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Twilio Stock Is a Winner, But How Much Higher Can It Go in 2020?

After a 25% rally over the past month, TWLO stock has sprinted into fully-valued territory

For the past six weeks, several analysts on Wall Street have sung a bullish tune about shares of cloud communications giant Twilio (NYSE:TWLO). Specifically, Bank of America, Northland Securities and Oppenheimer have all come out and called Twilio stock a “top pick” over the past six weeks, citing strong fundamental momentum and a relatively attractive valuation. KeyBanc also recently chimed in with much of the same bullish messaging.

The Market's Giving Twilio Stock a Chance to Catch Up With Cloud Peers
Source: rafapress / Shutterstock.com

Are all these analysts right? Will Twilio turn into a top performer in 2020?

They’re right about one thing: Twilio stock is a winner. In the long run, a big pivot towards text-based, business-to-consumer (B2C) communication will propel huge revenue, profits and share price growth for Twilio.

But I’m not so sure these analysts are right about Twilio stock being a “top pick” for 2020.

I do think there are reasons to believe that shares can and will run higher this year, including a rebound in the global corporate information technology (IT) segment. But shares won’t go that much higher. The valuation here is simply too stretched, even after considering the company’s robust long-term growth potential.

In other words, while Twilio stock was a great buy back in early November at $90, I don’t think it’s a great buy here in mid-January at $120. Don’t price chase. Let the rally calm down. Let the stock tumble back towards $100. Then, buy that dip.

Twilio Is a Long Term Winner

In the big picture, Twilio is a winner and TWLO stock will head higher in the long run.

The core bull thesis is pretty simple. Text messaging is the future of all communications, because it’s faster, easier, more convenient and often more cost-effective than alternative forms of communication. This will be especially true in B2C communications, where companies will increasingly deploy text message marketing to reach consumers because those texts have a significantly higher chance of being opened and read by the consumer than an e-mail or a phone call.

Today, though, only 14% of companies use text messages to communicate with consumers, compared with nearly 70% that employ e-mail marketing. This divergence won’t last long. Over the next several years, every company that uses e-mail marketing will start to deploy text message marketing. As they do, demand for premium B2C text communications tools will grow by leaps and bounds.

That’s great news for Twilio. Among various other cloud communications tools, Twilio provides the best B2C text communication tools in the market. That’s how they’ve grown their customer base from 25,000 at the end of 2015, to likely north of 180,000 by the end of 2019 — it was at 172,092 accounts at the end of the third quarter. It’s also why, even at 180,000 customers, Twilio is far from done growing. Millions of businesses out there use e-mail marketing. All of them will pivot towards text message marketing over time, giving Twilio ample room to sustain big customer growth for a lot longer.

Big customer growth will power big revenue growth. Big revenue growth will power big profit growth, since this is a big gross margin company (near 60% gross margins). And inevitably, big profit growth will power big gains in Twilio stock.

Twilio Stock Is Fully Valued

Although Twilio stock is a long term winner, it’s also fully valued in the near term.

There are two big revenue drivers at play here: number of customers and average spend per customer. Both of those metrics will trend higher over time. On the customers front, there are about 3 million businesses in the U.S. and E.U. with 10 or more employees. About 70% of them use e-mail marketing tools, about 2.1 million businesses. At present, Twilio is tapping into only 8% of that market. Given the strong tailwinds at play here, I think it is reasonable to assume that Twilio gets to somewhere around 500,000 active customers by 2025 (or nearly 17% penetration).

Average spend per client will gradually rise too, as Twilio employs a “land and expand” model to turn single-service customers, into multi-service customers. Concurrent customer and average spend growth will sustain big revenues. Analysts are modeling for 25%-30% revenue growth over the next two years, and if Twilio does grow to 500,000 customers by 2025, then the company should sustain 20%-plus revenue growth for a lot longer.

At the same time, gross margins will remain stable in the 60% range, thanks to steady and healthy demand drivers. Expense growth rates will moderate with slowing customer growth and increased average spend per client will drive positive operating leverage.

Twilio projects as a 20%-plus revenue growth for the next several years, with sizable upside margin drivers. My modeling suggests that this growth profile will result in $5 in earnings per share by fiscal 2025. Based on a medium-term average forward earnings multiple of 35 for the application software sector and a 10% annual discount rate, that implies a 2020 price target for Twilio stock of $120.

That’s roughly where shares trade hands today.

Bottom Line on TWLO Stock

Twilio is a great company. But thanks to a 25% rally over the past month, TWLO stock has sprinted into fully-valued territory. Consequently, while favorable fundamental drivers may push shares higher in 2020, near to medium term upside will ultimately be limited by what is already a stretched valuation.

As of this writing, Luke Lango did not hold a position in any of the aforementioned securities.


Article printed from InvestorPlace Media, https://investorplace.com/2020/01/twilio-stock-is-a-winner-but-how-much-higher-can-it-go-in-2020/.

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