Twilio stock (NYSE: TWLO) is down about 76% year-to-date and 85% from all-time highs. The valuation is now very attractive – trading at a one-year EV/Forward Sales of around x2.3. And considering a reasonable price 3-year CAGR outlook of around 30%, this ratio is expected to contract towards x1 by 2025 (assuming stable market capitalization and net debt).
Additionally, doubts about profitability should soon disappear, as CEO Jeff Lawson is convinced that the company will achieve a positive operating result from 2023.
Always a growth story
Against the backdrop of business digitalization and the growing adoption of cloud-based communication solutions, Twilio’s business has grown at a rapid pace. From 2017 to 2022 (benchmark TTM), Twilio’s revenue grew at a CAGR of over 50%, from $399 million in 2017 to $3,902 million for the last twelve months. During the same period, gross profit grew at a CAGR of 50%: from $216 million to $1,631 million.
While in 2022 growth has slowed sharply for many companies, Twilio has still managed to perform – despite the challenging macroeconomic backdrop. In the second quarter, the company generated $943 million in sales, reflecting a 41% year-over-year increase. Moreover, although Twilio guide with some caution for the third quarter, expecting just $965-976 in revenue, analysts remain confident that Twilio could defend a CAGR above 25% through at least 2025 (Source: Bloomberg Terminal, EEO, 14 october).
Expect profitability for 2023
Like many high-growth companies, Twilio has yet to prove its operational profitability. In recent years, this pressure has not been a problem for management, as investors value aggressive growth over profits and growth capital is cheap. But the environment turned bad at the end of 2021/2022.
That said, Twilio CEO Jeff Lawson is very confident that the company will achieve operational profitability in 2023:
we continue to affirm that for the year 2023 we are aiming for operational profitability .. which we have not stopped repeating to investors. And we are focused on achieving that goal.
When asked if this goal would be tied to an improving macro environment, Jeff replied:
I do not think so. We monitor macro trends. But (so far) we haven’t seen a large-scale impact or demand shift in our business. We have seen some categories that are enjoying some strength – such as financial services, [and] THIS.
In my opinion, profitability should be achievable against the background of reducing the number of employees and other “efficiency levers”. Just a few weeks ago, Twilio announced the layoff of approximately 11% of its workforce, which could probably support up to $120 million in lower operating costs.
Additionally, looking at Twilio’s income statement, the company could likely aim for a significant reduction in annual SG&A spending of $1.723 billion and R&D spending of $953 million (benchmark TTM), which consumes up to at 50.5% and 28% of income.
The problem with many growth companies is that they are priced at an excessively high valuation. But since October 2022, Twilio no longer trades at such levels – having lost around 85% of the stock’s value from all-time highs.
TWLO stock is now valued at around x2.3 EV/sales, which compares to x4.7 EV/sales for Salesforce (CRM).
Valuation of residual profits
To derive a more accurate estimate of a company’s implied fair valuation, I’m a big fan of applying the residual earnings model, which is based on the idea that a valuation should equal the discounted future earnings of a business after capital charge. According to the CFA Institute:
Conceptually, residual income is net income less a charge (deduction) for the common shareholders’ opportunity cost in generating net income. It is the residual or remaining income after taking into account the costs of all of a business’s capital.
With respect to my TWLO stock valuation model, I make the following assumptions:
- To forecast EPS, I rely on analyst consensus forecasts available on the Bloomberg Terminal through 2025. In my opinion, any estimate beyond 2025 is too speculative to be included in a valuation framework. But for 2-3 years, analyst consensus is usually pretty accurate.
- To estimate the capital charge, I rely on TWLO’s cost of equity at 9%.
- For the terminal growth rate after 2025, I apply 4.5%, which (about two percentage points higher than estimated nominal world GDP growth).
Given these assumptions, I calculate a base target price for TWLO of approximately 71.46/share.
My base target price does not calculate much upside. But investors should also consider the risk-reward profile. To test various assumptions about TWLO’s cost of equity and terminal growth rate, I constructed a sensitivity chart. Note that the matrix looks very favorable from a risk/reward perspective. With bearish assumptions, the bearish scenario is around $59/share, while with bullish assumptions, the bullish scenario could reach $277/share.
Reflecting on Twilio’s strong second quarter and the company’s CEO’s confident comments on the resilience of the business, I see no material risk to Twilio’s growth prospects and/or competitive positioning. But investors should note that the company could fail (simply based on probabilities and uncertainty) to generate operating profitability in 2023. This would certainly be seen as a strong disappointment by investors and the stock would likely be sold. up to $50/share. , otherwise at all-time lows around $30/share.
Investors should also consider that much of TWLO’s stock price volatility is driven by investor sentiment towards risk and growth assets in general. Thus, investors should expect price volatility even if Twilio’s trading outlook remains unchanged. Finally, rising real yields could add significant headwinds to Twilio’s stock price as higher discount rates affect the net present value of long-term cash flows.
I like the risk/reward of buying TWLO stock at prices below $70/share. In my opinion, a valuation of x2.3 EV/Sales simply does not take into account the company’s strong growth prospects and (hopefully) operational profitability by 2023.
According to my model – which I anchor on a residual earnings valuation – TWLO stock should trade at $71.46/share. To buy.