Twilio Stock: Down 65% From Its Highs, Speculative Buy (TWLO)

Investment Thesis

The market has pummeled Twilio Inc. (NYSE:TWLO) stock over the past year. It has been a dramatic fall from grace for the pandemic favorite, having lost 65% of its value since February 2021. Furthermore, a pleasant surprise from management in communicating its path to adjusted operating profitability didn’t help matters. As a result, the stock quickly digested its post-earnings euphoria and resumed its downtrend.

We have also discussed Twilio’s thesis extensively. We assigned a Hold rating in our previous two articles (here and here). We noted that the company has not been able to generate meaningful leverage despite robust topline growth. Furthermore, its free cash flow profitability has also continued to disappoint.

Nevertheless, we think that the sell-off seems overdone. Therefore, we are ready to upgrade our rating to a Buy. But, we consider it appropriate only for a near-term counter-trend trading opportunity and not for a long-term investment position. Therefore, investors are reminded to adjust their exposure and perspective accordingly.

TWLO Stock Key Metrics

Readers can refer to the significant value compression of TWLO and the communications leader Zoom (ZM) stock. Although their business models are different, both stocks are seen as peers in the communications space. As a result, the market was concerned whether these pandemic winners could sustain their gains post-reopening. Notably, TWLO stock’s NTM revenue multiple has dropped to 6.5x. It’s broadly in line with its valuation at the COVID-19 bear market bottom.

However, Twilio is not expected to be free cash flow (FCF) profitable over the next twelve months. While ZM’s pandemic growth has slowed dramatically, its FCF metrics are much more impressive than Twilio’s. Therefore, Zoom’s management could leverage opportunities to buy back stock or even consider potentially accretive acquisitions. In contrast, Twilio’s robust topline growth has not translated into meaningful FCF gains. Twilio’s management has guided for adjusted operating profitability in FY23. But, we remain skeptical of management’s long-term execution ability.

Where Is Twilio Heading in 2022?

Investors can glean Twilio’s deteriorating adjusted profitability margins over time. It’s clear that Twilio’s adjusted gross margins have been trending down despite its robust topline growth. The bifurcation over its growth and profitability has baffled us, particularly its gross margins. Therefore, it has also affected its GAAP profitability, and the company remains solidly in the red. But, Twilio guided to adjusted operating profits from FY23. Therefore, it demonstrated a pivot in management’s strategy on its balancing act between growth and profits.

However, investors should note that the company has not guided towards GAAP profitability, and neither did it guide towards FCF profitability. Furthermore, Twilio’s topline growth is expected to slow towards 30+% moving forward. Therefore, we aren’t sure when Twilio will turn GAAP EBIT profitable or FCF positive. Until Twilio addresses either of these two key profitability metrics, we aren’t going to be long-term holders of the stock. We can accept trading off near-term GAAP profitability if management can demonstrate solid FCF metrics. However, that flow-through from revenue growth to FCF has been anemic.

Furthermore, its net expansion rate (NER) has weakened over time, reaching 126% in FQ4. It’s a marked contrast from Snowflake (SNOW), whose net expansion rate (NER) reached a record 178% in its recent earnings card. Hence, Twilio has not demonstrated the kind of platform stickiness that we expect from a leading platform in the CPaaS space. Moreover, its NER is only in the 50th percentile of high-growth SaaS players that we track. Therefore, its relatively weak metric as a platform leader is hardly inspiring. Therefore, there’s some digestion and churn going on under the hood in the DTC space. Investors are encouraged to continue looking at major DTC players to have a broad appreciation of the impact of reopening. A look over to Shopify’s (SHOP) stock price could unveil some clues. The DTC commerce leader has also been undergoing lots of pressure lately as it is investing aggressively in fulfillment. It also represented a significant pivot from its asset-light strategy.

Is TWLO Stock A Buy, Sell, Or Hold?

Given our downbeat tone above, investors could be confused by why we re-rated TWLO stock. We are unlikely to consider a long-term position on TWLO stock, but we could consider a short-term opportunity. Therefore, we think speculative investors can still consider adding TWLO stock on a potential near-term rebound.

Investors should not rely on the average consensus price targets (PTs) on TWLO stock for adding exposure. As seen above, its average PTs have proven to be overly optimistic and highly inaccurate. However, the most conservative PTs seemed a better gauge. Notably, TWLO stock is trading markedly below even its most conservative PTs.

Furthermore, we also observe a similar trend on ZM stock. It’s also trading in line with its most conservative PTs, which was recently downgraded. Therefore, we believe there’s a near-term counter-trend opportunity for speculative investors to add TWLO stock. Our price charts also show an oversold stock.

As such, we revise TWLO stock from Hold to Buy for speculative investors/traders only. Our PT is $200, representing an implied upside of 26%.