Twilio Stock: A Crisis Continues (NYSE:TWLO)

The S&P continues to reach for new heights, but amid renewed fervor for risk-taking and tech stocks (especially those having anything to do with AI), there are a number of companies that have failed to join the party and have lingering fundamental issues that have tossed them into the penalty box.

Twilio (NYSE:TWLO) is chief among these holdouts. The software company best known for its communication platform-as-a-service solutions (CPaaS) has seen its share price slide nearly 20% year to date, with losses picking up steam after the company’s disastrous Q4 earnings print. In my view, there’s no light at the end of this tunnel.

With Segment struggles added to the list, Twilio is a basket of risks

I wrote a note downgrading Twilio to bearish in January, and since then a number of new circumstances have arisen. First, Twilio released Q4 results, and while the company thankfully didn’t see any further decay in growth metrics or net customer retention, it also didn’t show any meaningful signs of rebound. Second, the company has decided to undergo a strategic review of its Segment business, which comprises under 10% of its revenue.

The story of Segment is perhaps a cautionary tale about tech companies that are trying to grow too quickly at all costs. The company spent $3.2 billion to acquire Segment in late 2020, a customer data platform that helps integrate customer data into a single point of view to enable more relevant and seamless communications. It temporarily rebranded the business as “Twilio Data & Analytics” and put the unit under high-profile hire Elena Donio (an SAP Concur executive and previously a Twilio board member). Donio resigned late last year and Twilio has since rebranded the unit as “Segment.”

Today, as shown above, Twilio Segment grows at a rate that is slightly worse than the rest of the company – up 4% y/y in Q4, versus 5% y/y for total company. Against FY23 revenue, Twilio paid an ~11x revenue multiple for a company that is not profitable and is barely growing. The only bright side here is that Twilio paid for Segment in stock at a time when its share price was trading ~6x higher than today. Either way, when Twilio completes its operational review of Segment later this quarter and if it decides to offload the business, it’s unlikely to fetch anywhere near the original sum it spent to pay for it.

Outside of the Segment fiasco, here’s a reminder as to the other core risks that Twilio faces:

• Slowing net expansion rates threaten one of the most critical growth engines for the company. Several years ago, Twilio boasted net revenue retention rates in the 120%+ range, indicating massive upticks in customer usage. Now, that figure is closer to 100%, which the company attributed in part to weakness in the crypto and social media sectors. Nevertheless, the “land and expand” potential for Twilio is a core element of its appeal to investors, and the fact that it’s currently unable to stimulate growth from within its install base is deeply concerning.
• Gross margins are stuck at the low 50s. Twilio has long had a gross margin deficit to other software peers (where margins in the 70-80s are more common). As net expansion slows, so does Twilio’s opportunity to leverage scale to improve its margin profile and profitability – especially because expansion within the install base is a relatively “free” way to earn new revenue without expending sales resources.
• Leadership turnover, including the CEO. The company’s CEO, Jeff Lawson, recently resigned; to be replaced by Khozema Shipchandler, the company’s former president. It also lost its prior Segment unit head, Elena Donio; a former SAP Concur leader.
• Competition versus DIY. Twilio has faced high-profile defections in the past, including customers like Uber (UBER) and Meta (META). As companies review their opex and tech stack, many may choose to develop CPaaS solutions in-house rather than outsource to an expensive vendor like Twilio that charges per message/minute.

All in all, I remain bearish on Twilio. Steer clear here and invest elsewhere.

Q4 download

Unfortunately, Twilio’s latest quarterly results did little to assuage investors that a turnaround is anywhere near. Take a look at the Q4 results below:

Revenue grew 5% y/y to $1.08 billion, ahead of consensus expectations of $1.05 billion (+2% y/y). On an organic basis, Twilio’s revenue grew 8% y/y excluding the impact of divestments, which kept the same pace as in Q3.

Perhaps the most heartening news in the quarter was the fact that Twilio’s dollar-based net retention rate, at the very least, didn’t get any worse as it has over the past several quarters. Net expansion rates clocked in at 102%, versus 101% in Q3:

The company, however, continues to cite weak crypto activity and tough y/y comps as a major drag on performance. Per CFO Aidan Viggiano’s remarks on the Q4 earnings call:

We continued to see stabilization in volumes across our usage-based products throughout the quarter, as well as strong seasonal activity around the holidays, which helped to drive our revenue beat in Q4. Similar to the last two quarters, our Q4 revenue growth rate was negatively impacted by headwinds from customers in the crypto industry. Total Q4 organic revenue growth excluding crypto customers was 10% year-over-year and for the full year 2023, total organic revenue growth excluding crypto customers was 13% year-over-year. We expect Q1 headwinds from crypto to be roughly in line with Q4, after which we will have lapped the vast majority of the crypto impact.”

Management also expects trends to get worse before they get any better. The company neglected to provide a full-year FY24 outlook as much of the full year hinges on what it decides to do with Segment, but for Q1, note that Twilio’s outlook calls for organic revenue growth to fall back down to 5-6%, representing up to three points of deceleration from Q4:

The company is also guiding to pro forma operating margins in the 12-13% range, versus 16% in Q4.

Valuation and key takeaways

At current share prices near $58, Twilio trades at a market cap of $10.50 billion. After we net off the $4.01 billion of cash and $989 million of debt on its most recent balance sheet, Twilio’s resulting enterprise value is $7.48 billion.

Meanwhile, for the current fiscal year, Wall Street analysts are projecting Twilio will generate $2.68 in pro forma EPS on $4.35 billion in revenue, up 5% y/y. This puts Twilio’s valuation multiples at:

• 22x FY24 P/E
• 1.7x EV/FY24 revenue

The latter revenue multiple is quite cheap, but also a valuation that reflects tough operational challenges that are unlikely to be solved anytime in the near term.

In my view, with the stock market sitting at all-time highs and with cash still earning hefty interest, it’s not a great time to bank on speculative plays like Twilio. Continue to sit on the sidelines here and invest in higher-quality tech plays (names I particularly like right now include Okta (OKTA), Toast (TOST), and Asana (ASAN)).