Before I begin, I would like to give a special shoutout to my friend, Thomas Chua, whom I’ve worked with on this piece. He runs an incredible blog and writes on a level with such clarity that I strive towards. Do check out his writings at steadycompounding.com

Let’s talk about Twilio. If you haven’t already heard of them, they actually share some similarity with Google, Mastercard, and Amazon Web Services (AWS). What do they have in common?

Google and Facebook are a tax on e-commerce. Visa and Mastercard are tax on payment. And AWS and Microsoft Azure are a tax on cloud computing.

In the same vein, Twilio is a tax on communications software.

Twilio is the cloud communications tool that bridges software with communications systems

Twilio is a cloud communications platform used for customer engagement by over 221,000 active customers and more than 10 million developers.

Twilio is what allows you to text your Lyft driver or order a pizza online. It’s built into Hulu,  Twitter, and Salesforce alike, to help with communication and information sharing. Twilio is transforming businesses that never imagined themselves as digital companies and helping them grow, amidst intense pressure to either evolve or face their own demise.

Example of how Whatsapp uses Twilio’s API

Twilio’s application programming interfaces (API) allows companies to talk to their customers on a preferred platform—Whatsapp, Facebook Messenger, Chatbots, SMS, phone call, email, live agents, etc. Many of us have undoubtedly used Twilio without even knowing it.

Twilio targets developers, making it easy for them to integrate Twilio’s code into their own. Twilio also charges on a pay-for-what-you-use basis, similar to how AWS sells its computing power.

Twilio’s team of developer educators  run hackathons within large enterprises undergoing digital transformation to show them how Twilio’s API could be integrated into their software, shortening their communications product development cycle from months and years to days and weeks.

Twilio’s Products

Faced with a complex maze of thousands of global carriers, government regulations, proprietary software, networking gear and old protocols, it is very challenging for companies to develop an all-in-one solution that communicates with their customers from all around the world.

The pay-for-what-you-use model ensures that customers can test out new ideas for just a few pennies and scale when they have found success.

You can read more about their products here.

Twilio classifies their platform into three segments: (1) Segment Customer Data Platform, (2) Channel APIs, and (3) Solutions.

(1) Segment Customer Data Platform. In the past, companies often grappled with data in silos—customers’ data under different divisions and touchpoints (i.e., whether they purchased in-store, online, or subsequently contacted customer services) were stored separately and companies were unable to learn about their customers’ shopping habits at scale.

Their acquisition of Segment allows businesses to have a complete view of their customer data. Segment’s platform collects, cleans, and controls their customer data and these insights enable businesses to delight their customers with personalized and impactful communications.

Take Camping World for instance. America’s leading recreational vehicle (RV) and outdoor retailer signed a deal with Segment recently. Camping World is made up of three distinct businesses in 1) RV sales, 2) Outdoor equipment & gear retail, and 3) Good Sam—a membership club for RV & outdoor enthusiasts. Prior to Segment, these three divisions collected and stored customer data in silos. With Segment, Camping World is empowered to aggregate customer data across various digital touchpoints and uncover data driven insights to deliver an increasingly personalized experience for their customers.

(2) Channel APIs. This is Twilio’s bread and butter and it provides building blocks that enable customers to build what they need. This gives businesses the leeway to customize their customers’ experience while letting Twilio’s API handle all the heavy lifting pertaining to communications at the back. 

Here are the building blocks Twilio provides:

Messaging: 

  • Allows businesses to ensure that their messages reach end users wherever they are via SMS, MMS, and over-the-top (Whatsapp and Facebook Messenger).
  • We often see them used for appointment reminders, delivery notifications, order confirmations and customer care.

Voice:

  • Allows developers to embed phone call capabilities, enabling them to manage class via browser, an app, a phone, or anywhere else one can take a call.
  • It also supports advanced capabilities such as text-to-speech, conferencing, recording, and transcription.

Email: 

  • The acquisition of SendGrid Email API supports businesses with the sending of marketing messages, transactional emails (such as shipping notifications), friend requests, password resets, and sign-up confirmations.

