The latest quarterly report from Twilio Inc (NYSE:TWLO) highlighted the need for the platform-as-a-service (PaaS) company to diversify its customer base.
There are two metrics investors look at to understand Twilio’s progress as a platform: the number of active customers, which tells us the diversity of its customer base, and the dollar-based net expansion rate, which shows us how engaged active customers are.
The first metric indicates how many customers have spent at least $5 with Twilio in the latest quarter. That’s pretty self-explanatory.
The second number is somewhat like same-store sales (the metric retailers use to demonstrate growth at stores open at least 13 months) in that it’s meant to show whether an active customer is spending more or less money in a quarter compared to the same quarter a year earlier. If it’s increasing, that’s great, if it’s decreasing, it may or may not be a problem.
Why do I say that?
In the case of Uber, it’s already indicated that in the future it’s going to be using other providers and its own internal communication services. That means its spending with Twilio in Q1 2018 will be much less than in Q1 2017.
In other words, when Twilio releases its first-quarter earnings next May, Uber won’t account for 12% of the top line and that will get reflected in the dollar-based net expansion rate.
Twilio’s Last 5 Quarters by Metrics
| Q1 2016 | Q2 2016 | Q3 2016 | Q4 2016 | Q1 2017 | |
| Number of Active Customers | 28,648 | 30,780 | 34,457 | 36,606 | 40,696 |
| Dollar-BasedNet Expansion Rate | 170% | 164% | 155% | 155% | 141% |
Source: Twilio Q1 2017 press release
The Metrics Point Up
The number of active customers has increased in each of the last four quarters—that’s a good thing. Now, the dollar-based net expansion rate means active customers for a year or more are spending between 141% and 170% more each quarter than they did in the corresponding quarter a year earlier. As long as that number is solidly above 100% and active customers keep growing, the top-line will continue to prosper—and to date it has.
The Uncertainty Investors Face
There’s no question Twilio is growing revenues at a healthy clip. Unfortunately, the Uber news helped stoke a wall of fear in the minds of investors who now worry there will be more Uber-like defections.
It’s not unreasonable for investors to question Twilio’s business model.
However, everything the company said in early May about the situation leads me to believe it understands that it needs to build a wider, more solid foundation, where customer defections aren’t going to cause a billion dollars of market cap to evaporate in one day of trading.
The bigger problem, in my opinion, is one that InvestorPlace contributor Ryan Fuhrmann alluded to in the aforementioned article about Twilio.
“The rub with investing in many of the cloud-based upstart companies is the profit visibility. Twilio has yet to post an annual profit since incorporating. This year, analysts collectively project an earnings loss of 29 cents per share. In 2018, it gets only slightly better — the consensus estimate is a loss of 9 cents per share. This suggests profitability could still be two years, or more, down the road.”
Profits and free cash flow are the name of the game, folks. Twilio doesn’t have them, and investors need them for share prices to rise.
The Way to Play TWLO Stock
It’s a simple solution.
If you like Twilio, the company, but aren’t sure about Twilio, the stock, do yourself a favor and buy the SPDR S&P Internet ETF (NYSEARCA:XWEB).
Equal-weighted, it gives you 60 internet stocks including TWLO at 1.48%. The ETF is rebalanced quarterly, charges a reasonable 0.35% management fee and if you’re uncertain about its future profitability, as my colleague is, this is a safe way to hold it until the profit picture becomes clearer.
And hey, it’s up 33.5% from its inception lat June through May 31.
As of this writing, Will Ashworth did not hold a position in any of the aforementioned securities.
