by Travis Johnson, Stock Gumshoe | July 30, 2019 2:44 pm
This ad, yet another one that focuses on the potential for 5G cellular data networks to rewrite the investing world, comes in from the growth-happy folks at Motley Fool Rule Breakers… the ad letter that I saw was from Rex Moore, one of their analysts, and this is the section that caught my attention:
“One of America’s most trusted stock pickers recently featured my ‘hidden 5G superstar’ in his high-end stock-picking service… and it’s doubly important because his team recently made the stock a double recommendation to his members.
“But why should you trust him?
“Well, for starters, because he’s legendary for leading investors to huge winners after all the hotshots on Wall Street have declared it’s ‘too late’ to cash in.”
That’s a reference to David Gardner, of course, the founding Motley Fool brother who is most associated with “growth” investing and heads up their Rule Breakers newsletter — among the criteria he uses to pick “rule breakers,” he prefers companies that Wall Street writes off as “overvalued” (and these days pretty much all technology and growth stocks are trading at almost unimaginable valuations, so he should be like a pig in slop).
So what is the stock this time? They’re flogging a “special report” about this stock that they call the “5G Investors Playbook” in order to tempt new Rule Breakers subscribers ($99/yr at the moment), and the lead-in featured the oft-hyped story of Bob Pelissier, the truck driver who recognized the beginning of the dawn of the cell phone (or got lucky) and bought the FCC license for some spectrum in New Hampshire, eventually turning his $40,000 gamble into a fortune in the wild west era of the early spectrum wars.
We’re not going to see that kind of opportunity, of course, making a bet on your own business will always have more potential than investing in some well-known growth stock, but what might it be that they’re talking about?
Turns out, they’re hinting not just at the benefit of getting in early on one of the companies that’s directly exposed to 5G — like the telecom companies, the tower companies, or the chipmakers — but by betting on a company that itself will benefit from 5G’s adoption. So that means we’re pushing out that impact further into the future (conceptually we’d assume that the first winners are the network builders, the second winners are the device makers, the third winners are the companies that come up with new ways to take advantage of all that lightning-fast data to build new products or services that people don’t yet know they need).
Here’s more from the ad:
“There’s a small, very unassuming company I’ll tell you about today that could have already quintupled your money had you invested in it three short years ago, and given what’s going on right now in the cellular world and the key dates coming up… one of the world’s top growth investors thinks this is a great time to get in.”Are you getting our free Daily Update
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That sure does sound like a David Gardner favorite… buying stocks that have already risen by 400% often gives me a headache, but it’s certainly part of the “keep buying your winners” philosophy that has worked well for him with huge long-term gainers like Netflix and Amazon.
What other clues do we get about this David Gardner 5G stock?
“Thanks to this new window of opportunity coming up, this company’s growth is poised to skyrocket. Here’s why I say that:
* It’s been growing revenue by a heady 70% annually.
* Its active customer count has increased fourfold in four years.
* It has what stock geeks call a ‘huge moat’ and ‘high switching costs’… meaning customers find it very hard to switch to another company.”
OK, so that’s some good fuel to shovel into the Thinkolator… what else do they drop by way of hints for us?
“This company might best be thought of as a critical link for all the data that zips around the world on cellular waves. We’re talking data such as voice, texts, video, and pictures… and we’re talking about transmitting vast amounts of that data from one place to another.
“Any company, anywhere that needs to figure out how to get data like this to work with its products… can turn to the high-growth tech whiz I’m talking about today for help.”
And then we get a few more specifics… which is lovely, the Thinkolator loooves specifics:
“Its 2018 full-year revenue growth came in at 63%, including a 77% rise in the fourth quarter. That’s a massive increase from the 44% growth rate it posted for all of 2017. Revenue has multiplied 13-fold in just five years….
“By all indications, customers are not only staying with the company, but adding more and more of its services every year. And we’re talking big-time customers like Facebook, Airbnb, Uber, and Lyft.”
So who is it? Well, it’s a lovely day so I hauled the Thinkolator out of the garage and even gave it a little wash this morning, so she would sparkle just right in the sunshine while I put her through her paces… and she obliged, just a few shovelfuls of those clues and a quick pull on the starter and we had our answer oozing out the other end… this is Twilio (TWLO), a company that, surprisingly enough, I don’t think I’ve ever really written about.
