Twilio (TWLO) Q2 Recap

Twilio announced Q2 earnings on August 4th. The results were strong, beating estimates for both revenue and earnings by a large margin. Similarly, they raised Q3 revenue estimates by almost 10% of annualized growth at the top end. In spite of this, TWLO stock dropped a modest 2% the following day, as the stock had run up prior to earnings and market participants were likely expecting a bigger beat. On the earnings call, Twilio management highlighted several customers wins and momentum in telehealth. Subsequent to earnings, Twilio conducted a capital raise for another $1.25B, fueling speculation of an acquisition. In this blog post, I review Twilio’s Q2 earnings and other business updates that occurred during the quarter. I also dig into product enhancements and revisit the competitive landscape. For a refresher of my prior coverage of Twilio, interested investors can read past quarterly updates and my original investment thesis.

Headline Financial Results

• Q2 Revenue of $400.8M, up 45.7% year/year. This compares to the consensus estimate of $368.8M, which would have represented growth of 34.1%. Q1 organic (removing SendGrid contribution) revenue growth was 48%, so a slight deceleration, but reasonable given COVID-19 headwinds to impacted customers in travel and hospitality. Q2 FY2019 organic revenue growth was 55%. Some analysts have referenced the total Q2 2019 revenue growth rate of 86% to highlight significant year/year deceleration, but this isn’t a meaningful comparison, as Q2 2019 benefitted from an additional $46M in SendGrid revenue that did not exist in Q2 2018.
• Q2 Non-GAAP EPS was $0.09 vs ($0.08) expected, representing a beat of $0.17. This compares to $0.06 in Q1 and $0.03 in Q2 2019.
• Q2 Non-GAAP operating income was $9.5M, representing an operating margin of 2.4%. This compares to operating income of $1.5M in Q2 2019, for an operating margin of 0.5%. Q1 2020 operating margin was 1.7%.

• Q3 Revenue estimate of $401 – 406M, representing growth of 36 – 38% year/year. Consensus revenue estimate was $378.8M, for 28.4% year/year growth. On the earnings call, analysts flagged this estimate as demonstrating little sequential growth. However, if we assume a similar level of outperformance to Q2 revenue estimates, then growth could actually accelerate to 46 – 50% year/year in Q3. The original estimate from Q1 earnings for Q2 revenue represented 33 – 35% growth, so this Q3 estimate actually forecasts higher estimated year/year growth. Also, in Q3, we don’t need to differentiate organic growth in the comparison to the prior quarter.
• Q3 Non-GAAP EPS estimate of ($0.09) to ($0.05) versus ($0.06), which is roughly inline. Given the outperformance in Q2 on EPS of $0.17, we could expect this to flip positive in the actual Q3 report.
• Q3 Non-GAAP operating loss estimated in the range of ($15M) to ($10M).
• Due to the continued uncertainty of the length of the COVID-19 situation, Twilio is not providing 2020 guidance.
• Ended the quarter with cash, cash equivalents and marketable securities of about $1.9B.
• Subsequent to the earnings report, on August 5th, Twilio announced an additional capital raise for about $1.25B. Like other capital raises, Twilio specified the usage as “intends to use the net proceeds from this offering for general corporate purposes, which may include the acquisition of other companies or businesses, the refinancing or repayment of debt, capital expenditures, working capital and share repurchases.”

Other Performance Indicators

• Q2 Non-GAAP gross margin was 56%. This is down slightly from 57% in Q1 and 59% in Q2 2019. The new A2P charges from carriers contributed about 100 basis points to year/year gross margin comparisons. The other decline in gross margin is explainable by revenue mix, likely that lower margin SMS and voice traffic made up a larger percentage of revenue this quarter. Gross margin is still up from 54% in 2018. However, we will want to monitor this going forward, as higher margin software offerings (like Flex and email) are supposed to boost gross margin over time.
• Breaking down Non-GAAP expenses by category, we see a slight year/year reduction in expenses as a percentage of revenue across the board. This indicates greater operational leverage as Twilio scales.
  • R&D = 19% (23% in Q2 2019)
  • S&M = 24% (25% in Q2 2019)
  • G&A = 10% (11% in Q2 2019)
• DBNER was 132% for Q2, which compares to a 135% organic DBNER for Q1. DBNER in 2019 ranged from 125% to 142% and these values were not adjusted for SendGrid. The reduction from Q1 to Q2 was likely due to COVID-19 headwinds on certain large customer categories, like ride-sharing, hospitality and travel. DBNER above 130% is still at the high end of the range for software services companies.
• Twilio had 3,284 employees at the end of the quarter. If we annualize Q2 revenue, we get a revenue run rate of $1.603B. This translates to about $488k of revenue per employee.

