Shares of Twilio (TWLO 0.60%), a provider of cloud-based communications tools and services for developers, were pummeled last week. The stock fell more than 12% during the five-day period. This decline adds to an already disastrous return over the last 12 months. Shares have now fallen more than 50% during this period.
Most of last week's tumble came after the tech company reported its first-quarter results. Worse-than-expected second-quarter revenue guidance included in the update spooked investors. Adding to the reasons to be discouraged, over a dozen analysts cut their 12-month price targets for the stock after they digested the information in the report.
There are times when it makes sense to, as Warren Buffett has said, be "fearful when others are greedy..." But this may not be one of those times. Indeed, a good case can be made for Twilio stock still being overvalued, even after the stock's huge decline.
The issue with Twilio stock
The concern with Twilio stock stares a prudent investor right in the face. With nearly a $9 billion market cap, you'd expect the company to be generating several hundred million in annualized profit, at a minimum. And if a company of this size isn't profitable, Twilio should at least be serving up some incredible growth rates.
But here's the issue: Twilio is bleeding huge net losses. First-quarter revenue increased just 15% year over year to about $1 billion, and on that $1 billion of revenue, Twilio managed to lose $186 million, or $1.84 per share, in a single quarter. If your gut reaction is that this must just be a bad quarter, zoom out to the company's trailing-12-month net loss. It came in at a whopping $1.38 billion.
Twilio's business model simply isn't efficient. On the company's nearly $4 billion in trailing-12-month revenue, for instance, cost of goods sold was about $2.1 billion; selling, general, and administrative expenses were more than $1.7 billion; and research and development expenses closed in on $1.1 billion.
To Twilio's credit, the company is implementing changes to better optimize for profit in its core communications business. However, Twilio apparently wants to optimize for growth over profit in its data application business, management explained in the company's first-quarter earnings call. So this could hold the company back from making the substantial progress toward profitability it needs in order to justify its $8.7 billion market cap.
What investors should look for
In order to live up to its valuation, Twilio will either have to become dramatically more efficient when it comes to turning revenue into profit, or it's going to have to show investors that it can grow much faster than it is today. After all, investors often buy growth stocks like Twilio for future profits, not profits today. So investors are willing to forego profits if they believe rapid growth will help the company achieve significantly greater scale in future years, helping costs decline as a portion of total revenue and ultimately leading to big profits in the future. But with Twilio guiding for second-quarter revenue growth of just 4% to 5%, such a view is a stretch.
To be fair, Twilio believes the current macro environment is tough for its business. Further, Twilio has about $4 billion of cash, cash equivalents, and short-term marketable securities on its balance sheet, which is approximately four times greater than its long-term debt. So the company has a large cushion to fund its business while it aims to scale to the point that it is profitable. But its $8.7 billion market capitalization arguably already prices in strong growth and an eventual swing to profitability.
All of this to say, the risks to investing in Twilio stock may be too great at the stock's current market cap. Sure, strong growth could resume and the stock could subsequently surge over the next five years. But there are likely stocks with better risk-reward profiles for investors to consider.
