Twilio Inc.

Acquisitions are hot - in both the corporate and financial world, as battered stocks open the window for enticing M&A scenarios. Technology has been at forefront of this activity, as formerly ambitious startups seek reprieve from the brutality of public markets (and potentially a looming recession). Indeed, management teams have been forced to pivot from a "Growth-at-all-Costs" strategy to a model that scrutinizes capital allocation and shareholder returns. The unfortunate reality, however, is that there is no guarantee that the business will succeed in reaching profitability under a new strategy. Even if successful, the push to profitability may take several quarters, potentially devastating shareholder returns and employee morale.

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As of this writing, Twilio is down ~85% from its all time high of $450/share (~$60B market capitalization), trading around ~$70/share on a $12B market capitalization. This latest mark for Twilio values the business at under 2.5x forward sales, or roughly the same forward multiple as 3M or Kraft Heinz. If you're perplexed by these valuation peers - you're not alone. Twilio grew their top line by over 40% last quarter while also guiding sales growth north of +35% for the back half of 2022. 3M & Kraft, by contrast, are forecasting slight declines in sales over the next twelve months. Does this make sense?

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For many, this makes perfect sense. Twilio is a terribly unprofitable business - losing +$300MM on over $950MM in sales last quarter. The company has failed to produce free cash flow every quarter since Q2 '21, in which FCF was buttressed by $144MM in share-based compensation. The company's primary source of liquidity comes from secondary issuance, as detailed in the company's latest quarterly filing: "Our principal sources of liquidity have been (i) the net proceeds of $979.0 million, $1.4 billion and $1.8 billion, net of underwriting discounts and offering expenses paid by us, from our public equity offerings in June 2019, August 2020 and February 2021, respectively." Thus, not only is Twilio unprofitable - they are also extremely dilutive to existing shareholders, dragging the company's multiple below technology peers.

There is also concern of Twilio's "technology" categorization. Twilio fails to command any sort of pricing power, as reflected in their most recent quarterly report. In Q2 '22, Twilio saw COGS spike higher than sales growth thanks to an increase in "network service provider" and "cloud infrastructure" costs. As Twilio already runs a relatively unappealing margin profile, it is concerning to see such malleability in their top-line margins.

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_Goldman Sachs Communicopia - TWLO_

For others, however, Twilio provides a vital service to the App Economy and consequently the technology sector as a whole. The company's customers include household names like Uber & Lyft, in addition to thousands of other organizations who rely upon Twilio's telephonic APIs to communicate with customers, colleagues, and anyone else. With over 275K active customer accounts, Twilio benefits from an enormous first-mover advantage, not to mention extensive flywheel effects that can be derived from the company's scale. Indeed, Twilio's moat (if there is one!) comes from the company's vast distribution channels. Conceptually speaking, the replacement cost on Twilio's service would almost certainly surpass the company's current market capitalization (around $12B as of this writing).

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_Twilio Flywheel - Credit to Jake Singer/Flywheel Substack_

All of this being said, what does Twilio's future look like? Surely they wouldn't want to issue new shares in this environment, especially if the company isn't anticipating profitability until '23. Rather, I believe Twilio would be a perfect candidate for an activist investor, or potentially a full acquisition, given today's valuation and the business's reach in enterprise software. Twilio's services, particularly messaging, should fold into a larger suite of enterprise software services, with messaging serving as the loss leader.

I'm curious to hear everyone's thoughts: Is TWLO ripe for an acquisition? Or are buyout funds starting to gag on new debt issuance? Similarly, can an activist right Twilio's sinking ship? Or will the company fall victim to the brutality of public markets?

Thanks for reading!

Tom

I added a sizable amount fo $TWLO a few months back, but as the stock continued to fall I have not added further to the position. I'm having a hard time coming up with an opinion. The company is very relevant and they are growing revenue, as you point out. I don't seem them being acquired, at a valuation over $10B and with  founder Jeff Lawson running the company. Unprofitability alone is not a death knell.

Joshua Simka

Just to add some value to this conversation. Right now Twillio has more than 30% of it's current market cap in Net Cash.