TWLO: good or bad?

Investment Analysis Clubs Saul’s Investing Discussions
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Is Twilio good or is it bad? Is it a buy or is it a sell? We are people of action, and we want to know which way to go.

May I suggest a more nuanced approach? May I suggest that Twilio is neither good nor bad, and possibly neither a buy nor a sell?

If you’re the type of investor that wants to buy companies with sustainable competitive advantages, hold them for long periods of time, rarely ever trade, beat the S&P over time, Twilio might be a fine choice for you.

If you’re the type of investor who is looking for companies that can give you the maximum return, no matter how vigilant you have to be, how much you have to read, or how much volatility you have to endure, then Twilio probably isn’t a very reasonable choice at this point.

I think that pretty much explains the schism we’ve seen here over Twilio since they reported last week. There are investors who participate on this board in both of the groups above. If you’re in the first group, you’re probably going to think we in the second group have insanely concentrated portfolios, that we’re too quick to sell good companies, and that we are cruising for a bruising when the market waters get choppy. If you’re with me in the second group, you probably think the first group sure seem concerned over a silly little 30 or 40% drop in their portfolio!

Anyway, I think we can all get along, but I think we need to remember the lenses through which we’re seeing Twilio, or any other company we discuss. We can talk about the reasons we do what we do, but everyone has to make their own decisions.

My reasons for selling?

  1. Growth is slowing. NER, top line, organic…everywhere you look, growth is slowing, and the decline is more rapid than I expected.

  2. They don’t seem to realize they’re slowing down. Even if you accept their 75% growth number (which I don’t), compare that to their OpEx growth. They went from $117m of expenses a year ago to $253m in this quarter. Expenses were up 116%!!! This isn’t sustainable!

  3. If they’re spending money faster than they make it, why wasn’t EPS negative? Because they paid for it with stock. This quarter alone SBC was about $70 million. In Q2, same thing. Again, not sustainable!

If you want to debate those points, I’m in. Let’s talk! But if you want to debate whether Twilio is a good company? I simply don’t have a strong opinion about that. Maybe they are? I think they have created a valuable offering. Their numbers make it look like it doesn’t sell itself, but smart people like Bert disagree. So I’m willing to say the jury’s out.

Can they admit that hypergrowth is over, change their spendthrift ways, and settle into a sustainable business model? The market is saying yes. And I don’t necessarily disagree with that either.

But this isn’t how I invest. I look for the most favorable situations I can find, and Twilio no longer qualifies. I am not confident they will beat the market going forward, and I’m highly confident they won’t beat it by as much as AYX or many other companies.

That’s no slight to what Twilio has built. That’s just what the numbers are telling me.

Bear

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Bear if it wasn’t you I apologize, but I think you had made similar arguments about Chipotle not too long ago. That they were in real trouble and there were better opportunities elsewhere. I agreed! Also there wasn’t just 1 bad quarter showing signs of trouble like with Twilio, but multiple quarters.

So I agreed to sell, then a new leader took over at Chipotle and it climbed 100% from where I sold! In less than a year as well, I believe. But at the time, I thought the decision we made was sound.

After just 1 slow quarter, I’m not really seeing that with Twilio. I definitely don’t want to make the same mistake again as we did with Chipotle, and looking back, it was a mistake to sell. I think you’re being too quick to judge Twilio too soon. It was literally weeks ago Twilio was defined on this board as one of the “hero companies”.

Dominic
Still long Twilio but with a smaller position

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I definitely don’t want to make the same mistake again as we did with Chipotle, and looking back, it was a mistake to sell.

A better example for this board might be Shopify. Was it a mistake to sell? I don’t think so. For one, it doesn’t matter what a stock does after you sell it. The only thing that matters are the stocks you continue to hold. For another thing, stocks sometimes go up irrationally. I happen to think both Chipotle and Shopify are irrationally overvalued right now. If every stock I ever sold immediately doubled afterward, I’d question my process. But that’s not even remotely the case. Here are some I sold last year that are flat or even down since: Talend, Pure Storage, Nutanix, Pivotal, and Arista. I sold Square in January and it’s lower now. My advice: Don’t look back. As long as the process is right, the results will bear out over time.

I think you’re being too quick to judge Twilio too soon.

You need to say why you think that and be more specific. Otherwise we can’t really have a conversation about the merits and demerits of Twilio, or its likely future.