Customer Activity

• Twilio ended Q2 with 200,000 paying customers. This compares to 161,869 in Q2 2019, representing annual growth of 23.5%. Twilio had 190,000 customers at end of Q1 for sequential growth of 5.3% in Q2. Q1 to Q2 2019 customer growth was 4.6%, so we have seen accelerated sequential customer growth in 2020. Both Q2 and Q1 exhibited this trend.
• Revenue from the Top 10 customers represented 15% of total revenue, inline with the prior quarter and up from 13% in Q2 2019. Given that this metric has remained stable at 15% or lower for the past 12 months, it isn’t a concern. Whatsapp is still the largest customer, making up 7% of revenue. Investors will recall rumors in November 2019 that WhatsApp was scaling back usage. It doesn’t appear that has materialized.
• International customers contributed 27% of total revenue in Q2, down from 29% in Q2 2019 and up from 25% in Q2 2018. Management commented that this was affected by some decreased usage in international markets due to COVID-19. Twilio continues to see international growth as a big opportunity and several customer wins highlighted in Q1 and Q2 were from customers outside the U.S.

On the earnings call in prepared remarks, the Twilio leadership team shared some customer wins from Q2:

• Zoom Video (ZM) added Twilio’s email platform for their customer outreach. Zoom was already a Twilio customer. They needed an email platform that would reliably deliver email at scale to major ISPs.
• Expanded their relationship with Peloton (PTON). Peloton selected Twilio’s email platform for all of their marketing emails to optimize deliverability, allow them to iterate quickly and provide the scale they need for the future.
• Applied Flex to support contact tracing for COVID-19 response at several universities and city and state governments. Have signed more than 25 transactions with these types of organizations for Flex including New York City and the state of New Mexico.
• Red Ventures, which is a collection of major online properties like Bankrate, chose Twilio Flex to provide a cloud-based solution to improve cost savings while delivering a highly customized sales experience.
• Entered into a new relationship with BGL Group, a leading digital distributor of insurance and household financial services to over 10 million customers. BGL’s existing legacy contact center solution did not allow for large-scale remote working. BGL utilized Flex to deploy a remote contact center. They brought several hundred agents online within 2 weeks.
• Expanded their relationship with a Fortune 50 company serving millions of customers a week. The company is experiencing a spike in usage of their “buy online, pick up in-store” (BOPIS) option, and they needed a solution to verify the customer phone number at checkout or at pickup. This company is shifting to building 80% of their software solutions in-house. They selected Twilio to develop a solution for BOPIS using Twilio’s Verify, Lookup, SMS, Voice and Email products.
• Entered into a new relationship with a Fortune 50 multinational company that needed a more efficient and effective way to issue escalation alerts and notifications from their ServiceNow command center. They will be implementing ServiceNow Notify, which is powered by Twilio SMS and Voice, to seamlessly deliver communications to global employees and executives to ensure fast response times for their customers.
• Entered into a new relationship with CBRE Spain, a division of the world’s largest commercial real estate services firm. CBRE Spain built a solution in less than 24 hours using Twilio Studio along with Twilio Voice, IVR, SMS and email, to allow employees to book a desk over the phone, receive an SMS to confirm more information about the reservation and finally receive a personalized email with authorization to return to the office.
• Entered a new relationship with Tokopedia, an Indonesian unicorn that offers ride-hailing, e-commerce and travel services. Experiencing an exponential increase in traffic due to COVID, Tokopedia selected Twilio for SMS notifications.
• Entered a new relationship with E.ONnext, a company that provides electricity and gas service to more than 5M customers in the U.K. E.ONnext is delivering and developing a new customer engagement platform in an effort to become the leading residential energy provider. They are leveraging Voice, Messaging and Email to build a new engagement platform.
• Expanded the relationship with Car Finance 247, the U.K.’s No. 1 car finance broker, guiding their customers from initial loan application to car purchase. An existing Twilio customer, they added Flex in Q2 for their customer support and sales contact center.

