The 6 Biggest Risks to Twilio Inc. Stock

By Leo Sun Markets Fool.com

Twilio (NYSE: TWLO) has taken investors on a gut-churning roller-coaster ride since its IPO last June. The company, which integrates calls and SMS messages into apps with a cloud platform, saw its shares surge from an IPO price of $15 to nearly $70 before pulling back to the high $20s on concerns about its valuation.

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Image source: Getty Images.

But is Twilio now a worthy rebound play after that rout? Let's take a closer look at the six biggest risks facing the company (as outlined in its SEC filings) to find out.

1. Its dependence on Facebook

Twilio is heavily dependent on Facebook (NASDAQ: FB). Facebook's WhatsApp generated 10% of Twilio's revenues in the first nine months of fiscal 2016. That represents a decline from 17% in 2015, but Facebook recently added Twilio's services to Messenger, which should increase its weight on Twilio's top line again.

To make matters worse, Facebook is a "Variable Customer Account" which has "never entered into12-month minimum revenue contracts with Twilio." This means that Facebook can drop Twilio's services at any time, and it isn't obligated to pay Twilio a certain amount of guaranteed revenue.

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2. Its dependence on Amazon

Twilio's cloud infrastructure is outsourced to Amazon's (NASDAQ: AMZN) AWS (Amazon Web Services). This means that an outage atAWS, which happened several times in recent years, would knock all of Twilio's in-app phone and SMS services offline -- which would be devastating for top customers like WhatsApp, Uber, and Airbnb.

Amazon could also emerge as a potential rival to Twilio if it develops similar call and message processing services for AWS. AWS' superior scale would then enable it to offer those services at lower prices and render Twilio obsolete. But Amazon was an early investor in Twilio, and it uses its platform to deliver SMS messages for AWS -- so competing against Twilio would becounterproductive.

3. Its dependence on network service providers

As a middleman between network service providers and mobile apps, Twilio is highly vulnerable to service providers hiking their prices. Twilio admits in its latest 10-Q filing that "the fees that we are charged by network service providers may change daily or weekly, while we do not typically change our customers' pricing as rapidly."

Twilio also warns that "many of these network service providers do not have long-term committed contracts with us, and may terminate their agreements with us without notice or restriction." This means that if the carriers decide to launch their own cloud platforms for integrating calls and SMS messages with apps, they could cut Twilio out of the loop and gut its core business.

4. Potential competition from Cisco

Twilio also admits that legacy on-premise network equipment vendors like Cisco (NASDAQ: CSCO) could bundle Twilio-like services into their networking hardware bundles for service providers. Doing so could strengthen Cisco's service provider revenue, which dipped 2% annually lastquarter.

Integrating more cloud-based services would widen Cisco's moat against rivals in the software-defined networking market while pivoting its core business away from its slower-growth routers and switches -- but it could be devastating for Twilio.

5. Its dependence on growth abroad

Twilio generated 15% of its revenue from international markets in the first nine months of 2016. That's up from 14% in 2015 and 12% in 2014. Therefore, Twilio notes that it's been expanding its overseas sales team, but that its experience in selling products in non-U.S. markets was "limited."

Twilio also warns that the no-stack, developer-first model that generated such explosive growth in the U.S. might not gain "the same traction outside the United States." Moreover, carriers might not be as agreeable, similar platforms might emerge in different countries, and developers might prefer to develop their own call and SMS integration services from scratch. A consistently strong dollar could also gobble up the company's profits abroad.

6. Its lack of profitability

Twilio is still unprofitable by both GAAP (generally accepted accounting principles) and non-GAAP (adjusted) metrics, and will likely remain so for the foreseeable future. The company's expenses will likely rise as it spending on sales teams to acquire new customers and expand overseas goes up, and margins could be pressured by competition from bigger rivals. This means that Twilio's cash position will keep declining -- which could lead to yet another share-diluting stock offering.

The key takeaway

I personally own a small position in Twilio, but I believe that it will remain volatile this year due to the aforementioned risks. However, if investors are willing to ride out that volatility and Twilio maintains its "best in breed" reputation in call and SMS integration, they could be well rewarded over the next few years.

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Leo Sun owns shares of Amazon.com, Cisco Systems, and Twilio Inc. The Motley Fool owns shares of and recommends Amazon.com and Facebook. The Motley Fool recommends Cisco Systems. The Motley Fool has a disclosure policy.