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3 Reasons Why You Should Sell Twilio Stock Now

Antitrust concerns could be the trigger that sinks TWLO stock

Twilio (NYSE:TWLO) has delivered breathtaking returns over the past year. At the start of 2018, Twilio stock sold for just $25. It’s managed to more than quintuple since then, with TWLO stock jumping 6.53% yesterday.

3 Reasons Why You Should Sell Twilio Stock Now

But the good times could come to an end in a hurry. Twilio faces multiple headwinds that will stop the stock’s meteoric run. For one, TWLO stock could get caught in the government’s big tech antitrust crackdown. Second, its core business is unlikely to keep growing nearly as much in future years. And finally, after such a huge move, the valuation of the shares is rather aggressive.

Antitrust Concerns to Hit Tech Stocks

Over the weekend, news came out that the government is running an antitrust probe against Alphabet (NASDAQ:GOOGL). On Monday, this quickly spread to Facebook (NASDAQ:FB) and other tech giants. Not surprisingly, the FANG stocks got routed on Monday before recovering somewhat with Tuesday’s euphoric market recovery.

Still, there’s a great deal of concern about what will happen with big tech now that the government is investigating. It’s particularly worrisome for the sector since there appears to be bipartisan support for cracking down on the largest tech firms.

You may be asking, what does that have to do with Twilio stock? It matters because SaaS stocks could see their valuations get crushed. Generally, SaaS companies are run with one of two strategies in mind. The first is to become the dominant force in a particular application and then raise prices as competition fades. Salesforce (NYSE:CRM) is a classic example. The company still generates little in the way of accounting profits, but absolutely dominates its business. CRM stock is up 3,500% since its IPO. However, if they try to exploit their dominant market position, the government may start scrutinizing them as well.

The second strategy for SaaS companies is to sell to a bigger player. However, once your business gets large enough, there is only a limited pool of firms with the resources to make acquisitions. And now many of those firms will be in the penalty box, as they try to stay under the radar to avoid the government scrutiny bringing anti-monopoly charges against them. A basket of SaaS stocks fell more than 5% on Monday, and rightfully so. Valuation multiples for the sector — including Twilio stock — will sink if the government’s antitrust efforts have any teeth.

Stagnant Markets

A key problem for Twilio is that its core business isn’t a particularly attractive one. Prior to the Sendgrid acquisition, 90% of revenues came from traditional phone services. The company primarily makes its money selling programmable text and voice assistance to marketers. The problem with that as a core operation should be apparent.

People are using their phones less and less for voice. Folks are overwhelmed with robocalls and as a result the value of voice marketing has stagnated and may be starting to decline. Similarly, text messages aren’t nearly as hot an area as they were a few years ago. Data usage is exploding, and in doing so, is replacing many functions that used to be handled by voice or text.

These businesses certainly won’t disappear overnight, but they’re not the sort of wide runway growth fields that we traditionally associate with stocks in this sector.

The $2 billion Sendgrid acquisition earlier this year helps matters to some extent as it significantly diversifies the business. Unfortunately, its primary business, facilitating e-mail marketing, is quite mature as well. Email marketing will probably have better longevity than voice and text, but it’s not going to be a high growth field forever either.

Crazy Valuation

The massive rise in Twilio stock has far outpaced the business’ fundamentals. Once Twilio stock dropped after its IPO, it settled into a trading range around 7-8x sales. That’s a reasonable multiple for a SaaS company, particularly one whose business has less upside than the field as a whole. 10x sales would be a more optimistic but still defensible valuation for the business.

Twilio stock is now selling at an insane 24.1x sales, however. Yes, I know the company has a huge year-over-year posted revenue growth rate of 70%. But acquisitions helped boost that. Analysts see revenue growth dropping to 34% next year and then 26% the year after.

That’s simply not fast enough growth to justify the insane sales price multiple. You can buy something like Alteryx (NYSE:AYX), which is in the sexier field of data science, prediction, and analytics at 19.4x sales. And Alteryx consistently runs something like 50% annual revenues growth while being slightly more profitable than Twilio. It’s highly unlikely that Twilio stock will be able to maintain a higher P/S ratio than other SaaS companies which are growing more quickly.

TWLO Stock Verdict

My InvestorPlace colleague James Brumley recently published a thoughtful article about the risks at Twilio. I agree with his assessment, in particular, he highlights that the company continues to lose money on a GAAP basis despite the rapid growth rate. Additionally, cash flow has turned negative again after a brief period above zero.

As Brumley notes, at some point Twilio needs to start generating real and consistent profits and cash flow for shareholders or the valuation will shrivel up. Particularly as competition is heating up in some of Twilio’s business segments, Twilio needs to figure out some way to boost profit margins. Now with the government cracking down on big tech, this could be the catalyst that causes TWLO stock’s massive rally to fall apart.

At the time of this writing, Ian Bezek owned FB stock. You can reach him on Twitter at @irbezek.

Article printed from InvestorPlace Media,

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