Investing analysis of the software companies that power next generation digital businesses

Twilio (TWLO) Q3 Recap

Twilio announced Q3 earnings on October 26th. The results were strong, beating estimates for both revenue and earnings by a large margin. Similarly, the company raised Q4 revenue estimates by about 6% of annualized growth at the midpoint. In spite of this, TWLO stock dropped 5% the following day. As investors will recall, Twilio conducted their Investor Day on October 1st. During that event, leadership announced that they would exceed their Q3 revenue estimates, as well as provided several other bullish long term performance expectations. Those updates drove the stock up about 13%. Twilio also conducted their annual user conference, Signal, in late September, which included several new product releases and large customer use cases. Finally, Twilio acquired leading Customer Data Platform (CDP) provider Segment in October.

Obviously, the past several months were packed with exciting updates to the Twilio story. In this blog post, I review Twilio’s Q3 earnings, Investor Day and the Segment acquisition. I also dig into product enhancements announced at Signal 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

  • Q3 Revenue of $448.0M, up 51.8% year/year. This compares to the consensus estimate of $407.2M (and the company’s prior guidance of $401-406M), which would have represented growth of 38.0%. Twilio delivered a large beat of almost 14%. For comparison, Q2 revenue growth was 45.7%, so Twilio achieved sequential revenue acceleration of about 6%.
  • Q3 Non-GAAP EPS was $0.04 vs ($0.04) expected, representing a beat of $0.08. This compares to non-GAAP EPS of $0.09 in Q2 and $0.03 in Q3 2019.
  • Q3 Non-GAAP operating income was $7.0M, representing an operating margin of 1.6%. This compares to operating income of $5.1M in Q3 2019, for an operating margin of 1.7%. Q2 2020 operating margin was 2.4%.
Twilio Q3 2020 Earnings Presentation
  • Q4 Revenue estimate of $450–455M, representing growth of 36–37% year/year. Consensus revenue estimate was $432.1M, for 30.5% year/year growth. While this might appear to call for significant deceleration, investors should consider that Twilio’s original Q3 revenue estimate issued in Q2 called for 36-38% growth. The actual Q3 outperformance of 52% represented a beat of about 15% at the midpoint. Applying this same magnitude of beat to the initial Q4 estimate would imply Q4 actuals could land over 50% growth. Q4 is also seasonally Twilio’s heaviest usage quarter.
  • Q4 Non-GAAP EPS estimate of ($0.11) to ($0.08) versus analyst consensus for ($0.01). Given the outperformance in Q3 actuals on EPS of $0.08, Twilio could hit this estimate in the Q4 report.
  • Q4 Non-GAAP operating loss estimated in the range of ($15M) to ($10M). This is the same estimate that was issued for Q3 with the Q2 report. As noted above, Twilio delivered actual non-GAAP operating income of $7.0M.
  • Ended the quarter with cash, cash equivalents and marketable securities of about $3.3B.

Other Performance Indicators

Q3 Non-GAAP gross margin was 55%. This has been trending downward, from 56% in Q2, 57% in Q1 and 58% a year ago. While on the surface, this is concerning, there are a few explanations for the year/year decline:

  • The new A2P charges from carriers contributed about 130 basis points of the decline in year/year gross margin comparisons.
  • The growth of messaging (particularly in international markets) is pulling down the average gross margin.
  • Foreign exchange contributed about 100 basis points of negative impact, primarily due to the Euro appreciating relative to the U.S. Dollar.

Gross margin is still up from 54% in 2018. Also, the leadership team provided a long-term update on gross margin trends in the Investor Day presentation on October 1st. With the growing contribution of application services, they expect gross margins to trend up to the 60-65% long term target. Twilio leadership also points out that they are happy to process the lower gross margin SMS traffic, as it still generates gross profit and generates marginal incremental effort to service at their scale.

A2P fees contributed $10M to revenue in Q3, versus $7M in Q2 and $4M in Q1. A2P fees are charged by Verizon at this point and are simply passed through to customers. However, these started in 2020, so they account for about 3% of annualized revenue growth for Q3. This fee is a direct pass-through to customers and does not impact gross profit dollars.

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 = 20% (23% in Q3 2019)
  • S&M = 23% (26% in Q3 2019)
  • G&A = 10% (10% in Q3 2019)

DBNER was 137% in Q3, which compares to 132% for Q2. In Q3 2019, DBNER was 132% as well. A DBNER over 130% is best in class for SaaS companies.

Twilio Q3 2020 Investor Presentation, DBNER

Twilio had 3,664 employees at the end of Q3. This compares to 3,284 at the end of Q2 for an increase of about 11.6%. If we annualize Q3 revenue, we get a revenue run rate of $1.8B. This translates to about $489k of revenue per employee, just slightly higher than Q2.

While Twilio traditionally benefits from political traffic, it hasn’t been as large of a relative contributor to revenue as in the past. For Q3, political traffic represented about $10M of revenue or approximately 2% of the total.

Customer Activity

Twilio ended Q3 with 208,000 paying customers. This compares to 172,092 in Q3 2019, representing annual growth of 20.9%. Twilio had 200,000 customers at end of Q2 for sequential growth of 4.0% in Q3. Customer growth does appear to be slowing down sequentially as 2020 proceeds. We will want to keep an eye on this metric. Absolute customer growth is generally within 2019 ranges.

An active customer is defined as having generated at least $5 of revenue in the final month of the quarter. Twilio management has commented in the past about how some large companies are spending very little and represent expansion opportunities.

QuarterCustomer CountQtr IncreaseSeq Growth
Q1 2019154,797
Q2 2019161,8697,0724.6%
Q3 2019172,09210,2236.3%
Q4 2019179,0006,9084.0%
Q1 2020190,00011,0006.1%
Q2 2020200,00010,0005.3%
Q3 2020208,0008,0004.0%
Twilio Customer Metrics

Revenue from Twilio’s Top 10 customers represented 14% of total revenue, down from 15% in Q2 and up slightly from 13% in Q3 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 6% of revenue, down from 7% last quarter. As revenue from this customer appears stable, Twilio leadership will no longer break it out starting in 2021.

