Interesting article on the bear case for TWLO.
https://seekingalpha.com/article/4250117-understanding-twili…
Jim
16 Likes
Beside having a few good points, the author expects TWLO to not innovate their service portfolio for the long term. Decries the non organic growth with the SendGrid acquisition, again ignoring the potential of the effect to have just expanded their available services for future customers, lowering the need to eye outside TWLO for current customers.
“Overall, I expect Twilio’s bad economics to result in a (very) bad outcome for investors in the long term, unless the company is able to launch some other significant business to replace its main business. However, short term Twilio will look like an explosive growth company, and this can easily attract growth investors at literally any valuation level.”
So, let’s define short and long term to judge this assessment. If long term is 3 or 5 years and TWLO not only looks like, but actually grows explosive during those 3 or maybe even 5 years, how hard would it be to take a, let’s say 30% or even 50% drop in the stock price, vs. not owning TWLO during the whole time and therefore not having to swallow that 50% drop?
Of course it would hurt, but the gain would most probably still be way beyond “non risky” stock.
To me, his bear case doesn’t work very well.
12 Likes
Jim, why don’t you tell us what about the article you thought was interesting?
Bear
2 Likes
First, I really recommend you to use outline.com when reading these kind of articles:
Now as it comes to content, I’m a bit baffled at the contradicting statements from the article.
- On one hand, the author states that TWLO is in fact providing valuable service of consolidated large amount of providers into one API and scales the customer’s usage through a cloud service:
For nearly all but the very largest customers, it would be unthinkable and too expensive to go around establishing 1,000+ API connections to each operator in all godforsaken territories to achieve the same result. Hence, the adoption of this kind of API and network structure can be expected to grow like wildfire.
On the other hand he keeps calling this “arbitrage” as well:
The problem it solves (and thus the reason its revenues are like they are) is the telecom arbitrage
At one point he even calls it “an arbitrage that is too difficult for the customer to implement by itself”, which I think defeats the meaning of the word “arbitrage”.
- On one hand he keeps talking about how doomed this business model is supposed to be:
From what I described above, it’s easy to understand that Twilio’s business is structurally bad and challenged. Competition in the space will be intense and margins will be minimal long term.
Yet then goes on to predict a booming business for years to come:
However, there’s little doubt that programmable communications, specifically phone calls and SMSs, will still provide a significant volume tailwind, possibly for years to come. Hence, Twilio has significant ease in posting large revenue increases and attracting new customers. This means it can be seen as a growth company for years to come.
7 Likes
I’ve had this guy muted on Seeking Alpha since the mute function became available. I used to follow Tesla and he would put out short articles every 2 weeks, throwing out all sorts of theories. At one point he kept saying the Model X would be a flop because engineers couldn’t figure out how to line up the door handles.
I don’t mind reading the short side of the argument but the way he latches on to one little detail and generate a lengthy article or even a series of lengthy articles around it just made me suspicious of his motives.
10 Likes
This article just seems like a “hard sell” short…
I have some telecom industry exposure and the reality is large multi-site enterprises have serious serious efforts to get their communications services aligned, secure and reliable… and cost effective… it is inordinate pain for enterprises… multi-nationals have this problem at a level of magntiude higher…
and what TWLO has done is converted this large multi-faceted issue into a basic service / subscription issue with brilliant API… to do that, they have taken the pain of negotiating and maintaining reliable services on top of those 100s of telco’s services around the world.
Yes other people have done this to smaller extent but TWLO is miles and miles ahead of others…
I dont this this guy has any clue on real world telecom issues.
I am sticking with TWLO and adding more if it drops due to this FUD.
Hi Bear-
I find the article interesting because it is a different take on the bear case than the typical, it’s just overvalued, which adds no value.
There is danger of confirmation bias on this board because almost everyone owns TWLO, including me, so I value different opinions and different viewpoints, because I already know the bull case for TWLO.
His viewpoint of TWLO being a reseller of phone calls and messages is interesting because I haven’t heard it before, but companies are paying, and paying TWLO an increasing rate for their service, so I find the argument weak.
His 2nd reason:
“VoIP companies are uniquely positioned to replicate the same business.”
