The API Economy and Twilio

One of the bigger trends to emerge in software development over the past 5 years is the ability to outsource common software “plumbing” to third party providers through APIs. This has created big opportunities for the companies that provide these services, as the long tail of developers at enterprises going through digital transformation initiatives take advantage of this capability. I examine this trend towards API consumption and how it benefits the leading communications API provider, Twilio (TWLO).

One of my favorite software stack companies, Twilio, was recently included in an article published on Forbes about the API economy. The genesis for this was the acquisition of Plaid by Visa for $5.3B on Jan 13th. Plaid made a business providing programmatic data connections through APIs to various financial services, like checking an account balance at a bank or retrieving past purchase transactions.

Visa sees a huge opportunity to evolve into a platform that enables all kinds of financial services. Providing a product offering with open APIs for developers at FinTech companies to consume aligns well with this vision. Plaid had raised $310M previously, with a $2.6B valuation at its last round in September 2019. At a $5.3B acquisition cost, that valuation doubled in less than 6 months, representing a huge increase. This also provides an interesting perspective for investors on how software providers are being valued now that we are in 2020, versus the sell-off we witnessed in cloud/software companies in 2H2019.

Similar to Plaid, Twilio has long provided a set of APIs for developers to consume that enables common use cases in customer communications, like transmitting an SMS, connecting a voice call or sending an email.

I can attest to the usefulness of these types of APIs. Before the emergence of these API providers, development teams at internet companies needed to wire up these connections themselves. For example, when I led engineering at a large dating site from 2010 – 2015, we had to write/maintain code ourselves to connect to the major payment processors (Adyen, Worldpay) in order to run credit or debit card transactions. Now, any developer can easily do this through an API connection to Stripe. Similarly, to send an email to a customer, we had to stand up our own email servers and manage the delivery reputation of our source IPs with all the major ESPs (Hotmail, Gmail, Yahoo, Comcast, etc.). Twilio SendGrid handles all of this now.

While progressive, internet-first companies jumped on this trend of outsourcing software plumbing to third party APIs quickly, more traditional enterprises still have a long tail of new functionality being brought online through digital transformation efforts. Think of all the more “mundane” businesses, like airlines, banks, retailers, health care providers, who now send you a text, voice or email message to announce a status change, confirm an appointment or offer a discount. As the developers at these companies (often lured from progressive tech companies) are asked to add these new communications capabilities to their company’s offerings, they will turn to ready-made APIs from Twilio to enable them.

In the Forbes article, the author confirmed this by referencing Jeff Lawson (Twilio CEO) and Twilio as “one of the pioneers in the API economy”.

“With web services, you can go from idea to prototype quickly,” said Lawson. “Because of this, developers can focus on what customers really want. It’s why we are seeing an explosion of startups.”

But the megatrend of the API Economy is not just about tech companies either. “Every company is becoming a software company,” said Lawson.

Forbes, Jan 18 2020

This ease of integration for developers results in productivity gains, allowing them to spend more time building unique functionality for their companies and launching new apps faster. This should result in more applications being brought online from traditional enterprises making use of these capabilities over the next five years. As Twilio’s business model generates incremental revenue from metered API usage, TWLO stock should benefit.

Twilio CodeExchange

To further help developers accelerate this adoption curve of Twilio APIs, they recently announced Twilio CodeExchange. It provides a searchable directory of customizable code samples, written by other developers, but vetted by Twilio experts. All of the code is stored in Github, a popular source control platform. Twilio bootstrapped the offering with 12 working use cases that span five languages (PHP, Python, Javascript, Java, .NET). Based on Twitter activity around the announcement from other developers and Twilio’s large external developer base, I expect this to generate a lot of interest.

This “open sourcing” of code enabling communications use cases harnessing Twilio APIs is a powerful sales adoption motion. Imagine a developer at an enterprise presented with a new communications use case for a digital transformation project. They could easily search the CodeExchange directory for a sample, download the code to their local repository and make any customizations needed. Consider it open source software for API communications. This is a unique offering from Twilio – I don’t see a parallel program on other major communications API provider sites.

Vonage Projects Significant CPaaS Growth

Vonage (VG), a competitive provider of communications services, recently presented at an analyst conference. Looking through their slide deck, one slide struck me. They published projected growth rates for the CPaaS industry, of which their Nexmo product is a provider.

Look at the projected growth in CPaaS, which is Communications Platform as a Service. This is the space in which Twilio, and other communications API providers, offer services. Vonage projects this area to grow from $5B in spend in 2019 to $18B in 2022. That represents 3.6x growth in 3 years – which further underscores the enormous opportunity for CPaaS providers, of which Twilio (TWLO) is the leader.

Hedgeye Best Long Idea

On January 22, Hedgeye, an independent investment research business, announced that Twilio was their best long idea. Among other reasons, they cite the long tail of use cases in the communications as a service sector that will be unlocked over the next few years. They anticipate that this will have a positive effect on TWLO stock, seeing 70% or more upside over the next 2 years.

Investor Take-aways

I think all of these trends bode well for TWLO stock. The emergence of API-driven application development and their leadership in the growing CPaaS market should provide meaningful tailwinds for Twilio over the next 5 years. This further reinforces my long term recommendation. Of course, there will be bumps, as we witnessed in late 2019. But, baring major execution issues, we should see TWLO continue to capitalize on this large opportunity and appreciate considerably.