Twilio also published several press releases over the course of the quarter highlighting strategic customer wins in telehealth. These leverage Twilio’s recent HIPAA compliance, available for video, voice and SMS services. Twilio started working on HIPAA compliance over a year ago and announced achieving it for several products in February, just as the COVID-19 situation began having impact. HIPAA compliance requires extensive investment and represents a competitive advantage for Twilio, as well as a major growth opportunity in the future.

• Doximity Telehealth App. Twilio Programmable Video will power the Dialer Video product for Doximity, which provides a secure and reliable telemedicine tool that enables physicians to video call patients directly from a doctor’s smartphone. Over 100,000 U.S. physicians are already using the Doximity app for telemedicine visits regularly, making Dialer Video one of the most-used telemedicine technologies among U.S. physicians.
• Zocdoc Telehealth Video Service. Programmable Video will power Zocdoc’s new free, HIPAA-compliant telehealth video solution.
• Epic Telehealth Video Service. Programmable Video will power the new native telehealth offering from Epic, one of the nation’s largest electronic health record companies. The embedded solution allows providers to launch a video visit with a patient, review relevant patient history and update clinical documentation directly.

As part of Twilio’s follow-up offering for August 2020, Twilio published a separate slide deck that included some other interesting investor information, not contained in the standard quarterly earnings presentations. In it, they provided an updated list of notable customers, segmented by business vertical.

Analyst Reactions

Following Twilio’s Q2 earnings results, 10 analysts provided updated coverage ratings. Of these updated ratings, all analysts raised their price targets. Some have tripled their price targets since the beginning of the year. All but one analyst rated the stock at a Buy equivalent. The average price target for these updates is $304, representing a 9% increase from the closing price after earnings of nearly $278 on August 5th.

Date	Analyst	Rating	Price Target
8/4	Oppenheimer	Buy	Raised from $245 to $300
8/5	Mizuho	Buy	Raised from $260 to $315
8/5	Rosenblatt	Neutral	Raised from $235 to $255
8/5	Needham	Buy	Raised from $225 to $310
8/5	Piper Sandler	Overweight	Raised from $225 to $300
8/5	KeyCorp	Overweight	Raised from $270 to $330
8/5	DA Davidson	Buy	Raised from $175 to $315
8/5	Wells Fargo	Overweight	Raised from $250 to $315
8/5	Northland	Outperform	Raised from $225 to $290
8/5	Canaccord	Buy	Raised from $215 to $310

After the earnings results, Mizuho set one of the highest price targets, raising from $260 to $315. Analyst Siti Panigrahi provided this commentary.

Mizuho analyst Siti Panigrahi raised the firm’s price target on Twilio to $315 from $260 and reiterates a Buy rating on the shares. The company’s “strong” Q2 results and above-consensus Q3 guidance highlight that Twilio stands to be a “significant beneficiary” of COVID-19 in the short-term, boosting usage volumes “dramatically,” Panigrahi tells investors in a research note. Longer-term, the analyst expects the company to sustain “robust growth,” benefiting from the API economy and adoption of cloud contact centers, accelerated by COVID-19.

TheFly.com, August 5, 2020

Product Development Activity

Over the past several months, Twilio announced a number of product enhancements and new releases.

• Voice Diagnostics. This provides a set of tools that facilitate checking the readiness of a customer’s browser to conduct a voice call and troubleshooting network related issues. These tools consist of the Voice Diagnostics Web App, an RTC Diagnostics SDK and a Javascript Client Preflight Check. These tools were all released as open source projects. Twilio Programmable Voice using the WebRTC protocol allows users to make voice calls through their computer and browser, versus using a traditional phone. In order to work properly, the user must have the right version of browser, appropriate software updates and network configuration. These new tools from Twilio help developers embed these diagnostics into their client applications, so that end users can test and troubleshoot any issues with their voice connection.

