Date of Recommendation: Nov 13, 2019 Closing Stock Price: $98.34
Twilio (TWLO) stock should be considered for long term investment. Based on my characteristics for a successful software stack company, I expect Twilio to grow significantly over the next 5 years. This will be driven by their maniacal focus on developers and delivering solutions within a large and growing addressable market. Twilio is led by a technical founder who espouses customer-centric values. The company is continuously innovating its product offerings, often launching new products based on direct customer feedback. They run an annual conference that is developer-centric and choc full of hands-on, problem solving sessions.
As stated in this blog’s first principles, I will not spend time on deep financial analysis. Not because these aren’t important as part of an investment decision, but I think financial analysis is better handled elsewhere. I do like Twilio’s high revenue growth rate (over 40-50% organic growth in past quarters), dollar based net expansion rate (over 130%) and reasonable forward Price/Sales ratio (around 8 to 10 – high, but not as high as some peers). Gross margins are low for a SaaS company (mid 50s), due to cost of underlying telecom services. Twilio is slowly addressing this by building new higher-margin, pure software offerings. For a 5 year investment, I think product innovation and secular tailwinds will be the drivers of share price growth. In depth financial data and analysis can be found on Seeking Alpha.
Product Overview
From their web site, Twilio powers “the future of business communications”. They allow multiple communication channels to be easily embedded into web, desktop and mobile applications. Current examples of these channels are voice, text, chat, video and email. These communication channels are accessible through open, well-documented APIs that any developer can harness with a few lines of code. SDKs are provided for most popular development frameworks.
Why is this important? Mainly because this kind of basic application plumbing would be a major effort for a development team to build themselves. Developers should spend their time coding the parts of their applications that add value for their customers and outsource common functionality. Common functionality, in this case, represents allowing an application to easily connect a customer to a voice call, send them a text message, establish a video connection or generate an email. These are common functions in most modern internet applications and Twilio is the largest and most advanced provider of these services.
Here are some real-world examples of typical customer interactions powered by Twilio:
- A reminder or confirmation SMS message about your restaurant reservation or doctor’s appointment.
- The ability to place a direct phone call to the driver of your ride-hailing service.
- A transactional email (sign-up, purchase confirmation, access confirmation) sent by an e-commerce site or service provider.
- A customer service chat bot that you encounter on a web site.
Twilio also has product offerings in IoT, customer contact centers, two factor authentication and intelligent bots. They built a foundation of core services made available through open APIs.
Most recently, they have been focusing on providing packaged, but still programmable, software solutions. These solutions encapsulate combinations of core services and APIs, often created based on observation of customer activity. For example, Twilio noticed that a few customers were using the programmable voice API to assemble their own customer contact center. After discussions with the customer to understand the rationale for this, Twilio decided to build a new product offering called Twilio Flex, which is a customizable cloud contact center. They claim it is the world’s first fully programmable contact center platform. As I will discuss later in this post, Twilio’s commitment to continuous product innovation based on customer feedback will be a critical driver of their success as a company.
Developer Mindshare
Twilio focuses the majority of its marketing efforts on developers. This is reinforced from Jeff Lawson, the CEO, all the way down the chain. In fact, when you listen to Jeff speak on conference calls or public interviews, he often leads with Twilio’s developer focus. He goes further, claiming that every company is becoming a software company. To differentiate themselves, these companies are building custom software solutions in areas that improve customer engagement.
Our developer first approach continues to drive success as every company becomes a software company and looks for new ways to engage with customers across multiple channels. And we believe no one is as well-positioned as Twilio to support companies through this transition.
Jeff Lawson, Q2 2019 Earnings Call Transcript
However, Twilio’s commitment to a developer centric approach isn’t just spoken. It is demonstrated in how they distribute their service. Twilio ensures that developers are provided all the tools needed to make use of their services in a transparent, code-first approach.
Also, on an engineering standpoint, SDK mattered. Nexmo didn’t have any. Twilio did. No-one would ever want to re-build from scratch integration layers vendors should naturally come up with and provide their customers with.
Engineering Manager comment on Technology Comparison Site
If developers are increasingly driving decisions about technology solutions and using a “build a quick demo” approach to presenting new business ideas, then having easy access to all the tooling needed in the middle of the night will ensure grassroots engagement.
