Personal Finance

The Simple Reason Why I Won't Buy Twilio Inc. Stock

A man's smartphone links to a wide range of cloud-based apps.

Twilio (NYSE: TWLO) likely frustrated many investors over the past year. The cloud services provider went public at $15 last June, surged to the mid-$60s by late September, then crashed to the low $20s before rebounding slightly to the high $20s.

I started buying Twilio last November, and bought additional shares over the following months to lower my cost basis to the the high $20s. I eventually sold my entire position at the end of June, after selling covered calls multiple times for a small profit.

A man's smartphone links to a wide range of cloud-based apps.

Source: Getty Images.

I've still been keeping an eye on Twilio to see if it's worth buying back as a long-term investment. There's still a lot to like about the company, which processes voice calls, texts, videos, and other content for app developers. But I won't buy the stock now for a simple reason: it simply doesn't have a feasible path toward profitability.

Shouldn't investors focus on revenue growth instead?

For young companies like Twilio, growth investors often focus on revenue growth instead of earnings growth. The reasoning is that earnings growth can come later, after a company scales up and widens its moat against its rivals. But companies that aren't squeezing out a profit on high double-digit sales growth should be closely scrutinized, since the business model might be flawed.

Twilio's revenue rose 49% annually to $95.9 million last quarter. Base revenues, which excludes large customer accounts without 12-month minimum contracts, rose 55% to $87.6 million. Active customers (who spent at least $5 in the last month of the period) grew 35% annually to 43,431, while dollar-net expansion rate, which measures the company's revenue growth per existing customer, improved 131%.

On the bottom line, Twilio's non-GAAP loss from operations narrowed slightly from $5.7 million a year ago to $4.7 million. On a GAAP basis, its loss narrowed from $10.9 million to $7.1 million. Those slight improvements are underwhelming compared to its revenue growth, and could become a problem as its sales growth slows down:

Source: YCharts

Twilio's revenue rose 66% to $277.3 million in 2016, but analysts anticipate just 35% growth this year and 25% growth next year. If Twilio couldn't squeeze out a profit with 50%-60% sales growth, it's highly unlikely to do so on 20%-30% growth.

Limited ways to boost profitability

Twilio bulls will likely claim that the company could charge higher prices, scale up via acquisitions, or outsource some work to cut costs. They'll probably claim that it can leverage its partnership with Amazon 's (NASDAQ: AMZN) AWS (Amazon Web Services) -- which uses Twilio APIs in its Lex chatbots, SNS notifications, Chime enterprise communication service, and Connect cloud-based contact center -- to negotiate lower AWS rates.

But most of those arguments are flawed. Twilio can't really raise its prices because it already faces competition from Vonage 's (NYSE: VG) Nexmo and internally developed solutions from major customers likeUber . It's made a few acquisitions, but its choices are ultimately limited by its negative cash flow. Amazon also has more leverage against Twilio in negotiating rates, since it could easily switch to a rival service, like Nexmo, or develop its own AWS-based alternative.

WhatsApp.

WhatsApp. Source: Google Play.

Lastly, Twilio's top customers already include heavyweights like Facebook 's (NASDAQ: FB) Messenger, WhatsApp, Uber, Airbnb, and Coca-Cola Enterprises. Therefore, billions of users already access Twilio's service via various popular apps -- but Twilio still can't squeeze out a profit.

So as big operating costs rise -- like payments to AWS, where Twilio's services are hosted -- Twilio's chances of becoming profitable will gradually fade. That's why Wall Street expects the company to post net losses for the foreseeable future.

But don't lose hope in Twilio yet...

Twilio is still a very young company, so I'm not dismissing the idea that it could gradually evolve into the next Salesforce by launching new cloud-based services to complement its core APIs for voice, text, and video communications.

But as a long-term investment, there are still too many red flags for me to ignore. I'd love for Twilio to prove me wrong, but the company's decelerating sales growth, high expenses, and limited choices for lifting its profits indicate that investors should avoid the stock for now.

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Leo Sun owns shares of Amazon. The Motley Fool owns shares of and recommends Amazon and Facebook. The Motley Fool recommends Salesforce.com and Twilio. The Motley Fool has a disclosure policy .

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.


The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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