International customers contributed 27% of total revenue in Q3, down from 28% in Q3 2019 and up from 26% in Q3 2018. Twilio continues to see international growth as a big opportunity and several customer wins highlighted in Q2 and Q3 were from customers outside the U.S. If Twilio can achieve the same penetration internationally as in the U.S., then international expansion could become a long term revenue driver.

Twilio Q3 2020 Earnings Presentation

On the earnings call in prepared remarks, the Twilio leadership team shared some customer wins from Q3:

  • Expanded their relationship with Philips, a leading health technology company. In response to COVID, Philips built a virtual waiting room using Twilio SMS to replace their physical waiting space in just six weeks.
  • Health care providers like Yale New Haven Health and Boston Medical Center introduced new procedures to minimize patient exposure to viruses when visiting facilities for appointments. With this new solution, the patient texts the hospital when they arrive, and the hospital texts them back when a room is available so they can go straight to an exam room.
  • Entered into a new relationship with Banner Health, one of the largest not-for-profit healthcare systems in the country. After investigating several vendors, Banner Health selected Twilio to power patient notifications across multiple channels, beginning with their voice API. They view Twilio as the leading engagement platform that can power a consistent digital patient experience across the company.
  • Expanded their relationship with a Fortune 50 bank that was forced to close many branches in response to COVID. The bank was looking for a better way to engage with customers via digital channels. They selected Flex, integrating it with programmable messaging and Salesforce to power their new omni-channel digital customer engagement strategy to improve lead conversion and provide better customer service on-demand.
  • Signed a new Flex deal with Robinhood, a major provider of commission-free trading. As demand for their platform has accelerated as a result of COVID-19, Robinhood is continuing to scale its customer support with Flex.
  • Expanded relationship with Alaska Airlines, the fifth largest U.S. airline based on passenger traffic. In an effort to reduce direct interaction between employees and guests in response to COVID, Alaska is using Twilio’s programmable SMS connected to their reservation system to allow agents to send a customer’s boarding pass via SMS.
  • Entered a new relationship with Prometric, a global leader in technology-enabled testing and assessment solutions. With the acceleration of digital technology driving new consumer behaviors, as well as an increasing need for remote test proctoring as a result of COVID-19, Prometric selected Twilio as the video management service for their application with Flex as the user interface between the proctors, security agents, readiness agents and test-takers. 
  • At the annual Signal event on Sept 30 – Oct 1, Twilio also highlighted a few large customers by including them in keynote sessions. These included Delta Airlines and Nike. The CEOs of both companies participated in speaking sessions.

Leadership also highlighted some impressive stats around customer usage of Twilio services:

  • Messages sent and received nearly doubled in the first half of 2020, compared to the first half of 2019.
  • During the same period, developers using Twilio to access the WhatsApp Business API more than doubled.
  • In May 2020, Twilio SendGrid surpassed three trillion processed emails, sending an average of 2.5 billion emails per day this year.
  • Have experienced more than 500% increase in Twilio Video daily usage since COVID-19 hit.

Partnerships

In addition to customer adds, on September 9th, Twilio announced that Deloitte Digital had joined their Partner Build program as a premier Global Systems Integrator (GSI). As a SI partner, Deloitte Digital will build a Twilio practice to offer their Global 2000 clients fully built solutions that leverage Twilio Flex for contact centers, as well as communications APIs like video, voice and messaging. They will also collaborate on delivering pre-packaged solutions for health care, through Deloitte’s ConvergeHEALTH Connect product.

This new partnership is important for Twilio as it represents one of the largest additions to date to the Build program, which was first announced in 2018. Newer packaged solutions, like Flex, can require customization for large enterprises to adopt. Having a global SI available to perform this work, makes the integration easier. Also, when a large consulting firm like Deloitte builds a practice around a particular vendor’s technology, they are automatically motivated to sell that solution to their clients. The net result should drive more customer wins for Twilio. Analysts have been asking about the status of Twilio’s SI partnerships on past earnings calls. This announcement provides at least one major relationship to reference.

During Signal, Twilio also announced a new network of partner solutions for Twilio Flex, called Twilio Flex Ecosystem. This provides customer organizations with access to more than 30 validated solutions from partners such as Google, Salesforce, Zendesk, and Calabrio to help businesses execute their contact center transformations. 

Twilio Investor Day Presentation – Oct 2020

Analyst Reactions

Over the course of October, many analysts updated their price targets on Twilio. These actions followed the Investor Day event, the Segment acquisition announcement and the Q3 earnings report. In total, 18 analysts provided updated coverage ratings. Some have tripled their price targets since the beginning of the year. The vast majority maintain a Buy rating equivalent. Of those analysts that updated their price targets following the Q3 earnings report, the average price target is $366. This represents a 28% increase over the closing price of $286 on October 27th.

DateAnalystRatingPrice Target
10/27CanaccordBuyRaised from $380 to $385
10/27RBCOutperformRaised from $375 to $400
10/27MizuhoBuyRaised from $350 to $370
10/27Goldman NeutralRaised from $290 to $330
10/27KeyCorpOverweightRaised from $330 to $350
10/27Piper SandlerOverweightRaised from $315 to $365
10/13DA DavidsonRaised from $330 to $380
10/13Morgan StanleyOverweightRaised from $270 to $340
10/13JMP SecuritiesRaised from $320 to $360
10/13NorthlandOutperformRaised from $290 to $340
10/13NeedhamBuyRaised from $320 to $340
10/12FBNRaised from $340 to $360
10/12RosenblattBuyRaised from $255 to $375
10/5ArgusRaised from $310 to $330
10/2BairdOutperformRaised from $315 to $340
10/2CowenOutperformRaised from $310 to $350
10/2Wells FargoOverweightRaised from $315 to $325
10/2OppenheimerBuySet at $300
Ratings Assembled from MarketBeat, YCharts

After the earnings results, RBC Capital set the highest price target, raising to $400 and keeping an Outperform rating. Analyst Alex Zukin provided the following commentary.

