Cloud communications app maker Twilio Inc (NYSE: TWLO ) has been punished by Wall Street as customer reliance concerns have come to the forefront. After a red-hot start on Wall Street, TWLO stock came crashing down after announcing that its biggest customer, ride-sharing service Uber , is starting to break away from Twilio and insource its cloud communications services.
If Uber can do that, can't other big tech companies do the same? TWLO counts a lot of big tech companies as big customers, like Facebook, Inc. (NASDAQ: FB ), Netflix, Inc. (NASDAQ: NFLX ), salesforce.com, inc. (NYSE: CRM ) and Twitter Inc (NYSE: TWTR ).
Consequently, a trend toward these companies insourcing cloud communications could be disastrous for TWLO stock.
TWLO stock has appropriately dropped. Once a $70 stock, TWLO now trades around $25.
But does this huge drop make TWLO stock a buy?
Not quite yet. At best, I think TWLO stock is fairly valued at these levels. Consequently, I'm not a buyer of TWLO stock until it's undervalued.
The Good, Bad, & Ugly About TWLO Stock
There are two big positives and two big negatives about the TWLO growth narrative.
The first big positive is that TWLO is in the right space at the right time.
Twilio is a cloud communications app maker, and that puts the company in the cloud-computing space. That is the right space to be in, because everything is going to the cloud. That includes data storage, commerce and analytics.
It also includes communication, where TWLO is king. TWLO provides cloud communication solutions for everyone that matters in this space. That means revenue growth should be big into the foreseeable future.
The second big positive is that TWLO has a robust margin expansion narrative. With scale, margins continue to trend up, and management believes that operating margins can hit 20% in the long term. Operating margins were -8% last quarter. That represents huge growth.
But Twilio also has its negatives, the first of which is the fact that the company's robust revenue growth narrative is threatened by Uber-like departures.
Uber's breakup with Twilio shows that Twilio could get squeezed out by its own customers. What is stopping other tech giants from following in the footsteps of Uber? They all have adequate resources to do so. This is a risk that will exist for TWLO until the company reaches a much larger scale.
The second big negative is that growth is slowing at an alarming rate. Customer growth has fallen from 44% last year to 35% last quarter, while base revenue growth has fallen from 79% last year to 43% last quarter. Revenues are expected to rise just 40% this year and 25% next year. This a slowing growth story.
TWLO Stock Still Isn't Undervalued
Put it all together, and you get a stock with big but slowing growth, promising margin expansion potential and huge execution risks.
Even ignoring the execution risks, the best-case scenario for revenues over the next five years is that they grow at 25% per year (from fiscal 2017 to fiscal 2022). That puts revenues at $1.18 billion in 2022.
Also in a best-case scenario, operating margins at that time hit management's 20% long-term target. That implies operating profits of about $236 million. Slap a 35% tax rate (possibly lower depending on tax reform) on that, and you get to net profits in 2022 of about $153 million.
At that point in time, revenue growth will come down to 10-15%, while margins will be maxed out. Consequently, earnings growth should match revenue growth at about 12.5%.
That sort of growth easily deserves a 25x multiple (double growth). A 25x multiple on $153 million implies a market cap at the end of 2022 of about $3.8 billion. Discount that back by 10% per year, and you get an end-of-2017 fair value of between $2.3 and $2.4 billion.
TWLO stock's current market cap is $2.3 billion.
Bottom Line on TWLO Stock
Its cheap, but not cheap enough.
If TWLO stock drops much further, that will be the time to start buying this beaten-up name.
As of this writing, Luke Lango was long FB and NFLX.
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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.