Bear

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Bear, what an awesome post. You managed to put it beautifully in terms of what we are looking for in a company instead of what the company is. Thanks for thinking it out so well, and especially for posting it for all of us.
Saul

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If they’re spending money faster than they make it, why wasn’t EPS negative? Because they paid for it with stock. This quarter alone SBC was about $70 million. In Q2, same thing. Again, not sustainable!

Now perhaps Twilio needed to buy SendGrid for strategic reasons…maybe having email was that important for Twilio’s future competitive advantage and maybe SendGrid or email in a competitor’s hands would allow a competitor to become viable and erode Twilio’s dominant leadership position. It is unfortunate, though, that Twilio had to pay for SendGrid using shares rather than cash. SendGrid is a slower growing enterprise so Twilio not only diluted itself but also slowed its growth rate. The dilution and growth deceleration will mean lower returns for equity holders. So, Bear, Twilio the company may turn out to be great for their customers (i.e. lowering their costs and increasing their communications efficiencies), but TWLO the stock may not be as good to shareholders (i.e. lower returns than had they been able to pay for their acquisition with cash). My decision to sell was the same as yours as I believe that there are better places for my investment dollars.

We can look to other companies like Salesforce (CRM) and Atlassian (TEAM) as examples of what happens to shareholder value when acquisitions are made using cash rather than using shares. These larger cloud companies are so cashflow positive that they can pay for acquisitions with cash (or issue debt that will later be paid down). I am in the process of looking at TEAM which seems to be an extremely well run company that is growing revenue at around 35% and generating a FCF margin of around 30%. It’s market cap is around $30B. While it’s slower growing than our hypergrowth SaaS companies, TEAM has managed to transition into a cash generator. Can our MDBs, ESTCs manage to morph into cash generators like TEAM and CRM have done? My remaining questions for TEAM are a) what’s the TAM (how much room to grow, b) how dominant is TEAM (i.e. will it be able to maintain pricing and its low S&M spend or will competition erode its profitability). If we find that TEAM will likely be able to maintain its 35% growth and its 30% FCF margin for an extended period into he future then it may be a worthwhile investment (perhaps continued stock price appreciation of 35% per year).

Chris

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Bert’s take is now public on SA:

https://seekingalpha.com/article/4302155-twilio-case-buy-sha…

Personally, I agree with Bert’s overall sentiment. I’m out of TWLO for now but see a great longer term case and major buying opportunity setting up. With this morning’s negative news (see the next thread), it’s probably not the best buying opportunity yet.

But I’m keeping it on my watch list. Recent negative news should temporarily depress the shares and create a wonderful buy point (a bit down the road).

Dave

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3. If they’re spending money faster than they make it, why wasn’t EPS negative? Because they paid for it with stock.

I’m afraid you are accounting challenged. :wink:

The cash from the sale of shares does not go to Profit or Loss but to Additional Paid-in Capital on the Balance Sheet. The dilution does reduce the EPS but cannot change its sign.

Denny Schlesinger

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I’m afraid you are accounting challenged. :wink:

The cash from the sale of shares does not go to Profit or Loss but to Additional Paid-in Capital on the Balance Sheet. The dilution does reduce the EPS but cannot change its sign.

However, in all future periods, the increased share count would reduce the EPS assuming that the acquired company (SendGrid) does not pull its own weight in that regard.

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3. If they’re spending money faster than they make it, why wasn’t EPS negative? Because they paid for it with stock.

I’m afraid you are accounting challenged. :wink:

The cash from the sale of shares does not go to Profit or Loss but to Additional Paid-in Capital on the Balance Sheet. The dilution does reduce the EPS but cannot change its sign.

Denny, I’m not talking about the cash from the sale of shares. I’m talking about covering the expenses of running the company.

I’ll break it down for you, Denny. Their quarterly operating expenses were $253 million. They paid $68m of those $253m with SBC. If they had used cash instead of SBC to compensate those employees, they would have had to report a huge EPS loss instead of a gain.

Just look here: https://investors.twilio.com/all-news/press-release-details/…

Go to the “Reconciliation to Non-GAAP Financial Measures” and you can see the adjustments in EPS. They adjusted EPS up by 46 cents due to stock-based compensation, and another 2 cents due to “Payroll taxes related to stock-based compensation.” Without SBC, their loss per share would have been 45 cents for the quarter, instead of 3 cents of positive EPS.