• Voice Notifications App. Provides a sample, open source application that can be used by developers at customer organizations to jumpstart the creation of automated voice notifications. Examples are for school closures, weather alerts or emergency notifications. The app provides working code in ReactJS that could be configured to run in the customer’s hosting environment. This provides customers with a convenient starting point for creating their own custom notification system that leverages Twilio’s Programmable Voice service to distribute the messages.
• Twilio Conference Jitter Buffer Controls. Twilio Conference uses a jitter buffer to smooth out irregularity in media packet arrival times when mixing audio for conference participants. This release provides customers with more visibility and control over the jitter buffer. This allows developers to programmatically tune the behavior of their conferences and optimize the experience for participants with different network conditions.
• Super SIM Public Beta. This represents an exciting advance in IoT support. Twilio’s Super SIM was announced at Signal 2019 and is now available as a public beta. It provides a cellular connectivity platform for connecting IoT devices globally. Like with Twilio’s other programmable communications services, customers can connect their IoT devices to the Twilio network from anywhere in the world through a single management system. This removes the need for customers to negotiate with individual cellular networks, as they roll out a global fleet of IoT devices. All functionality is available through APIs to program connectivity operations, from changing SIM status and tracking data consumption, to sending machine-to-machine messages to devices. Pricing is based on a per active device per month (starting at $2), and data starts at 10¢/MB.
• Regulatory Bundles – Evaluations API. Phone Numbers with compliance requirements (like Know Your Customer) for documentation require Regulatory Bundles. With the new Evaluations API, Twilio makes it possible to understand whether a Regulatory Bundle Evaluation passed or failed and provide the specific field-level failure reasons.
• Studio Flow API v2. Beta release of the Studio REST API v2. This provides full support for publishing of Flows via the REST API, Twilio’s helper libraries and the Twilio CLI. Users can test and deploy new Flows through all their hosting environments. Flows can be templatized and integrated with the CI/CD pipeline.
• Announced Support for the Shaken/Stir protocol to help reduce robocalling. Once SHAKEN/STIR is fully implemented amongst the rest of the telecommunications industry, Twilio will be able to verify customer calls received on the Twilio platform, providing consumers with the information necessary to decide whether to answer the call or not.

In June, Twilio announced a new offering, called Edge Locations. These are regionally deployed Points of Presence (POPs) that provide local ingress/egress connectivity for customer applications onto the Twilio network. These ingress/egress points service REST calls, websockets, and webhook callbacks. Edge Locations both optimize routing to Regions, as well as speed up expensive operations, such as Transmission Control Protocol (TCP), Transport Layer Security (TLS), and authentication.  

Edge Locations will greatly improve Programmable Voice, Programmable SMS, Notify and Webhook Callback performance. They bring Twilio’s public and private network connectivity geographically closer to a customer’s location for improved performance. Twilio products can now be accessed through eight public Edge Locations and seven private Edge Locations globally.

These are available now. Customers can target a specific Edge Location through a configuration setting in their Twilio connection code. Edge Locations provide customers with the following benefits:

• Reduced latency for highly interactive, real-time interactions such as voice dialing, muting, sending chat messages, etc.
• Increased flexibility and options for network failover between Edge Locations.
• Improved security, quality of service and availability by removing the public Internet.

This development by Twilio is very interesting. First, it further highlights the ongoing narrative around moving compute and network entry points closer to customers through a distributed web of POPs. I have been discussing this theme in coverage of Fastly and Cloudflare. It also mirrors the approach taken by Agora, with their network of 250 POPs to facilitate audio, video and real-time chat traffic. Given these trends around edge computing, I would expect Twilio to continue to add more POPs over time.

Twilio has a serverless runtime environment as part of the Runtime product. This allows developers to create Twilio Functions that execute within Twilio’s serverless environment to handle events such as an incoming phone call or SMS message. Twilio Functions obviates the provisioning of server infrastructure for customers to run communications event code securely and at scale. Functions can be written in Javascript and execute as part of a node.js environment. Along with Functions, Runtime provides operational tools, like access to a CLI, debugging and application performance data.

Combining Edge Locations with their Runtime product gives Twilio the basic infrastructure to deliver a programmable edge compute solution tailored to the unique needs of distributed communications. With the launch of Super SIM, these edge compute capabilities would provide a mechanism for developers to push programmability for IoT use cases out to the network edge as well.

On July 9th, Twilio announced the acquisition of Electric Imp. The Electric Imp platform provides a fully integrated solution for managing IoT devices and securely routing their data to a customer’s cloud application. It consists of three tiers – hardware to embed in an IoT device, a cloud-based management layer that coordinates communications to the devices and finally a central application that is embedded within a customer’s cloud to provide the integration between the customer’s application and their IoT device data.

This acquisition provides Twilio with a broader set of capabilities around IoT and is the basis for their Super SIM offering. I think this represents the beginning of more development around IoT products for Twilio that should dovetail nicely with the roll-out of 5G networks and proliferation of IoT devices. Twilio’s core capabilities in facilitating programmable, distributed communications between humans, systems and devices should play well here.

