Why We Invested in Twilio Inc.

Domain Money Advisors | Investment Memo| 12/10/2021

Introduction

Twilio Inc's ("Twilio") stated mission is to fuel the future of communications with application programming interfaces (APIs) that allow developers to embed voice, text, chat, video and email communications in any application. Twilio’s APIs allow developers to focus on building apps instead of connecting with various communication channels like texts (SMS), which are prone to complexities given the many global systems in place.

If you have ever received a two factor authentication text or an appointment reminder text on your phone, that text was likely sent using Twilio's services.  Accordingly, the company's goal is to be the leading cloud-based communication platform.

Twilio is expanding beyond its core communications API product to offer a broader set of tools for their clients to engage with customers. Following the acquisition of the customer data platform, Segment, in November 2020, Twilio is expanding beyond messaging to allow companies to build data-driven engagement campaigns.

Here’s how the CEO of Twilio explained it in his third quarter 2021 earnings presentation:

Customer Engagement consists of the myriad ways that companies use communications with the ultimate strategic goal of building relationships across the many interactions they have with their customers. However, the communication layer is the last mile of customer engagement -- transmitting the message is just the last step. What you say, to whom, when, and on what channel -- that's the intelligence component, and it's incredibly hard to get right. That's the next phase for Twilio -- helping customers deliver more relevant and impactful messages, not just more of them.

Twilio illustrates their technology design below, from their core messaging capability up to their engagement platform.

This technology is appreciated in the marketplace. Twilio counts some of the most recognizable brands from a variety of industries as customers. The company can power the communications for applications of any size.

Current State of the Business & Financials

Twilio’s core business grew substantially over the past 2 years – from $295M in the third quarter of 2019 to $740M in Q3 in 2021.  

Twilio’s share price responded in kind, more than quadrupling from below $100 per share in 2020 to an all-time closing high of $443 in February of 2021. However, despite the continued growth in the business, shares have declined from the highs to trade at $265 per share, with an estimated market capitalization of $47.18B.

We’ve identified two prominent investor concerns and outline our responses to their theses below: 

Concern 1: Gross profit margins are ~50% (less than typical software-as-a-service [SaaS] business) and trended modestly downward over the last 2 years (~53% -> 49%).

  • Our view:  The Gross Margin story is driven by the costs the company pays to telecommunication companies to send messages.  Twilio cannot achieve pure play SaaS margins (~80%) because of this cost. 

Concern 2: Operating margin remains at ~-30% even as the business continues to grow at scale.  Investors want to see margins improve as was done by competitors when similar scale was achieved.

  • Our view: When considering operating margins (including SG&A and R&D) one must also consider the size of Twilio’s opportunity, and their ultimate goals. We believe the size of this opportunity justifies their significant spending.

Opportunity

Twilio is primarily a communication API provider and this continues to account for ~90% of revenue.  Additionally, Twilio is undoubtedly the leading company in the space based on the IDC MarketScape for the Communication-Platform-as-a-Service industry (CPaaS).

Twilio measures the size of their core messaging opportunity at $63B in 2023, which provides a sizable growth opportunity when compared to the $2.96B in annual revenue it earns today (Annualized Q3 2021 revenue).  As more companies move their infrastructure to the cloud, Twilio will benefit as the leading cloud-native communication service provider.

The Twilio opportunity is not limited by their core business. As indicated briefly above, the Engagement Cloud platform is a strategic lever for growth. Not only is the platform a growing portion of their business, but its margins (~75-80%) are more similar to traditional software-as-a-service (SAAS) companies – much higher than their core business.   

Twilio estimates the total addressable market (TAM) for their core messaging platform and Engagement Cloud will reach $110B in 2023. Given their leading market position and revenue, we see significant runway until they have addressed a sizable percentage of this opportunity.   

All together, we think that Twilio can achieve organic revenue growth  >30% over the next 5-10 years.

Investment Rationale

We believe that the doubt created by Twilio’s cost structure (50% gross margins, -30% operating margins) will be alleviated as Twilio continues to scale and demonstrates they can compound sales growth > 30% over the next 2-4 quarters.   The stock should reprice higher as investors begin to understand the magnitude of Twilio’s opportunity and that the company can be very profitable despite sizable SG&A and R&D spend.  

We believe that Twilio is a strong long term holding and will compound capital at a rate greater than the market as they continue to grow and scale.


Important Disclosures Accounting and other general information about Twilio Inc presented in this document is sourced from earnings reports (recent SEC filing) from 2020-2021 as well as a Twilio Investor Presentation from March 2021. Price information is sourced from Yahoo Finance.

TWLO stock is held in accounts managed by Domain Money Advisors, LLC in the Domain Core, Domain Access and Domain Balanced strategies.

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