLO PS Ratio (Forward 1y) data by YCharts

Based on the revenue 2019 estimates below, Twilio is forecast to grow at a 31% clip and SendGrid around 24%. Using basic math, the purchase of SendGrid will slow down the growth rate of Twilio.

Chart TWLO Revenue Estimates for Current Fiscal Year data by YCharts

Using these actual numbers, the combined company will generate 2018 revenues of $775 million and 2019 revenues of $1,004 million. The projected growth rate is about 29.5% for a roughly 150 basis point hit to the Twilio pace.

The market just isn't going to like slower growth, especially considering the stock is soaring based on the current growth in the 70% range. Even assuming Twilio can blow away expectations again, the upper limits has to be combined growth of 40% in 2019.

When the company last reported similar growth in February 2017 for the Q4'17 quarter, the stock was down at $25. A similar repeat of the growth rate acceleration of the current magnitude becomes difficult as combined revenues top $1 billion. Remember, the market will likely have to view the prospects for 2020 growth down in the 30% range. With about 135 million shares outstanding, the market will eventually question paying $13.5 billion for revenue in the $1.3 billion range. The projection now is down at roughly $1.225 billion.

Takeaway

The key investor takeaway is that Twilio vastly overpaid for SendGrid to obtain a slower growing Email business. The merger distractions and integration headaches should naturally hurt execution in the short term and slowdown customer decisions. Ultimately, an investor has to question whether paying over 10x '20 sales estimates is a wise move for the realities of what will be decelerating growth.

Disclaimer: The information contained herein is for informational purposes only. Nothing in this article should be taken as a solicitation to purchase or sell securities. Before buying or selling any stock, you should do your own research and reach your own conclusion or consult a financial advisor. Investing includes risks, including loss of principal.

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.