Will Twilio Inc's 300% Post-IPO Rally Burn Out?

By Markets Fool.com

Shares of Twilio (NYSE: TWLO) have more than quadrupled from its IPO price of $15. That enthusiasm was driven by the popularity of its cloud platform, which connects popular apps like Facebook (NASDAQ: FB) Messenger, WhatsApp, Uber, and Airbnb to users' phone numbers.

Continue Reading Below

While Twilio's sales are impressive, its stock looks very pricey relative to its growth potential. Moreover, 36% of shares werebeing sold short as of Sep. 26 -- indicating that investors are betting on a big pullback. Is it time to take profits in Twilio, or does the stock still have room to run?

Image source: Getty Images.

How fast is Twilio growing?

Twilio's revenue rose 70% annually to$64.5 million last quarter, and its active customer accounts grew 45% to 30,780. It expects its full year revenue to rise 52% to 54%, compared to 88% growth in 2015. That growth is impressive, but it doesn't justify the stock's whopping P/S ratio of 25, which is much higher than the industry average of 5 forapplication software companies.

Several tech companies with comparable sales growth also have much lower P/S ratios than Twilio. Optical fiber equipment vendor Acacia Communications' (NASDAQ: ACIA) revenue nearly doubled annually during the first six months of 2016, yet the stock only trades at 11 times sales. Momo (NASDAQ: MOMO), also known as "China's Tinder," posted 199% sales growth last year but trades at 19 times sales.

Continue Reading Below

Twilio isn't profitable. Its non-GAAP net loss narrowed from $7.5 million to $5.9 million between the second quarters of 2015 and 2016, but its GAAP loss widened from $9.5 million to $11 million. That disparity was mainly caused by stock-based compensation expenses more than doubling year-over-year to $8 million. Twilio expects to remain unprofitable by both metrics through the end of the year.

Potential tailwinds

Twilio's valuations look steep, but the company hasn't been sitting still. Last quarter, it integrated its platform into Facebook Messenger, expanded a partnership with Amazon (NASDAQ: AMZN) Web Services (AWS), and launched four new features -- Add-ons, Notify, Programmable Wireless, and Sync.

Add-ons makes it easier for developers and businesses to access partner technologies which integrated with Twilio's API (application programming interface). Notify is an API for delivering notifications via SMS, push notifications, and messaging applications. Programmable Wireless helps developers and businesses program cellular connectivity, and Sync is a real-time synchronization API.

These new partnerships and features should allay some concerns about Twilio's dependence on Facebook's WhatsApp, which generated nearlya fifth of its revenue last year. The integration with Messenger also indicates that its relationship with Facebook remains solid. Its partnership with Amazon, which delivers messages for AWS' Simple Notification service, means that AWS probably won't launch its own Twilio rival anytime soon.

WhatsApp. Image source: Google Play.

Twilio also recently acquired Kurento's WebRTC (web real-time communication) media server technology. That acquisition complements its 2015 acquisition of secure authentication start-up Authy, which specializes in two-factor authentication. Both purchases, along with the new partnerships and features, will help Twilio expand an ecosystem around its core mobile number-based services.

Potential problems

However, Twilio's huge post-IPO pop can also be attributed to a perfect storm of hype and a low float. The company only sold about 10% of its shares during its IPO, which inflated demand and squeezed the price higher. After that happened, automated algorithms and high-frequency traders propelled the stock higher, causing mainstream traders and investors to chase the momentum. Once that momentum runs out, the short sellers will likely swarm in and the stock will drop.

Twilio's lockup period will expire in late November, allowing insiders and institutional investors to sell their shares. I believe that if Twilio is still trading in the $60s by then, many of those shareholders will likely sell, and the stock's valuations will drop to more reasonable levels.

The key takeaway

I personally like Twilio's "best in breed" reputation, its new partnerships, and its expanding ecosystem. But I believe that the stock is grossly overvalued, and that its price was inflated by the IPO's low float and media hype.

Therefore, I believe that Twilio could be a great long-term investment, but not at current prices. Investors should wait for the lockup expiration to pass, let short sellers drive the stock down, and buy the stock at much lower prices.

A secret billion-dollar stock opportunity
The world's biggest tech company forgot to show you something, but a few Wall Street analysts and the Fool didn't miss a beat: There's a small company that's powering their brand-new gadgets and the coming revolution in technology. And we think its stock price has nearly unlimited room to run for early in-the-know investors! To be one of them, just click here.

Leo Sun owns shares of Amazon.com. The Motley Fool owns shares of and recommends Amazon.com and Facebook. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.