I don’t have the technical expertise to determine if this is a good argument or not, but it is something to watch, if increased competition is coming from a different technology.
So far this is a non issue with the revenue growth TWLO is showing.
For me, the strongest argument against TWLO is the gross margin. With a gross margin at 55%, basically the same as a retailer, can they increase it , and if not, will they ever get to be really profitable?
I don’t think they can ever get to an operating margin of say 20%+ with this low of a gross margin, which makes this business worth less per dollar of sales than the businesses that have gross margins of 80%+.
Not sure how much credibility this author should get.
Thanks,
Jim
6 Likes
Oh my Paulo Santos… If anything, this guy writing a bearish article about a company like Twilio should be a very bullish indicator. He has been basically stubbornly wrong about every great growth stock of the last decade, hasn‘t he?
One sentence of him made me pause while reading:
„Given this, the main business Twilio is in is intrinsically competitive.“
It didn‘t catch my interest because of the -probably unintended - techno sound it created in my head („is in is in“) but because of the BS it is. Every business is intrinsically competitive; so what’s the point? Did he want to say that they have above average competitive pressures? If so, why is Twilio growing like mad? They are already charging premium prices compared to their competitors, but still they are vastly outgrowing them. Charging lower prices is by far not the only reason for competitive success in business. Maybe the author and his readers would be better served if he were to discuss the reason for their current competitive strength rather than making tautological statements.
Also, to this day I have never heard of anyone who believes that a net retention rate is equal to a growth rate the way you described it. Where did that come from?
Having said all that, I think his main point - a streched valuation - is somewhat valid. I like that he pointed out the lack of deferred revenue bc of the usage based business model, which should be reflected as a discount to the valuation multiple compared to SaaS businesses. Also, the lower gross margins in the mid 50s are a reason to attribute a smaller multiple to the shares. But then there is the monster growth this company has, giving reason for a more elevated valuation compared to their peers (which by the way comes largely from the usage based business model in my opinion; why does he think it is a bad business model? I have no clue).
I suspect that this author usually starts his analysis from that valuation angle and argues backwards to try to make the business look bad. Which methodically is just really flawed, and hasn’t served him well in the past. As others have already said, he actually laid out the value proposition for Twilio‘s customers quite well, but then he concludes they have a bad business model. I agree that gross margin pressure could be an issue in the future (it hasn’t been yet) and that the market could be expecting a too rosy future for them (thus, maybe a too high valuation might lead to low/negative investment returns if things don’t play out as expected), but to argue that their business model is weak is quite a stretch in my opinion.
Niki
15 Likes
With a gross margin at 55%, basically the same as a retailer, can they increase it , and if not, will they ever get to be really profitable?
I don’t think they can ever get to an operating margin of say 20%+ with this low of a gross margin, which makes this business worth less per dollar of sales than the businesses that have gross margins of 80%+.
I agree with Niki that Twilio should sport a lower PS ratio based on their lower GM, but I pretty ardently disagree with the two bolded statements. A retailer with a 55% GM would be very unusual. Many are in the 30% range. That’s when you have trouble ever getting to profitability. 55% leaves plenty of room to pay for OpEx and still crank out 20% or even better, once you’re at scale.
Not only is it possible, but they’ve actually been close to profitability (at times) already. The only reason they’re not there today is because they’re spending to grow the business.
To my point about a lower PS ratio…Twilio will achieve greater than $1 billion in 2019 revenue. At today’s price, the PS would be around 17. Whether that’s too high or not high enough depends on how fast Twilio will grow in 2020 and beyond. I’d love to read an article that has insight into that. But they haven’t shown any signs of slowing down yet.