Conversations: 

  • Supports cross-channel, multiparty conversations. 
  • For example, if your customer prefers to communicate on SMS while your business support is on Whatsapp, Twilio Conversations allows your customer to receive your responses on SMS even though you are replying on Whatsapp.
  • Two-way messages will be the next wave of innovation in messaging. Take the SMS message from Standard Chartered for example:
  • Traditionally, it has always been a one-way communication, and customers are unable to respond even if they wish to find out more. Twilio Conversations enable customers to reply to a human being or a bot that could enhance customers’ experience.
  • Morgan Stanley is one such example, when they inform clients about a new product launch, clients could respond directly to the messages and their queries would immediately be routed to their wealth managers.

Video: 

  • Provide the building block to add voice and video to web and mobile apps. 
  • These are often used in video consultations, telemedicine, e-learning, recruiting, social networking, and more.

(3) Solutions. These are off-the-shelf solutions built on top of Twilio’s Channel APIs. This saves businesses time in building their own applications and yet provides them with optionality to customise their software, which is a key differentiator from the current SaaS offerings. Here are the solutions offered:

Contact Center: 

  • Twilio Flex is the industry’s only fully programmable contact center that allows companies to deploy a broad array of customer engagement channels while providing the tools to easily create, change or extend any part of their custom solution.
  • Having witnessed how difficult it is to set up a contact center with legacy players such as Cisco in my previous job (it took up to a year and there were multiple hiccups after deployment), I have come to appreciate the benefits of a contact center built on cloud. Take the following use case:

During the height of COVID-19 pandemic, the Government of United States was having issues with keeping up with their helplines and the amount of calls skyrocketed to 75,000 calls a day from 30,000 per day during ordinary times. Calls lasted longer, at 30 minutes compared to the average of 4 to 6 minutes as many people were insecure and anxiety was high.

To deal with the surge, Twilio Flex was deployed, in just four days! It created a system that allows an AI-assisted interactive voice response (IVR) system to deal with commonly asked questions and automatically directed calls to their local services, preventing the helpline at the country level from choking up.

User Verification

  • Twilio Verify helps reduce online fraud by using Twilio Authy (two-factor authentication APIs) with second-factor passwords sent to a user via SMS, voice, email or push notifications.
  • Marketing Campaigns
  • Twilio’s marketing campaigns help digital marketers build and send email campaigns at scale with easy-to-use drag and drop editing, automation, and contact management.

All of Twilio’s products are built on top of the Super Network—Twilio’s very own software layer that allows customers’ software to communicate with connected devices globally. Think of this as a platform where Twilio optimizes reliability, cost efficiency, speed, and quality at which users can communicate with each other while using Twilio’s product. 

“Developers First” Approach

Twilio’s goal is to be in the toolkit of every software developer in the world. They enable developers to build, scale and operate real-time communications within software applications, ultimately empowering every developer and company to improve their interactions with their customers through software.

There has been a shift in power to developers as software is rapidly disrupting industries. The demand for developers is not limited to technology companies—in 2012, 57% of all developers were employed by non-software companies, according to a survey by the U.S. Bureau of Labor Statistics. Nike now employs more software engineers than it does clothing and apparel designers.

Part of their core strategy in wooing developers to adopt their solutions is to provide a broad set of lower-level building blocks that can be used to build any digital experience—allowing developers’ creativity to flourish across the widest set of use cases.

Customers are charged on a usage basis, which means a developer can just take out his credit card and immediately start building a prototype. If there’s success, Twilio will follow up with their sales team and expand the relationship by introducing additional use cases.

This gives Twilio a very efficient go-to-market engine and allows the company to spend less on sales and marketing when compared to its peers who are growing at similar rates and scale. The management team claims that a substantial majority of their customers were acquired through the self-service model.

Table comparing Twilio’s S&M spending as a percentage of revenue with other players

Business Model

As Twilio’s customers succeed, they share their success through their usage-based revenue model. In other words, the more their customers use their products (e.g., more emails sent), and the more they use different types of products (e.g., installing chatbots on top of email capabilities), the more Twilio charges.

