Twilio Q1 Review: Cautious Optimism

May 24, 2022 3:59 AM ETTwilio Inc. (TWLO)2 Comments7 Likes
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Riyado Sofian
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Summary

  • Twilio released Q1 earnings with Revenue beating estimates by a mere 1%.
  • Q2 Guidance was weak as the company faces tough YoY comps. However, Twilio expects a reacceleration of growth for the back half of the year.
  • Unprofitability remains the biggest concern when investing in Twilio, especially in today's market environment.
  • However, the company has strong competitive advantages and remains the dominant player in the cloud communications and customer data platform category.
  • On the other hand, the stock trades at the lowest valuation multiple ever, offering compelling value for investors.

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For a more in-depth analysis on Twilio (NYSE:TWLO), I'd like to direct readers to my Twilio deep dive. This is a review of Twilio's recent Q1 results. Enjoy!

Investment Thesis

Twilio is the leading cloud communication and customer data platform as a service provider. The company reported Q1 earnings that beat Revenue expectations. However, guidance was weak which saw the stock breaking new 52-week lows. Furthermore, the company is still unprofitable, which may have contributed to the selloff as investors rotate from growth to value.

Despite the risks, Twilio has a strong market position, supported by its technology, switching costs, network effects, and culture moats. Furthermore, Twilio is trading at the lowest valuation multiples ever, which offers a large margin of safety for long-term investors.

Growth

Q1 Revenue grew 48% YoY to $875 million due to increasing usage and adoption of Twilio's products (Programmable Messaging, Programmable Voice, Email, etc.), higher A2P (application-to-person) fees imposed by certain carriers, and Revenue from the recently-acquired Zipwhip. However, as you can see below, Revenue growth is slowing down, although expected due to the law of large numbers.

Twilio Revenue

Source: Twilio Investor Relations and Author's Analysis

US Revenue and International Revenue were $570 million and $305 million, respectively, accounting for 65% and 35% of total Revenue, respectively. In Q1 last year, the US-International Revenue mix was 71/29. This tells us that the International segment is expanding more rapidly, which may eventually surpass the US segment in terms of Revenue generation.

Twilio Revenue by Geography

Source: Twilio Investor Relations and Author's Analysis

According to Twilio's prepared remarks, Q1 Revenue includes the following items:

  • $32 million from Zipwhip, including $14 million in 10DLC A2P fees;
  • $21 million from all other acquisitions closed after January 1, 2021, excluding Zipwhip; and,
  • $42 million from U.S. 10DLC A2P fees within the core Twilio messaging business, excluding Zipwhip, consisting of approximately $30 million from AT&T and T-Mobile and $12 million from Verizon.

Excluding these items, we arrive at Twilio's Organic Revenue, which grew 35% YoY to $780 million in Q1, a reacceleration from Q4's 34% growth rate. However, do note that as of Q1, Revenue contribution from Twilio Segment has been included in Organic Revenue, which I believe to be about $60-$65 million, based on historical figures.

Twilio Organic Revenue

Source: Twilio FY2022 Q1 Investor Presentation

Robust growth was also due to 14% more Customers joining the platform, which totaled 268,000+ Customers in Q1. Despite the slowdown in Customer growth, QoQ net adds were 12,000 Customers, compared to Q4's QoQ net adds of just 6,000 Customers, a very positive sign as Customer growth is a leading indicator of Revenue growth.

Twilio Customers

Source: Twilio Investor Relations and Author's Analysis

The higher QoQ Customer net adds in Q1 may likely be due to increasing demand for first-party customer data platforms (like Twilio Segment) as companies navigate through major data privacy changes.

Twilio Segment continues to be a key topic in many of our customer conversations, as companies are struggling to navigate privacy changes such as Apple’s IDFA updates and Google’s planned deprecation of cookies. Going forward, companies will need to rely on their own first-party data to build one-to-one relationships with their customers, and increasingly, they’re looking to Twilio Segment as the foundation of their customer engagement strategies. That’s why a significant physical and online commerce business recently selected Twilio Segment as their CDP.

