The last three months have been nothing less than horrific for Twilio Inc (NYSE:TWLO). Twilio stock is down 50% since its late-September peak, and until yesterday, it was pressing into new multi-month low territory.
The market has simply had a tough time rectifying the company’s market cap and its still unimpressive revenue; never even mind the lack of net profits.
The doubt has become so predominant, in fact, that as of Monday, there were more shares that have been sold short — a risky bet that TWLO stock will go down — than were in the effective float. According to the latest tally, 10.03 million shares of TWLO were held as short positions.
And yet, what was supposed to be the beginning of the end for Twilio stock came and went without any fanfare, and without dishing out any meltdown. That is, a huge swath of shares owned by insiders became free-trading shares on Tuesday. They didn’t dump their TWLO stakes though, which means they didn’t torpedo the stock’s value as a result. They mostly held onto their shares.
The stock’s failure to fall apart now casts a shadow of doubt on all those short trades, and Wednesday’s bullish action may well mark the beginning of a surprisingly decent rally.
TWLO Stock: The Theory
There were and still are two key facets to the massive amount of short-selling of TWLO that has piled up over the course of just a few months.
One of them is the conventional one — the hype whipped up for and around the June IPO drastically overstated the company’s plausible potential, and with shares soaring from an initial public offering price of $15 then to a peak of $70.96 by late December, the potential downside move was just too great to pass up. At that peak price, Twilio’s market cap was a breathtaking $6.1 billion, even though the company’s trailing twelve-month revenue at that time was at $219 million.
Yes, Twilio’s cloud-based, all-encompassing telecom platform is an amazing technology, but it’s not that amazing.
The other dimension was more unique to Twilio, and perhaps the more dangerous of the two. That is, the stock IPO’d in late June and put 10 million shares into the public float. Then there were another 7 million shares injected into the float on Oct 20., yet another smaller issuance in the meantime has pushed the total float — the number of shares “out there” in investors hands — to 21 million.
The twist? Of those original 10 million shares issued as part of the IPO, a huge number of them can’t be sold until the six-month restriction is lifted. Once that happens, a huge number of major shareholders and insiders can sell their Twilio stock, effectively adding shares to the float.
The greater supply versus the same demand poses the risk of pulling the rug out from underneath TWLO. Indeed, that’s what many of those short-sellers were counting on, so they could “sell high” and then “buy it low” after the plunge.
The Reality for TWLO
What if, however, the restriction on all those insider-owned shares was lifted, yet nothing terrible happened?
That’s exactly how it panned out. The lockup period on millions of shares of Twilio stock ended on Tuesday, December 20, and the market barely blinked. Indeed, on Wednesday TWLO stock jumped 15% on Tuesday’s lack of an implosion. So much for the bet that a massive influx of supply would be trouble.
See, many of those traders with short positions in TWLO were likely counting on a bearish train wreck Tuesday … a steep wave of selling that would allow them an easy “out” without creating an inflated degree of buying (due to a simple lack of sellers). Those folks didn’t find an accommodating market; it’s not likely the bulk of those short positions were closed out.
It’s a significant problem now simply because when most of those short-sellers start to reverse those trades, it will create a short-covering rally — there are going to be a lot more buyers than sellers as those short positions get closed out. Those floodgates may have been opened yesterday, when all those short-sellers’ confidence swung to sheer panic at the prospect of the stock moving in the wrong direction.
In other words, TWLO is a buy, even if only a short-term, speculative one.
Bottom Line for Twilio Stock
While a short-covering rally is apt to be in the cards, Twilio stock is still too high on risk and low on long-term reward for the average investor to get excited about.
Analysts expect this year’s projected top line of $269.3 million to grow to $349.4 million next year, which is still miles short of justifying the company’s current market cap of $3 billion. The trailing price/sales ratio is 12.2, versus the marketwide norm of 1.6. And as was noted, net earnings aren’t even on the radar.
Point being, any rally from here won’t be built to last.
Still, with 10 million shares currently held short that need to be exited sooner or later, the near-term trip could certainly be a lot of fun. The party seems to have started on Wednesday.
As of this writing, James Brumley did not hold a position in any of the aforementioned securities.
