Twilio: Normalization Aberration

Jun. 01, 2022 10:45 AM ETTwilio Inc. (TWLO)13 Comments11 Likes

Summary

  • Twilio still forecasts organic growth normalizing at 30% growth rates in an aberration from other tech stocks.
  • The company is still generating losses causing the market to flee the stock.
  • The stock trades at less than 4x '23 sales targets.
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Twilio (NYSE:TWLO) got caught up in the major tech collapse of the last year despite the company still reporting strong normalized growth rates. The market is throwing away stocks like the cloud communications operator due to a current market thesis of avoiding those companies not generating large profits. My investment thesis is ultra Bullish on Twilio down close to $100 with the strong growth rates to ultimately drive profits.

Not The Time

The time to worry about low gross margins and the level of profits was when Twilio traded at about $400 with a market cap hitting $80 billion. The stock traded at rich multiples of sales topping 15x forward estimates, remarkably high considering the communications company doesn't have the software type margins.

The recent financials brought those fears forward with GAAP gross margins dipping below 50%, far below the 56% highs from prior years.

Chart
Data by YCharts

The good news for shareholders is that the non-GAAP gross margins are still above 56% when excluding certain pass through fees. Investors always need to understand the difference between gross margins alter the valuation equation. A software company with 80%+ gross margins always warrants higher multiples over a communications or fintech company with high transaction costs limiting gross margins.

Though, the long-term story remains strong. Due to a lot of tech companies with massive revenue pull forwards, Twilio wrongly gets lumped into the group. The company actually saw organic growth dip to 43% in Q2'20 due to covid slowdowns leading to communications demand surging, but Twilio only saw organic growth peak at 54%, just 6 percentage points above pre-covid levels.

Organic Growth slide

Source: Twilio Q1'22 presentation

Naturally, Twilio now faces a period where some of the demand pulled forward in 2020 impacts the growth dynamics in 2022. Still, the company just hit 35% organic growth and even the Q2'22 target of at least 27% growth is impressive.

The market likes to sweat over decelerating growth. Such a concern is logical when Twilio is at $400, not so much down at $100 and trading below 4x 2023 sales targets.

The cloud communications revolution is only in the early innings. Companies of all sorts need to enhance communications with customers and Twilio provides those tools via a unified customer engagement platform.

The company has long discussed a TAM north of $110 billion in 2023 with the addition of Zipwhip last year. The business has only reached meager revenue targets of $5 billion next year with plenty of slow moving enterprises yet to transition communications offerings to the cloud and a data platform.

TAM slide

Source: Twilio March '21 presentation

In essence, the market shouldn't fret organic growth slowing down to more normal rates. Twilio entered the covid crisis with growth above 40%, but natural declines in growth rates over the last couple of years as the revenue base has soared above $3.5 billion this year is just natural. The management team has targeted 30% organic growth rates warranting higher stock prices.

Look Past Losses

The market always moves towards extremes. The time to dump Twilio for not making a profit was last year. The time to invest in the stock based on the future is now.

Sure, Twilio guided to a Q2'22 loss of up to $40 million or $0.22, but the company did spend the last year increasing investments to grow the business. A downturn in the economy will allow the cloud communications provider to pullback from additional investments to improve the leverage in the business.

Also worth noting, Twilio typically blows past estimates. The actual losses will likely top analyst targets for the $0.20 loss and the June quarter is normally the weakest quarter. The analyst predictions have the company producing smaller losses the rest of the year leading into profits going forward.

Twilio aggressively spends 43% of revenues on R&D and S&M costs amounting to $526 million in GAAP costs and $371 million in non-GAAP costs. The company can easily leverage these categories, but investors need to look back at the TAM slide.

When a market leader isn't garnering 5% of a massive market opportunity, the company should have the incentive to invest in order to capture those opportunities. The IDC Customer Data Platform report highlighted a fragmented market with Twilio Segment only capturing 10% of the market share in 2020. Twilio is already the market leader in this area and some incremental investing will help capture more of this market making the stock more attractive and the profit stream higher in the future.

Takeaway

The key investor takeaway is that Twilio is far more interesting here trading at the yearly lows. The company still forecasts impressive 30% organic growth rates while the stock is valued as a slow growing enterprise trading at only 4x 2023 sales targets. The market hasn't caught onto Twillio, as it normalizes at far higher growth rates than most tech stocks.

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Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such 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.

Additional disclosure: 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.

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