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Morningstar | Twilio Continues to Send Strong Signals With Beat and Raise Cadence; Raising FVE to $66

Twilio reported stellar third-quarter results, surpassing our expectations as well as consensus on the top and bottom lines. Enterprises are seeking to enhance the customer experience as well as operational efficiency by incorporating various forms of digital communications apparatuses, and these secular trends along with strong execution have led to a remarkable year thus far for the communications platform-as-a-service, or cPaaS, leader. The fact that management was able to raise full-year guidance by more than 7% this late into the year is indicative of the tremendous health of the business.

Our estimates were already ahead of consensus, leading to a modest fair value estimate increase to $66 per share from $63. We will maintain our no-moat rating for Twilio, as we continue to believe that characteristics endemic to its business model make the spectrum of possible outcomes too broad as they continue to invest in growth. Our positive moat-trend rating also remains intact, and there was plenty of evidence during the quarter that the firm is not only further penetrating its addressable market, but also extracting more value from existing customers by identifying and incentivizing new use cases across the different layers of its platform.

Revenue of $169 million represented a 68% increase year over year. Twilio’s dollar-based net expansion rate, which measures the increase in spending by accounts which were active in the prior period, came in at 145%, versus 137% last quarter and 122% a year ago. Metrics such as this lend credence to our thesis that switching costs are increasing for this business, particularly as the extent of use and use-cases proliferates across multiple touchpoints in the enterprise. Our calculated average revenue per account increased 28% year over year, implying that potential switching costs in conjunction with the superior reliability that the Super Network offers are allowing the firm to maintain pricing power.

While the firm continues to invest heavily in growth, the operating model seems to be scaling nicely, with leverage on the gross and operating margin lines starting to bear fruit. Non-GAAP gross and operating margins widened 200 basis points and 1020 basis points, respectively, to 55.4% and 2.5%. The firm indicated that a slight change in Verizon’s pricing may start to impact gross margins in 2019. While we think this is indicative of the structural disadvantage that the firm’s reliance on network service providers represents, we do not think this will be a material risk longer-term. As has been the case in the past, the firm is passing on these additional surcharges from Verizon to customers, and we think the firm's product superiority will continue to facilitate pricing power.

Twilio Flex, the firm’s fully programmable contact center solution, continued to see strong adoption. We were pleased to hear that longtime customer Lyft chose to expand their relationship with Twilio through the Engagement Cloud product, as it illustrates that even as the firm’s core voice and messaging products become increasingly commoditized, Twilio is able to add value for their customers by upselling more involved use-cases in the orchestration layer of their platform. Moreover, products within this layer of the platform are inherently higher margin, which gives us confidence that the firm will be able to improve its margin profile longer term.