Equity capital markets update - Twilio IPO August 1, 2016

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1 IPO activity has been light in 2016, particularly in the technology sector with only a handful of US issuers successfully completing listings. Twilio, a leading cloud communications platform based in San Francisco, CA, raised more than $170 million in its initial public offering at the end of June, and was the first unicorn to approach the market in some time. The transaction was very well-received by the market, and we believe it makes an interesting case study for IPO execution amidst a volatile backdrop. Company and situational overview Twilio has appeared on many IPO backlog lists over the past year, and its offering was highly anticipated as it hits on many of the themes the market desires in technology issuers including: A hot space: cloud platforms and embedded communications Seasoned management team, partnered with marquee investors Unique combination of scale and growth vs. the average software IPO Trailing revenues of ~$200mm Annual growth >75% over the past 2 years Projected annual growth of ~40% over the next 2 years High-profile client wins, and a developing track record of growing revenue from these relationships A potential hurdle for Twilio was its current lack of profitability. In more constructive investing environments, technology growth investors typically are not as focused on current cash flow, and in fact may actually question a strategy that does not maximize the investment of cash flow back into the business to drive market share growth and footprint. However, in a challenging and risk-averse market (such as the current new issue environment), demonstrating the ability to generate cash can be a key investment criteria (and requirement) for many investors. In this example, Twilio was able to convince an otherwise skeptical IPO market that its cost structure is attractive relative to software peers at the same stage of development and that it will generate profitability at scale. Effectively the issuer was able to build a tangible bridge to profitability that gave credibility to their long-term projection model. Valuation perspectives With the lack of a broader IPO and high growth technology deal calendar, this transaction was bound to face heightened scrutiny from investors and the technology community at large. As such, the company and underwriters took a conservative approach with valuation during the marketing period. The midpoint of Twilio s $12 $14 price range implied a fully diluted equity market capitalization of $1.2 billion, which would represent a slight premium to the company s last funding event in July The price range corresponded to an Enterprise Value of roughly 2.9x 3.5x 2017E Revenues, which is conservative relative to where high growth software IPOs have priced and traded in recent years. T. Rowe Price an existing equity investor provided additional valuation support by disclosing its intent to purchase up to 15% of the shares in the offering at the market clearing price. This public commitment to purchase common stock is an outlier for technology deals, and undoubtedly helped build momentum in the order book, which in turn supported and bolstered valuation. Price range Share price $12.00 $13.00 $ E EV/Revenue (x) 2.9x 3.2x 3.5x Equity value ($mm) $1,124 $1,226 $1,329 1 Per Twilio PitchBook profile 1 P age

2 Marketing and pricing During a roadshow the underwriters gather order size data at various prices that can be used to construct a rudimentary demand curve. Despite best attempts to run a data-driven process, inevitably there is a great deal of subjectivity in any bookbuilding process. Investor feedback and price discovery inherently involve gamesmanship, and underwriters are rarely able to elicit perfect information. As part of the bookbuilding process, underwriters gather as much feedback as possible from investors around investment theses, projections, valuation methodology, long-term price targets and appetite to build on their allocations in the aftermarket. Given the variability and nuance in the process, the underwriters ability to probe and read the true intentions of investors is critical to accurately price an offering. In the Twilio transaction, a successful seven day US roadshow created a significantly oversubscribed order book with quality investor feedback a testament to the business, management team and underwriters success in articulating the investment thesis and value proposition. Outsized demand for the shares introduced IPO pricing flexibility for Twilio, including the possibility of pricing the deal above the $12-$14 marketed range, which had its own set of merits and considerations. While pricing at the high end of a price range sends a strong signal to the market, pricing above the range sends an even stronger message, and sets the expectation for substantial price appreciation in the aftermarket. That math may be counterintuitive, as a simple supply / demand curve would suggest trading equilibrium finds a fair price, and where the IPO price is set should not technically impact that price, as shown in Table 1. Table 1: Pricing an IPO Supply Shares Demand Low end of price range ($12) High end of price range ($14) Above the range price ($15) $12 $14 $15 Price However, deal expectations are such that an above the range price typically signals outsized demand not just in the marketed pricing range, but at the higher price and beyond. This can create a tricky backdrop for the underwriters by definition a higher price should lead to less demand, but in this case the market is now actually expecting better performance out of the higher priced security. With these elevated expectations if the stock opens in positive territory, but not high enough, the price reaction can be volatile as early IPO trading is often a momentum-driven event. On the Twilio deal we assume that this dynamic, in conjunction with a dicey IPO market backdrop, generated a healthy debate around pricing strategy. Ultimately the Company and underwriting syndicate were comfortable enough with the strength of the order book to price a full-sized deal at $15 price per share, $1 above the initially indicated price range. Twilio opened on the first day of trading at $23.99 (+60%) and closed that day at $28.79 (+92%) implying a 2017E Revenue multiple of 8.5x. Twilio is currently trading around $41, more than 2.5x its IPO price from less than 1 month ago and above most analyst month price targets perhaps a good example of how trading momentum can decouple a stock price from the market s perspective on fundamental valuation metrics in the aftermath of IPO momentum trading. 2 P age

