The Sky's the Limit for These Two SaaS Companies

Markets Motley Fool

Meet Twilio (NYSE: TWLO) and 2U (NASDAQ: TWOU). Though they operate in different industries, both companies are cloud-based, disruptive, and ... unprofitable. These companies are playing the long game though, reinvesting current profits in their businesses for a bright future. The combination of scalable business models and fast-growing industries make these software as a service, or SaaS, players promising companies. Do they have a place in your portfolio? 

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A cloud-based communications disruptor

Twilio helps developers embed communications software into applications, enabling companies to communicate more effectively with customers. You probably know Twilio better than you think: Its software is responsible for notifying you when your UBER is outside, your plane is delayed, and even your WhatsApp messages. 

These capabilities are all part of what Twilio calls its Programmable Communications Cloud. It offers software developers a series of communications API's (application programming interfaces) -- like grocery shopping for software development. Imagine a developer working on an application. Instead of figuring out how to integrate a communications function, they just turn to Twilio, and it is already done for them. This saves developers a huge headache and expedites build times. On top of this, developers can access the company's Super Network, allowing them to connect users globally -- just like how a text message travels across a network. Developers have flocked to the Twilio platform, and even the 1,000-pound gorilla in the cloud computing space, Amazon, invested in the business back in 2015. 

Rise of the phoenix?

The company's growth has been nothing short of stellar with revenue more than tripling in the past three years to $305 million.

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When Twilio IPO'd last June, the stock took off from just $15 per share to nearly $70 in its first three months of trading. Since then, it has seen a consistent decline to less than $30. The company is not yet profitable, but margins are improving. Still, its $49 million loss in the trailing 12 month period has left many investors uneasy as the latest guidance fell short of analyst expectations.  

Meanwhile, UBER stated in May that it would be relying less on Twilio to reduce spending on the platform over the next year -- a significant setback considering the ride-hailing company accounted for over 10% of Twilio's top line. Not every company has UBER's resources to handle communications in-house, but the announcement has further shaken up investors in the past two months.

With all that in mind, the future still looks promising for this company. Last quarter, Morgan Stanley announced it would be using Twilio technology for communications between financial advisors and their clients. And the total customer count topped 40,000. Revenue growth is still strong, while Twilio customers spent 41% more year over year in the latest quarter.

A cloud-based education disruptor

2U is transforming the stigma surrounding online education by forging long-term partnerships with prestigious universities, including Georgetown and North Carolina, to develop online graduate programs. The company gets a share of the tuition for providing services like student acquisition, content management, data analytics, and much more. As of now, it only offers select online graduate courses, but feedback from the universities is glowing. 

The company's motto is "No Back Row" -- class sizes average 12 students, so each student gets a personalized experience without the hassle of relocating to the actual campus. The virtual platform focuses on maintaining the quality of the program, making it possible to get a prestigious MBA from your living room and without taking a break from your career. The number of students on the 2U platform is growing each year, over 77,000 in total, and universities are recognizing the appeal. 

One risk though, is its reliance on a select number of universities. For instance, the University of Southern California accounts for 34% of revenue, which fortunately, is down from 55% in 2014. 2U acknowledges this risk, but it signs 10 to 15 year contracts, giving the company time to build out its client base. It is also the top dog in the space, but it remains to be seen if universities can handle the online infrastructure in-house (or should I say in-school). It seems like a tough task for a university, and 2U is certainly taking advantage of that while boasting impressive student retention rates. 

Teach the market a lesson

Like Twilio, 2U is not yet profitable. Its losses are narrowing as net income margin has improved by 16 percentage points in the last two calendar years. For now, the company is pushing to sign on more universities, taking a cut from the tuition of each student with more than 80% gross margins.

With a market cap of $2.3 billion, 2U trades at a pricey 10 times sales. Investors have driven the stock nearly 50% higher in the past year hoping to invest in what could be the future of education. 

In the latest quarter, the company announced a new partnership with the University of Denver for an MBA program. Also, the University of Southern California, 2U's first partner, is rolling out an online version of its nation-leading physical therapy program. More and more universities see the promise of online education.

These are two promising, high-growth companies centered on communications and education, two markets with huge potential. The ability to quickly scale -- when 2U, for example, creates a new feature on its platform, it can immediately implement it for all clients -- has the market excited, but with that excitement comes high valuations. But I believe the upside for these stocks is worth the premium, and if you're comfortable with a little volatility and a long-term mindset, you should give both of these companies a closer look.

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Ryan Reeves owns shares of Twilio. The Motley Fool recommends 2U and Twilio. The Motley Fool has a disclosure policy.