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The 3 Biggest Misconceptions About Twilio Inc.

By Leo Sun - Oct 4, 2017 at 10:12AM

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Many investors misunderstand the cloud service provider’s core business and overestimate its headwinds.

Twilio (TWLO -5.80%) had a wild ride since its IPO last June. The cloud service provider went public at $15 per share, surged to the $60s three months later, then plummeted to the low $20s this May before stabilizing in the high $20s.

Twilio advanced just over 3% this year, indicating that the once-hot IPO had stalled out. Its price now occasionally rises or falls on headlines about growing competition or lost customers, but many of the reports seem ill-informed about its core business. So today, let's take a moment to address three common misconceptions about Twilio.

A smartphone accessing cloud services.

Image source: Getty Images.

1. "It just sends text messages."

Twilio's cloud platform is best known for ferrying SMS messages between apps to users. But that's not all it does -- it also handles cloud-based voice calls, messages, videos, and various other services.

Offering these additional services helps Twilio attract more customers and boost its average revenue per customer, which it reports as its "dollar-based net expansion rate." That rate rose 131% annually last quarter, indicating its existing customers were paying more for its services.

Adding on other services could enable Twilio to expand as a diversified cloud services company like its much bigger industry peer Salesforce (CRM -4.89%). That's probably why Twilio hired former Salesforce COO George Hu as its new COO earlier this year.

2. "Amazon will render Twilio obsolete."

A common bearish argument against Twilio is that Amazon's (AMZN -5.00%) AWS (Amazon Web Services), the biggest cloud platform in the world, could render the platform obsolete by simply introducing similar messaging, voice, and video APIs for app developers.

That argument overlooks the fact that Twilio itself is hosted on AWS, and that Amazon uses Twilio's APIs in its Lex chatbots, SNS notifications, Chime enterprise communication service, and Connect cloud-based contact center. As a result, the two companies are better described as partners rather than competitors.

But this doesn't mean that Twilio investors should consider Amazon a loyal ally. For example, Amazon recently launched Pinpoint, a two-way text messaging service built into AWS, and Twilio stock plunged. Twilio CEO Jeff Lawson subsequently tweeted that Twilio was "helping to power engagement" on Pinpoint, but that seemingly confirmed that Twilio wasn't the exclusive API provider for the new service.

3. "Vonage's Nexmo and first-party solutions will kill Twilio."

Twilio has a clear first mover's advantage in its market of cloud-based APIs for messages, voice calls, and videos. However, the bears claim that rival platforms, like Vonage's (VG 5.72%) Nexmo, could lure away customers with competitive rates.

Meanwhile, more companies like Uber, which is reducing its dependence on Twilio, could replace Twilio's services with internally developed platforms. While those challenges sound dire, investors often don't notice that Twilio's growth has remained robust throughout those developments.

Twilio's revenue rose 49% annually last quarter, marking an acceleration from its 47% growth in the first quarter. That growth is remarkable when we consider that Uber, its largest customer, started pivoting away from Twilio's services during the first quarter. Vonage also closed its acquisition of Nexmo last June, so it doesn't seem like Nexmo is stealing much of Twilio's thunder.

We should also note that Twilio's "base" revenue, which excludes big customers that haven't entered 12-month minimum revenue commitment contracts, rose 55% annually last quarter and accounted for 91% of its top line. Its active customer base grew 41% to 43,431 accounts. That momentum should remain robust, with analysts expecting 35% sales growth this year and 25% growth next year.

But I'm not saying that Twilio is a great buy... yet

The aforementioned bear cases are overblown, but Twilio hasn't offered investors a clear path toward profitability yet -- and its bottom line could remain in the red for years to come.

That problem, which plagues many younger tech companies, makes Twilio a risky play at eight times sales -- which is significantly higher than the industry average P/S ratio of six for application software makers. Therefore, I don't plan to start a new position in Twilio anytime soon, but I'll keep an eye out for improvements to its margins and a potential path toward profitability.

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Stocks Mentioned

Twilio Inc. Stock Quote
Twilio Inc.
$91.57 (-5.80%) $-5.64
Salesforce, Inc. Stock Quote
Salesforce, Inc.
$172.45 (-4.89%) $-8.86, Inc. Stock Quote, Inc.
$107.56 (-5.00%) $-5.66
Vonage Holdings Corp. Stock Quote
Vonage Holdings Corp.
$18.59 (5.72%) $1.00

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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