RBC Capital analyst Alex Zukin raised the firm’s price target on Twilio to $400 from $375 and keeps an Outperform rating on the shares. The company reported a “very strong” Q3 with 52% growth in revenue vs. consensus calling for 38%, the analyst tells investors in a research note. Zukin adds that Twilio’s Q4 revenue guidance looks “highly conservative” and believes that the management is trying to remain “cautiously optimistic” given the “tricky” macro backdrop and the looming election.

Thefly.com, October 27, 2020

Product Development Activity

Over the past several months, Twilio announced a number of product enhancements and new releases. Several of these were unveiled as part of Twilio’s annual Signal event that ran from Sept 30 – Oct 1. The event was packed with informative sessions focused on helping developers and users at customer companies maximize their benefit from Twilio products. 

The interesting aspect of Twilio’s product strategy with most of their newer application solution releases is that they generate value for Twilio on two levels. First, some packaged applications generate usage revenue for the whole solution, like Flex for contact center on a per seat basis. Second, packaged solutions, whether monetized or offered for free, generate incremental usage of Twilio’s underlying communications API’s. While customers will pay for Flex on a per seat basis, their usage of Voice, SMS, social and Email APIs as part of running the contact center generates incremental revenue for Twilio.

Hence, Twilio can afford to offer some software packages for free or a discounted rate, because they are driving revenue through usage of the underlying communications APIs. This appears to be the strategy with WebRTC Go and Frontline, announced at Signal. This motion will likely continue to allow Twilio to build higher level software solutions on top of their programmable communications platform.

The following is a list of the major product releases that occurred over the past several months.

Microvisor

Introduced at the Signal event, Microvisor delivers a managed IoT software platform for device builders. The software package includes many common IoT software infrastructure components, like security, version updates and network connectivity. This leverages the Electric Imp acquisition from July and represents a big step forward in Twilio’s support for IoT developers. This product offering is starting as a closed private beta.

Twilio Blog Post

This is a significant extension of Twilio’s offerings in IoT. Previously, Twilio supported IoT efforts by providing cellular connectivity. This product release moves Twilio more deeply into the IoT device stack. Twilio’s goal is to accelerate IoT adoption by providing critical, but common, infrastructure to IoT device developers, so that solution providers can focus on delivering value to their individual or business customers.

In order to build the world’s leading customer engagement platform, Twilio developed deep expertise interfacing with telecommunications networks around the world — this expertise enabled Twilio to make Super SIM the best option for global cellular IoT connectivity. With Microvisor, Twilio expands its IoT ambitions to leverage the company’s true secret sauce: developer experience, developer relations, and the creation and operation of a mission-critical developer platform that scales from innovators to enterprises.

Twilio Press Release, September 30, 2020

Twilio leadership claims that Microvisor is the only platform that offers embedded device developers the convenience of a fully managed IoT platform, but with the open source programmability to customize the solution to meet their exact needs. In order to manage a large installment of connected IoT devices, embedded software developers normally have to address device security, cellular connectivity, firmware upgrades and connectivity retries. All of these require specific domain knowledge and contribute little to the actual experience of the IoT service. The new Microvisor platform abstracts away many of these common infrastructure challenges by offering:

  • Lifetime Managed Security.  A one-time fee will provide constant monitoring of vulnerabilities and application of security patches to the devices and associated cloud components.
  • Over-the-air software updates and debugging. Developers can debug devices remotely, wherever in the world they are deployed, and push code updates frequently and safely, without worrying about breaking the device with a bad update.
  • Support for any language and embedded OS. The architecture of Microvisor lets developers reuse any existing embedded code and continue developing in the language and embedded OS of their choice. This is achieved using hardware isolation technology, which is becoming available on popular IoT microprocessor systems.

Microvisor is in private beta currently with customers starting new IoT projects. In early 2021, this will transition to a public beta. Through 2021, Twilio plans to expand support for more hardware options, cloud middleware and connectivity methods, based on feedback from beta customers. In terms of pricing, Twilio is planning to announce a simple “one-time fee for 10 years of service”. This fee will cover security monitoring, software updates and other Microvisor management services. Separately, Twilio will still charge for wireless usage per their existing pricing plans.

Regardless, Microvisor should make it easier for start-ups with IoT business ideas to get off the ground and focus on value-add features versus figuring out how to get device communications off the ground.

Frontline

As workforces become more mobile, some estimates place the percent of workers without a permanent desk as high as 80%. Many of these individuals, like those in sales support, delivery, hospitality, wealth management and healthcare are still expected to remain in contact with their customers. To accomplish this, they often leverage their personal mobile device, even using their own phone number to communicate via SMS or voice. However, these communications are not available to the employer and disappear if the employee leaves the company.

Twilio’s new Frontline product provides a mobile application for employees that connects them with customers via SMS, WhatsApp or Voice. While the app is installed on the employee’s mobile device, the login, messaging and phone number are tied to their company identity. This allows the workers to have the convenience of their own mobile device, without having to rely on their personal phone number. This release was highlighted during the Signal event as part of a use case with Nike during the keynote.

As a mobile app, Twilio Frontline gives employees the communication tools they need to efficiently answer questions, solve problems and build relationships with their customers. Because Frontline is a packaged software application available for both iOS and Android, businesses don’t need to develop their own application from scratch. It is built on top of Twilio’s Conversations API, which supports multi-channel messaging experiences. This provides a single UI for responding to SMS or WhatsApp messages. The app also supports standard messaging features like emojis and attachments.

Twilio Frontline Product Video

The product is being launched as a private beta. It’s not clear if Twilio will monetize usage of Frontline separately, or simply offer the app for free in expectation of generating revenue from the increased usage of communications API’s.

Video WebRTC Go

Twilio has raised significant enterprise interest in their Video API offering, attracting health care providers like MDLive and Epic. They want to further capitalize on the migration of previously in-person 1:1 experiences to online video. At Signal, they released Video WebRTC Go which provides developers with a toolkit, sample code and documentation to enable them to address 1:1 video use cases like tutoring, dating, counseling, etc.