Finally, investors should keep in mind that Twilio’s annual user conference, Signal, is coming up on Sept 30th. At this event, Twilio typically announces major new product additions or enhancements. In 2018, Twilio used this event to announce the general availability of Flex. In 2019, they announced Conversations. Along these lines, I would expect some new product announcements at Signal this year. These are typically products that generate incremental revenue streams, versus extensions of existing products.

Competitive Activity

Because Twilio covers so many categories, it’s not feasible to go through every company that offers overlapping services and perform a direct compare/contrast to Twilio. That exercise would have to include all the CPaaS independents (both public and private), cloud vendors, cloud call centers and email marketers. With that said, I think it is constructive to examine the main CPaaS providers, as that represents Twilio’s core market for programmable communications services.

First, the addressable market for Twilio’s services is large, in theory encompassing all types of programmable communications. For just voice and text messaging CPaaS, in 2018 IDC forecast total market growth from $2B in 2017 to $10.9B in 2022, representing a CAGR of about 40%. With the acceleration of digital transformation in 2020, these numbers may have stepped up further. Twilio also has solutions for email, video and contact centers, which represent large market opportunities on their own. Twilio sizes their total addressable market as being over $50B.

In some ways, market position could be the simplest investment thesis for Twilio. That is to select the largest player in a rapidly growing market. Competitive offerings have existed in the market for several years now. Public traded CPaaS providers like BAND and VG haven’t significantly increased their share of market, relative to Twilio. The same can be said of the smaller, private players like MessageBird, Plivo, etc. They occasionally win a noteworthy deal, but are unlikely to expand market share rapidly and dislodge Twilio. This situation is akin to Geoffrey Moore’s well-known segmentation of markets into gorillas, chimps and monkeys. The safest stock pick is to select the gorilla in the market, as their dominance is usually self-fulfilling for long periods of time. The gorilla can generally re-invest the most capital into growth, attract enterprise customers as the “safe” bet, retain talent and set the competitive bar for the market.

Gorillas are the market leaders. They are easy to spot because they promote the efficacy of their approach to grow their market. Chimps promote a different product approach to address the same customers, usually without much success. Monkeys attempt to clone the Gorilla’s product approach and usually describe what they do relative to the Gorilla, often with a lower price and exaggerated performance claims. This seldom leads to more than modest success.

Geoffrey Moore, the gorilla game

Regardless of whether you subscribe to Geoffrey Moore’s theory or agree that it applies in this case, the rapidly growing addressable market for CPaaS will provide plenty of fodder for all players. Twilio has the momentum, leadership and product/market fit to continue to capitalize on the secular tailwinds of programmable communications for a long period.

If we compare Twilio’s performance to its larger competitors, as represented by those companies that are publicly traded and report earnings, we see that Twilio has the greatest share of market revenue. More importantly, it is growing revenue at a faster clip than most. Agora, with almost 3x revenue growth, is less than 1/10 in size. Twilio also has existing relationships with a significant number of customers, from which it drives an impressive net expansion rate over 130%. For a company operating at this scale, these growth metrics are impressive. If Twilio’s hegemony in the market at this size were at risk, we would expect to see its growth rates slow to the single digits.

As the market leader, Twilio benefits from name recognition, stability and the perceived safety (at least for domestic customers) of being a U.S. company. Additionally, I think one of the most important competitive differentiators for Twilio is its breadth of product offerings. I am observing a trend among enterprise IT buyers to reduce the number of vendors they engage with for services. These buyers seem to be shying away from picking a point solution for every use case, unless there is a clear technology advantage to do so. From this perspective, Twilio offers large customers access to the most customer engagement channels from a single vendor. For an API-driven CPaaS vendor, this does provide advantages to customers in terms of allowing developers to code to a single API interface, maintain one SDK and reference one set of developer documentation. Also, a larger player would offer extensive customer service and access to integration specialists. Billing would be consolidated and probably benefit from volume discounts at scale. Finally, thoughtful application of large relative R&D spend would keep product offerings competitive.

Twilio is the only major CPaaS provider that offers the full spectrum of products – spanning video, voice, SMS, chat, social (WhatsApp) and email. While some investors questioned the acquisition of SendGrid in 2018 for $2B on a valuation basis, I think the move was very strategic. It made Twilio the largest provider of programmable email solutions. Twilio SendGrid processes more than 70B emails a month.

