Twilio (TWLO +5.23%) stock has been on a tear this year, up over 150% year to date on the back of digital transformation tailwinds due to the coronavirus and a blowout first quarter. This rise in its share price has also made its high valuation even more pricey. But this company has a lot going for it and, over the long term, should continue to grow to be a market-beating investment.
Let's dive into this communications platform, its growth levers, and why this stock may be cheaper than it looks.
The business of a communications platform
Twilio has greatly simplified the process to integrate communications messages such as text, voice, video, or email into existing software tools. It provides easy-to-use software application program interfaces (APIs) for all of its communications tools to allow customers to access its super network of 25 cloud data centers in nine different regions around the globe. This moat has enabled it to drive a tremendous 10-fold increase in its organic revenue (blue bar in graph below; gray bar is SendGrid acquisition).
Image source: Twilio's fourth-quarter 2019 earnings presentation.
Most of Twilio's revenue (75%) comes from usage-based fees, where it charges a tiny amount for every text, email, or voice call. The remaining revenue comes from larger customers that sign extended contracts for unlimited usage and pay monthly subscription fees.
Its most recent quarter posted a 48% year-over-year organic growth on a 23% increase in active customer accounts and a 135% dollar-based net expansion rate. What's even more impressive is that its reported net expansion rate includes customers that leave the platform, so you can see that this platform is incredibly sticky. But having customers increase their usage is only one growth lever this company has at its disposal.
Numerous growth levers
Twilio estimates its programmable communications addressable market to be $66 billion annually. With trailing 12-month revenues of $1.3 billion, the company has tapped a tiny 2% portion of its opportunity. It's focused on growing its customer base through software developer awareness programs, but recent events have provided even more tailwinds.
A recent survey of over 2,500 large company information technology decision-makers found that COVID-19 has accelerated their digital transformation plans. An amazing 92% say that "transforming digital communications is extremely or very critical to address current business challenges." Twilio's multiple customer wins to power virtual medical appointments this year and a 540% increase in usage of its video tools during the pandemic are great examples of this acceleration.
Image source: Getty Images.
Beyond messaging, Twilio has built a set of contact center tools that enable customers to get voice and chat services up and running quickly. Customers like Shopify and Lyft give it serious credibility in this multi-billion-dollar market.
The company's international business is another growth avenue. Over the last three years, its international revenue has more than tripled, but it's still only 28% of the total. With capabilities in over 180 countries, look for the company to continue its impressive run outside the U.S.
These opportunities are tremendous, but what about its lofty valuation?
Looking at valuation
When comparing Twilio's price-to-sales ratios with some of its software-as-a-service (SaaS) peers, the valuation doesn't look so pricey. It's priced much more favorably than DocuSign or Okta, even though its growth rate is comparable or better. It's also important to note that Twilio has crossed the $1 billion annual revenue mark, whereas DocuSign and Okta haven't yet. This provides further evidence of Twilio's staying power and the value the platform brings to customers.
Looking at the long term as to what Twilio could become, Adobe is an apt comparison.
|
Metrics |
Twilio |
DocuSign |
Okta |
Adobe |
|---|---|---|---|---|
|
Price-to-sales ratio |
27 |
32 |
38 |
17 |
|
Three-year CAGR |
51%* |
37% |
54% |
26% |
|
Trailing 12-month revenues |
$1.3 billion |
$0.8 billion |
$0.6 billion |
$12.0 billion |
|
Market capitalization |
$35 billion |
$35 billion |
$27 billion |
$206 billion |
Note: CAGR = compound annual growth rate. *Twilio's growth rate is organic, not including the SendGrid acquisition. Data from Yahoo Finance, table by author.
The pdf document and creative cloud SaaS giant has almost 10 times the revenue, and its market cap is almost six-fold larger. With a lower (but still impressive) growth rate, Adobe's dominance in its market could be representative of what Twilio could become in the years to come. Adobe's business model has matured and it sports a profit and impressive cash flows, but as the communications platform scales, its bottom line and cash flows should improve. I wouldn't be surprised to see Twilio's market cap match Adobe's in the next decade or so, creating superior returns along the way.
Some would point to Salesforce with its high single-digit price-to-sales ratio as a counter-argument. But much of the customer relationship management juggernaut's growth has come from years of acquiring other software companies. Twilio's market is big enough that an acquisition strategy isn't required to drive future growth.
The bottom line for investors
The company reports its second-quarter earnings next week, and as is often the case with highly valued fast-growing companies, its stock price could respond wildly as a result. If headwinds of coronavirus-affected industries drag results down, the stock could take a hit. On the other hand, if digital transformation tailwinds propel the quarterly growth to unexpected numbers, the stock could jump positively too.
Regardless of what happens as a result of this upcoming report of 90 days' worth of business results, this growth stock is worth holding for the next decade or two, even though it might look expensive today.