Bear

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However, in all future periods, the increased share count would reduce the EPS…

That’s what I said: “The dilution does reduce the EPS…” :wink:

Denny Schlesinger

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The cash from the sale of shares does not go to Profit or Loss but to Additional Paid-in Capital on the Balance Sheet. The dilution does reduce the EPS but cannot change its sign.

There are three different stock events this year.

  1. TWLO acquired SendGrid via a stock swap at 0.485 shares of Twilio for every share of SendGrid.
  2. TWLO had a public offering
  3. TWLO is compensating employees with stock, and backing this expense out of Non-GAAP earnings.

As to #3, compensating employees with stock is great. It aligns them with the success of the company, and conserves cash (increases Free Cash Flow). The SEC requires including this as an expense under GAAP. However, not including this as an expense under non-GAAP earnings distorts the big picture.


Quarter  Revenue  SBC     % 
Q3 2019  $295     68.27   23%
Q2 2019  $275     70.74   26%
Q1 2019  $233     58.32   25%
Q4 2018  $204     31.99   16%

?3162 Headcount
$230M TTM SBC
$72,700 per employee average
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I’ll break it down for you, Denny. Their quarterly operating expenses were $253 million. They paid $68m of those $253m with SBC. If they had used cash instead of SBC to compensate those employees, they would have had to report a huge EPS loss instead of a gain.

Unfortunately I misinterpreted your post, sorry.

This interpretation also has a problem. Saul uses adjusted numbers – which back out SBC – to evaluate investment opportunities, I assume you do as well. If that is the case, then you should use the same numbers to make the bear case to be consistent.

Denny Schlesinger

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This has been a big debate for a long time. But the truth is GAAP EPS is a better reflection of what’s going on in the company. If a company goes around paying for things in the form of shares, the expense doesn’t magically go away.

if you’re evaluating two companies with the same financials, but one pays expenses mostly in cash, and the other just gives stock, the company that pays in stock will appear more profitable when in reality they’re not. It’s no different than a company selling stock in the open market to raise cash to pay for things. The only difference is how it’s treated as an expense.

The one advantage is these companies that pay employee expenses in stock is employees become owners and more likely to want to see the company do well.

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As to #3, compensating employees with stock is great. It aligns them with the success of the company, and conserves cash (increases Free Cash Flow). The SEC requires including this as an expense under GAAP. However, not including this as an expense under non-GAAP earnings distorts the big picture.

It’s not the SEC but the FASB who is in charge of GAAP https://www.fasb.org/home

As for the big picture, Saul uses the adjusted numbers to evaluate his investments because he thinks it’s GAAP that distorts the big picture and I agree with him. :wink:

Denny Schlesinger

June 11, 2002
Options Math

https://softwaretimes.com/files/options%20math.html

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if you’re evaluating two companies with the same financials, but one pays expenses mostly in cash, and the other just gives stock…

June 11, 2002
Options Math

https://softwaretimes.com/files/options%20math.html

Denny Schlesinger

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If a company goes around paying for things in the form of shares, the expense doesn’t magically go away.

I’m sorry, but this just doesn’t relate to reality. It is not as if a company that gives a big options grant to senior personnel would alternatively be giving them the cash equivalent of those shares. Yes, they might have to raise salaries a tad if there was no SBC, but the whole point of the SBC is that the fortune of the individual is tied to the future fortune of the company. Issuing those shares costs the company nothing … it costs the shareholders dilution, dilution which is presumably considered unimportant if the company grows as they all expect it to do.

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it costs the shareholders dilution, dilution which is presumably considered unimportant if the company grows as they all expect it to do

This is the point we always come back to when SBC comes up. Yes of course this is how the accounting works. The question is how much is too much?

Perhaps let’s just leave that an open question? There’s no point in arguing and trying to prove I understand the accounting better than you or vice versa.

Bear

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Bear,
On your points #2, and #3 we have known their low GMs, high stock dilution post sendgrid acquisition. Not sure if this is entirely new news that we learnt this Q. On SBC we compare all companies based on non GAAP. So, not sure why we should not evaluate TWLO the same way. I do agree that their SBC is high and should be watched.