Twilio runs a very popular annual customer conference called Signal. It runs for 2 days and was recently attended by over 4,000 people, mostly developers. The focus is hands-on learning.
What you learn at SIGNAL, you’ll put into practice. Learn from customers who have leveled up their business with Twilio, hone in your development practices in deep dive talks from product experts, and be the first to see Twilio’s brand new products.
why Attend, Signal Site page
Reviewing the sessions at Signal 2019, I was struck by a few points:
- The main audience of most sessions is clearly developers, not leaders. The sessions are hands-on and code oriented, where the participant is encouraged to bring a laptop and exits with some sort of working solution.
- The sessions are clearly oriented around Twilio products, but are geared towards borrowing best practices from either real-world customer solutions or reasonable simulations of the art of the possible.
- They mix in some personal skills improvement sessions, like “Being a Woman in Product” and “Level the playing field by being a rock solid colleague at critical work moments.” These types of sessions provide additional value for the target customers – developers and product managers.
Leadership in a Large Addressable Market
Twilio’s offerings are categorized with the moniker of CPaaS, which stands for Communications Platform as a Service.
This IDC Market Analysis Perspective presents the worldwide voice and text messaging communications platform-as-a-service (CPaaS) market. This market is forecast to grow from $2 billion in 2017 to $10.9 billion in 2022. The voice and text messaging CPaaS market has rapidly evolved into a mainstream segment with many companies entering the segment and adding APIs to their portfolio to leverage the tremendous interest and demand for APIs. IDC is predicting that CPaaS will continue to grow at strong CAGR of 39.2% from 2017 to 2022.
IDC, Market Analysis Perspective – CPaas, Sept 2018
As another measure of the rapid growth in this space, IDC provided a different statistic “Specifically, the global voice and text messaging CPaaS market is expected to grow from $867 million in 2016 to $8.2 billion by 2021—growing nearly tenfold”. Between these estimates, this indicates a base market expansion of about 40 – 50% a year.
Technically, these market size metrics speak to Twilio’s core offerings in text messaging and voice communications. If we add in the opportunity for Flex, Twilio’s new contact center as a service offering, (CCaaS) the market potential is much larger. That market is expected to grow to $24 billion by 2023 at an annual growth rate of about 50% per year.
Twilio’s own estimates of their total addressable market is about $50 billion, if you include all of their product offerings.
The growth rate of the market and the popularity of Twilio’s services are further evidenced by Twilio’s own dollar based net expansion rate (DBNER). In past quarters, this has been over 130%. This metric represents the growth in spending experienced by an existing customer over the period of one year. This means that once a company starts using the Twilio service, their own business growth and application of new use cases results in meaningful expansion of spend, without any incremental work on Twilio’s end.
Twilio is the largest provider of voice and text messaging, with 2019 revenues currently targeted for $1.116B. This represents a growth rate of 72% over 2018 revenue (high 40’s organically, if you remove contribution from SendGrid). Both overall revenue and growth rate are higher than those of competitive offerings from other publicly traded companies.
Comparing the offering of Twilio to competitors, an analyst from Morgan Stanley recently published the following:
Highlighting that the company is building out a next-generation communication platform, with multiple expansion markets still in their infancy, Morgan Stanley’s Marshall upgraded Twilio to Overweight from Equal Weight and raised her price target on the shares to $135 from $130. Further, the analyst thinks that the recent pullback in the shares, coupled with top placement in her newly introduced unified communications framework, provides an opportunity.
Marshall pointed out that Twilio continues to remove the constraints of traditional business-to-consumer communication, giving the company a meaningful runway for growth that is being missed in the recent pullback. Twilio’s depth of platform and share position should help them outgrow this market, she contended, adding that she sees outperformance of application businesses like SendGrid and Flex over the coming quarters as a catalyst, driving increased stickiness of the platform and eventual margin leverage.
Meta Marshall, MOrgan Stanley, Sept 19, 2019
At the same time, Meta downgraded competitor Bandwidth (BAND) on concerns over breadth of platform coverage.
As the CTO of a major Internet property in the sharing economy space in 2019, I can say that there really wasn’t another option considered for either our SMS or transactional email solutions. Twilio is the best of breed provider. Ironically, we were using SendGrid for our email solution before Twilio acquired them.