WebRTC is the primary standard for powering video applications and offers many features out of the box, like support for major web browsers, access to microphones and cameras, and connectivity to the internet. However, developers still need to set up signaling, media relay, logging and apply other best practices.

Twilio’s Video WebRTC Go package abstracts away most of this implementation complexity. The toolkit is available for web (React JS), iOS and Android. Once live, the service offers developer support tooling like log analysis and diagnostics to ensure the the video experience is smooth. Source code is available under the Apache 2.0 license, which is the most flexible.

Twilio Blog Post

Video WebRTC Go is fully available now and is being offered for free with a fairly high usage limit of 100k participant minutes per month. The assumption is that if a company builds a video product that really takes off, they would eventually graduate to a paid tier. Any online product might also leverage other communications API’s like SMS, Email, Voice, etc.

Event Streams

Event Streams provides a single API that consolidates event data from all Twilio touchpoints into a single data stream. This can be connected to a data streaming tool, like Amazon Kinesis, that would eventually feed back to a company’s data warehouse for analysis. This dramatically simplifies activity data collection and processing for large Twilio customers.

Every business is looking to better understand their customers, yet building a single view of a customer’s journey is difficult as the data is often spread out across different products and systems and accessed through disparate interfaces and formats. Twilio’s platform presents businesses with a unique purview across all channels to break down silos and deliver customer intelligence that leverages multi-channel customer interaction data — ultimately providing one single view of the customer experience.

Twilio Press Release, September 30, 2020

Data is sourced from all Twilio powered channels, including Voice, SMS, Super SIM, TaskRouter and others. This allows customers to conduct real-time monitoring of communications and easily aggregate activity data into reports. This data can be leveraged to optimize communications with end customers, based on how they engage with the enterprise across these different channels.

The product is being offered as a private beta initially, for free up to 100,000 events and 3 data sinks. Beyond these levels, we can assume Twilio will monetize usage. Interestingly, this capability was announced before the Segment acquisition. Segment would further facilitate the transmission of this activity data into the various enterprise software tools used for CRM and marketing.

Quick Deploy

Quick Deploy is a new capability that allows users to launch a Twilio app without requiring any coding. The feature leverages Twilio’s CodeExchange, which provides a number of pre-built applications that perform common functions associated with Twilio API services. Examples are Basic IVR, SMS Auto-response, One-Time Passcode Verification and even a Basic Video Chat. Users can customize the apps for their use through configuration and data entry. These apps are then deployed to the Twilio serverless environment, Runtime. Developers can access the source code, if they wish to fully customize a feature.

Quick Deploy provides an easy way for customers to spin up new apps to address their communications use cases. The benefit to Twilio is that these apps all utilize Twilio’s communications API’s. By providing pre-packaged code, friendly configuration and a runtime environment, non-technical personnel can make use of Twilio’s services without having to engage their development team. This should help expand usage.

Investor Day

Twilio held an Investor Day event on October 1st, coinciding with their Signal user conference. It was packed with business updates and financial projections. Twilio hadn’t held one of these for a couple of years, so investors and analysts were eagerly anticipating the event. Twilio published a detailed slide deck to accompany the presentation. I recommend that all Twilio investors read through the deck and listen to the webcast.

Here is a compilation of the significant take-aways from my perspective. This update was extremely valuable for investors and provided deep insight into the product and go-to-market strategy, including positive execution indicators that reinforce the upward trajectory of Twilio’s application solutions business.

  • As noted above, Twilio pre-announced that Q3 revenue was expected to be above the high end of the previous range of $401-406M.
  • Twilio annual organic revenue growth will exceed 30% for the next 4 years. In response to a question on the webcast, leadership further clarified that this is not a CAGR, but that growth would be over 30% in each year. This represents an important distinction, as revenue growth could be well over 30% in the near term and then marginalize to 30% by the end of the period. Also, note the organic label, as that would not include the contribution from Segment, where revenue growth is currently tracking at about 50%+ per year on a lower base.
  • Enterprise customers account for 36% of revenue, defined as companies with greater than 2,000 employees. The rest is split between mid-market (100 – 2,000 employees) and growth (less than 100 employees) companies. This implies that Twilio has a diversified revenue mix, with a large opportunity to expand within the enterprise segment. We know that Twilio has been landing large enterprise customers recently (Delta, Nike, etc.) and isn’t stuck in the SMB segment.
  • Messaging revenue has accelerated in 2020. In 2019, messaging grew 49% year/year. In Q2, it grew 59% year/year.
  • Application Services are growing faster than API revenue streams and currently contribute 12% of revenue. These constitute the high-margin software solutions built on top of Twilio’s core communications platform, including pre-packaged applications like Video, Flex and Conversations.
Twilio Investor Day Presentation, Oct 2020
  • Delivered enormous year/year growth in a few solutions, likely due to the digital transformation acceleration and remote work requirements as a consequence of COVID-19. Video usage is up 599% year/year, software messaging (Chat, Conversations) increased 208%.
  • Flex revenue has increased 184% year/year and the product now has over 600 customers. Leadership highlighted a new Fortune 100 insurance customer that moved 10,000 agents to Flex. Nike was also called out as a new Flex customer during the Signal event. This growth in the Flex business is noteworthy for investors, as Flex was hailed as a huge opportunity when announced in 2018, but arguably has taken some time to ramp up.
  • Email utilization has accelerated to 36% revenue growth so far in 2020, versus 31% in 2018, at time of SendGrid acquisition. This underscores the cross-sell opportunity and Twilio’s advantage in coverage of all customer communication channels in one platform.
  • As of Q2, Twilio had 142 customers that spent more than $1M in the prior 12 months, 15 that spent more than $5M, and 7 that spent more than $10M. These numbers are up significantly from the IPO in late 2017. As I was editing this, NET released their Q3 results. They are demonstrating similar growth in large customer traction, announcing their first $10M ARR customer. We could draw some interesting parallels in the up market customer motion by both companies.
Twilio Investor Day Presentation, Oct 2020
  • As of Q2, Twilio had 359 of the Global 2000 as customers, representing 18%. These customers spent about $30M, which is less than 10% of revenue for the quarter. This underscores the large opportunity Twilio has to continue moving up market and expand its enterprise business.
  • Broke out gross margin for several products – Messaging is 45%, Voice is 74%, Email is 87% and App Services is 89%. This provides evidence that Twilio has a path to improved gross margins over time, as software-enabled solutions make up a larger percentage of revenue.
  • Leadership set a long-term profitability model of 60-65% gross margin and 20%+ operating margin.
  • S&M expense already shows strong leverage at just 24% of revenue with a long term goal of 16-19%. This operating leverage in the GTM motion was highlighted as highly favorable, relative to other cloud-based software providers.
Twilio Investor Day Presentation, Oct 2020