The most useful indicator to identify increased activity from existing customer accounts is the Dollar-Based Net Expansion Rate (DBNER). This number, expressed as a percentage, shows how much existing customers are spending from one year to the next.

Here is what Twilio’s DBNER look like:

Source: Q4’20 Earnings Presentation

In their most recent earnings call, the CEO outlined the following for maintaining growth at scale:

  • Keeping team size small and keeping the entrepreneurial spirit alive.

    So the team that we’re building, obviously, having great leaders throughout the company and organizing ourselves into small teams. And each small team feels itself like a start-up that’s pursuing an opportunity to serve our customers. And I think that small team structure enables us to innovate and to continue to drive new products for our customers and to truly keep our ear to the ground and keep our teams close to customers.
  • Long runway with huge TAM

    We provide building blocks that customers can use to build a wide variety of things in their customer engagement journey. And then based on their activity and what we hear from customers who come to us and what they’re building, they often show us unsolved business problems that they need solved because of the very nature of the fact that they’re building on our APIs. And so that provides us some tremendous visibility into the big unsolved problems that our customers need solved, which then drive our road map further.

Growth Strategy

Here’s Twilio’s two-pronged strategy for growth: 1) Growing the developer community, and 2) Expanding use cases for Twilio’s products

(1) Growing the Developer Community

In line with their goal to be in the toolkit of every developer in the world, Twilio engages new and existing developers via a number of conferences and events hosted throughout the year. In 2020 alone, Twilio hosted 285 virtual events. 

Of these, the biggest is the annual SIGNAL conference. At this event, the full capabilities of Twilio’s APIs are put on display, with Twilio experts demonstrating extensive use cases. The event is also highly interactive and hands-on as Twilio experts work together with developers to craft product roadmaps and allow developers to try out new product launches before anyone else.

Aside from conferences and events, Twilio also maintains a comprehensive library of guides and blog posts to help developers navigate through Twilio’s offerings, debug errors, and uncover different use cases. 

By working with developers to simulate and solve real life challenges, Twilio provides a compelling proposition to attract new users and retain existing users within the community.

In fact, the number of active Twilio customers has grown by more than 500% since 2017 and the amount of developers on their platform has grown from 1 million in 2016 to more than 10 million in 2020.

Twilio’s Active Customers count

(2) Expanding use case for Twilio products

Based on customer’s feedback, Twilio is continuously innovating its product offerings by developing new products, enhancing products, or acquiring companies that complement the existing offering

For example, Twilio Flex, the programmable cloud contact center was built because Twilio noticed that quite a number of customers were using the voice API for purposes of constructing a contact center. After speaking with customers, Twilio introduced Twilio Flex, a highly customizable cloud contact center that made it easier for customers to plug a contact center solution into their business without having to assemble one from scratch.

Similarly, Twilio is active in the acquisition space, having acquired 9 companies since inception. Notable ones include Segment and SendGrid.

By continuously introducing complementary use cases, it prompts greater usage of Twilio’s products by existing developers. This is evident in Twilio’s DBNER and cohort analysis.

Twilio has executed the “land-and-expand” strategy masterfully. By offering a free trial period, Twilio encourages new users to try out their product capabilities. Once onboard Twilio’s platform, Twilio actively engages users and continuously expands their product offerings. This delivers immense value to users as they uncover new use cases all the time.

We can see from the chart below that customers who started using Twilio from the various time periods have increased their usage over the years.

Twilio has also demonstrated an ability to increase the amount of sales from existing customers as they deliver more solutions and benefit when their customers grow. The value they provide can be seen in their most recent DBNER of 139%, this means that they can grow revenue by 39% without even securing another customer.

Twilio’s Total Addressable Market (TAM) is rapidly expanding as today’s economy becomes increasingly digitized and they venture into different verticals.

