Microsoft (MSFT 1.57%) recently launched Azure Communication Services, an extension of Azure's cloud platform which enables developers to add video, voice calls, chat, and text messages to websites, applications, and mobile platforms.
Instead of building those features from scratch, developers can simply add a few lines of code from Microsoft's API (application programming interface) and outsource the feature to Azure. That approach is generally less buggy, less time-consuming, and easier to scale than internally developed communication tools.
Microsoft's strategy likely sounds familiar, since Twilio (TWLO 0.80%) provides similar cloud-based communication tools for developers. Let's see why Microsoft is expanding Azure into Twilio's backyard, and what that fresh competition could mean for the high-growth underdog.
Image source: Getty Images.
What's Microsoft's strategy?
Under Satya Nadella, who took over as Microsoft's third CEO in 2014, the tech giant adopted a "mobile first, cloud first" strategy to curb its dependence on Windows and other desktop-based software.
That strategy tethered Windows tightly to cloud services, transformed Office into a suite of cloud services, and expanded Azure into the world's second-largest cloud infrastructure platform after Amazon (AMZN 0.87%) Web Services (AWS).
That evolution boosted Microsoft's "commercial cloud" revenue 36% to over $50 billion, or more than a third of its top line, in fiscal 2020. That segment's strongest growth engine is Azure, but the cloud platform's revenue growth has gradually decelerated over the past year:
|
Azure Revenue |
Q4 2019 |
Q1 2020 |
Q2 2020 |
Q3 2020 |
Q4 2020 |
|---|---|---|---|---|---|
|
Growth (YOY) |
68% |
63% |
64% |
61% |
50% |
YOY = Year over year. Constant currency terms. Source: Microsoft.
That deceleration is likely pressuring Microsoft to find fresh ways to expand Azure. That's why it's been expanding Azure's data center regions and launching new edge computing, AI, and hybrid cloud services for the platform.
Adding a Twilio-like service to Azure complements that strategy. It would also widen its moat against Amazon, which links similar cloud-based communication services like Amazon Lex, Chime, and SNS to Twilio.
Should Twilio be worried?
Twilio enjoys a first mover's advantage in this market, and it's still growing rapidly. Its revenue rose 44% in 2017 and 63% in 2018, and it jumped another 75% in 2019 with its acquisition of SendGrid significantly boosting its sales last year.
Image source: Getty Images.
In the first half of 2020, Twilio's revenue grew 51% year-over-year. Its active customer accounts climbed 24% year-over-year in the second quarter, and its dollar-based net expansion rate -- which gauges its revenue growth per customer -- hit 132%. That key ratio has stayed above 100% since Twilio's IPO four years ago, and suggests its ecosystem is extremely sticky.
Twilio expects its revenue to rise 36%-38% year-over-year in the third quarter, and analysts expect its revenue to increase by 41% for the full year. Those growth rates are impressive, but Twilio remains unprofitable on a GAAP basis -- and its net losses are still widening.
Prior to Microsoft's entrance into the market, Twilio already faced competitors like MessageBird, the European start-up that pulled some of Uber's business away from Twilio, as well as Vonage's Nexmo and Bandwidth.
Yet Microsoft poses a more serious threat than all those rivals, for two reasons. First, it can aggressively bundle Azure Communication Services with its other software and cloud-based services. Second, Microsoft can afford to give away its service for free, as it did with Teams to challenge Slack (WORK +0.00%), to pull customers away from Twilio.
Microsoft doesn't disclose Azure's profitability, but it can easily offset any potential losses with the growth of its other businesses. Twilio doesn't have that luxury, and competition from Microsoft could force it to burn a lot more cash.
But don't jump to conclusions
Twilio's investors should pay attention to Microsoft's recent moves, but they should also recall that plenty of other companies, including Slack, survived Microsoft's attacks before.
There could also be enough room for Twilio, Microsoft, MessageBird, and others to all grow without trampling each other in the cloud-based communications space. Some companies might also intentionally avoid Microsoft and its prisoner-taking ecosystem, and opt to stick with smaller stand-alone players like Twilio and MessageBird instead.
Nonetheless, competition from Microsoft could still make it tougher for Twilio to justify its valuation -- which looks unmistakably frothy at 21 times this year's sales. Therefore, I don't believe Microsoft will kill Twilio's business, but it could certainly wound its stock.