Some of the major customer developments highlighted by management include Vivid Seats, Compass (COMP), Galileo Global Education, and Nubank (NU).

The slowdown in Revenue growth is also reflected in Twilio's Dollar‑Based Net Expansion Rate, or DBNER. While a 127% DBNER is still commendable, we can see that it is below its historical average.

Twilio DBNER

Source: Twilio Investor Relations and Author's Analysis

All in all, Twilio showed strong growth in Q1, although we may experience a further slowdown in growth due to tough YoY comps. However, I believe Twilio has a bright future given its competitive positioning as the leading cloud communications and customer data platform.

Profitability

Gross Profit grew 42% YoY to $425 million in Q1. On a non-GAAP basis, Gross Profit was $460 million. Below, you can see how Gross Margins have trended over the last few quarters. Although we saw a QoQ uptick, Q1 Gross Margin was lower than last year's 55% Margin. The YoY decline was due to the growth in the international messaging business, higher A2P fees, and higher network service provider fees.

Twilio Gross Profit

Source: Twilio Investor Relations and Author's Analysis

As you can see below, the messaging business has lower Gross Margins than other Twilio products. Messaging is often the first product that Customers adopt followed by other higher-margin products such as email and application services. Therefore, we should see Gross Margins improve as Customers utilize other products offered by Twilio.

Twilio Gross Margin by product

Source: Twilio March 2021 Investor Presentation

GAAP Operating Profit is still in negative territories as the company reinvests for growth. One thing that caught my attention was the significant QoQ improvement in Operating Margin from (34)% in Q4 to (25)% in Q1. Although still too early to tell, this may be the beginning of a clear pathway to Operating profitability. Even so, even after adjusting for non-cash and one-time expenses, Non-GAAP Operating Margin is still at breakeven levels. As such, we are not seeing any meaningful operating leverage just yet.

Twilio Operating Profit

Source: Twilio Investor Relations and Author's Analysis

Here, we can see the same thing for Net Profits — still deep in the red zone. Again, that uptick in Net Margins in the latest quarter is encouraging to see. But one quarter doesn't make a trend so investors should keep an eye out for improvements in Margins in subsequent quarters.

Twilio Net Profit

Source: Twilio Investor Relations and Author's Analysis

Overall, Gross Margin profitability is not the best by historical standards. However, we may see Gross Margins improve as more Customers branch out to higher-margin products. On the other hand, Twilio's bottom line is still negative which could be punished in today's market environment.

Financial Health

As of Q1, Twilio has $5.2 billion of Cash and Short-term Investments with a Total Debt of $1.3 billion, thus, leaving the company with a Net Cash position of $3.9 billion. Do note that Twilio's sources of liquidity primarily came from the issuance of equity and debt over the last few quarters. Cash Flow from Operations is still somewhat volatile, fluctuating between positive and negative, so it is not a reliable source of liquidity as of yet. Nonetheless, Twilio's balance sheet looks strong with a Current Ratio of over 8x.

Twilio Balance Sheet

Source: Twilio Investor Relations and Author's Analysis

The same goes for Free Cash Flow — it is still in negative territories as the company is focusing on investing in future growth. FCF was $(25) million so the cash burn is still manageable given Twilio's cash position.

Twilio FCF

Source: Twilio Investor Relations and Author's Analysis

Outlook

Management provided the following guidance for investors:

Twilio Q2 Guidance

Source: Twilio FY2022 Q1 Earnings Release

Revenue is expected to grow by 37% YoY in Q2. If you can recall this is quite a deceleration from its Q1 growth rate of 48%, let alone the 50-to-60%+ growth rates that we've seen in 2020 and 2021. Similarly, Q2 Organic Revenue is expected to grow by only 28%, a slump from Q1's 35% growth rate. Despite the slowdown of growth, management COO Khozema Shipchandler provided the following statement:

As a reminder, our 30%+ organic growth target through 2024 is on an annual basis and we remain confident in achieving this target. For 2022, the setup in the second half of the year provides for a more favorable comparison.

