Without question, one of the hottest names in the markets for the first half of this year was technology firm Twilio (NYSE:TWLO). Between January’s opening price and the end of June, Twilio stock gained nearly 56%. But as my high school football coach used to say, you play hard for all four quarters. Unfortunately, TWLO is not getting that memo.
While shares are still in the black, it’s been a disappointing ride for the second half of 2019. Severe technical weakness bled into a less-than-desirable outing for Twilio’s third-quarter earnings report.
Despite a recent rally in TWLO stock, the tech firm is now only up 11.5% year-to-date. Though respectable, it doesn’t come close to matching the enthusiasm inherent earlier this year.
So, what happened? It’s easy to blame the Q3 report. While the company beat expectations for per-share profitability and revenue, it noted some eyebrow-raising nuances. For instance, net-dollar expansion for the quarter grew 132%, below the 138% analysts had targeted.
In response, Twilio CFO Khozema Shipchandler stated that, “We’re running into the law of large numbers.”
More importantly, management disappointed in their Q4 guidance, calling for EPS between 1 cent and 2 cents, and revenue between $311 million to $314 million. However, analysts targeted EPS of 7 cents and revenue of $322 million. Combined, these factors sent Twilio falling.
Moreover, the secondary issues surrounding Q3 hasn’t done TWLO stock any favors. For example, mentioning the law of large numbers appears deflective. And embarrassingly, Twilio re-reported its full-year forecast “due to a calculation error.” I’ll let you ponder the irony.
Still, these are merely symptoms of the root headwind impacting Twilio stock.
Twilio Stock Raises Credibility Concerns
To understand why TWLO stock is suddenly having technical challenges in the second half, we should understand what made the equity such a hot commodity earlier. As a small, innovative tech firm that integrated communication needs under a third-party umbrella, Twilio facilitated the operations of such powerful names like Uber (NYSE:UBER) or Lyft (NASDAQ:LYFT).
In Uber’s case, TWLO enabled the ride-sharing giant to operate seamlessly in Paris. By integrating communication channels under Twilio’s platform, Uber didn’t have to start their own infrastructure from scratch. Essentially, you’re probably using Twilio even if you don’t know it, thereby lifting the bullish case for Twilio stock.
Just as importantly, TWLO has made key acquisitions to bolster its coverage responsibly. Up until Q4 2018, the company’s goodwill represented a small percentage of total equity; in this case, just a hair under 9%. But since the $2 billion acquisition of SendGrid, Twilio’s goodwill exploded to $2.3 billion in Q1 2019.
At that point, goodwill represented over 68% of total equity. In the latest Q3 2019, this metric has dropped to 53%. Still, this is a mighty big acquisition, especially compared to the measured acquisitiveness previously.
Now, I understand that SendGrid filled a critical gap for the organization. In tech, you have to pay to play. But this goes to the heart of why investors have panicked.
With TWLO, you must separate the technology from the investment thesis. While SendGrid fills a technological gap, it creates one from an investment perspective. Thus, management must deliver outstanding – preferably astounding – growth to justify the SendGrid premium.
What we saw in Q3 was an “okay” earnings report. But when you’re taking big risks, you need big results. That didn’t happen, which is why TWLO stock has a credibility challenge.
Does a Bullish Case Remain?
That said, I am intrigued by Twilio stock thanks to the sharp discount over the past few months. Twilio has proven the value of its communications platform. As the economy becomes more digitalized, the need for the company’s innovation only grows.
Therefore, I’m not opposed to initiating a short-term position at these levels. Plus, with deflated expectations, Twilio has an opportunity to shine in Q4. If so, that could catalyze a strong run in Twilio stock toward prior highs.
However, I say short term because Twilio itself serves many companies with credibility issues. Today, several tech firms run largely on narrative and upside potential. But if the fundamentals don’t justify their market premiums, a panic can ensue. Thus, the same thing that happened to TWLO may happen to Twilio’s clients.
Until we get a better picture, Twilio stock is a cautiously bullish trade.
As of this writing, Josh Enomoto did not hold a position in any of the aforementioned securities.