As a result of the secular tailwind of programmable communications and a well executed growth strategy, Twilio has consistently delivered strong revenue growth of 60% CAGR over the past 3 years

Move Into Customer Engagement

Twilio has spent over a decade building the leading cloud communication platform. However, the company’s vision is more than communication: it’s about end-to-end customer engagement, ultimately providing businesses with the holy grail—a single view of the customer journey.

In Jeff Lawson’s latest move to acquire Segment for US$3.2 billion, he has shifted Twilio’s overarching vision from communications into customer engagement. 

Segment’s job is to destroy customer engagement data silos—what they bought, when they needed help, how they use your apps and websites, and more—all these data are siloed across dozens of software systems inside a company, making it very difficult to analyze and understand your customers.

As the leading customer data platform, Segment enables developers to unify customer data from every customer touchpoint, and empowers marketing, sales, and customer service leaders with the insights they need to design and build relevant, data-driven customer engagement. A combined Twilio and Segment means Twilio can help any business make their customer engagement across every channel more personalized, timely, and impactful.

Over time, the addition of Segment will allow Twilio to integrate data intelligence into Twilio Flex and every one of the company’s offerings to provide highly-personalized customer touchpoints.

Competitive Landscape

Twilio operates mainly in the domain of Communication Platform as a Service (CPaaS) and is currently ranked by G2 as the market leader in this area. Their main competitors include Vonage, Bandwidth, Plivo, Telnyx, and Podium, of which only Vonage and Bandwidth are publicly traded.

If we compare Twilio with publicly traded competitors, we see that Twilio not only has the largest market share, but is also growing at the fastest rate amongst competitors. Coupled with the impressively high DBNER, it is a testament to the value that Twilio’s product and ecosystem delivers as customers consciously choose to utilize Twilio’s offering over their competitors. 

TwilioBandwidthVonage
Revenue – 2021 (USD mn)1,761.80343.001,185.00
Revenue Growth (YoY)55.30%47.52%7.13%
Market Cap (USD bn)63.003.203.10

Furthermore, Twilio is the only major CPaaS provider that offers the full spectrum of products – spanning video, voice, SMS, chat, social (WhatsApp) and email. As businesses trim the number of external vendors they integrate with, Twilio’s comprehensive suite of products offers yet another reason for customers to choose Twilio. 

Being the trailblazer of CPaaS, Twilio has captured significant developer mindshare and done an excellent job at retaining it. With a well established developer ecosystem and a clear strategy to transition towards customer engagement, we believe that Twilio is well positioned to ride on this momentum and expand its leadership in the CPaaS arena.

Moat

High switching costs. Communication is easy to do at a basic level, but hard to do well at scale and have a global reach. Small amounts of latency, network variability, and disruption can really sour your customers’ experience. Once companies have built their software using Twilio’s API, they are incentivized to stay with the system due to the ease of use and risk of disrupting their system.

The company’s developer ecosystem is one of the long-term competitive advantages and they are laser-focused on making developers successful—by listening to their needs and delivering solutions with constant engagement, developers have a strong preference for Twilio’s products.

Network effects. Twilio’s Super Network allows companies to communicate with their clients seamlessly throughout the globe. The network gets stronger with every additional customer, because it adds a data point to make the network more efficient.

Here is what Twilio highlighted in their annual report:

“With every new message and call, our Super Network becomes more robust, intelligent and efficient, enabling us to provide better performance and deliverability for our customers. Our Super Network’s sophistication becomes increasingly difficult for others to replicate over time as it is continually learning, improving and scaling.”

Risks

Apart from the obvious risk of the tech industry being a rapidly changing one and that valuation of software companies are at historical highs, there are two main risks that could derail the company’s growth story. 

Culture dilution. One of Twilio’s competitive advantages is its incessant focus on the customer. Rapid growth risks derailing that corporate culture as the company’s headcount balloon from 2,905 employees on 31 Dec 2019 to 4,629 employees on 31 Dec 2020.

Customer concentration. Who could have forgotten the Uber saga? Uber was their largest customer in 2016 and spent more than $60 million per year, which in retrospect, was unsustainable due to their meteoric growth.

