Despite its market capitalization of more than $50 billion, Twilio (NYSE: TWLO) isn't a household brand and doesn't create any of your favorite applications. It just improves it. Twilio allows a developer to programmatically send and receive phone calls, texts, and more using his/her existing web programming skills. The service is best suited for real-time mobile communication that requires zero server-side processing. Rather than depending on established software applications, Twilio prioritized an API building blocks approach, which enabled developers to mix and iterate for their own apps. This meant that Twilio's customers were better positioned – with a tailored solution – to tackle incremental challenges, experiment with new ideas, and remain adaptable in a competitive business context.
Twilio's business is thriving, but the stock is trading nearly one-third of the way down from its all-time highs in February. Half of the drop may be attributed to the market's first response to Twilio's most recent financial statement in late October.
According to the report, Twilio's third-quarter sales increased by 65 percent, to $740 million. In addition, the firm surprised the market by producing a profit on an adjusted basis. Twilio now has more than 250,000 active customer accounts, up from 208,000 a year ago. And you know why I am writing this piece right? Of course, insiders are once again showing me where to look. This time, one of Twilio Directors, Jeffrey Immelt (GE's CEO), bought $1 Million in shares on November 11th.
Twilio's organic revenue has been "decelerating" to 38% year on year in the third quarter, the company's slowest rise in almost two years. A dollar-based net expansion rate of 131 percent is likewise the lowest we've seen at Twilio since late 2019, but it's hard to argue with a firm that gets returning customers to spend 31 percent more than they did a year ago. Twilio is undoubtedly doing something right by engaging its increasing customer base and convincing them to invest in new products.
Twilio's current-quarter projection called for slower revenue growth and a larger-than-expected loss. It was also reported that COO George Hu would be departing the firm, with Twilio's CFO taking over the position. Executive leadership changes are often a source of concern, and Hu came to the company four years earlier with an outstanding background as the previous COO of Salesforce (NYSE: CRM). It's still not a deal-breaker, and as long as CEO Jeff Lawson is in charge, we have faith in Twilio's leadership.
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What is most concerning, though, are Twilio's contracting gross margins. According to GAAP, its gross margin fell from 52 percent to 49 percent. Two significant headwinds are to blame for the compression. To begin with, certain cellphone providers have started charging Twilio application-to-person (A2P) fees to use their SMS networks through Twilio. This pressure is reducing the profitability of its messaging services. Second, Twilio faces an increasing number of rivals in the cloud-communications sector, including Vonage's Nexmo, Bandwidth, and MessageBird, which might limit its pricing power.
Twilio's market valuation of roughly 20 times trailing sales isn't "cheap", but it has previously traded at significantly higher multiples. With sustained profitability still some years away, valuation worries will persist. We believe the market premium is more than justified, but this might alter if growth slows significantly from here. This is probably why the Gurufocus Fair value model, which uses historic valuation as a variable, marks it as "modestly undervalued".
The latest in its optionality
Twilio just launched Engage, which it touts as the first growth automation platform for the digital era, last month. Engage is the company's mix of its own powerful communication tools with the customer data platform obtained from the Segment acquisition.
I have been trying for my own project to find a one-stop shop for designing and managing all my customer's communications, whether it happens on the phone, by email, chat, push notification, SMS or Whatsapp. It seems Engage is trying to solve that, even though I think it still lacks the push notification channel. It makes much sense, Segment takes care of the customer data integration and analysis, while Twilio conversation API takes care of the interactions.
Engage will tap into a different customer profile from Twilio, as the Twilio value proposition is engineered for developers, while Engage is more of a finished software to be used out of the box for non-developers. It gives Twilio the optionality to go after the likes of Hubspot and Zendesk customer base. Still, it is a crowded space where acquiring new customers can be costly. Not sure it will help with the margins in the near term.
The business continues to dominate its revolutionary cloud market niche, but deteriorating gross margins, increasing losses, and increasing share count are challenging to ignore. I am holding for now, but won't add any more shares
The author of this post owns shares of TWLO. The Rookie Investor recommends TWLO. The Rookie Investor has a disclosure policy. This article by The Rookie Investor is not financial advice as it does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. eToro is a multi-asset platform that offers both investing in stocks and cryptoassets, as well as trading CFD assets. Please note that CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 67% of retail investor accounts lose money when trading CFDs with this provider. You should consider whether you understand how CFDs work, and whether you can afford to take the high risk of losing your money.
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