The markets were clearly pleased with the announcements. TWLO stock enjoyed a 13% jump on October 2nd, most likely tied to the Q3 revenue guidance update and four year revenue growth projection. Analysts also reacted favorably to the event, with nine raising their price targets and maintaining a Buy rating.

Segment Acquisition

After some speculation, Twilio made the formal announcement on October 12 that they will acquire Segment for $3.2B in class A stock. The deal closed on November 2nd and should provide a modest revenue and EPS contribution to Q4 results. Twilio conducted an analyst call and published a presentation detailing Segment business performance and their combined vision going forward. The markets viewed this move favorably as well, with the stock jumping nearly 8% after the announcement was officially released.

For those not familiar, Segment offers a Customer Data Platform (CDP), which consists of software tools and APIs to enable online businesses to collect, clean, combine and distribute their customer data. This data can be aggregated around a unique customer identifier to form a full profile of each customer, which includes a history of their interactions with the business across all channels. That customer profile data can then be piped to CRM, marketing, loyalty or other tools to inform future interactions with that customer.

Segment Web Site

Segment enables these capabilities by providing compact code snippets that can easily be embedded into a company’s web site and mobile apps to collect customer data. That data is then imported into Segment’s cloud data store, cleansed and consolidated. Segment users can easily configure destination applications for customer data to be shipped. This is all done through an intuitive UI and includes 350+ integrations to most of the major SaaS-based business applications.

In my experience, Segment’s data collection, cleansing and customer aggregation capabilities are very robust, reliable and efficient. My team used their tooling at an online consumer marketplace recently. The challenge for any engineering team is that modern Internet businesses collect customer data from multiple channels. This data has to be tagged, aggregated and de-duped by customer. The process can be laborious to set up and very error prone. Similarly, numerous internal teams want customer data imported into their preferred visualization, CRM or marketing tools. Hooking up these pipes manually, even with open source solutions, represents undifferentiated development overhead that could be better spent on product features.

With Segment, this customer event data import and export is dead simple, usually handled through configuration, versus code. If a new destination is requested, it can be added through the user control panel. This process saves a development organization major cycles, as the mechanics of instrumenting web and mobile apps for customer interaction capture can quickly suck up significant time and generate ongoing headaches for the unlucky developer assigned to the task. Done manually, the developer has to make code changes for every new event that the marketing team wants to capture and every new tool they want to use. Segment offers a very convenient “replay” feature. This allows historical data to be quickly populated into a new destination tool.

Twilio and Segment leadership size the market for CDP at about $17B, which means the total TAM for the combined company would be $79B. According to IDC, Segment had the largest share of this market in 2019 and was 2x the size of their largest competitor.

Twilio Segment Acquisition Investor Deck, Oct 2020

Beyond the immediate financial contribution, this acquisition represents a strategic move by Twilio in my opinion. Combining Segment’s customer data collection capabilities with Twilio’s own communication tools and extensive contact data set would create a powerful platform to address the full lifecycle of customer engagement.  Twilio’s communications tools are “single shot” currently. They rely on other systems to measure customer behavior resulting from an SMS, voice or email communication. With Segment, Twilio will be able to close the loop on customer communications and offer enhanced services to drive the effectiveness of an omni-channel customer engagement campaign. This would be very powerful, as they could optimize customer response based on measured preferences for communication channel (SMS, email, voice, social, etc.), frequency, content, etc. This data could be fed into Twilio products such as Flex, Marketing Campaigns, or provide the basis for new customer engagement offerings.

Twilio Segment Acquisition Investor Deck, Oct 2020

In terms of valuation, Twilio shared that they paid a similar multiple to that of the SendGrid acquisition. At the time of that acquisition closing in 2019, the deal was worth about $3B (up from $2B at time of announcement due to share appreciation). SendGrid’s quarterly revenue in the Nov 2018 report was $37M, up 31.4% year/year. For 2019, Twilio expected revenue from SendGrid of about $170M. This places SendGrid’s multiple between 13.5 (time of announcement) and 17.6 (deal close). If we assume a top-end multiple of 18, then Segment’s annual revenue would be about $180M.

Segment currently has 5,000 customers with 250k developers using the platform. They also have over 350 integrations to external systems for data ingestion and export. Given that Twilo has over 200k customer and 10M developer relationships, there is likely opportunity for future cross-sell and evangelism of the Segment offering. Additionally, Segment has some impressive customers, including a number of digital natives like Atlassian, Instacart and Pager Duty, as well as more mainstream enterprises like Fox, VMWare, Levi’s, Reuters, Jersey Mike’s, Gap and IBM. Some of these may have light Twilio utilization and could be encouraged to increase their CPaaS spend.

Segment is a high performance business with revenue growth greater than 50% year/year. Additionally, their non-GAAP gross margin is about 75%, which should pull up Twilio’s average from the mid 50% range. At time of acquisition, SendGrid revenue growth was 31% and has increased to 36% most recently, presumably through cross-sell. This could bode well for Segment’s potential revenue growth from its current 50% base.

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. In my analysis of Twilio’s Q2 results, I included a fair amount of comparison to other public and private CPaaS vendors, both in financials and product offerings. The advantages I outlined for Twilio were largely maintained through Q3.