Bear
5 Likes
TWLO margin will increase with SEND in the mix…
Also by squeezing telco suppliers… remember NFLX in early days… they would write a big fat check which will bring content owners stand in line to get NFLX money, even though at the end, NFLX reduced the effective value of the content per viewer, they brought a scale that was very attractive to content owners…
Same thing applies… TWLO bring in large capacity biz and telco is a competitive space with low marginal cost of additional capacity usage… TWLO will continue to get better pricing from telcos…
I have a friend who is trying to build a biz similar to TWLO (messaging api) - but in a very focused small niche vertical with specialized SW… his input was that you can find providers offering 50% lower price than TWLO (on a per minute basis or a per message basis)… but the value is in solving the problem for that enterprise and thats what delivers the moat and get premium price…
Per minute or per message business is commoditized… solving customer problem business is not…
back to margin and valuation, I agree that even with increasingly enhanced margin, TWLO would still remain much lower margin business than typical SAAS, leave alone elite players like AYX… but guess what, head room here is way too high… if TWLO gets to $20B in revenue within next 5 to 8 years, it wouldn’t surprise me at all. in fact I kind of expect that…
I dont think you can expect that with someone like AYX… it may get there but it is not easy to see that today… its a new market and we dont know where the ceiling is… with TWLO, its very very likley… and yes at that point (or even earlier), 15% to 20% free cashflow yield would be quite feasible for TWLO even with ~60% gross margin
8 Likes
A retailer is an extreme (bad) example.
I was thinking of Ralph Lauren
Gross margin 61%
oper. margin 8%
A better comparison is hardware companies that have some software.
ANET
gross margin 65%
oper. margin 30%
CSCO
gross margin 62%
oper. margin 27%.
Both of which, if they had gross margins of 55%, would have operating margins of 20%.
Thus, the 20% is the best case for oper. margins.
I would challenge the assumption of:
“The only reason they’re not there today is because they’re spending to grow the business.”
I think we all are assuming the fast growing companies can stop spending for growth, and turn on the profits. Won’t they always keep spending for growth? They will always have to spend on R&D. How long before they stop spending for growth until a competitor catches them?
We have a few examples of companies like CRM that have grown enough to scale. We have survivor bias, there are probably 100x more companies that have failed to make that transition. I would love to see a study on that.
And I can’t think of one example for a tech company with this low of gross margins.
It’s all about revenue growth right now, so as long as TWLO keeps growing revenue like crazy , it should perform well. I’m betting on that since it’s my top holding.
Jim
4 Likes
Which methodically is just really flawed, and hasn’t served him well in the past.
maybe it has served him well if his goal is to write articles that get lots of views ,being a profitable writer rather than being an profitable investor.
Writers don’t have to be right they only have to attract attention.
Who knows, a decade from now he might be right but my investment horizon does not extend that far.
1 Like
I pretty much agree with Jim. I am long on TWLO, but like the rest of these stocks, keep a close eye on it and, if it seemed to be slowing, would have no hesitancy in picking up my chips and finding another table.
Some of the companies we are playing with could become the next Netflix or Amazon, but also likely, many of their growth paths will either peter out or go belly up when the business cycle changes. Right now, growth stocks like these are doing far better than value stocks, but this is a pendulum which swings back and forth. Sure, this time it’s different, but as we tend to learn every decade or so, there’s nothing new under the sun and in retrospect it never was very different (just ask those who were investing during the dot.com era).
To the article? His revelation that VOIP phone companies have the infrastructure to clone TWLO is not an untruth, but the effort to re-create the TWLO software structure is significant. Just as important is that each of these companies tends to create an introspective environment to prevent their competitors from poaching - which means that, even if they took the the effort to recreate an environment similar to TWLO’s, they are unlikely to develop a universal product which would support their competitors’ infrastructure (and unless they did it as a one-off for a large account, they would have the same marketing/profitability issues as TWLO, so what incentive would they have to get involved?).
As they say, “laissez les bon temps rouler” - but just remember, as we approach an interest rate inversion, to keep an eye on an empty chair and be prepared if the music stops.
Jeff
3 Likes
This is why, at some level I still hold AMZN after ~15 years, with the expectation this company will take over the world and own me. I’m also sleeping with one eye open and more comfortable than the most vocal here with a solid position in cash.
My investment horizon is only mine, my risk tolerance the same. I’m growing my positions in cash, Trade Desk and Mongo. I’m holding or selling others. As Sarah Connor said, ‘there’s a storm coming.’ ‘Be Prepared’ is still the Boy Scout motto; I’m an Eagle Scout. To each his own, as expected on a Foolish board.
-kiplin
3 Likes
This guy has been shoring Amazon since it was about $100 so I’m not a strong believer in his ability to assess game-changing businesses. As Niki mentioned he does have a history of starting with his opinion then looking for data points to back it up.