3 Reasons I’m Cautious Against Twilio Stock

An expensive acquisition by TWLO and unfavorable environment for tech warrants a careful approach

Twilio Stock Has Become a 'Hold' for This Type of Investor

Source: Web Summit Via Flickr

Inarguably, Twilio (NYSE:TWLO) is one of the top technology surprises this year. Since the January opener, Twilio stock has skyrocketed over three-fold. For late-to-the-game investors, the temptation is to jump on this momentum train. However, both broader market weaknesses and a questionable acquisition suggests caution is in order.

On Monday after the market close, Twillio’s leadership team announced that it will acquire SendGrid (NYSE:SEND) for $2 billion. The deal involves an all-stock transaction that should close in the first half of 2019, according to a CNBC report.

On the surface, the acquisition makes sense. Twilio specializes in cloud-based communications services. Prior to the buyout announcement, the company brought several communication channels, such as voice, video and fax, under one umbrella. However, email was a notable exception.

With SendGrid, TWLO not only has an email outlet they can offer clients, it has significant expertise. SendGrid has a similar cloud-based approach to Twilio, but with a focus toward email. Now, the combined entity covers all fronts, which should theoretically boost TWLO stock.

That said, prospective investors can’t ignore the acquisition price. Adding together both firms’ 2017 revenues will only get you under $511 million. It’s a dicey proposition in light of the current market situation.

Here are three reasons why I’m still cautious on Twilio stock:

The Markets Punished Twilio Stock

I’m going to start with the obvious concern for TWLO stock: The markets didn’t like the move at all.

On the Monday close and prior to the buyout announcement, Twilio stock enjoyed a typically solid day, up 1.5%. In sharp contrast, during extended trading, the markets took on a bearish tone, with shares down as low as 4%. The end result didn’t change much from the initial volatility, with TWLO settling at a 3.5% loss.

But this isn’t the first time that Wall Street has questioned the cloud company’s technical viability. Since the opening session this month, Twilio stock has dropped 12.5%. That’s uncharacteristic volatility for TWLO, which has mostly seen wide open roads in 2018.

I also don’t need to remind people the enormous troubles that TWLO stock has suffered in the recent past. After a dramatic rally following its initial public offering, Twilio shares completely fell apart. It took about a year-and-a-half for speculators to enjoy their daring rewards.

Moreover, it took about two years for those who bought at the prior highs to become profitable. This is something you must keep in mind before buying Twilio stock near these new highs.

The SendGrid Buyout Is a Highly-Leveraged Affair

I understand the leadership team’s point that the deal makes structural sense. However, I’m not sure it makes financial sense.

For starters, TWLO stock currently has a market capitalization of $7.42 billion. Its enterprise value is $7 billion. Moreover, the company has yet to produce positive earnings since at least four years ago. Free cash flow is consistently negative, and the company has recently tacked on over $423 million in debt.

With an acquisition price of $2 billion, Twilio must make this work or things could quickly go sour again.

Another worrisome point is revenue growth. Over the last four years, Twilio’s annual sales growth averages 66%. But that growth rate has declined significantly in the past two years. This year, we’re on track for 23% growth. That’s decent, but not the rip-roaring performance we’ve been accustomed to.

The same dilemma is working against SendGrid. Annual revenue growth averages nearly 38%, but this year, SendGrid is trending toward 15%.

What that tells me is that demand for email-based cloud-communications services has declined. So I doubt that Twilio stock will benefit substantially from the SendGrid buyout.

The Current Cycle Doesn’t Favor High-Growth Tech Stocks

Finally, before you think about investing in TWLO or any other tech stock, you should note that the present environment doesn’t favor speculative, high-growth names. Instead, the Street is looking for stability.

Evidence for this dynamic can be found in the big banks’ earnings performances. I recently covered Wells Fargo (NYSE:WFC), which in my opinion gave a disappointing result due to declining lending-related revenues. My InvestorPlace colleague James Brumley covered Bank of America (NYSE:BAC), which surprised on both profitability and sales.

However, most banking stocks have suffered due to the broader selloff. On top of that, gold prices, which analysts typically use to gauge market sentiment, has started to look interesting. Generally, that means investors fear continued volatility, and are therefore looking for portfolio protection.

Simply put, it’s just not a great time to jump onto a momentum play. Add in that this fundamentally questionable company is near all-time highs, and you can see my hesitation toward Twilio stock. If you’re really dead-set on TWLO, then you should wait. I believe a better entry point will come soon.

As of this writing, Josh Enomoto is long gold bullion.

Article printed from InvestorPlace Media, https://investorplace.com/2018/10/3-reasons-im-cautious-against-twilio-stock/.

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