For this quarter’s analysis, I highlight several themes that I feel will continue to drive Twilio’s lead in the programmable communications and customer engagement space. In the simplest sense, Twilio’s position relative to competitors is an exercise in maintaining share of a large and rapidly growing market. As mentioned in the Segment acquisition commentary, Twilio estimates the TAM for their existing set of services as $62B in 2020. The acquisition of Segment would add another $17B to that, for a total of $79B. Additionally, in their Investor Day presentation, Twilio estimated that the TAM for their existing services would grow to $87B by 2023.

These are obviously large numbers. For investors, TAM projections are often fuzzy and directional at best. Still, Twilio is tracking towards about $1.7B in revenue for 2020, so they would occupy a small percentage of the total market. In the past, IDC has forecast a CPaaS CAGR of about 40% between 2017 to 2022, so we can expect continued growth in demand. On top of this, Twilio had published a study in July in which they surveyed over 2,500 enterprise decision makers globally to gauge the effect of COVID-19 on their company’s digital transformation roadmap. The overall sentiment was that social distancing and remote work accelerated companies’ transformations by several years.

COVID-19 was the digital accelerant of the decade. COVID-19 accelerated companies’ digital communications strategy by an average of 6 years. 97% of enterprise decision makers believe the pandemic sped up their company’s digital transformation.

Twilio Covid-19 Digital Engagement Report, July 2020

This implies that customer demand for Twilio’s services will continue to be high. Further, if we look at top line growth rates in the most recent quarter for Twilio’s primary stand-alone public CPaaS competitors, we don’t see a material change in traction or closing of Twilio’s leadership gap.

TWLOBANDVG
Q3 Revenue$448M$85M$317M
Annual Growth51.8%40.2%5.0%
Gross Margin55%49%48%
DBNER137%131%N/A
Customers208,0002,015N/A
Data Assembled by Author from Company Financials

As revenue increases and gross margins remain roughly stable, Twilio will be able to funnel their large gross profit into further R&D and S&M investment, which in turn will drive more growth. Based on insights gained from Investor Day, it is clear that Twilio is applying this investment towards the release of new software-driven product offerings with high margins, like Flex, Conversations, Video and now Frontline.

Of course, this represents a current snapshot and the space is continually evolving. Also, some new entrants have emerged to compete with Twilio for CPaaS spend. These include cloud vendors (MSFT), UCaaS providers (RNG, FIVN) and video specialists (API). However, I feel there are several themes in Twilio’s product and go-to-market strategy that will keep them ahead of these competitive offerings. These include a complete suite of communication services, value add software solutions, customer intelligence and neutrality.

Service Coverage

Twilio offers solutions for the broadest set of programmable communications services. They span SMS, voice, video, chat, social channels and email. No competitor addresses all of these channels, usually missing at least one. Twilio is still the only CPaaS provider that offers its own email solution. Video and social channels are also only addressed by a couple of other CPaaS providers.

Twilio Investor Day Presentation, Oct 2020

Additionally, Twilio has the broadest international coverage, with reach extending to over 180 countries. Bandwidth (BAND), for example, had been primarily isolated to a service geography of North America. They recently announced the acquisition of Voxbone, which will extend their reach into 60+ countries.

Having the broadest channel and geographical coverage is an important consideration for modern Internet businesses that span the globe and engage with customers through multiple touch points (web, mobile app, voice call, email, chat, social). A CTO or VP of Engineering looking for a programmable communications solution for their company’s software applications would prefer to use a single vendor for all channels and locations. This is because each vendor has a unique set of APIs to which the company’s developers would need to code. Having to distribute SMS communications through one vendor and email communications through another increases complexity and overhead. Additionally, it limits the ability for a single provider to track communication effectiveness across multiple channels for each customer, noting successful or failed delivery, and adjusting future communications attempts to the most productive method.

The same argument for simplicity applies to geographical coverage. It would be less desirable to split communications traffic by recipient location amongst different vendors. Sure, the development team could programmatically check for user country before sending an SMS, but that would incur additional overhead in maintaining API integrations to multiple providers.

I experienced this firsthand at an international consumer marketplace for the boating industry. We used Twilio for SMS, WhatsApp and Email communications to both renters and owners in our software application. Our customers were located all over the globe. Being able to send them communications regardless of location or channel through one provider was very convenient. Some of our customers would travel between different countries and even switch between SMS and WhatsApp depending on location.

While a vendor could make a play based on price, I don’t think the cost savings is generally worth the overhead, as developer resources should be spent on value-added feature building. Additionally, reliability of delivery is an important consideration. This is particularly relevant for email communications, where the provider needs to go to great lengths to maintain a favorable email reputation with every ISP in the world in order to ensure that emails sent don’t land in the spam folder. This is not a trivial undertaking that can be achieved simply by standing-up some email SMTP servers. With critical customer communications, a CTO wouldn’t want their engineering team having to waste time troubleshooting why customers in Brazil aren’t receiving their text messages or users on Comcast.net don’t receive emails.

Value Added Applications

On top of their core communications services, Twilio has been building packaged software solutions that are either licensed to customers or offered for free. These address a particular business function, where an out of the box solution will add value for the customer. In these cases, the source code is open, allowing the customer to modify or customize any aspect of the solution if needed.

Twilio Investor Day Presentation, Oct 2020

Examples of packaged solutions that are licensed separately include Flex (cloud contact center) and Marketing Campaigns (email marketing tool). The new Frontline offering announced at Signal falls into this category as well. Under the covers, these solutions utilize Twilio’s Channel APIs. So, while the software licensing generates revenue from customers, any communications sent over voice, SMS, email, etc. by the user drives incremental revenue to Twilio through these Channel APIs.

Twilio also provides open source starter projects oriented around particular use cases. These software packages are usually offered to customers for no incremental charge, with the expectation that usage will drive revenue from Channel API metering. Examples of these are the new WebRTC Go package announced at Signal, as well as other open source starter code projects, like those included in Twilio’s CodeExchange. These starter projects are well ahead of competitive offerings and make adoption that much easier, particularly for companies with limited development capabilities. Modifying existing code or configuring an app through an Admin UI is much easier than writing code from scratch.