When Uber began pulling the plug out, Twilio’s stock fell more than 30% in one day. Jeff Lawson and then CFO Lee Kirkpatrick ran a blameless postmortem and it came down to two root causes:

  1. A small handful of customers (e.g. Uber and Whatsapp) who, because of Twilio’s usage-based pricing model, had grown too large and therefore represented risk to Twilio. The company needed to manage their “customer concentration” better, even if it meant proactively lowering prices.
  2. There weren’t enough salespeople covering all of Twilio’s accounts. In 2016, there were only fifteen quota-carrying sales reps covering more than 36,000 accounts and prospects. The sales reps were stretched incredibly thin and couldn’t give sufficient attention to their largest customer. Since then, they have grown to have hundreds of sales reps.

Losing Uber back then seemed to confirm the bear thesis—that Twilio’s services could easily be replaced. However, Uber actually had big outages in setting up their own communications solution and it resulted in more cost and pain, rather than savings.

It became clear that Twilio’s technology wasn’t as easily replicable and the cost of bringing it in-house doesn’t make sense for most companies. Even Whatsapp, owned by one of the most tech-savvy companies-Facebook, still employs Twilio for its services.

They have since reduced the concentration of top customers from 30% in 2016 to 13% in 2020.

Management

Twilio is being run by a proud developer, meaning that he understands what a developer needs and is great at attracting talented developers into Twilio. In his book, Ask Your Developer, Lawson spoke at length about how he attracts talent, especially when he has to go against the big boys like Facebook and Google.

TL;DR for the book: Developers are creative individuals and you often need to empower them, giving them room to solve challenges and problems. Provide them with the best infrastructure available and increase their productivity—a lot of developers leave their existing jobs not because of compensation, but because they do not have the right tools to do their work. 

Twilio also does not have the practice of tying bonuses to weird corporate objectives, such as revenue or profitability, with the idea that the whole company will band together to achieve this goal when the truth is that no single employee has the kind of impact to make or break these goals. Rather, the company focuses on employees’ intrinsic motivation, like autonomy, mastery, and purpose, after ensuring that they are paid a fair compensation.

As we can see from Glassdoor reviews, Lawson commands a super high approval rating from his employees. Many of the reviews state that he does walk the talk in providing autonomy and empowers his employees.

Prior to co-founding Twilio, Lawson was the founder and Chief Technology Officer of NineStar, Stubhub.com and Verisity. He was also one of the original product managers for Amazon Web Services (AWS).

When we look at Twilio, Lawson does have skin-in-the-game, with most of his net worth tied up in the company.

Financials

Here’s a quick breakdown of Twilio’s financials

FY20FY19*FY18
Revenue (USD mn)1,761.801,134.3650.1
Growth (YoY)55.30%74.50%62.90%
Gross Margin (% of Rev)52.00%54.70%54.70%
S&M (% of Rev)32.20%32.50%27.00%
R&D (% of Rev)30.10%35.50%26.40%
G&A (% of Rev)16.40%17.80%15.80%
Operating Income / Loss (% of Rev)-26.70%-31.20%-16.50%
Total Debt (USD mn)434.00492.00359.00
FCF (USD mn)6.8-31.33.3
Business MetricsFY20FY19*FY18
Active Client Account221,000179,00064,286
Growth (YoY)23.50%178.40%31.50%
DBNER139%136%150%

*Includes Sendgrid acquisition in 2019

Given its size, Twilio continues to grow at an astonishing pace. In their attempt to venture into customer engagement and to capture greater market share, Twilio has invested heavily in S&M and R&D efforts (more than 60% of revenue!) to encourage product adoption and innovate product offerings. They are investing aggressively to expand market share before turning on the profitability switch.

Despite running operating losses now due to its aggressive investment, the nature of Twilio’s business involves minimal marginal cost, meaning that it costs Twilio an insignificant amount of money to onboard and serve an additional customer. Hence, as Twilio continues to scale, it will benefit from operating leverage. 

