WTF To Make of TWLO?
Not Investment Advice
This chart more or less sums up the sentiment, but is this a walking dead destined to dilute shareholders forever never to generate any real cash flow as the markets would suggest?
I’d argue no. and guess what? If i’m wrong, the risk is somewhat limited on the downside. I don’t intend to focus this necessarily on the pure numerics (in this post at least). After all, you can sketch out all the scenarios, but if management isn’t on board to implement, whats the point? The cost reduction is so straight forward that its there for the taking.
Lets get philosophical for a moment: What is CPaaS supposed to be? The common answer you hear is messaging. But CPaaS isn’t SMS, it isnt voice or video. The concept of CPaaS is meant to let businesses easily weave real-time communications into their applications and services. To achieve that, I’d argue TWLO, Sinch and everyone else are doing the right things - create or acquire the applications that RTC is meant to serve. And while doing this, the theory is that monetizing on higher margin software will not only increase the value proposition to customers, but also increase the value of Twilio as gross margin increases.
So if the vision is correct, WTF happened? I’d boil this into several parts:
Capital market investors clearly got this wrong in the last 2 years. At $400, this was a clear clear short (which I was). In fact, if you put valuation aside for a moment, the forecast for 2022 when it was $400 vs. the forecast for the year now is not that far off. Fundamentally its the same business.
Execution. Simply put, they’re just not good at selling software. The fact that Flex is now only $100M after 5 years is rather pathetic and spending $3B on Segment for CDP, one of the least proven ROIs in software with extremely difficult implementations, was simply a bad idea. Looking at it from another angle - If you were a customer who wanted to stitch together the customer channels and data with RTC, who offers a better value prop: CRM or TWLO? CRM owns many many customer facing touch points and can easily integrate RTC from one of the vendors, the same cannot be said about TWLO.
Unwillingness to put the north star on hold. Times are tough guys, vision sometimes has to wait another year. Other companies are getting the message but not here! Consider the following comparison. Kaleyra is one of the more commodity players in CPaaS, think more aggregator and less IP. At 20% gross margin, KLR is able to be both non-GAAP and cash flow positive which gives you a good feel for where the core TWLO business can be as a baseline. In Q2, core RTC is 84% of revenue and ~46% in margins and software is roughly 11% at just under 80% margin. TWLO’s core margins are substantially better which really makes you wonder how its possible that they are spending this amount of money in sales and marketing in software.
What’s intriguing here are the variety of possibilities which include:
Voluntary desire to listen and right-size the software ambitions and take a more gradual approach
Involuntary reaction to an activist
Some variety of buybacks and capital returns
Sale (unlikely). Putting aside the lack of desire to sell at bottom feeder prices, I find it extremely unlikely that someone like CRM would pay a premium for a set of applications that it already has. If a strategic wants RTC, they’ll buy a smaller one without all the apps. That really just leaves potentially Cisco and maybe Google.
TWLO has a further consolidator of core CPaaS market
Regardless, at 1x 2023 and 14x EBITDA, its hard to ignore the “what could go right” at the current junction. Of course, the economy and reliance on consumer transaction/end points is looming, but even if you double the EBITDA multiple, I’d still argue this is an extremely compelling opportunity.