Twilio had a quick surge after its IPO about three years ago, then spent a year or so in the doldrums until things started to pick up again in early 2018… and the stock has been remarkable since then, going from $25 18 months ago to today’s $140, and becoming a $18 billion company with, yes, a silly valuation.
“Silly” doesn’t really stand out in today’s tech stock market, though — lots of companies are unprofitable and trade at 20X sales, like TWLO does… heck, some of them get up to 30 or 40X sales (though the winner of the silliness wars of late, of course, is Beyond Meat at more than 100X sales).
What do they do? Twilio is what’s called a “communications platform as a service” (CPaaS) company, which basically means that they offer a platform that lets software and app developers integrate direct customer communication into their offerings — so when you’re on a website and you get the little box popping up with a salesperson or tech support offering to chat with you, that’s Twilio (or one of its competitors)… when Uber sends you a text about the discount you have pending, that’s probably Twilio… you can see some of the “built with Twilio” stories that give you a better idea of the real world applications here in their website — and here’s how they describe themselves:
“Millions of developers around the world have used Twilio to unlock the magic of communications to improve any human experience. Twilio has democratized communications channels like voice, text, chat, video, and email by virtualizing the world’s communications infrastructure through APIs that are simple enough for any developer to use, yet robust enough to power the world’s most demanding applications. By making communications a part of every software developer’s toolkit, Twilio is enabling innovators across every industry — from emerging leaders to the world’s largest organizations — to reinvent how companies engage with their customers.”
It’s not all fancy new texting and in-app video chats, of course, Twilio also bought SendGrid last year in a bid to further integrate mass emailing into their platform (that acquisition also goosed the revenue growth a little bit), but the idea is that Twilio offers up ways for companies to engage with their customers automatically and on the customer’s terms, and to integrate all the communication with that customer.
So… how much is that worth? Will it be dramatically juiced by 5G?
I don’t really know, of course, but Twilio does seem to have built a platform that customers are now invested in enough that they’re probably reluctant to change — which helps create that “moat” around a business. Moats are not impregnable, and I don’t know what kind of price Twilio charges for its services to these big customers, but it sounds like, as with a lot of these “communications as a service” companies (Atlassian, Slack, etc.) they are probably onboarding a lot of small businesses for free or for very low cost, and relying heavily on power users (Coca Cola, Twitter, Uber, etc.) to pay up for a more robust product. And when the ax comes down to cut costs, assuming it ever does (they’ve got a LOT of big name customers who don’t make any money, which presumably can’t go on forever), it’s usually not the customer-serving areas that are cut, so perhaps they’ll become truly essential over time.
And I can see how 5G could further increase the size of the market over the next five years, though it will also bring in new systems and new competition — each wave of increased data speed, whether broadband or cellular, increases customer expectations, so in a few years people will probably have even higher expectations about an instant response from a company than they do today, and that should raise the tide for communications platform providers like Twilio.
What are the actual financials like? Well, that’s where it gets a bit hinky.
Twilio actually stands up pretty well in comparison to many of the other “cloud software” stocks that are doing so well in recent years — it’s fairly large, with a market cap of $17 billion, but also has a large potential addressable market if they can remain a leader in customer-focused communications integration, and it trades at “only” 16X the revenue that analysts expect in 2019 (or 12X 2020 sales, if you want to get a bit rosier).
That’s similar to the valuation of the larger Shopify (SHOP), which is growing revenues more slowly, and is a lot cheaper than Atlassian (TEAM) or The Trade Desk (TTD), for example — these companies aren’t direct competitors and aren’t in the same business, and I’m sure they’ll each have distinct futures eventually, but you have to start somewhere and they mostly trade in unison.
I own a few similarly valued companies, and these high-growth, crazy valuation ideas can certainly work very well as speculative investments… but at some point it’s almost certain that they will stop working, and that even if business does well they should have either a long period of stock market stagnation as investors wait for earnings to catch up with the stock price, or a quick reset if investors abruptly give up on the “this company will own the world in the future” story. That’s not a guarantee, of course, they could go up forever or they could fall 90%… after all, even Amazon fell by 80-90% a couple times on its way to its absurd 20-year returns (in case you’re checking, returns since 1997 are around 98,000% for those rare souls who stuck with it through the very bad years — not bad compared to the 435% you would have gotten from the S&P 500, but requiring a lot more antacids).