This motion of creating new solutions will likely continue, as we saw with Frontline, introduced at Signal. I could foresee Twilio continuing to build on their platform base and offering more of these software solutions, perhaps at a faster rate. As another example, Twilio has been highlighting the fact that they ran their Signal virtual user conference on software written by their internal teams. This “virtual event software” made use of Twilio’s underlying video, email, chat and SMS APIs. I wouldn’t be surprised if Twilio eventually marketed this as a packaged event management solution in the future. Investors can likely think of many other examples of software-driven customer experiences that utilize communication channels under the covers. These building blocks are available for Twilio’s development teams to rapidly assemble into new product extensions.

Customer Intelligence

As an outcome of their broad channel coverage, Twilio collects a wide range of customer interactions. In the past, they have published some impressive utilization stats:

  • Processed over 3 trillion emails by May 2020 and generate 70B new ones each month.
  • Sent an email to over 50% of all email addresses in the world in the past 12 months.
  • Sent over 66B SMS messages last year.
  • Have collected over 3B individual phone numbers.

Longtime Twilio investors have probably noticed a shift in their product marketing from describing themselves as a communications platform to highlighting being a “Customer Engagement Platform” and referring to enabling customer journeys. I think this change in messaging is subtle, but underscores the difference between Twilio and other CPaaS competitors, who still refer to themselves as API platforms.

This shift implies that Twilio has evolved to addressing the full lifecycle of communication with customers – not just facilitating single, isolated interactions through SMS, voice, video, email, etc. Twilio is leveling up to connecting these isolated interactions into an end-to-end customer journey. This aligns with their more recent product extensions – adding contact center support with Flex and a mobile customer management app for deskless workers with Frontline. By moving up the communications stack, Twilio is able to gather more intelligence about how enterprises are engaging with their customers. This data can be leveraged to provide enterprises with insights and prompts to further improve the likelihood of a positive future customer interaction. This allows the Twilio sales team to tell a story of optimizing customer engagement outcomes, which is more closely tied to enterprise success than saving $0.02 per 1,000 SMS messages.

With the Segment acquisition, Twilio is taking customer intelligence to a whole new dimension. Segment will allow Twilio to fully close the loop on customer interactions. After sending a communication to a customer (email, SMS, voice call, etc.), Twilio will then be able to measure that customer’s response based on their interaction with the company’s web site, mobile apps or other CX channels. They can tie a customer communication to a meaningful business event, like a product sale, event registration or video view. This will provide a very powerful feedback loop that will make Twilio’s engagement tools much more effective than those of competitors. Enterprises using most competitor solutions would need to rely on separate systems to measure the impact of communications and then try to tie that back into a holistic view of the customer. Additionally, the Twilio feedback loop would be able to automatically optimize future communications by channel, message, time of day, etc. in order to maximize response. This automated optimization is similar to techniques leveraged by other personalization systems.

Cloud Neutral

On September 22, Microsoft announced the launch of Azure Communication Services, which is viewed as a competitive offering to Twilio. Like Twilio, Microsoft’s new service provides programmable APIs for developers to use for communications. They currently support video, voice calling, real-time chat, SMS and phone number provisioning. These are positioned as an extension of the same communications services that make Microsoft Teams so useful, but now available separately for developers to consume to build new digital experiences. Also, they highlight integrations with other Microsoft services, like AI for chat context and language translation.

On the surface, this announcement is concerning as it represents another entrant into the CPaaS space. Microsoft, in particular, could leverage their existing customer relationships and offer these products in a bundled fashion with core infrastructure. They might peel away some Twilio customers or land new ones on their service who might have considered Twilio.

However, I am largely ambivalent about this move by Microsoft for a few reasons. First, this service would only be relevant for Azure customers. AWS, GCP or other cloud vendor customers would be unlikely to utilize this capability on a stand-alone basis. Second, the channel reach is not complete, as it is currently missing email and social. Finally, the communication bias appears to be single shot, without closing the loop and forming a cohesive view of customer interactions. As an extension to Teams, these services might be more relevant for building internal corporate applications that send communications to employees.

Most importantly, though, I believe that CTO/CIO’s at large enterprises value working with an independent provider of software services where possible, in order to avoid lock-in with any particular cloud vendor. As I discussed in a prior post, independent software providers have the advantage of allowing customers to pursue a multi-cloud strategy and leverage best-of-breed solutions from neutral providers where possible. Programmable communications is one of the easiest services to integrate from a third-party, with no real advantage in locating the service origin with proximity to compute or data. As I argue in the blog post, independent software providers have the advantages of network effects, focus, talent and product development velocity. While Microsoft has incredible resources behind them, these are dispersed across a large organization. Independents, like Twilio, have the advantage of focusing on a subset of customer problems every day. Over the long term, this focus will yield more targeted product extensions and a more purpose-built end-to-end engagement solution.

Twilio Take-aways

Twilio’s growth continues to impress, particularly as the company approaches $2B in revenue. In Q3, annualized revenue growth accelerated about 6% from Q2. Even if we account for the bump from political ad spend and the increase in A2P fees, revenue growth accelerated 2%. This sets up a favorable Q4, which tends to be Twilio’s strongest quarter.

Even with higher revenue growth, Twilio is maintaining consistent profitability. They delivered positive income again in Q3, and have maintained an operating profit margin of about 2% for the past two quarters. Keeping this low for now is fine with me, as Twilio continues to invest in R&D and S&M to pursue the large opportunity in front of them. Even with more investment in their go-to-market effort, Twilio still maintains one of the lowest ratios of LTM sales and marketing spend as a percentage of revenue (at 24%), as compared to other cloud software peers. This is in spite of increasing their quota carrying sales rep headcount by 79% year/year in Q2.

Twilio Investor Day Presentation, Oct 2020

Supporting their revenue growth is an impressive DBNER of 137%. Any value over 130% is best in class for a software company, particularly at this scale. Additionally, Twilio currently generates a small percentage of their revenue from large enterprises, as compared to peers. Customer companies with 2,000 or more employees made up 36% of revenue in Q3. This implies Twilio has significant runway in this segment. They have only penetrated about 18% of the Global 2000 at this point. Yet, Twilio continues to land larger customers (recent examples like Nike and Delta), so we know the up market motion is possible. Also, international only accounts for 27% of total revenue. This is another area where Twilio has been ramping up their GTM investment.