Email traffic handled by Twilio is typically what we call “transactional” email, which is targeted on an individual customer basis. This is in contrast to bulk email like newsletters, which represent one-to-many email blasts. Transactional emails are the highest value, as they are associated with actions that the recipient really cares about, like for e-commerce purchases, critical event notifications, appointment scheduling, etc. Those email addresses are often a primary indicator of a user’s identity on the Internet. Having data on all these email addresses and their delivery rates provides Twilio with valuable signals about customer engagement with the various communications channels. Combined with phone numbers gathered through SMS, chat engagements, WhatsApp, voice calls, etc., Twilio likely has a huge database of consumer engagement behavior. Twilio can leverage this information to optimize delivery of communications.

If you think about aggregating each consumer’s communications activity across different channels, valuable insights would surface about each person’s preferences for channel (most likely to engage with email, SMS, voice), time of day, frequency of messaging, etc. CPaaS vendors that are only addressing a couple of channels, and avoiding email, will not benefit from these network effects. Similarly, they force enterprise buyers to contract and manage multiple vendors.

In this comparison set, Agora is new on the scene. In many ways, they are different from the traditional CPaaS provider. I include them for completeness and because investors have questioned whether they compete with Twilio. Currently, I believe Agora is going after a different market segment. They cater to application types where the communication is purely virtual, with no physical analog like SMS or email. Typical solutions focus on gaming, social interactions and education. They are also well-equipped for one-to-many broadcasts, with high tolerances for number of participants. Twilio, on the other hand, is more focused on enabling video/voice communications on a 1:1 level and supplementing that with the physical channel, like SMS or email. Due to their recent investment in HIPAA compliance, many new use cases for Twilio are manifesting in healthcare to facilitate direct doctor-to-patient video communication embedded in an app, in which other channels like SMS and email are used to schedule the appointment as part of the overall customer engagement workflow. This divergence of market segments between Twilio and Agora is fine, as there are large markets in both areas that better suit each company’s strengths. I think Agora will be interesting to watch, particularly with their software-defined real-time network (SD-RTN) connecting more than 250 points of presence (POPs) worldwide.

Looping back on the full competitive set, one might argue that skipping an SMS or email offering future-proofs competitive platforms, as SMS and email may one day go away, in favor of live video/voice interactions. However, that evolution hasn’t manifested yet. People still value asynchronous methods for certain types of communications, particularly associated with commercial functions like shopping, news distribution, scheduling and status updates. Early in Twilio’s history, analysts were similarly worried that in-app notifications (push notifications) would render SMS obsolete. That didn’t happen either.

Price discounting is a tactic used by the smaller competitors, that generally carries more weight for SMB customers. At an international consumer marketplace where I was CTO, we used Twilio for SMS, voice and email. I was barraged with offers from Twilio competitors promoting the cost savings of their solutions. These promotions based on price alone were not effective for me. Programmable communications channels are a critical component of the functioning of our international marketplace. As such, I was more concerned with reliability, international coverage, integration with popular social channels (WhatsApp) and customer support. Price was just one component of that. I would happily pay a little more for each transaction, if I was confident that a potential renter from Poland would receive their trip confirmation and details via SMS or WhatsApp and email. Our team didn’t have time to troubleshoot delivery issues by country or Email Service Provider (like, why does this customer’s email keep getting delivered to the spam folder?).

In this case, Telnyx even provides a “Savings Calculator” that provides an estimate of annual savings if the customer switched from Twilio to Telnyx. However, it is limited to just those services that Telnyx supports, in this case voice and SMS. Pricing is constrained to the U.S. and doesn’t take into account the volume discounts that a larger customer could negotiate with Twilio. Also, Telnyx doesn’t support integration with social apps, which is often necessary as a communications channel with international customers, some of whom wish to toggle back and forth between SMS and WhatsApp, depending on what country they are in.

Twilio is also the only CPaaS vendor that I could find that offers a programmable, serverless runtime environment. This creates further differentiation from competitive offerings. Additionally, they offer extensive tooling for non-developers in Twilio Studio. This provides a drag-and-drop interface to create IVRs, SMS autoresponders, and other workflows through visual configuration and pre-programmed logic. Most competitors just expose a programmatic API for users.

Future Opportunities

As noted above, Twilio conducted an additional capital raise of $1.25B following earnings. With $1.9B in cash and equivalents prior, Twilio really didn’t need additional capital for operations. This move kicked off speculation that this raise is to fund an acquisition. Twilio recently acquired Electric Imp to bolster its IoT capabilities. It’s possible they are considering another acquisition in this area. Or, they have their sights on something larger in another category. As we have fully lapsed the SendGrid acquisition, Twilio leadership may be looking at a new category to supplement their offerings.