We expect a second quarter non-GAAP operating loss of $35 million to $40 million. While we’re continuing to make certain investments, primarily in headcount, we remain on track and committed to delivering annual non-GAAP operating profit in 2023 and beyond - exclusive of potential future M&A. To reinforce our commitment to annual non-GAAP operating profit in 2023 and 30%+ annual organic growth through 2024, the Twilio Board recently granted performance-based equity awards to our executive team that are directly tied to these metrics.

In other words, management is confident that they'll achieve 30%+ Organic Revenue growth over the next few years. Furthermore, the slowdown that we see in the first half of 2022 is due to tough YoY comps, and it should be followed by a reacceleration of growth in the back half of the year. In addition, it is nice to see that there's a new executive compensation package that has been set up to align with shareholder interests.

Looking forward, Twilio should continue to benefit from the ongoing digital transformation, changes in consumer privacy, and shift to direct-to-consumer business models. Twilio is well-positioned to capture these trends as the company is the leading cloud communications and customer data platform, fueled by its technological capabilities to collect actionable first-party data.

Risks

  • Management Changes — There have been many changes in the executive team as of late. For instance, subsequent to Q1, Twilio has made several hires to fill roles such as Chief Marketing Officer, Chief Digital Officer, and Chief Privacy Officer. In addition, perhaps the most notable change thus far, is former Twilio Board member, Elena Donio, stepping in as the company's new President of Revenue, following the resignation of the company's Chief of Revenue, Marc Boroditsky, who has been with Twilio for over 7 years. Although not a major concern, it does raise concerns about the internal challenges happening in the company.
  • Unprofitability — Another major risk would be unprofitability, whether on a GAAP or Non-GAAP basis. Yes, the company is investing in future growth. But what happens when the company reduces spending? Would margins improve? Would the company turn profitable? These are questions worth considering when investing in Twilio.
  • Dilution — Because it is unprofitable, Twilio, from time to time, issues shares to raise funds for future growth. In addition, as shown below, Share-based Compensation is still high at about 20% of Revenue. Due to these two reasons, investors run the risk of dilution. In fact, since its IPO back in 2016, shares outstanding grew from 53 million to 178 million as of Q1 this year.

Twilio SBC

Source: Twilio Investor Relations and Author's Analysis

Conclusion

In summary, Twilio is still showing strong growth, although we are likely going to see a further deceleration in Q2 before growth reaccelerates in the back half of the year. Profitability remains the biggest concern for me and I would like to see meaningful improvements in margins over the next few quarters.

My bull thesis remains intact. The company is the leading cloud communication and customer data platform, supported by its switching costs, technology, network effects, and culture moats. It has a long growth runway ahead as the world becomes increasingly digital and increasingly dependent on first-party data. The anticipated launch of Twilio Engage in the second half of the year will also be a positive catalyst for the stock.

The stock now trades at the lowest EV/Revenue multiple ever at just 4.6x. I believe there's a large margin of safety for the stock. However, we may see further selloffs as investors favor cash-generating companies in what seems to be a tough macro environment. As such, investors should approach the stock with cautious optimism.

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This article was written by

Riyado Sofian profile picture
1.81K Followers
I tell stories about the most innovative companies in the world and help investors find the companies of tomorrow.I am a long-term growth investor in search of innovative companies that make the world a better place. My investment strategy revolves around finding what I call "divergent stocks" — disruptive companies that have strong fundamentals and long growth runways, but depressing prices.I also recently launched my YouTube Channel: The Simple Analyst (I'm not a natural speaker but I'll get better over time!)
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Disclosure: I/we have a beneficial long position in the shares of TWLO either through stock ownership, options, or other derivatives. 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.

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