2019 was going to be a great year for Twilio (TWLO -0.03%) investors, but then the third quarter happened. The stock was up more than 70% on the year in August, but Twilio got caught up in a broad sell-off of cloud-based software companies, which was compounded by a Q3 2019 earnings report that disappointed. The stock is now up a mere 3% year to date as of this writing.
Granted, there was nothing wrong with the results. Total revenues for the cloud communications company were up 75% year over year to $295 million, and active customer accounts were more than 172,092 compared with only 61,153 at the same time in 2018 -- not bad at all.
Some perspective is needed, however. Those numbers do include Twilio's $3 billion takeover (based on share prices at the time of deal closing) of email software platform SendGrid, which it finalized in February 2019. I was critical of the high price tag last fall when the merger was announced, and some shareholders must be getting skeptical as well, since shares have taken a massive tumble as of late. With valuation getting a big reset, though, now I'm interested.
What's changed this year?
In 2018, Twilio's full-year sales surged 63% higher to $650 million, and it generated an adjusted net profit of $4.1 million compared to an adjusted loss of $20.1 million in 2017. In light of that, Twilio's results this year, at least in terms of revenue, look fantastic. The fast-growing cloud software outfit has managed to add to an already sizzling top-line rate.
Metric |
Three Months Ended Sept. 30, 2019 |
Three Months Ended Sept. 30, 2018 |
Change (YOY) |
---|---|---|---|
Revenue |
$295 million |
$169 million |
75% |
Gross profit margin |
53.6% |
54.4% |
(0.8 pp) |
Operating expenses |
$253 million |
$117 million |
116% |
Adjusted net income (loss) |
($3.6 million) |
$4.3 million |
N/A |
However, besides the $3 billion in equity it cost Twilio shareholders to acquire the new email communications toy, the acquisition has come at a price. Gross profit margins generally haven't been rising as sales increase, and operating expenses have been soaring, since the SendGrid takeover never was about creating cost efficiencies. As a result, Twilio is back to running in the red, even on an adjusted basis. Free cash flow (money left over after cash operating and capital expenses are paid) is negative $44.6 million over the last 12 months.
Plus, there's also the problem of decelerating top-line growth when backing out the $49 million in sales from SendGrid. When looking at Twilio minus the email platform, year-over-year sales growth last quarter came in at "only" 47%. Life can be tough when the bar is set high.
Embracing the movement
Enough of the negative. While Twilio has taken a step back as of late, it's beginning to look like growth at a value to me. Where once I was skeptical, I've become a buyer as the stock price has moderated. At some point, double-digit growth is worth paying attention to, even if it does mean some cash burn in the short term. Besides, Twilio is the pioneer of -- and has a huge head start in --the cloud-based communications industry.
Granted, valuing this stock takes some educated guesswork based on long-term assumptions, so here's my semieducated guesswork. According to Grand View Research, the unified communications industry was worth about $56 billion in 2018 and should grow an average pace of about 16.8% a year through 2025 -- making it worth roughly $167 billion at that point. Speaking more broadly, Gartner says cloud services spending should easily top $200 billion this year and exceed $300 billion by 2022. These are big numbers, and Twilio still does less than $1 billion a year in total sales.
Lots of upside is still priced into the stock at current levels. The current price-to-sales ratio (sorry, value investors; no profits means no traditional valuation metrics will work here) values Twilio at 11.0 times trailing one-year revenue. Is it a frothy price? You bet. But it's lower than it was at the time the SendGrid acquisition was announced, and since then, Twilio has grown its core non-SendGrid top line by about 50%. And 11.0 is also far cheaper than the near-20-times multiples shares were going for over the summer.
For the sake of relative comparisons, Salesforce.com (CRM -0.52%) is currently trading at 8.5 times price to sales. The fellow San Francisco-based cloud company is growing far more slowly (revenues expanded by 23% through the first half of its current fiscal year against the comparable prior-year period), although gross profits on services rendered of 76% are higher than Twilio's 54% margin. All told, Twilio looks like the better value at the moment.
All of this is to say that while the valuation is subjective and speculative, if you believe Twilio's momentum can sustain the type of results it just posted in Q3, now looks like good timing to pick up some shares. Just remember to keep those positions small and be ready to buy more over time as you build into a full position.