Twilio Stock Is Too High

After a 155% rally since March 23, Twilio stock (NYSE: TWLO) looks fully valued based on its historic Price to Sales (P/S) multiples. Twilio, a U.S-based cloud communications platform as a service (CPaaS) company, has seen its stock rally from $90 to $229 off the recent bottom compared to the S&P which moved around 50%. The stock is leading the overall markets by a huge margin as investor sentiment is overall positive about cloud-based solution providers due to no direct Covid-19 impact. Notably, the software stocks have seen some negative movement since September 1st due to a bout of profit-booking after a strong run – TWLO’s stock is down 16%. Despite this, the stock is still up 133% from levels seen at the end of 2019.

Twilio’s stock has surpassed the level it was at before the drop in February due to the coronavirus outbreak becoming a pandemic. This seems to make it fully valued as, in reality, demand and revenue growth will likely be lower than last year.

Some of this rise over the last 2 years is justified by the roughly 184% growth seen in Twilio’s revenues from 2017 to 2019. However, its losses have also jumped from -$63.7 million in 2017 to -$307 million in 2019. While the company has never reported positive net income, its high revenue growth rate, which is much better than other loss-making companies, has been the driving factor behind its stock growth – revenue grew with a CAGR of 60% over the last three years. 

The company has seen high revenue growth over recent years, and its P/S multiple has also increased. We believe the stock is unlikely to see a significant upside after the recent rally and the potential weakness from a recession-driven by the Covid outbreak. Our dashboard What Factors Drove 316% Change in Twilio Stock between 2017 and 2019? has the underlying numbers.

Twilio’s P/S multiple changed from around 5x in 2017 to just above 11x in 2019. While the company’s P/S is around 26x now, there is a downside risk when the current P/S is compared to levels seen in the past years – P/S of around 11x at the end of FY 2019 and close to 13x  as recently as late 2018.

So what’s the likely trigger and timing for the downside?

Twilio is a U.S-based cloud communications platform as a service (CPaaS) provider. Its solutions enable developers to build, scale and operate real-time communications within their applications, facilitating tasks like make and receive phone calls, send and receive text messages, etc. The ongoing Covid-19 crisis and the looming economic slowdown have caused losses for businesses across the world, resulting in lower IT spending. This is likely to harm the company’s growth due to a drop in new deals and lower contract renewal rates. Further, Twilio is a loss-making company and its high revenue growth rate is the main reason behind the strength in its stock. While it reported a 47% y-o-y revenue jump in its Q2 2020, we expect the Q3 results to see a drop in its revenues growth rate, which is likely to pressure its stock price.

However, over the coming months, we expect continued improvement in demand and subdued growth in the number of new Covid-19 cases in the U.S. to buoy market expectations. Following the Fed stimulus — which helped to set a floor on fear — the market has been willing to “look through” the current weak period and take a longer-term view, with investors now mainly focusing their attention on 2021 results. Though market sentiment can be fickle, and evidence of a sustained uptick in new cases could spook investors once again.  

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