Twilio: (TWLO: $52, down 14% yesterday)
Twilio fell the most since it started trading in June after the mobile and web-applications maker said the company and select shareholders will sell more stock. Despite Monday’s drop, Twilio is still up more than 250% since its IPO at $15 in June, closing up at $29, up 92% the first day. Now is the opportunity we’ve been waiting for to invest.
Twilio is a rare opportunity to invest in the only pure-play Platform-as-a-Service (“PaaS”) provider that is taking large slices of the Communications Software market, which IDC estimates to reach $46 billion in 2017. This new greenfield opportunity is being called Communications-Platform-as-a-Service (“CPaaS”). Twilio is known as the cloud-based category leader in CPaaS.
Riding the wave of the app and developer economy is a great place to invest. The clear growth in cloud computing is widely recognized. High-growth trajectories from Amazon Web Services (AWS), Microsoft Azure, Google Cloud, and Salesforce.com’s PaaS reflect the paradigm shift in how developers are building applications.
What does all that PaaS and CPaaS jargon mean in layman terms? The Information Technology (IT) department across Corporate America is undergoing a massive transformation. Historically, companies used to build out internal IT departments with staff and equipment. Right now, everything is shifting to the cloud. Instead of purchasing all the equipment to store data, the process is being run through massive data storage centers made available through the cloud for a simple license fee that scales up and down with volume. Instead of hiring a team of mobile software developers, the process is taking place through open sourcing the projects through the cloud, again on a pay-as-you-go basis. Twilio is leading the trend with a tight grip on communication services. Specifically, Twilio enables developers to build, scale, and operate real-time communications within software applications – to include SMS (texting), voice, video, and authentication.
The company is led by Jeff Lawson who is low-key and personable, but high in engineering intensity and entrepreneurial discipline. He is brilliant, and we at The Bull Market Report believe in him and hold him in high regard. You WILL hear more from this man and this company in the future.
Why is Twilio’s platform considered to be the leader? Listen to this: Twilio has 30,000 customers - from small developers to large enterprises - who use Twilio to power some 75 billion annual connections that reach 1 billion devices. Match.com makes matches without revealing phone numbers; Airbnb sends rental notifications, and the American Red Cross deploys volunteers, all through Twilio. ING, the European banking giant, recently announced it was closing down 17 hardware and software systems across its global call centers and replacing all of it with Twilio. Twilio’s largest customer, WhatsApp, uses them to verify customer accounts and logins. Apps from Lyft, Expedia, Netflix, Coca-Cola, Salesforce and the New York Times all have Twilio inside. The company saw 70% growth last quarter.
Here is more about the business model. The revenue model is transactional. Twilio largely prices its products on a transactional usage-based model. For example, its voice business is priced on a per-minute basis, while its message business is on a per-message sent basis. Programmable video is priced per gigabit. The reality is that Corporate America wants a scale-up/scale-down service on a pay-as-you-go basis, so the entire technology industry is just going to have to get used to no longer having the degree of revenue visibility that once existed.
Due to the nature of the business model, we look at revenue growth as the key indicator of business momentum. The outlook is exciting. There is substantial growth opportunity ahead through international expansion, adding other enterprise customers, and the roll-out of new products. While Twilio has been experiencing high revenue growth running 80-90%, there is strong likelihood for continued explosive growth, primarily via expanding the business internationally, which accounted for just 14% of revenue in 2015. Twilio began investing in Europe only in 2014 and Asia just in 2015 and has already yielded strong results. These geographic regions are just getting going. Additionally, Twilio is gearing its sales force to pursue business with a greater number of enterprise customers such as ING and Nike, where the more big names the company can win the more likely we are to see trickle-through effects in terms of enterprise-level retention rates.
The financial picture calls for the major inflection point to come in 2018. Twilio did $167 million in sales last year, up from $90 million the year before. At its current growth rate Twilio would hit a $1 billion annual run rate in the second half of 2018. Lawson calls telecommunications services a trillion-dollar market, with big portions of it poised to migrate from hardware to software. Following Twilio’s total revenue growth of 88% YoY in 2015, consensus estimates call for growth to decelerate to 50% per year in 2016-2018 but we think they can outdo these estimates. By 2018, management has committed to be EPS, operating cash flow, and free cash flow positive. This inflection point considers ongoing investments to build out partnerships that will support the future of the company.
Customer concentration risk* is among the single biggest concerns investors currently have. In 2015, Twilio’s 10 largest customers contributed 32% of total revenue. A meaningful though undisclosed revenue contribution came from just two customers – WhatsApp and Uber. These two customers, however, have very different profiles and it is important to understand the nuances. The bottom line is that investors will just have to live with the customer concentration until the business can grow out of it. WhatsApp is a mobile instant messaging platform with approximately 1 billion users globally and was acquired by Facebook in 2014. WhatsApp has been a Twilio customer for about four years and was a customer before Facebook purchased it. WhatsApp uses Twilio for both voice and messaging.
Uber uses Twilio’s Programmable Voice products to enable voice calls between the driver and the rider, uses Twilio’s Programmable Messaging products to notify riders of an approaching ride or to engage drivers during increasing demand, and finally uses Twilio’s Authy product to authenticate phone numbers of new users.. Overall, both the relationships with WhatsApp and Uber appear to be on solid footing.
The other main concern is the long-term competitive threat of Amazon’s AWS. However, AWS, the leading cloud platform, is not currently a competitor. Should AWS decide to provide a competitive cloud platform for communications, it would pose a threat to Twilio’s business but that talk is just speculative. Twilio has noted that it has a “great” relationship with Amazon, which is an investor in Twilio. In July, Twilio announced that it now “helps AWS extend text message delivery for SNS customers.” AWS VP of Mobile and IoT Marco Argenti commented, "AWS believes in the value of efficient, scalable technology solutions that can elevate the developers' role to concentrate on building great applications, rather than managing infrastructure. We are thrilled to be working with Twilio, and we'll continue to work together to help empower developers to communicate with their users seamlessly across devices." All in all, we find some comfort in the close relationship the two companies currently share.
BMR Take: Twilio is not cheap, trading at 12x 2017 sales, relative to its peer group average of around 4x. However, Twilio is better positioned than all its peers by a large distance as a pure play in CPaaS, an explosive growth opportunity. We believe Twilio is on the path to ultimately produce annual sales greater than the current market cap of $4.4 billion with sales this year of $315 million. The timeline is a ways out, but the recent sell-off is an opportunity to invest in this powerful, explosive company.
*Note that we at The Bull Market Report do not view the customer concentration as a worrisome issue. With growth as noted above, we don’t see it as a threat to the well-being of the company.
And one more thing. The world is always looking for The Next Big Thing. Twilio just might be a candidate for this exciting category.