I found it very interesting that the following slide was included in Twilio’s investor presentation for the capital raise. I haven’t seen a slide like this in past Twilio investor decks.

I think another hint about Twilio’s expanded view lies in a shift in marketing messaging. Twilio has traditionally described themselves as a communications platform. More recently, they highlight being a “Customer Engagement Platform” and refer to enabling customer journeys. I think this change in messaging is subtle, but could be telling. This would imply that Twilio is thinking about the full lifecycle of communication with customers – not just facilitating single, isolated interactions through SMS, voice, video, email, etc., but trying to connect these interactions into an end-to-end customer journey. The move into contact center with Flex aligns with this positioning, as that facilitates not just voice communications, but also supports engagement across other touch points, like chat, SMS and email.

Enhanced customer engagement would imply additional services to facilitate marketing or customer relationship management. One interesting asset that Twilio possesses is a broad and rich database of user contact information. With SendGrid, they have sent over 3T emails to date and claim to have delivered an email to 50% of the world’s email addresses over a 12 month period. With SMS, they sent over 66B messages last year and have collected over 3B individual phone numbers across more than 100 countries. In many cases, email addresses and phone number data is enhanced with other metadata, like IP addresses and names. Email addresses and phone numbers might also be linked.

Twilio could leverage this rich data set to offer some sort of products for marketers. This could be similar to customer data sets provided by companies like ZoomInfo or LiveRamp. Alternately, Twilio could enhance tooling around email or SMS marketing. They have done some of this organically with SendGrid in the form of the Marketing Campaigns product. There are a number of private start-up companies that have built sophisticated capabilities to drive interactive, responsive SMS campaigns across multiple customer lifecycle phases. The same applies to managing email marketing. An acquisition of one or more of these might be in the works.

The other area where Twilio is enhancing their capabilities is in IoT. In past analyst calls, Twilio leadership has mentioned IoT as a longer term strategic play. With the upcoming roll-out of 5G, cellular networks will be much more supportive of devices with limited cellular signal reach. All types of compact, smart devices could be brought onto the network, no longer constrained by needing access to WiFi or a larger antenna to connect to a more distributed cellular network.

Twilio is promoting the application of IoT capabilities in an upcoming webinar with the SmartRent company, which provides property management services. Rently also makes heavy use of Twilio’s existing IoT products. An interested renter can gain physical access to a property through an app. In this case, after appropriate authentication, the company can grant access to the customer for some period of time. This is facilitated by unlocking a door by sending a secure message to the cellular-network connected lock. Sensors within the property might also indicate the period that the client is on the property.

If we consider that Twilio’s business is fundamentally about providing API’s for developers to programmatically send messages to devices (SMS to cell phone), it is easy to assume this capability could be extended to offer a similar framework for sending secure messages to IoT devices. Given Twilio’s existing integration with other customer communications channels, like two-way SMS, one could even imagine the controls for IoT devices being instigated via SMS. Lime, an international provider of on-demand scooters, is a well-known customer of Twilio IoT. In that case, Twilio facilitates programmatic communication with several hundred thousand scooters spread across 30 countries. Twilio’s acquisition of Electric Imp gave them new capabilities in IoT, which are being incorporated into the platform. We could envision further moves into the IoT arena either through acquisition or organic development.

Edge compute and distributed serverless environments have been getting more visibility lately with announcements from Cloudflare and Fastly, and the rise of Agora. As we continue to look at the evolving nature of edge networks, it is interesting to consider that Twilio just launched their Edge Locations offering with 10 POPs distributed across 5 continents. As mentioned above, Twilio offers a programmable serverless environment as well, called Twilio Runtime. With it, developers have the ability to upload code and run it within the Twilio environment. This capability is could be expanded for IoT solutions in the future. With the roll-out of 5G, having the ability to programmatically interact with IoT devices (both ingestion of data inwards and sending signals outwards) will be necessary. Edge compute provides efficiency and reduces latency, versus requiring all interactions to be processed at the origin. This could be another future product expansion for Twilio, allowing them to leverage their existing capabilities in enabling programmatic IoT device communications.

