Twilio (TWLO 5.00%) has been a volatile and frustrating stock to own. The cloud platform provider went public at $15 last June, skyrocketed to nearly $70 three months later, then crashed all the way back to the high $20s.
But even after that big drop, Twilio still trades at nine times sales, compared to an industry average of four for application software makers. Investors are also still betting heavily against the stock -- 31% of its shares were being shorted as of March 24.
Image source: Getty Images.
Amid all that pessimism, is it time to finally move on and sell Twilio? Let's answer four key questions about the company to decide.
Is Twilio's growth story still intact?
Twilio's revenue rose 66% to $277.3 million in 2016. Its "base" revenue -- which excludes revenue from "Variable Customer Accounts" with big customers that have never signed 12-month minimum revenue commitment contracts -- rose 79% to $245.5 million. Analysts expect Twilio's revenue to rise 33% this year and 32% next year. That represents a gradual slowdown, but it's probably still high enough to justify its P/S ratio of nine.
Another cloud service provider, Veeva Systems, is expected to post 21% sales growth this year but trades at 13 times sales. Veeva's big brother, Salesforce, trades at seven times sales, and is also expected to post 21% sales growth this year. Based on those comparisons, Twilio doesn't look that pricey relative to its top-line growth.
Is it too heavily dependent on a few customers?
One of Twilio's biggest weaknesses is its dependence on big customers. Facebook's (FB 3.91%) WhatsApp accounted for 9% of its sales last year, and Uber accounted for "more than 10%." To make matters worse, WhatsApp is a "Variable Customer Account," which isn't required to pay minimum payments, and it can switch to a rival service at anytime.
WhatsApp. Image source: Google Play.
However, investors should note that WhatsApp's weight on Twilio's top line was nearly cut in half from 17% in 2015, even as its total revenues rose 66% in 2016. That's because Twilio is diversifying its business with more Active Customer Accounts -- which rose 44% annually to 36,606 last quarter. Those new customers included big companies like Capital One, Atlassian, and "one of the largest U.S. airlines." Therefore, I wouldn't worry about Twilio's dependence on major customers unless its new customer growth starts slowing down.
Is its competitive moat wide enough?
Twilio has a great first mover's advantage in its market of integrating phone calls, SMS messages, videos, and other features into mobile apps via a cloud-based platform. It enables WhatsApp users to add contacts via phone numbers, and lets Uber passengers call or message their drivers -- features that would be much tougher to develop from scratch.
But Twilio also isn't immune to the competition. Last year, Vonage (VG +0.00%) acquired Twilio's smaller rival Nexmo. That seemed like a minor threat until Uber's nemesis Lyft started using Nexmo alongside Twilio as a "potential" alternative provider for SMS messages.
If other Twilio customers follow Lyft's lead, Twilio might need to slash prices or pile on more features to stay competitive. There's also the looming threat that Facebook, Amazon, or another tech giant will simply create a Twilio and Nexmo rival and bundle it into their own data centers -- thus rendering their smaller services obsolete.
Will it ever achieve profitability?
The cloud SaaS (software-as-a-service) market generally has low margins, because it requires high marketing expenses to secure new customers, and high R&D expenses to develop and maintain new services. Since Twilio has weak cash flows and is headquartered in the pricey Bay Area, it relies on big stock bonuses to attract top talent.
All those factors make it tough for Twilio to ever achieve profitability. Its GAAP operating loss widened from $35.4 million in 2015 to $41.3 million in 2016. However, its non-GAAP loss narrowed from $22.9 million to $12.2 million during the same period. That disparity was partly caused by stock-based compensation expenses, which gobbled up 9% of its revenue in 2016. Twilio hasn't offered investors a road map toward profitability, and it could struggle to do so -- since rising competition could require it to boost its marketing and R&D expenses.
The verdict: Stick with Twilio (for now)
Twilio's top-line growth is intact, its valuations are fair, and its dependence on top customers isn't an issue unless it stops reaching new customers. However, I'd still keep an eye on its ability to counter rivals like Nexmo and narrow its GAAP losses. If it fails to do either, I'll consider selling my shares. But for now, I'll stick with Twilio because I still believe it's the best-in-breed player in an oft-overlooked market.
