If Youre Investing In Twilio, You Should Understand These Risks

This month, tech company Twilio (NYSE: TWLO)reported earnings and saw a massive sell-off on the news.

In this Industry Focus: Tech segment, Motley Fool analysts Dylan Lewis and David Kretzmann talk about a few of the most important risks that long-term investors need to understand before buying into this company. Find out how long-term investors can take some of the risk out of investing in recently public companies like Twilio, how much Twilio's loss of its contract with Uber will affect the company, the most important business metrics investors should be watching to measure how Twilio is performing, and more.

A full transcript follows the video.

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This video was recorded on May 19, 2017.

Dylan Lewis: When you think about investing in a recently public company, I know my tendency, at least, is to wait until we see three or four quarters of results. You see them growing the base of their non-big customers. In the instance of Snap, you see them figuring out their monetization strategy. There's so much that an early public company needs to work out. And in Twilio's case, there are some metrics that people might not be super familiar with that you want to see trending in certain directions. So I think this is a reminder, in some ways, of why it can be better to wait and watch from the sidelines for these hot new public IPOs.

David Kretzmann: Definitely. And in general, I think a safe rule of thumb for investors is to wait at least six months after a company goes public. Just wait on the sidelines, let a company get a couple quarters under its belt, just get a sense for the direction management is taking the company in, and see if their strategy is playing out in a successful way. In the case of Twilio, the founder and CEO, Jeff Lawson, who gets a lot of high praise from the industry and tech in general, he has a background with [Amazon.com] Web Services, and Twilio's business model is kind of similar to AWS, in some ways.

Lewis: And I believe they have a stake in Twilio as well.

Kretzmann: I believe so. They at least have a partnership. But he still owns over 7% of the company. That's after the six month lock-up expiration, which is, essentially, six months after the IPO, the insiders can sell their stock if they want. But he still owns a sizable stake. He seems to be pretty well regarded in the space. So it's nice to see a key insider like that still retaining a large stake, even after he could have, maybe, sold out.

Lewis: Yeah. If you're looking for the actual impact here that we're seeing for revenue, with Uber moving away, they projected that the hit from the declining business -- Uber won't disappear overnight; it will be a slow, gradual slope off -- it looks like it will be a $10 [million]-$11 million hit to revenue in 2017. I think, all told, if you look at Uber's contribution, somewhere in the $40 [million]-$60 million over the course of 2017. For a company to lose $1 billion in market cap over that, I think a lot of the market reaction speaks more to those moat concerns than to them losing a specific customer. And that's really the thing to watch. Can this company continue to add new customers, build them up, and stay diversified in that customer base? Because that's what's going to fuel their growth going forward.

Kretzmann: Yeah. To me, that's the No. 1 thing for investors to watch. I think that's the main factor that will determine whether or not this is a business that can be sustainably profitable over the long term. If you do own shares of Twilio, or if you're looking to buy shares, this is a company that I wouldn't make a large position in a portfolio, especially now. It's still an unproven concept, they haven't proven that they can be profitable and produce positive free cash flow. There are still some questions about the moat. So I would make this a smaller position in the portfolio, if you are looking at it. Then, if they are able to prove themselves out over time, the stock should do well. And that would, naturally, make the position a bigger part of your portfolio. And that would be the time I would look to, maybe, add a bit more.

Lewis: Yeah. And I can see why people would like this business. There are a lot of reasons it's been on my watch list for a little while. Any time you have a business that's doing the heavy lifting and the dirty work so that people can just plug something in and make it happen, particularly on the tech side when it scales really well, that's going to be really appealing to investors. With their core business and what they do, I think there's a lot to like, as long as the core business metrics are moving in the right direction, I think it's something for investors to certainly watch.

Kretzmann: Yeah. And by and large, I think those core metrics are moving in the right direction. Uber leaving raises some questions about it. But by and large, the core business is still in pretty good shape at this point.

David Kretzmann owns shares of Amazon. Dylan Lewis has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Amazon. The Motley Fool recommends Twilio. The Motley Fool has a disclosure policy.