Why I Won’t Buy Twilio Stock

Shares of Twilio (NYSE:TWLO) have been on fire. The stock has more than tripled over the past year, pushing the market capitalization of the cloud communications software provider to nearly $70 billion.

The market seems to love Twilio, but I have some pretty big reservations. Here are a few reasons why I won’t be buying the stock.

1. The valuation is high

Twilio grew its revenue by 55% in 2020 to $1.76 billion. That puts the price-to-sales ratio at nearly 40.

That may not seem all that crazy relative to other high-flying software-as-a-service (SaaS) stocks. Video-conferencing phenom Zoom trades for over 60 times annual sales, for example. But all revenue is not created equal.

Thumbs down.

Image source: Getty Images.

2. Twilio’s gross margins are bad and getting worse

Software companies generally have high gross margins because the cost of producing an additional unit to sell is essentially zero. Software-as-a-service providers may have additional costs related to infrastructure, but gross margins are still often quite high. DocuSign, for example, reported a gross margin of 74% in its latest quarter.

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Twilio’s gross margin isn’t nearly as high, and it’s not getting any better as the company scales. It managed an adjusted gross margin of 56% in the fourth quarter of 2020, down from 57% in the prior-year period. Its cost of revenue is mostly fees paid to network service providers, as well as cloud infrastructure costs and some other items.

The fees Twilio pays to network service providers are based on the volume of phone calls initiated and text messages sent on its platform. In other words, the more Twilio’s customers use its various services and generate revenue for the company, the more fees Twilio pays.

In order to turn a profit, Twilio needs to produce enough gross profit to cover all its operating costs. But with gross margin constrained by those usage-based fees, the company hasn’t even come close.

3. Twilio is wildly unprofitable

Twilio reported an adjusted net income of about $36 million for 2020, but that doesn’t mean the company is profitable. That adjusted figure excludes some very real costs, most notably stock-based compensation. Without those adjustments, Twilio reported a net loss of $491 million for the year. That’s worse than 2019 when Twilio reported a net loss of $307 million.

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Operating costs are growing more slowly than revenue, which is good. But the size of Twilio’s net loss means that the company may still be years away from reporting a real profit. And that assumes growth doesn’t slow down anytime soon.

4. A key metric isn’t as impressive as it seems

Software-as-a-service companies often report the dollar-based net expansion rate, which represents how much existing customers have grown their spending. A rate of 100% means that existing customers haven’t increased spending at all. A rate above 100% means that they have.

Twilio’s dollar-based net expansion rate for 2020 was 137%, which is impressive. But be careful comparing this metric between different companies. For an SaaS company that sells subscriptions, and thus needs to convince customers to subscribe to additional products or upgrade subscriptions to boost existing customer spending, the net expansion rate is a measure of the company’s ability to deepen their relationships with customers. For Twilio, which largely operates on a usage-based model, the net expansion rate will be high, as long as its customers are growing usage of their own products.

Of course, it’s good that Twilio’s customers are growing, but this metric just isn’t a great measure of Twilio’s ability to pitch additional products or of the “stickiness” of its products.

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Not interested in this frothy growth stock

Twilio’s revenue growth is certainly impressive, and there are plenty of reasons to like the stock. But I just don’t think the company is worth $70 billion. Gross margin probably isn’t going to improve much as the company grows, and the scope of Twilio’s losses means that it will likely take a long time before the company is genuinely profitable.

Will there ever be enough profit to justify the sky-high market capitalization? I’m not betting on it.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.


View more information: https://www.fool.com/investing/2021/02/20/why-i-wont-buy-twilio-stock/

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