Product Development Velocity
The scope of Twilio’s product offerings is impressive. A quick review of their product page reveals 22 distinct product offerings, across 5 groupings: Solutions, Services, Channel APIs, Super Network and Tools. Each quarter, Twilio rolls out either a completely new product offering, or at least significant enhancements to existing ones.
In Q2, they delivered Twilio Conversations, which allows a company to consolidate communications across multiple channels into a single stream, or conversation. Examples of channels are SMS, MMS, WhatsApp and Chat. In an increasingly omni-channel world, customers expect to be treated as a single entity across all communications with a company, regardless of channel. Twilio Conversations enables this.
What is most interesting about Conversations is the pricing model. Twilio charges a per user per month fee for maintaining the consolidated view of all conversations between the company and the customer. This ranges from $0.01 to $0.03 per user per month, depending on volume. Twlio’s standard charges for SMS/MMS/WhatsApp apply separately. Therefore, usage generated by Conversations represents high margin, recurring, SaaS revenue. This is an example of how Twilio is expanding its offerings into “Solutions”, which sit on top of the lower margin “Channel API” services that currently generate the majority of revenue.
In 2018, Twilio introduced Flex. As mentioned above, Flex is a fully-programmable contact center platform. The genesis for the product offering was observation of existing customers using the programmable voice API service to create a basic contact center. Given that customers were investing their own developer resources to build these, it only made sense for Twilio to offer this as an official product.
As with Conversations, pricing for Flex is incremental and separate from Twilio’s other services. “Carrier connectivity, such as phone numbers, PSTN connections, and SMS are charged at Twilio’s regular usage-based prices.” Flex pricing is simple and transparent – either $1 per user hour or $150 per month per seat. Like Conversations, revenue from Flex usage is high-margin. On various calls, Twilio’s CFO has estimated revenue from Flex could grow to several hundred million dollars annually in the future.
As another indication of the pace of Twilio’s product development activity, their blog is very active. In one random sampling, I see 6 posts published in a 3 day period. This is a high frequency, even for a technology company. The posts are clearly developer and product manager focused, often providing working solutions for a problem with code samples. This kind of continuous and relevant communication is critical to engaging Twilio’s target customer base.
Technical Founder, Still in Charge
Jeff Lawson is the founder, CEO and chairman of Twilio. Prior to Twilio, Jeff was the technical founder of at least 3 other companies, including Stubhub, which was acquired by eBay. He has a computer science degree from University of Michigan and still “makes time to hack on new software and hardware projects.”
Jeff is a software developer at heart. He often references this on earnings calls and at conferences. As I pointed out in the characteristics of a successful software company, this background in software development gives Jeff two major advantages as the CEO. First, his customers (fundamentally, other developers or CTOs) and his own engineering organization will accept him as a peer and assume he is knowledgeable and appreciative of their problems. This lends credibility to Twilio as a service provider and an employer. Second, Jeff understands at a deep technical level the problems Twilio is solving. He can provide meaningful input to the product and technology roadmaps. Finally, hiring and maintaining a top-notch product development organization is ensured, as he can’t be “BS-ed”.
Values and Organization
Twilio’s values are laid out on their main site, in the About the Company section. They are summarized as the “principles we use to build an impactful, high-growth business while staying true to ourselves.” There are 10 values, divided into 3 categories “How we act”, “How we make decisions” and “How we win”. I like the categorization – I haven’t seen that in other companies (at least that I have worked for). Usually values are presented as a simple bullet point list. The categories provide additional meaning. Also, I like how the values are aligned with an understanding of “culture”. For me, company culture represents a common set of beliefs that guide how employees should behave personally, interact with others and approach decisions.
Of note among the values is to “Wear the customer’s shoes”. Apparently (I haven’t experienced this myself), customers who visit the Twilio offices are encouraged to “donate” their shoes in exchange for a pair of red Chucks with in the Twilio logo. The customer’s shoes are then labeled and hung somewhere in the offices. These shoes provide a constant reminder of purpose for all employees’ efforts. This is a great example of a company bringing a value to life and making it tangible for employees, versus printing the values on large banners and hanging them from the wall.
For all these reasons, I recommend Twilio as a long term holding in any investor’s portfolio. It will likely be volatile over any short period of 3-6 months. However, I expect the stock to more than triple and trade over $320 within 5 years.
