Kyle Harrison’s Post

Great piece. I’ve seen a lot of PE companies go full-tilt in scale mode as the funding flows in, with only an eye on top-line growth. These companies have all been in the news over the last 6-12 months with layoffs, restructuring, and in some cases collapse - and there’s some mighty big ones in there too. They all have this common theme of, essentially, scaling with one model and continuing with that ‘expensive’ operating model… “as long as the investors keep getting excited it’s OK.” It isn’t. The companies that are now riding the turbulence, or even thriving, set out staged growth goals and upon achieving the next level, the business remodelled for appropriate efficiency and agility to scale. It’s actually a continual process and starts with the thinking one of my previous CEOs used to prescribe: “what should we look like when we are double this revenue?” - then set about organising your business for that scale such that your processes, systems and most importantly productivity are already in front of the scale you desire. Does this hit short-term margins, yes, but makes the longer term margins attainable and improves the resilience of the organisation or, as she put it: makes you anti-fragile.

Your OpEx are too high for those margins.

You’re mixing cause and correlation. Valuations should never have been that high in 2021. That was VC series A flipping to VC series B, C, D…flipping to public markets - you (the investors pushing for explosive growth at any cost / high CAC). Twilio’s valuation multiples should never have been so high as to drop so much. Fascinating how you’re blaming the company for the drop when in fact it was speculation that led to its highs.

I’m not sure why you talk about gross profit margins. It would not matter even if they had a 95% gross margin. The reason why this business is not good is because a) they have a generic product b) tech gets competed away really fast and c) they are losing heaps of money. The company has negative EVA meaning that the larger it grows the more money it will burn. That’s not a business model, that’s hopium 101. There are so many companies in the cloud sector today operating at a loss. If they had a 95% profit margin you would have 100s of people lined up tomorrow to eat that profit. Analyzing it from that perspective is not very productive.

Anyone with a ‘Robinhood Snacks’ subscription can tell you “what’s going on”. It’s much more at a macro level: check the NASDAQ and NYSE. Public tech company valuations were drastically inflated, and for a while. Tons of other shitstorms at the macro level as well that aren’t worth delving into but should be apparent if you had to take an economics class at any point in your life. Doesn’t take a 16 page dissertation on LinkedIn. Takes about 5 sentences and a sprinkle of common sense.

Nobody can deny the value of strong gross margins! I try to steer people away from taking SEC Filings at face value for these types of analyses though, since differences in accounting and expense classification across companies can blur the lines between "Costs of revenues" and "Operating expenses". Point being - whether expenses reside above or below the Gross margin line can vary significantly across companies. Deep comp analysis will often try to normalize expense classifications across categories to account for this. There is a lot less flexibility in what can sit outside of Gross profit and Operating income. Building on that point, all three of the companies you compared Twilio to most recently reported negative operating margins - so their cost profiles are actually more similar than different in that regard. Question for you, if gross margins were driving the bulk of the story here, wouldn't we expect to see the difference multiples mirror that more closely? E.g., Datadog's 77% / Twilio's 50% = 1.54. Even if Datadog traded at 15x Revenue, if gross margin was to blame, wouldn't we expect Twilio to still be somewhere in the 10x Revenue range instead of <2.5x Revenue?

Well CAC payback should have been measured on gross margin…

I hate that this has drawn me in. I cannot ignore the over simplicity of this post. I wish we would all stop thinking revenue revenue revenue, GM is important, but what is most important is available cash and profit. Meat and potatoes may not be the stuff that unicorns live off, but look around - there are not many unicorns. Having an idea and people to fund it, then using other peoples money to market market market, without the right PMF - that is Twilio's problem. The product and business fundamentals need to be right.

The simplest answer is most often correct: It was overvalued. At its peak Twilio was trading at over 70X Revenue, was not profitable (still is not), and had negative free cash flow. An investment is the present value of all future cash flows. Even if you forecast generous growth assumptions, a shift to profitability, and positive FCF, it was, like a lot of other equities in 2021, still wildly overvalued.