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  • Brett Schafer

Not So Deep Dive: Twilio Stock (Ticker: TWLO)

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Show Notes

(Ryan) What they do: Twilio is a cloud communications platform. They state, “We enable developers to build, scale and operate real-time customer engagement within software applications.” Now to use less technical terms, they essentially offer a set of APIs for developers to use when building their app.

So as an illustration, say someone is building a ride-sharing app. Imagine the final codebase as a completed lego set. Twilio provides lots of those legos. (That’s how Jeff Lawson has defined it before). And in Twilio’s case, those legos are designed for communication functions. These APIs or functions can include voice, video, email, text messaging capabilities, and lots more. When these functions get used, Twilio receives revenue. So in the US, any time a text message is sent using a Twilio SMS API Twilio receives 3/4th of a cent.

Ian, do you want to explain it a little more from the developer’s side?

  • Building blocks for developers, picks and shovels of apps

  • Stripe is the building block for payments

  • Plaid is the building block for financial data

  • Twilio is the building block for communication

  • Video conferencing interface

  • As a developer, I can have my app create video-conferencing rooms, but instead of having to build the whole thing from scratch, I can use Twilio’s framework for video conferencing. It gives me a snippet of code that I use to ‘call’ the API which basically means using the code that Twilio has written. I then have to “pass in” or give Twilio all the parameters it needs. For instance, who the participants are, what resolution to use, etc.

  • Other apps use it for messaging interfaces, normal calls, etc.

  • Twilio provides SDKs, samples, and documentation

(Ryan) History: Twilio was founded in 2008 by Jeff Lawson, Evan Cooke, and John Wolthuis. At the time it was based in both Seattle and San Francisco and it served the same sort of function that it does today. (Obviously more solutions today, but as far as I know there wasn’t any major pivot).

And Jeff was a coder himself. He started Twilio in his late 20’s, but I believe he had a bit of an entrepreneurial background even before that. Apparently, in 2009, he attended some mixer called the SF New Tech Meetup where he demoed the product. So in front of ~1,000 people, while he was explaining the tec, he coded a Twilio app right then and there which provided conference call functionality. And in a few minutes, he opened a line and let everyone in the audience call in. That sparked the interest of lots of investors and then they had the sort of stereotypical silicon valley VC story. Funding round after funding round and by 2016 they went public.

(Brett) Industry/Landscape/Competition:

  • The industry is Cloud Communications. This is a very new industry so hard to identify the size and/or competitors

  • The industry is apparently called Communication-Platforms-as-a-service (CPaaS)

  • An internet research firm is forecasting a 33% CAGR through 2024 to $17 billion. Who knows whether that will be anywhere close to correct but it is clearly a large and growing market

  • Competitors: MessageBird, Vonage API, Sinch, Plivo, and many others

(Ian) Management and Ownership:

  • Jeff Lawson is the founder and remains the CEO

  • Really good interview on Invest Like the Best

  • Also an interview on the Motley Fool

  • He owns about 3% of the company (about $2 billion)

  • He was a product manager at Amazon Web Services

  • The original CTO at Stubhub

  • Serial entrepreneur, lots of good stories in his interviews

  • He seems to think a lot about the culture and leading his company

  • Wrote a book called “Ask Your Developer”

  • Non-generic core values

  • “Draw the owl”

  • Nearly 80% institutional ownership

(Brett) Valuation:

  • Market cap of $65 billion, ticker TWLO

  • Trailing P/S of 28.7

  • Trailing P/GP of 56.7

  • Trailing P/OCF north of 100 since they are really close to breakeven

  • 11.2 million options/RSUs outstanding vs. 177 million shares

(Ryan) Earnings:

  • Q2 Revenue of $669M, up 67% YoY

  • This currently puts them at an annual revenue run rate of $2.6B

  • Dollar based net expansion rate of 135%

  • Roughly 50% gross margins

  • They’re operating at a GAAP loss

  • But they’re slightly cash flow positive. The only caveat is that they spend so much on SBC (they actually talk about this directly, that they want all employees to act like owners and they get equity grants upon hiring).

  • For reference, this quarter, 42% of revenue was spent on SBC.

(Ian) Balance sheet and liquidity:

  • Nearly $6 Billion in cash

  • About $4.5Billion in goodwill, resulting from all their acquisitions

  • Goodwill is added for any premium paid over book value

  • Nearly $1 Billion in debt

  • Senior notes, half due 2029, half due 2031

  • 3.625% and 3.875% respectively

  • Cheap money, suspecting they will continue to make acquisitions and expect cash will be more expensive going forward.

Anecdotal Evidence:

  • (Ryan) Nothing.

