Twilio's (NYSE:TWLO) stock more than doubled over the past 12 months as the cloud services provider attracted the bulls with its robust revenue growth. However, Twilio now trades at 24 times this year's sales estimate, making it a pricey stock in an expensive sector.
Let's examine Twilio's business, strengths, and weaknesses to see if its high-flying stock still has room to soar.
Twilio's core strengths
Twilio's cloud platform processes calls, text messages, videos, and other content for mobile apps. Developers simply add a few lines of code to their apps to outsource those services to Twilio. Popular apps like Airbnb, Lyft (NASDAQ:LYFT), and Instacart all access Twilio's services for integrated messages and calls.
Twilio's platform allows developers to focus on maintaining their core services -- like Airbnb's booking tools or Lyft's ride-hailing features -- instead of fretting over how to integrate mobile messages and calls. Developing those features from scratch can often be buggy, time-consuming, and difficult to scale as an app expands.
Twilio enjoys a first mover's advantage in its space, and its growth is tethered to the expansion of the mobile app market. It also gradually expanded its ecosystem by acquiring smaller companies like BeepSend and SendGrid.
Robust revenue growth with a sticky ecosystem
Twilio's revenue rose 44% in fiscal 2017, 63% in 2018, and 75% in 2019. Its acquisition of SendGrid, which it lapped last February, significantly boosted its sales last year.
In the first half of 2020, Twilio's revenue rose 51%, and it expects its third-quarter revenue to grow 36%-38%. Analysts expect its revenue to rise by 41% for the full year.
Twilio's active customer accounts grew 24% year-over-year to over 200,000 in the second quarter. Its dollar-based net expansion rate, which gauges its revenue growth per customer, hit 132%. That was down from 141% a year ago, but that ratio has consistently remained above 100% since Twilio's IPO four years ago -- which indicates it excels at retaining customers and squeezing out more revenue with fresh features.
Twilio's business also seems well insulated from the COVID-19 crisis. During last quarter's conference call, CEO Jeff Lawson noted that "new use cases" for Twilio's services were emerging throughout the pandemic as more people relied on mobile apps and cloud-based contact centers to communicate.
Widening GAAP losses and competitors at the gates
On a non-GAAP basis -- which excludes stock-based compensation, acquisition-related expenses, and other one-time expenses -- Twilio remained profitable in 2018, 2019, and the first half of 2020. But on a GAAP basis, which includes all those expenses, its operating losses widened throughout all three periods.
That's why Twilio has repeatedly raised cash with secondary stock and convertible debt offerings over the past four years. Twilio's cash and equivalents fell 11% year-over-year to $475.7 million in the second quarter, but it won't run out of cash anytime soon. Unfortunately, Twilio's stock offerings and liberal use of stock-based compensation also boosted its number of outstanding shares by more than 70% since its IPO.
The bulls might claim that dilution doesn't matter for a high-growth company like Twilio, but it's a dangerous habit that will repeatedly inflate its valuations as the stock hits all-time highs.
Meanwhile, Twilio faces a growing list of competitors, including the European start-up MessageBird, which gained Uber's business after the latter reduced its usage of Twilio's services; Vonage's (NASDAQ:VG) Nexmo; and Bandwidth (NASDAQ:BAND).
Twilio enjoys a first mover's advantage against these rivals, but widening its moat could become increasingly difficult as its operating losses widen and it runs out of room to raise cash with secondary offerings.
Is it the right time to buy Twilio?
Twilio is still an impressive growth stock, but its valuation is frothy, it's burning cash, and it lacks a clear path toward GAAP profitability. It also looks wobblier than other cloud stocks -- like salesforce.com and Veeva -- which are firmly profitable on a GAAP basis.
I'm still bullish on Twilio's long-term growth potential, but I think its stock is overheating with the broader market. Therefore, it might be wiser to stick with other cloud stocks until Twilio addresses some of its biggest weaknesses.