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Twilio Stock Is a Long-Term Winner, But Valuation Concerns Are Warranted

Luke Lango

One of the market’s best-performing stocks over the past several quarters has been software giant Twilio (NASDAQ:TWLO), and with good reason.

Twilio Stock Is Ready to Top Out, but Keep Your Eyes Peeled for a Big Dip

Source: Web Summit Via Flickr

Twilio stock is up more than 300% over the past two years. The company has pioneered a new market called Communication Platforms-as-a-Service (CPaaS), which essentially gives enterprises the ability to communicate in real-time via voice, text, and video with their customers.

Enterprises love this market, and Twilio is the king of the market. Consequently, as the CPaaS market has exploded higher over the past two years, so has Twilio’s revenue and customer base, causing Twilio stock to soar.

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This trend should continue in the long-run. TWLO is the unrivaled king of a non-cyclical growth market with huge potential. The company also has healthy gross margins, and significant room for operating-spending leverage. As a result, Twilio is clearly poised to generate robust revenue and profit growth over the next several years. That combination will ultimately drive Twilio stock meaningfully higher in the long-run.

But in the short-term, valuation concerns related to TWLO stock are warranted, and that may put a lid on Twilio stock in the near-term.

Valuation concerns are nothing new for Twilio stock. Bears were concerned about valuation when Twilio was a $30 stock. No,it’s a $125 stock. Clearly, TWLO stock has been able to shrug off valuation concerns in the past. That may very well continue to happen as investors concentrate on the  long-term outlook of TWLO stock.

Nonetheless, investors should be cautious about TWLO. Twilio stock is a long-term winner. But  in the near-term, investors will be concerned about the stock’s valuation at its current levels, and as a result, on any operational hiccup, TWLO stock could be weak.

The Long Term Outlook Is Promising

The CPaaS market is the future, and that bodes well for TWLO stock’s long term potential.

We live in a world in which everyone is connected via phones, and phones are used primarily for real-time communication (think texts, push notifications, and the like). Consequently, it is increasingly important for enterprises to reach their customers through real-time communication, in order to maximize reach and awareness.

CPaaS enables enterprises to do that by giving them real-time communication tools they can use to reach their customers via messages, voice, and video. For example, Uber can text its customers when their rides are close, and Postmates texts its customers when their food is close to being delivered.

CPaaS is all about consumer-facing companies communicating directly and dynamically with their customers, in order to personalize and enhance their customers’ experience.

That is the future. And TWLO is pioneering this future with the industry’s best CPaaS solution. That’s why this company has consistently reported revenue growth north of 50%, customer growth north of 30%, and retention rates north of 95%.

But TWLO only has roughly 60,000 customers. There are well over 100 million businesses globally. Not all of them will tap into the CPaaS market, but it’s clear that Twilio is in the first inning of a huge growth opportunity. Indeed, IDC thinks that the CPaaS market is just getting started. Revenues across the space in 2017 were  $2 billion, and its revenues in 2022 are expected to come in at $10.9 billion.

Consequently, as long as Twilio remains the leader of the  CPaaS market, this company should grow rapidly for a long time. That huge growth will power TWLO stock higher over the long-run.

The $125 Price Tag  Is a Stretch for Now

Although  TWLO’s long-term growth outlook is powerful, in the near-term,  concerns about the valuation of Twilio stock are warranted. That’s because, even if we assume that TWLO  will grow a great deal over the long-term, the current price of Twilio stock seems stretched.

Using numbers from IDC and Twilio, it’s easy to see that Twilio’s share of the CPaaS market has dropped as the market has matured over the past few years. That makes sense.

Back in 2015, TWLO was largely the only real player in the market. Since then, multiple companies have entered the market , and as those new players have jumped onto the scene, Twilio’s market share has dropped. That’s natural and nothing to worry about.

Based on the latest available data, from 2017, Twilio controls about 20% of the CPaaS market. In a best-case scenario, as the market matures and the number of new players drops, Twilio will be able to increase its market share to 25%.

IDC thinks this market will be worth over $10 billion by 2022, up more than 500% from 2017. Assuming growth slows but remains robust, the CPaaS market could easily double between 2022 and 2025 and hit $20 billion.

If TWLO’s market share reaches  25% when the market is worth $20 billion,  its top  line would reach $5 billion. Assuming its gross margins expand towards 60%, and its operating-spending rate normalizes lower to 35%, then 25% operating margins seem doable by 2025. In that scenario, its operating profits would be $1 billion.

That could easily result in earnings per share of $5   That’s up dramatically from this year’s projected EPS of 10 cents. But, it’s still not enough to warrant a price per share of $125 . Based on a forward price-earnings multiple of 37, which is average for application software companies, that implies a reasonable 2024 price target for Twilio stock of $185. Discounted back by 10% per year, that equates to a 2019 price target of under $115.

The Bottom Line on Twilio Stock

TWLO stock is a long-term winner. But near-term concerns about its valuation are very well-founded, and will likely limit the advances of TWLO stock for the foreseeable future.

As of this writing, Luke Lango did not hold a position in any of the aforementioned securities. 

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