What, then, is an investor to do? Well, you can try to ride the current momentum and just put a stop-loss order in, hoping that whatever decline comes is not so fast that it blows past your stop loss. That has made a lot of people a lot of money in these kinds of stocks for the past few years, and there will always be naysayers or reasons to bet against momentum but those same naysayers would have probably told you the same thing a year ago, when TWLO was trading below $60 (and 12X sales) going into earnings and was on the verge of popping 40% in the following month.
Or you can use a small amount of money to bet on a possibly fantastical future, know going in that the current price is silly and you’re thinking about 2023, and not worry so much about the downside risk… particularly if you research the company and the industry really deeply and get so comfortable with the long-term prospects that you are sure you’ll want to buy more if the stock reports a terrible quarter and drops 40% in a day.
Or you can decide to invest in something more boring… but you don’t get to dream about 500% returns in a couple years from boring stocks.
That’s pretty much it — and all of the cloud software stocks like Twilio (TWLO) are very much in the same basket, so you can try to pick and choose among them if you like TWLO better than Shopify (SHOP) or The Trade Desk (TTD) or ZenDesk (ZEN) or Zoom (ZM) or Okta (OKTA) or Zscaler (ZS) or Atlassian (TEAM) or ServiceNow (NOW) or Slack (WORK), but they are all trading based on the same general presumption: Growth will continue, interest rates will remain low and that will make it easier to bet on the future at the expense of the present, and investors will continue to love software… and especially “recurring revenue” software companies that sell their products as subscriptions and have the potential for explosive margin growth in the future.
Barron’s, for example, published a piece over the weekend that was ominously titled “Sky-High Software Stocks Are Beginning to Look Like They’re Forming a Bubble”, naming a bunch of similar companies (including TWLO) and scaring investors a bit… I assume that a single Barron’s article won’t be enough to shift sentiment or change the assumptions people are making about the future of these market darlings, but certainly the valuations are wild and that eventual swing in sentiment could hurt all of these stocks at once. All you have to do is look at what happened to most of those stocks on Monday, almost entirely as a result of that article, to see the degree to which they rise and fall together when sentiment shifts:
And in case you want even a bit more volatility, Twilio is going to release earnings tomorrow — their past couple quarters have been decent but not overwhelming, the stock wasn’t all that much more volatile around earnings than it has been in a typical week this year, but, well, you never know what will happen when a company hosts that quarterly conference call.
Analysts are expecting about two cents in non-GAAP earnings (they lose a lot of money if you insist on real accounting, of course — mostly because a lot of their payroll costs are “non-cash” stock awards), which would actually be worse than a year ago, and the expectation is that they’ll post $264 million in revenue, but since the valuation is very high and the earnings are fairly meaningless, probably it will be the forecasts they make (or don’t make) about the future in the conference call that gets the most attention. I’ll be curious to see what they say, but I’m not rushing out to buy TWLO shares on the day before earnings… probably mostly because I’ve already got quite a lot of my portfolio exposed to similarly-valued cloud software stocks with nutty valuations.
And it’s worth noting that “real” news like earnings sometimes doesn’t matter, either — Atlassian (TEAM) had great earnings on Thursday night and that drove the stock up by 10% or so… but the Barron’s article that brought down the whole segment put them right back where they were before earnings. Unlike the nicely predictable lunar cycles, you never know when the investor sentiment tide will ebb or flow.
So do you embrace the big picture, look forward to that future with Twilio-embedded communications running over 5G and forming the foundation of customer relationships for thousands of big companies, and try to get your brain around the possible exponential growth that human beings have a really hard time envisioning? Or do you fear the valuation, worry over the distinction between 15X sales and 25X sales, and fret about the popping of a bubble?
Only you can make that call, and there’s no right or wrong answer until we get to look back in a few years to see the evidence — Twilio is an impressive company, from what little I’ve learned about them in my few minutes of research today, but like lots of other impressive companies who may benefit from an increasingly connected world and a faster and faster movement of data, it ain’t cheap. Which is probably half the reason that David Gardner likes them.
As always, it’s your money… so it’s your decision — let us know what you think with a comment below. Just know going in what your expectations are, what portion of your portfolio you’ll be putting at risk, and what decisions you’ll be preparing to make if the stock price turns against you.
Disclosure: Among the stocks mentioned above I own shares of Amazon, Facebook, The Trade Desk, Shopify, and Okta. I will not trade in any covered stock for at least three days, per Stock Gumshoe’s trading rules.
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