Twilio's (NYSE:TWLO) stock recently surged to an all-time high after the company posted strong fourth-quarter numbers that easily beat analysts' expectations. Its revenue soared 65% year over year to $548.1 million, beating estimates by $93.2 million.
Its non-GAAP net income grew 13% to $6.5 million, or $0.04 per share, which also cleared estimates by $0.11. Those headline numbers look healthy, but is Twilio stock getting overvalued after rallying more than 1,200% over the past three years? Let's delve deeper into its strengths and weaknesses to find out.
Evaluating Twilio's strengths
Twilio's cloud-based platform allows developers to easily integrate voice calls, text messages, and other content into their apps with a few lines of code. In the past, developers needed to create those features from scratch, which was buggy, time-consuming, and difficult to scale.
By outsourcing those communication features to Twilio, companies like Lyft and Airbnb can focus on developing their core features instead of fretting over integrated calls and messages. Twilio enjoys an early-mover's advantage in this market, and it deploys a "land and expand" strategy -- wherein it locks in customers with one service to cross-sell additional services -- to boost its revenue per user.
That strategy has enabled it to consistently grow its revenue while keeping its dollar-based net expansion rate, which measures its year-over-year revenue growth per customer, well above 100%.
Twilio's revenue rose 55% in fiscal 2020, compared to 75% growth in 2019, which was boosted by its $3 billion acquisition of SendGrid. It ended 2020 with a full-year net expansion rate of 137%, compared to 136% in 2019.
Twilio also posted a non-GAAP operating margin of 2% in 2020, compared to an operating loss in 2019. It attributed that improvement to the reduced weight of its R&D expenses on its top line.
Twilio expects its revenue to rise 44%-47% year over year in the first quarter of 2021, while analysts anticipate 38% growth for the full year. Those estimates suggest there's still plenty of room for Twilio to grow.
Exposing Twilio's weaknesses
Twilio's sales growth is impressive, but it's slowing down. The company is increasingly relying on acquisitions for growth, and it faces rising competition from other similar services, including Vonage's (NASDAQ:VG) Nexmo, Bandwidth (NASDAQ:BAND), Microsoft's (NASDAQ: MSFT) Azure Communications Services, and MessageBird -- the hot European start-up that pulled Uber away from Twilio. All that competition could throttle Twilio's ability to raise its prices.
Twilio is also struggling with new A2P (application-to-person) fees from carriers like Verizon, which are charged whenever an app accesses its SMS network. Those headwinds reduced its non-GAAP gross margin from 58% in 2019 to 56% in 2020, and that contraction could continue for the foreseeable future.
Moreover, Twilio's heavy dependence on stock-based compensation (SBC) is worrisome. Its SBC expenses and associated payroll taxes rose 47% year over year to $389.3 million, or 22% of its top line, in fiscal 2020. It excludes those expenses from its non-GAAP earnings, but its GAAP loss widened significantly for the full year, from $307.1 million to $491 million, and it probably won't narrow those losses anytime soon.
That's why Twilio funded its $3.2 billion purchase of Segment with stock instead of cash last November, and why it recently announced another secondary offering to capitalize on its soaring stock price.
Twilio's aggressive usage of stock bonuses and secondary offerings boosted its number of outstanding shares, on a GAAP basis, from 86.1 million in 2016 to 146.7 million in 2020. It expects that share count to continue rising in 2021, which will make it very difficult to tame its red-hot valuations.
At $440, Twilio is valued at $71.2 billion, or nearly 30 times this year's sales. That high price-to-sales ratio could limit Twilio's upside potential, especially as its revenue growth decelerates, its gross margin contracts, it integrates new acquisitions, and it continues to issue new shares.
An attractive company at an unattractive price
Twilio's stock won't drop off a cliff anytime soon, but its weaknesses could overshadow its strengths over the next few quarters. I wouldn't call its stock overvalued yet, but investors who expect Twilio to continue its big multi-bagger gains this year could be sorely disappointed.