After hours Wednesday, Twilio fell -4% after reporting Q4 earnings.
Quick reminder on Twilio: we think of the company as the "Stripe" or "Amazon Web Services" of the communications industry. It builds application programming interfaces (APIs) that allow software developers to easily integrate communications tools like SMS and voice calls into their applications. For example, Lyft sends you a ride receipt using Twilio's APIs.
Back to today's results from Q4. Overall, they were mixed.
Let's pick apart the two negatives and understand how they may impact our investment thesis on Twilio.
The dollar based net expansion rate is a bit concerning. If customers are spending less with Twilio over time and not adopting its new products, that could make customers less valuable for Twilio and change the long-term earnings power.
However, this rate naturally has to come down with size/time. Existing customers can't keep spending 40%+ more each year; the law of large numbers eventually kicks in for every company. +124% is still pretty decent, in our view, but this is a trend we'll be closely watching.
The forecasted losses, while seemingly worrisome, are due to smart investments. Like many tech companies we've seen this earnings season, "investing for future growth" was a recurring theme on Twilio's Q4 call.
It would be more concerning if Twilio's forecasted losses were coming from huge customer churn or price cuts. But they're not.
Twilio's losses will stem from heavy investments in systems and infrastructure to regain trust with customers after the Q3 billing system hiccup. They're also investing heavily in sales & marketing because it's efficient and driving profitable revenue growth over time.
Overall, we think these two risk factors are modest but important to monitor throughout 2020. They don't seem structurally concerning enough to derail our investment thesis, but we'll see how other hedge funds react in their upcoming filings.
Finally, in terms of the stock's -4% after hours move, a quick reminder.
In investing, fundamentals drive stocks in the long term, but expectations matter more in the short term.
What the "buyside" (i.e. hedge funds and mutual funds) expects is often more important for a stock's near-term trading behavior than what the "sellside" (i.e. investment banking analysts) expects. Hence we closely track what buyside investors expect each quarter to gauge positioning (i.e. does Twilio have a low bar this quarter, or does it need to really crush results?).
Today, clearly the buyside expectations for Twilio were very high. The stock had risen +30% YTD through yesterday, most of that driven by an increase in its valuation multiple. Sentiment was rosy; the buyside expected more than just "great."
Overall, we're please with the trends we see in Twilio's business. The communications API sector is growing, Twilio's gross profit margins are holding fairly stable, and it's investing in the right areas for future growth.
Short-term dislocations will be common in stocks like Twilio. The key is holding through them and investing more, opportunistically.
For example, we saw a 20%+ decline in TWLO back in the fall 2019 on a technical rotation out of momentum stocks plus lofty expectations for TWLO's Q3 results. It was painful, but nothing in the fundamentals suggested a 20% decline in the company's intrinsic value. Sure, we saw some execution stumbles in Q3, but we felt the net results were good. The stock has recuperated that entire loss since then.
These gyrations are the cost of generating long-term alpha, in our view. Stay calm, stay focused on the fundamentals, and invest like a business owner -- not a fast-money trader.
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