I would like to delve more into your #1 though. Sendgrid has held steady around 30% growth over the last 2 Qs. Organic growth of TWLO has indeed slowed from 54% last Q to 47% this Q and projected only to about 35% next Q. But they did say their Q3 2018 was buoyed by election rev (ended with 68% growth) and in Q4 2018 they had that one time 10% customer and some more election rev (ended with 78% growth). If we discount those as one time benefits then one could argue TWLO organic growth is still at around 45% going into 2020. This should put the combined company at 40-42% for 2020. TWLO should end 2019 with a P/S of around 11.2. If TWLO could put 40% growth rates for a few years that seems like a good valuation. Management seems to believe that their TAM is big enough that such growth is possible and they are investing for that growth. There do not appear to be extended sales issues (like ZS) or sales execution issues (like NTNX) or possible new rivals (AYX today). The main culprit seems to be primarily tough compares to 2018. BTW, MDB has the same problem this Q and next Q. And they have already warned enough times about it.

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Twilio’s slowing growth rates and their botched EPS is definitely concerning, but ultimately, they are still growing 40%+ and per the conference call, they were facing a tougher comp due to the political ads the previous year.

In the conference call, they noted that Sendgrid is expected to grow 30%+ and I believe one of the analysts had mentioned that their non-top 10 customers grew slightly more than the previous quarter from 85% or 86% YoY which was encouraging (I might be getting this wrong since there was a little back and forth on this based on % of revenue the top 10 made up).

Anyway, let’s assume Twilio does slow down in their growth rate and 40% or even high 30%'s is their future growth prospects given their low EV/S, wouldn’t this still be considered a good stock to own based on CAGR alone? Per Tom Tunguz and SaaS Capital (a few months old and some definite declines since June after the sector rotation rout but I think fundamentally it’s still the same):

https://tomtunguz.com/the-saas-valuation-environment-in-mid-…
https://www.saas-capital.com/blog-posts/private-saas-company…

Average SaaS company multiples are generally in the 8-11 range, so Twilio sits at around a 11.96 right now and is growing around 40% or so. If you look at some of the companies with multiples less than the average, they are companies that have really dried up and are growing revenues significantly less.

Basically what I’m saying is that while I don’t think Twilio is going to see multiple expansion anytime soon or ever again, it’s hard for me to believe that they will see much more multiple compression simply due to their revenue growth rates. They’re still growing faster than Zendesk and Hubspot and have similar multiples as these two companies who are growing mid-30s. So at a 10-11 EV/S with 40% growth rates or even 30%, then theoretically Twilio should see stock appreciation right around that range too, which I assume is pretty decent and I personally think may be a floor if my theory that their EV/S multiple won’t compress too much more.

If you read some of the comments by people who work at Twilio in the Blind App, it’s all very complimentary of the company and Jeff Lawson and when prospective employees had offers from some of the top tech firms, they went with Twilio. Remember, the caliber of people who can work at a company like Twilio are highly compensated employees who generally make $300k+ (refer to https://www.levels.fyi/) and most are able to work at any Silicon Valley tech firm they want. Since a large part of these people’s compensation is stock, it would only make sense for them to work for companies where their stock is appreciating.

So yes, Twilio has definitely hit a speed bump in their growth story and senior management was a bit meh on the conference call, but it’s still hard to see Twilio sinking too much more just given their current valuation and growth rate relative to other tech companies discussed on this board.

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On your points #2, and #3 we have known their low GMs, high stock dilution post sendgrid acquisition. Not sure if this is entirely new news that we learnt this Q. On SBC we compare all companies based on non GAAP. So, not sure why we should not evaluate TWLO the same way. I do agree that their SBC is high and should be watched.

I’m not trying to evaluate them on GAAP. I’m just illustrating how high the SBC is. Another way to put it: AYX’s was 8.6% of revenue this Q. Twilio’s was 23.1% of revenue.

I would like to delve more into your #1 though. …This should put the combined company at 40-42% for 2020. TWLO should end 2019 with a P/S of around 11.2. If TWLO could put 40% growth rates for a few years that seems like a good valuation.

If you are happy with that, great. I was expecting it to be more like 50% for the combined company (well over 50% for organic Twilio) for a few more quarters at least, and then to fall off slower. I don’t think Twilio will crash and burn. I just see better opportunities elsewhere. I don’t want a 40% grower with 55% margins when I can invest in 60%+ growth companies with 80%+ margins – I don’t care if the valuations of the former are 40% or 50% cheaper. It would have to be 75%+ cheaper to get me interested. (The numbers are most of it, but I really do think there’s still risk that Twilio can’t rein in the spending.)

BTW, MDB has the same problem this Q and next Q. And they have already warned enough times about it.

If MDB’s growth slows to ~40%, I would be very concerned.

Bear

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