Twilio: More Downside Risk At This Valuation

Summary

• Twilio beat Q1 financial targets, but the market was disappointed with meager sequential Q2 revenue guidance.
• The company guided Q2 organic revenue growth at below 40% with further slowdowns ahead.
• The stock still trades at an insanely expensive 21x forward revenue estimates.
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Twilio (NYSE:TWLO) was one of the major beneficiaries of the lockdowns around the globe as enterprises scrambled for ways to communicate with customers digitally. The stock rallied to extreme levels based on growth that isn't sustainable and investors have already lost $150 from the peak. My investment thesis remains highly bearish on the stock until the price reflects more normal growth rates.

Moderating Growth Rates

Due to a constant flow of acquisitions, Twilio has typically reported revenue growth rates far ahead of organic growth making the investment story appear far more appealing than reality. For Q1, the company reported revenue growth of 62%, but excluding revenues from the Segment business acquired last November, the growth rate was only 49%.

In the last 5 years, Twilio hasn't had a reported growth rate below 45% other than a few quarters back in late 2017. Currently, analyst estimates have the growth rate falling towards 30% by Q4 with the organic growth rates dipping towards this level when excluding the Segment business which amounted to $45 million last quarter.

Data by YCharts

My biggest concern is that some of these growth rates actually fall below expectations as the global economy normalizes. Enterprise developers and decision makers are likely to take extended vacations this Summer and could delay the implementation of new communications platforms. Even worse, so much demand was pulled forward during the COVID-19 shutdowns that new digital communications projects may dry up later in the year to temper short-term growth rates.

Twilio guided to Q2 revenues of ~$596 million for a growth rate of ~49% and meager sequential growth over the $590 million reported in Q1. The growth is forecast to decelerate 1,700 basis points from the 66% growth rate in Q1. When excluding a similar $45 million in revenue for the Segment business, the organic growth rate falls to only 37%. Not to mention, Segment revenues could easily top $45 million as the business is growing substantially.

While profits aren't a major concern for fast-growing companies, investors do need to start keeping an eye on the lackluster profit picture as Twilio now tops $2.4 billion in annualized revenues. The communications platform only offers 55% gross margins.

Despite the massive growth rate, Twilio reported a GAAP net loss of $207 million. The company did report non-GAAP income of $17 million, but the amount excluded an incredible $137 million in stock-based compensation and another $20 million in related payroll taxes.

While this number is positive for cash profits, the issue is the massive share dilution of such large stock-based compensation. The communications platform business is a relatively low-margin business, yet Twilio is spending aggressively in R&D to build the business.

Stretched Valuation

While a lot of the aspects of the business are positive as more and more enterprises transition communications to digital, investors shouldn't overpay for the stock. A lot of the stay-at-home beneficiary stocks such as DocuSign (DOCU), Teladoc Health (TDOC) and Zoom Video (ZM) have begun giving up the massive gains of the last year. Right now, Twilio ties Zoom Video with the highest forward P/S valuation multiple of over 21x.

Data by YCharts

The company had an insane market cap of $58 billion heading into the Q1 earnings report. Why investors were willing to pay far in excess of 23x 2021 revenue estimates is perplexing and the market is punishing the stock with another 10% decline.

Like all of the above companies, Twilio faces issues with pulled forward demand and projects escalated last year that won't occur this year. In addition, consumers are likely to return to more in-store visits and shy away from some of the curbside pickup that boosted communications demand during COVID-19. These digital communication platforms will have elevated usage from 2019 levels, but the market shouldn't necessarily expect usage to top 2020 peaks in the short term.

Takeaway

The key investor takeaway is that Twilio remains an extremely expensive stock as the world normalizes for the rest of 2021. The biggest risk to the stock is that some of the digital communications shift slows down this year as inherent in the weak Q2 sequential growth guidance.

Investors need to prepare for the new world of Twilio growing at a 30% rate and those stocks just don't typically trade at over 20x forward revenues. The stock still has substantial downside risk despite the large losses already in the last couple of months.

Analyst’s 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.

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.