Areas to watch include gross margin and customer growth. Twilio’s non-GAAP gross margin has been ticking down for the past 3 quarters, and is now 3% lower year/year. Much of this can be attributed to the A2P fees, relative mix of international messaging traffic and some currency fluctuations. As part of Investor Day, Twilio leadership set a long term target of 60-65% for gross margins. This should be achievable, given the increased uptake of higher-margin application services, like Flex, Email, Video and Voice. Segment will also contribute meaningful revenue in 2021 at a 75% gross margin.

Sequential customer growth slowed down to 4% in Q3, after peaking in the 5-6% range in Q1 and Q2. This could be due to some pull-forward as COVID-19 impacted businesses initially. If Twilio can maintain 20% annualized customer growth, combined with their high DBNER, then revenue growth in the 30-40% range should be achievable for some time.

Investor Day provided more optimism for the long term trajectory for Twilio. Leadership committed to greater than 30% revenue growth for the next four years. They revealed rapid growth of application services, now contributing 12% of revenue. Additionally, Flex is experiencing real traction with 600+ customers and several lands with Global 2000 companies. Leadership provided evidence that their operating leverage would produce profitability, with a long term operating margin target over 20%.

The Segment acquisition is very exciting and opens up new opportunities for Twilio. It is accretive to the overall business financially, with estimated revenue of $180M, growing at 50%+ a year. On the product side, Segment rounds out Twilio’s feedback loop and should enable new offerings that address the full lifecycle of customer engagement. Many cross-sell opportunities exist and these capabilities provide a further differentiation from one-dimensional competitive offerings.

Looking even further out, Twilio is demonstrating thoughtful and strategic product expansions. While nascent, IoT could become a meaningful revenue contributor down the road, particularly after 5g roll-out. Facilitating 1:1 video interactions embedded within customer software applications appears to be gaining traction, particularly within health care. Frontline provides another example of a stand-alone application, like Flex, built on top of Twilio’s Channel APIs. Rolling this out with Nike represents a huge initial demonstration of the potential. I think we will see more of these packaged software solutions in the future, that will drive new license revenue and incremental usage of Twilio’s Channel APIs under the covers.

Investment Plan

Twilio (TWLO) stock is up around 200% (or 3x) so far 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 currently trading around $300, I am confident this price target is achievable before 2024. However, I will wait until the end of 2020 before updating this price target, allowing me to see Q4 results and get a glimpse into 2021. 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 one of my largest holdings. While Twilio is not likely to double again in 2021, I am confident Twilio will continue to grow its revenue along a predictable trajectory long into the future. This view was reinforced by leadership’s perspective shared at Investor Day. If nothing else, Twilio’s leadership position in a large, rapidly growing addressable market assures this. In spite of competition, Twilio is maintaining its share in core markets and expanding its reach with new bets on IoT, video and customer engagement tracking.

NOTE: This article does not represent investment advice and is solely the author’s opinion for managing his own investment portfolio. Readers are expected to perform their own due diligence before making investment decisions. Please see the Disclaimer for more detail.

15 Comments

  1. Irnest Kaplan

    Oustanding analysis !
    Thank you

  2. Victor Tango

    One more article that provides usefulness and validity through a vast info of research findings. The study and the careful assessment of the features of this publish are outstanding. I am champing at the bit to read your new analyses.

  3. Volker

    I concur, really outstanding. I learn so much from each analysis you are providing. Thank you so much!!!

  4. Nguyen

    Hi Peter,

    Thank you for your great analysis as always. I was wondering if you are planning to cover JFROG soon? I’m a software developer and all the company I worked before use Artifactory which I believe is second to none currently. Looking forward to hearing from you soon 🙂

    • poffringa

      Thanks. I may publish a deep dive on JFROG in the future, as they do fall into my coverage scope. I usually shy away from new IPO’s for a couple of quarters. I am familiar with their toolset and agree with your product assessment.

      • Ruben

        Growth is slowing down at JFROG though, from high 60s to high 30s in a couple of quarters. Could be pandemic related, as we are seeing with DDOG. Anyway, thanks for this great article!

  5. Frank Wang

    Hi Peter, this is awesome. I love TWLO product for a long time since I am a software engineer myself. I currently own 5% TWLO in my position. After read your analysis, I have even more confident for the future of TWLO. Keep up the great work!

  6. Tool

    Great coverage. What do you think about that Twilio not making it into the ‘Rule of 40’ guideline (or just on the verge, really)?

    • poffringa

      Thanks. I think it’s fine, as Twilio isn’t focusing on maximizing profitability at this point. I think they are still demonstrating sufficient operating leverage, with a positive Non-GAAP operating margin of about 2%. They also have one of the best ratios for S&M spend / revenue in the SaaS universe. Rule of 40 generally is applied to ensure that a company with high revenue growth isn’t achieving that simply by overspending on S&M. This isn’t the case for Twilio.

  7. ali hobballah

    Outstanding analysis !!! Ty so much for sharing .. This is by far the best note I ever read on Twilio . Beats any Walls street big bank report

  8. Alex

    Great Job!!! The best website about software companies out there. Already learned a lot…THANKS

  9. Victor Tango

    Hi Peter,
    At your coverage table noticed that DOCU has a new 5 year target $610 is it correct?

    • poffringa

      Yes – when I first initiated coverage of DOCU in April, it was trading at about $100 and I set a 5 year price target of $245. DOCU has already passed that at least once. So, in my Q2 DOCU recap for October, I raised the 5 year PT once again to $610. I think this is achievable by 2024.

  10. film

    I value the blog article. Much thanks again. Much obliged. Clarisse Cassius Cristina

  11. Colin

    Excellent analysis, so much work put in. Thanks especially for the insight into the Signal acquisition. Had been a bit concerned about the company making too many acquisitions rather than developing their own software, but you have reassured me. Does become more difficult to follow as a punter as it becomes more diverse, so your thorough analysis is greatly appreciated.

    Thanks