Twilio Take-aways

I thought Twilio’s revenue performance was strong in Q2 for two reasons. First, it was the first quarter of pure organic growth, representing the full absorption of the SendGrid acquisition into reported revenue with no more need to adjust for the past inflation of revenue growth. Second, while there are categories of business that are driving incremental Twilio spend due to the COVID-19 situation, there are other major categories, like travel, ride-sharing, hospitality, etc. which are still far below pre-COVID activity levels.

Yet, in spite of these conditions, Twilio still delivered 46% year/year revenue growth. On an organic basis, this was just a 2% deceleration from Q1, which experienced little COVID-19 impact. Further, Q3 revenue growth estimates appear to imply a re-acceleration, if we apply the same outperformance from Q2 to the Q3 estimate.

Profitability measures also continue to make progress. While 2020 was originally presented as an investment year, the revenue outperformance has driven a step up in operational leverage. We are seeing Non-GAAP measures like EPS and operating margin turn positive. Twilio benefits from strong operating leverage in Sales & Marketing spend, with the lowest Non-GAAP percentage of revenue as compared to peers.

Twilio continues to add new customers at an impressive rate. While some of this can be attributed to COVID-19, the higher year/year rate of customer adds continued from Q1 to Q2. This is in spite of a larger absolute number of customers, now at 200k. These increases will provide a long tail of revenue growth going forward, as these customers will presumably continue increasing their spend over time. Twilio’s DBNER of 132% is impressive for a company approaching a $2B annual revenue run rate. We don’t expect this rate to stay in the 130% range for an extended period, but this rate is higher than comparable software providers of this size. In simple math, if Twilio is adding customers at a rate of 20% growth a year and those new customers then increase their spend by 130% a year, we should expect high revenue growth (40% range) to persist for some time.

Customers continue to add email to their Twilio package. Most of these are likely migrating from managing email distribution themselves with open source tools. While it is easy to stand up an outbound email server, managing deliverability across multiple Email Service Providers is very challenging. As part of the SendGrid acquisition, Twilio leadership envisioned this kind of cross-sell opportunity.

HIPAA compliance came at the perfect time, as evidenced by Twilio’s multiple customer wins around telehealth. Twilio leadership views healthcare as a large opportunity for them, both for video and their other solutions. Also, HIPAA compliance represents a barrier to entry for competitors.

Looking beyond Twilio’s current strong execution with the existing product set, there are additional vectors to fuel future growth. I have discussed several above, including marketing, customer engagement data, IoT and edge networks. With the additional capital raise and hints within the associated investor deck, Twilio may be lining up more acquisitions. The upcoming Signal user conference could also provide tangible indications of future directions.

Gross margin continues to be a sticking point, dropping to 56% this quarter. This is down 1% from Q1 and 3% year/year. Part of this can be attributed to the new A2P fees that represent a pure pass through. The other part is likely attributable to revenue mix. Twilio needs to deliver on the promise of higher margin software services, like email, Flex and potentially new offerings. At the same time, this lower gross margin penalty has already been applied by the market to Twilio’s valuation ratios. Its EV/Sales ratio is about a third lower than some peers growing at the same revenue rate. Regardless, if Twilio revenue growth can continue at its high rate, then presumably stock price would scale proportionally. In the Follow-on Offering Investor Presentation, the CFO highlighted a long term gross margin target of 60-65%, so we can likely expect some margin expansion over time.

Investment Plan

Twilio (TWLO) stock is up over 155% year to date in 2020, after consolidating in 2019. In November 2019, when the stock was trading at $98, I set a 5 year price target of $320. With the stock peaking at $288 in early August, I am confident this price target is achievable before 2024. However, I will wait until the end of 2020 before updating this price target, given the lingering uncertainty with the macro environment. In the meantime, I still think that investors will benefit from owning TWLO over the long term.

For my personal portfolio, I currently have a significant allocation to TWLO and it represents my second largest holding. Funny as it might sound for value investors, I consider TWLO to be a “safety” stock. It is unlikely to keep doubling year/year, but I am confident Twilio will continue to grow its revenue along a predictable trajectory long into the future. If nothing else, its position in a large, rapidly growing addressable market assures this. As operating leverage kicks in at scale, this will translate into increasing profitability and cash flow, which should drive the stock price.

I will continue monitoring Twilio’s performance this year and will be on the look-out for any announcements around use of its capital raise. Additionally, investors have the annual Signal event to look forward to in late September. This usually corresponds with exciting product announcements. As those materialize, I will provide additional updates either in blog posts or newsletter highlights.