  • (Brett)

  • (Ian) Works well. Lots of good documentation, and it seems absurdly cheap as a customer.

Future growth opportunities:

  • (Ryan) Zipwhip acquisition. $850 in an equal blend of cash and stock. Zipwhip operates a very similar business model to Twilio except its sole focus is on toll-free messaging. Actually based in Seattle. So, F45 is a local gym here, and let’s say they wanted to let a customer know when their training session was, they can just send out automated texts using Zipwhip’s solution. They also have an API that helps text enable a company’s landline. More broadly, gobbling up these niche CPAAS companies seems to be their strategy and it’s one that I think makes sense. (Not quite as big as either their Sendgrid or Segment acquisitions).

  • (Brett) They tend to acquire companies to add new products/segments, so I’ll do one of those. They acquired Segment for $3.2 billion recently. It is like Twilio but for customer data, pulling from all the different sources a company may have and putting it into one place. Looks like a good combination and could be an easy upsell to customers. In the press release, Lawson said “data silos are the enemies” which sums up the reasoning for it

  • (Ian) International expansion. International represented 32% of revenue in the most recent quarter. Up from 27% the year prior. Its growth is outpacing US growth, doubled YoY. According to the CFO, it is one of their focused areas of investment. It is logical, some language barrier/investment I would imagine in some markets, but the great thing is a salesforce is not needed for all sales. Self-serve is how many smaller companies interact with Twilio.

Highlights and lowlights:

  • (Ryan) Highlights: I love these consumption-based business models. Seems like a win-win all across the board. After reading the first 10 pages of the 10-K, I can see how Twilio’s size and early lead can be an advantage. I don’t see how any other company can add new solutions at the same rate as Twilio, either through acquisition or organically. 42% of headcount is in R&D. Lowlights: There aren’t many. The only potential one would be that they seem to be pretty loose with equity compensation. Total shares outstanding over the last 5 years have grown at ~18% per year.

  • (Brett) Highlights: They are sort of building out their own market, which can make it very easy to grow, products are ubiquitous for any people-facing organization management seems great at deploying software but I’m just going off of what investors feel in general. Lowlights: It is structurally lower margin due to them having to use other networks to communicate, lots of share dilution, and I worry that most of this is a commodity and it is a race to keep adding new products that never really have any defensible position.

  • (Ian) Highlights: High switching costs. It would be a nightmare to pull Twilio out of our app. I suspect this is slightly less relevant for huge companies, but still a problem. I really like Jeff Lawson and his vision. He pioneered an API company before it was popular. Now everyone is trying to do it. He seems like the type of guy who could effectively lead the company for another 10+ years. Lowlights: Acquisition risk, though they seem to manage that well. Just now becoming profitable??? Hard to knock them with the rapid growth, but I’d like to see what mature EBITDA margins look like given the lower gross margin.

Bull case:

  • (Ryan) Sustained 130% DBNR over the next 5 years. They’ve previously guided for 30%+ revenue growth over the next four years. If they can meet those assumptions, even with some multiple compression you should do ok. If they do 25%+ compounded annual revenue growth per share over the next 10 years then this will beat the market. And it’s not unreasonable to assume that.

  • (Brett) If you plan to hold for a long time, I think you need to expect $25 billion in annual revenue by 2030 to expect reasonable returns. That would require a 28% growth rate but I think they could do it.

  • (Ian) Twilio continues to add ancillary services and grows with its customers. It is very easy to see how it benefits from continued tech sector innovation.

Bear case:

  • (Ryan) Slower than expected growth would hurt this investment. Since I’m not a developer it’s hard for me to know what would cause the slowdown, whether it’s no-code tools or something like that. Also, I’ve mentioned this before, but I think employees tend to view equity-based compensation retrospectively. So, yes people are incentivized to work harder when things are going well, but when half their compensation goes away due to slower than expected growth or just general market conditions, I wonder what happens to morale. When a company doesn’t run on cash flow, hitting stall speed can kill it.

  • (Brett) All comes down to growth slowing and/or margins never materializing. Continued elevated spending in S&M could be the downfall here. CPaaS model should lead to less need for S&M spend but it was 72% of GP last quarter. Lastly, companies that rely on the growth of new start-ups/IPOs and stuff like that worry me that growth is attached to the business cycle.

  • (Ian) Something structurally changes in programming. For one reason or another, APIs fall out of style because of low-code tools or some other disruption.

Chit Chat Money is sponsored by 7investing. Use our link or enter promo code “CCM” at check-out to get $10 off your first month of the service.

Disclosure: The author and podcast guests are not your financial advisors. Ryan Henderson and Brett Schafer are general partners and portfolio managers at Arch Capital. Clients of Arch Capital may hold securities discussed on this show.

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