Also, Twilio expects long-term gross margins of 65% as it gains leverage with telecom providers and starts to provide higher margin products such as the Engagement Cloud—Twilio Flex and SendGrid commands higher gross margins of 70% to 85% range.

In terms of its financial position, Twilio has taken on some debt since 2018 and ended 2020 with ~USD 359.00mn of debt on its balance sheet. With close to USD 3bn of cash and short term investments as of end 2020, debt levels look highly manageable. 

Valuations

Despite reinvesting heavily for acquiring market share, Twilio has started to turn free cash flow (FCF) positive. In fact, Twilio would be gushing out cash today if it decided not to invest so heavily into acquiring new customers. By turning off the S&M to acquire new customers and just rely on growth from existing customers, Twilio could easily command a 25% FCF margin.

In our valuation model, assuming that Twilio’s growth would slow from 45% in 2021 to 37% in 2025, and that they are able to command a 25% FCF margin in 2025, it’s approximate intrinsic value (IV) would range from $269.27 to $352.50 today.

Do note that valuation is more art than science. 

If growth slows down at an accelerated space to 30% in 2025, then its IV would range between $234.45 to $306.66 today. 

Of course, the opposite could happen as well, if growth remains constant at 45% (management guidance for the upcoming year), then Twilio’s IV would be between $312.02 to $408.81

What is more important is looking at what the market is assuming at today’s prices. With today’s share price of $390, the market is assuming that Twilio’s growth rates would sustain at above 40% for the next few years. Although stretched, it isn’t an absurd assumption given that the grandfather of SaaS companies, Salesforce, is still growing at 24.3% after hitting more than $20 billion in revenue.

Personally, I would be comfortable with deploying my first tranche closer to the $300 price point.

Alternative Valuation

Despite reinvesting heavily for acquiring market share, Twilio has started to turn FCF positive. In fact, Twilio would be profitable today if it decided not to invest so heavily into acquiring new customers. By turning off the S&M to acquire new customers and just rely on growth from existing customers, Twilio could easily command a 25% net profit margin.

The company did $1.7 billion in trailing revenue and management guided for 44% to 47% growth (FYI: Most SaaS companies have the habit of sandbagging growth estimates a little).  At $370/share, the enterprise value is at $60.1 billion. This puts the forward EV/sales at 24x. Obviously not cheap but let’s take a look at our 5 years earnings model.

Assuming Twilio is able to grow its revenue at 40% for the next five years and command a 25% net margin, it will come up with a net income of $2.36 billion. Put on a PE multiple of 50x , we will arrive at a market cap of $118.4 billion, and this gives us a CAGR of 12.94% if we buy at today’s price of $373.77.

Just for context, even at today’s size, Adobe grew its revenue by 43% and Salesforce by over 20% despite the crisis. And both of these SaaS companies command a multiple of above 50x.

These are our assumptions and they result in a 13% CAGR. Do note that valuation is more art than science. We try to be conservative with the levers because we want to be surprised to the upside, not the downside.

Personally, I would be comfortable with deploying my first tranche closer to the $300 price point.

Conclusion

Ultimately, Twilio’s core business revolves around communication, which is defined as the process by which information is exchanged. Exchanging information is necessary for all businesses regardless of its size, industry, or business model. A startup will have to relay information to raise product awareness, Amazon has to relay information regarding when you can expect to receive a purchase you made, your trading broker has to set up a contact center for help and support, and the list goes on… but you see the point we make. 

Communication is inherent in every business and pervades across all types of businesses. 

As the world we live in continues to become digitized, the mode of communication is increasingly shifting from physical to virtual. For all of the reasons that we’ve discussed above, we believe that Twilio is best positioned to capture the lion share of this growing market for virtual communication. Twilio’s offering serves as the building blocks that forms the infrastructure of a digital economy. A bet on Twilio is a bet on the inexorable digital future.

Important Note: This is not investment advice. I am not a registered investment adviser. I’ve worked with the author at steadycompounding.com on this piece and we both have a position in Twilio.

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