Why Investors Must Be Patient With This Cloud-Based Communication Stock

It may take some time to be profitable, but there are encouraging signs ahead for Twilio (TWLO 1.47%). In this segment of "The Virtual Opportunities Show" on Motley Fool Live, recorded on Feb. 8, Fool contributor Demitri Kalogeropoulos examines a few ways the communications company is planning to grow and be attractive to investors.

Demitri Kalogeropoulos: The stock I wanted to highlight here is Twilio. You might have heard of this one, the ticker symbol TWLO. I've watched it for a couple of reasons, they actually report earnings tomorrow, that will be Wednesday the ninth. I'm going to be watching this report, this is a cloud communications company. Jose mentioned one part of Salesforce's (CRM 0.42%) company is in this cloud communications and that is basically where Twilio focuses on.

They help enterprises communicate with their customers, whether it's through text messages or automated phone conversations, online chats, and they are getting into a lot of these cool spaces we talked about using more AI. Trying to get more conversational and a lot of these chats, get to develop a real deep roots in a lot of these tech environments.

Growth has been really good lately. Sales were up 60% in the last quarter in Q3. Actually, they've been up by 60% or more in each of the last four quarters. This is definitely one of those companies that got a big boost through the pandemic. They're doing a really good job at diversifying their business, and they've been making some big acquisitions, and they're also growing their customer base and then building up their portfolio so they can add more value to customers.

You're seeing customers sign up a lot more with basically almost a 100% or more renewal rates and they're signing up at higher prices every year which is great in terms of larger contract values. That's basically the formula for success for a cloud-based business like this. They do have a really pretty big exciting growth opportunity, I think ahead as you see more communication shift online.

The two worries and their stock is down about 40% or more since the ties in late 2021, it got caught up in a lot of the downturn that we saw with a lot of growth stocks. The first concern that I think investors have is the slowing growth. Revenue gains are obviously not going to stick in that 60% range forever and in fact, they have been slowing on an organic basis this past quarter and they probably will this next quarter. Sales are expected to rise about 50% in Q4 versus 65% last quarter.

But let me go ahead and share a slide or two from my investor presentation here, highlight what they're talking about and see, OK. This is just a look at their investor presentation, a summary of their organic revenue trends. You can see this gray line is showing that they've made an acquisition or two about a year ago, which made that number look a little different. So, as I said, 65% on an inorganic basis, but organic-wise, growth decelerated a little bit. This is still a fantastic growth and it's still a pretty relatively small business, I think it's got some room to grow.

The other highlight I wanted to show here is this dollar-based net expansion that I mentioned before in terms of the average client renewing their contract at about what rate over 100%, and that number has been over 130 consistently throughout the pandemic and they need to keep it that way and that's a great sign in terms of engagement and that the company is adding a whole lot more value.

I think if they keep doing that, Twilio is definitely going to have opportunities to continue to boost that contract size, get a bigger client base. They already serve a lot of Fortune 500 companies and things like that, but they are trying to build that out and once their communications get more improved like the management is talking a lot about, what I mentioned, those AI bots that are getting better and better at being able to chat with you. There's a lot of opportunities there to build on that, it's an exciting one to watch.

I'll be watching them and I think it's after market close tomorrow, so the stock has been down, it's not a particularly exciting time. Investors are demanding a lot from companies like this and Twilio is not sustainably profitable right now. They are focusing a lot on growth and it probably won't be forecasting huge profits in the next year or so, but that makes perfect sense for a company like this. If you're willing to hold onto something through a period like that, I think you might be excited to look at this growth stock right there.