While a few stocks from the 2020 and 2021 tech hype have emerged just fine from the crash of 2022, Twilio (TWLO 1.47%) has not. The stock is down 85% from its all-time high set in 2021 but has seen a better 2023, with it up around 40% year to date.
Although that's an impressive run for most years, it still lags behind some of its software peers. Plus, a lot of its run-up can be attributed to the cheap valuation it entered the year at.
But has Twilio's stock come too far, too fast? Or is this rally due to continue?
Twilio's business is falling on hard times
Twilio's products specialize in customer communication. Its most notable product is the automated text messages companies send to remind you of an appointment, confirm delivery, or communicate information about an upcoming lodging stay. In addition, Twilio has multiple other products like market campaigns, customer data platforms, and programmable voice, making it a one-stop shop for items centered around customer acquisition and retention.
However, one item that has bitten Twilio is its pricing model. It doesn't use a subscription method to bill its customers, but rather a pay-as-you-go model, so clients only pay for what they use. While they may receive discounts for committed bulk usage, clients can save money by reducing their usage. This can hurt Twilio during difficult economic times, when customers may be looking to reduce costs in any way possible.
This is playing out in real time, as Twilio's revenue growth is slowly approaching zero. In Q1, Twilio's revenue rose 15% year over year, but management only guided for 4% to 5% growth in Q2.
TWLO Revenue (Quarterly YoY Growth) data by YCharts
Still, this is likely only a temporary slowdown, as budgets are tight. Once management gives its sales team the green light to open up its customer acquisition budget, Twilio will likely see another surge of interest. This is reflected in Wall Street analysts' 2024 revenue guidance, in which they expect Twilio to increase sales by 11%.
While that's not Earth-shattering growth, it at least pulls Twilio into market-beating growth territory.
In the meantime, Twilio has taken steps to rightsize the company and has gone through multiple layoffs. Although it achieved non-GAAP (generally accepted accounting principles) profitability, it still has a ways to go before producing actual profits, thanks to its stock-based compensation expense. In Q1 alone, it paid out $160 million in stock to employees, about 33% of its gross profit. While this figure will tick down as restructuring costs subside, it's still a significant line item and a risk to Twilio.
That's a significant risk that investors must weigh, even if the stock looks dirt cheap.
The stock may look cheap, but there's a reason why
Twilio's stock currently trades at 3.1 times sales. Before rushing out and buying a software stock with that low valuation, investors must understand that Twilio's profit potential isn't the same as many software companies. Because it has to pay fees for text messages and other communication products it uses, its gross margins hover around 50%, while its software brethren have margins from 70% to 80%.
Using Twilio's medium-term projections as a guide, we can see where Twilio may be sitting in a few years. During its 2022 investor day, Twilio guided that it expects stock-based compensation to make up 15% to 20% of revenue and aims to achieve a 20% non-GAAP operating margin over the medium term. With stock-based compensation currently making up 16% of revenue, it's right on track.
It's a bit light on its non-GAAP operating income, at a 10% margin. But through various cost-cutting projects, this figure should improve.
However, that doesn't include long-term profitability, which is a problem for investors. If you think about it, those projections make little sense. If Twilio guides for stock-based compensation to make up 20% of revenue with a 20% non-GAAP operating margin, it has a 0% GAAP operating margin. When a company sets a long-term goal to break even and is happy about it, it may be time to find a new stock.
Even though Twilio's stock looks cheap and is amid a rally, there are much better software stocks. As a result, it may be best to steer clear of Twilio's stock until management can provide better updates on its long-term goals or achieve real profitability.
