There are lots of eyes on the Twilio (TWLO) IPO this week. It’s scheduled to price tonight. So far the IPO market in 2016 has been dominated by healthcare deals. Normally we tend to have a more balanced mix with more technology deals like Twilio. As a private company Twilio received quite a bit of VC interest at high valuations. So some of the interest in the IPO is based on the “valuation gap” between the private market valuations in technology versus the public markets. (We’d also add that BOX was an example of the gap, it’s what has helped to keep companies private longer where capital raising has been easier.) Mattermark published a deeper look at this in the context of Twilio.
As we go to press the capital markets are saying that the TWLO deal is “well oversubscribed and worthy of a trade.” These words have to be taken with a grain of salt since the markets can change on a dime but it suggests it will come tonight. The proposed price range is $12 to $14 on 10 million shares plus a 1.5 million shoe.
Twilio is a software company that provides developers with simple cloud-based interfaces to embed communications into their applications. (Still with me?) From a technical standpoint it is tedious, time-consuming and dull but it’s a critical part of how modern applications like Uber and AirBnB work. When you book and Uber and communicate with the driver via messages and calls it’s done using the Twilio platform.
We like the space and view Twilio as an important name to own in technology. To that end we’ve beefed up the TWLO IPO roadshow deck to include many more slides from the video-intensive roadshow presentation. We also put together a full IPO Candy TWLO roadshow transcript.
We’ve actually had a very similar company come public little more than a year ago - Apigee (APIC - $12.96) came public in April 2015 at a price of $17/share. There was strong demand for the deal but as can be seen in the chart investor interest took time to develop post-IPO. The shares were a real bargain and have found some sponsorship with investors now. Note the RS has gone from almost nothing to a very respectable 71.
Apigee is a more general purpose technology which serves developers in any application, not just for communication. As the first company to come public in the space Apigee management had to do much of the heavy lifting in terms of educating investors and communicating with the markets about their value proposition. As a “money losing SaaS” company they took an extra hit early in 2016 when the whole sector got pummeled.
From a positioning point of view Twilio is going for the “platform” designation and comparing itself to other industry leaders in related segments. It’s interesting to note that Stripe is still private. We’d expect them to be watching TWLO with great interest.
TWLO Valuation
To cut to the chase the deal is expected to price in the $12-14 range. At $13 that’s a market capitalization of $1.3B on sales of $167M in 2015. That may look rich but the company is growing fast and I’d estimate revenues in 2016 to come in around $300M which puts the valuation at a reasonable 4.3x.
As a reference point Apigee at the current price has a market cap of about $400M on revenues of about $100M but they are not growing as fast at about 35-40% versus the 80% growth at TWLO. We’d point out that many of the same major trends Twilio presents are driving Apigee as well. The trend toward more custom application development (versus packaged applications) and the need to integrate with myriad in-house and external cloud-based services are now imperatives in the software world. The key building block in this type of architecture is the API.
New Relic (NEWR) is a valid comparable and sports a market cap of $1.5B on expected 2016 revenue of $250M. NEWR is trading at 6x forward sales and is growing at 55-60%.
All these companies are losing money but have the desirable combination of high gross margins on recurring revenues. In the case of TWLO that gross margin is on the low side at 55%. However the model is fairly efficient in terms of CAC. The long term model for TWLO is 60-65% GM and eventually 20% operating margins.
Main Investment Points
Twilio is building a strategically valuable software infrastructure business. In much the same style as how Amazon built AWS. Our own twist on the story as presented would highlight the following key points:
1. The company is effectively embedded in most modern enterprise applications. While they are replaceable doing so would be inconvenient and consume precious development resources. So as long as Twilio continues to execute they have almost no risk of displacement once they are in.
2. Their usage-based business model means it’s easy for developers to adopt (low friction) but then revenue to Twilio scales as those applications are deployed and grow over time. So each new customer continues to grow. The reported expansion rate on customer contracts has been high at 150%.
3. The global communications network they have built gives them an asset that would take time for competition to replicate. It’s similar to what Akamai (AKAM - $54.70) did in the content delivery space. FWIW AKAM enjoys a $9.7B market cap today which is about 4.4x current sales.
4. Management appears to be very serious about the long term and has built a company with a distinctive culture and value system. They also want to exercise control over the company for a long time as evidenced by their dual class share structure (class B is a supervoting stock.)
5. The platform positioning makes add-on acquisitions (like Authy) attractive and rapidly integrated. If done with strong price discipline these acquisitions can be very accretive and further improve positioning.
6. Twilio is at the center of a high-stakes game that companies including Oracle, IBM, Microsoft, Google and Amazon can’t afford to lose in. That is likely to translate into an acquisition of Twilio at some point. Many speculated that it would occur before the IPO.
Biggest Risks
As with any IPO there is a litany of risk factors enumerated in the TWLO prospectus but we’d isolate it to a few:
1. Although efficient the company loses money - about $30M per year. This is often overlooked in “risk on” markets but as we experienced earlier this year it’s a real downer in “risk off” times.
2. Competition is serious. Amazon comes to mind first given their dominance with AWS and services they already have like messaging. Amazon tends to disrupt with pricing so if they do get deeper into the communication end of the market it could cause pain for Twilio and slow their growth. Other larger players with a major footprint in development and/or cloud communications include Microsoft and Google. At the lower end of the spectrum communication software companies like BroadSoft (BSFT - $43, $1.3B Cap) could get more granular and develop some special capabilities “closer to the metal” but so far we’ve not seen it.
3. Having a new “currency” as a public company might spur management to step up the pace of acquisitions. As we noted at the opening of this note the valuation of many private companies are at high levels, that makes acquisitions very expensive unless they are done with discipline. Any kind of “land grab” mentality will cost shareholders.
Conclusion
We like the company and the space. I expect we’ll put some in the portfolio tomorrow. Once the stock settles will complete our intrinsic valuation model to guide our position sizes over time. Summer can be a quiet time in the market and we may see opportunities for better prices later. We will be watching TWLO closely after pricing and into street coverage when the quiet period ends.
Seems like a safe initial buy around the IPO price. As a limit we might suggest the NEWR valuation of 6x 2016 revenues which for TWLO would translate to $21-22/share.
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