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Don't Get Greedy With Twilio Inc. Stock (Yet)

By Leo Sun - Dec 15, 2017 at 11:33AM

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Investors can nibble on this speculative stock, but they shouldn’t go all-in.

Twilio (TWLO 1.62%) has taken investors on a wild ride over the past one and a half years. The cloud communications platform provider went public at $15 last June, surged to the mid-$60s three months later, then stumbled all the way back to the mid-$20s.

Bottom-fishing investors might be wondering if it's finally time to buy the beaten-down growth stock. I still believe that Twilio is a good speculative play, thanks to its first mover's advantage in the CPaaS (cloud platform as a service) space and its robust revenue growth. However, I also think that investors shouldn't get greedy with Twilio yet, for five simple reasons.

A smartphone links to cloud-based services.

Image source: Getty Images.

1. It isn't "cheap" yet

Twilio's revenue rose 66% to $277.3 million last year, and is expected to jump another 40% this year. However, the company still isn't profitable by GAAP or non-GAAP measures.

This means we can't value Twilio with traditional price-to-earnings multiples. However, its price-to-sales ratio of six merely matches the industry average for application software makers.

Twilio's two closest CPaaS rivals, Vonage (VG 1.27%) and Bandwidth (BAND 4.73%), both trade at about two times trailing sales. Therefore, it would be premature to call Twilio "cheap" and start a full position at these prices.

2. Rising stock-based compensation expenses

Twilio's stock-based compensation (SBC) expenses rose 86% annually to $14.2 million last quarter, which gobbled up 14% of its revenues. That's up from 11% in the prior-year quarter.

Silicon Valley-based companies like Twilio generally spend more cash on SBC expenses than companies like Vonage and Bandwidth, which are respectively based in New Jersey and North Carolina. Going forward, those SBC expenses should remain elevated and prevent Twilio from achieving GAAP profitability in the foreseeable future:

TWLO Net Income (TTM) Chart

Source: YCharts

3. Growing competitive threats

Twilio has a "best in breed" reputation in the CPaaS space for cloud-based voice calls, text messages, videos, and other content. The company capitalized on the rise of "no stack" apps, in which developers create a core service (like Uber's ride-hailing service) and outsource other features -- like mobile payments, mapping services, and integrated calls and messages -- to other companies.

Many companies -- including Facebook, Amazon (AMZN 3.15%), Uber, and Airbnb -- currently integrate Twilio's APIs into their apps to add voice calls, text messages, and other communication features.

However, it's unclear if Twilio can maintain that lead, as new competitors like Vonage's Nexmo and Bandwidth, which owns its own nationwide IP voice network, aggressively pursue new customers. Meanwhile, big customers like Uber -- which recently decided to reduce its dependence on Twilio in favor of an internally developed platform -- could produce their own in-house CPaaS solutions.

Twilio's relationship with Amazon -- it runs APIs for various Amazon services while being hosted on AWS (Amazon Web Services) -- is also on shaky ground. Amazon could eventually bundle more Twilio-like services (like the new SMS features in its Pinpoint service) with AWS to render the company obsolete.

4. Uncertain plans for the future

During a recent investor day presentation, Twilio claimed that it would add its APIs to virtual assistants, fax services, AR/VR platforms, and even holographic computing platforms over the next eight years.

Those prospects sound exciting, but Twilio might be getting ahead of itself. Expanding into those markets, which its CPaaS rivals are also likely targeting, would cause its expenses to rise. That could cause Twilio's losses to widen and its cash flow to dry up, and potentially lead to additional follow-on offerings.

5. The insiders aren't excited

If Twilio was truly bottoming out and approaching a turning point, we should see a lot of insider purchases. CEO Jeff Lawson arguably set a near-term floor by purchasing 100,000 shares at $23.43 in May, but his fellow insiders weren't as enthusiastic.

Over the past 12 months, Twilio's insiders bought 10.2 million shares on the open market, but still sold 18.9 million shares. That ratio isn't bad, but I like to see the buys outnumber the sells before I get greedy with a stock.

The key takeaways

Twilio still has great long-term growth potential since its base revenue (revenue from customers who entered 12-month contracts with Twilio) and dollar-based net expansion (the amount of revenue it generates per customer) are respectively growing at double- and triple-digit rates.

However, Twilio's valuations, lack of profitability, and competitive headwinds will still make the stock a popular target for short sellers. Therefore, investors can nibble on this stock as a speculative play, but they shouldn't get greedy and make it a core holding yet.

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Stocks Mentioned

Twilio Inc. Stock Quote
Twilio Inc.
$85.17 (1.62%) $1.36, Inc. Stock Quote, Inc.
$109.56 (3.15%) $3.35
Vonage Holdings Corp. Stock Quote
Vonage Holdings Corp.
$19.08 (1.27%) $0.24
Bandwidth Inc. Stock Quote
Bandwidth Inc.
$19.71 (4.73%) $0.89

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

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