3 Table 2: TWLO share price performance Source: S&P Capital IQ Monday morning quarterbacking When IPOs trade up as strongly as Twilio out of the box, the natural question for issuers and their financial sponsors is, was money left on the table? In other words, the magnitude of the price appreciation suggests demand at the IPO price was not satiated, and the deal theoretically could have priced at a higher level, increasing proceeds raised without additional dilution. Most agree that investors should be compensated for their risk when participating in IPOs, and a healthy early return is consistent with the long-term interests of all stakeholders. Additionally some issuers appreciate the positive press and goodwill that accompanies positive IPO trading and the branding of a successful IPO. However in most IPO pricing scenarios the inevitable question typically tracks back to: how much is enough? EY s recent investor survey suggests a 10%-20% initial pop is sufficient, so what does a corporate client and its existing investor base make of a 50%-100% one-day pop? As discussed above interpreting the feedback and orderbook on a transaction like Twilio, especially with the current new issue market backdrop, is an art, not a science. Also, the downside risk of pricing the deal too high is substantial the book may feel solid at a higher level, but as mentioned any chink in the trading momentum armor can have an immediate and precipitous impact on the stock price. Choppy trading at the open can result in a stock breaking issue price on Day 1 (i.e., trades below the IPO price) despite all other indications pointing to a strong and stable allocation strategy. Ideally, the banks would have more clarity into the impact of each $1 of value on aftermarket trading; however, in this scenario the combination of market volatility, company characteristics, trading vagaries and imperfect buyside information made the game theory difficult to simplify and predict. Along these same lines, there can be concern that underwriters have an inherent conflict of interest when advising corporate clients on the pricing decision. While the syndicate has the most information via a direct dialogue with the investors interested in the deal, they are selling the security to 100+ of their best equity clients most of which will be counted on to participate in future deals the same banks underwrite. If a deal is underpriced and trades up substantially, the biggest winner may be the underwriters buyside equity clients as substantial value has transferred from issuer to investor. As such, boards often seek perspective from independent advisors to help interpret the information that the underwriters are processing, and frame out the true pros and cons of the pricing decision for all stakeholders, but in particular the issuer. In this 3 P age

4 case Twilio had a nice-to-have problem where the Board and underwriting syndicate were evaluating high end vs above-the-range outcomes; however, the same dynamic, game theory and inherent conflicts are relevant for pricings at all levels. Summary All of this information considered, and with the broad underperformance of the 2015/2016 IPO class providing context, Twilio and its underwriters likely used an appropriate level of conservatism to arrive at their pricing recommendation and outcome. In the current market environment, investors have negotiating leverage, and given the asymmetrical implications of a poorly traded deal, it is very difficult for a syndicate to call investors bluff even when it holds a strong orderbook hand such as in the case of Twilio. With the opening trades clearing 60% above the IPO price, there was clearly demand at prices above the $15 offer price. It is inadvisable and likely not possible to capture all, or even a significant portion, of that upside. However, with the benefit of 20/20 hindsight, investors likely could have been tested at higher prices - and it is unlikely that increasing the IPO price another $1 or $2 would have broken the aftermarket success of the deal. But again this evaluation is made with the benefit of hindsight, and as such it would be very difficult to aggressively challenge the pricing strategy in this transaction. In other words, it would be easy for some to look at the Twilio outcome and question the accuracy of the underwriting syndicate; however, the backdrop likely forced the team s hand at this price, and by all accounts the issuer and associated parties are pleased with the outcome. As always the EY ECM team is available to provide color on the broader new issue market and/or this transaction in particular if helpful. Please reach out with any questions. 4 P age

5 Table 3: Offering summary Issuer (Ticker) Exchange Twilio Inc. (TWLO) NYSE Transaction Launch Date June 13, 2016 Pricing Date June 22, 2016 Base Deal Size Deal Size (Incl. Greenshoe) $150.0mm $172.5mm Base Deal Shares 10,000,000 Total Deal Shares (Incl. Greenshoe) 11,500,000 Share Mix 100% Primary Filing Range $ $14.00 Offer Price $15.00 Open Price / First Trade $23.99 Current Price (7/29/16) $40.63 Market IPO Market Cap (Current) Use of Proceeds Bookrunners $1.2bn $3.4bn General Corporate Purposes; Working Capital Goldman Sachs; JP Morgan Absolute Share Price Performance Offer to 1-Day +91.9% Offer to 2-Weeks % Offer to Current % Relative Share Price Performance vs. S&P 500 Offer to 1-Day +90.6% Offer to 2-Weeks % Offer to Current % 5 P age

6 EY Assurance Tax Transactions Advisory About EY EY is a global leader in assurance, tax, transaction and advisory services. The insights and quality services we deliver help build trust and confidence in the capital markets and in economies the world over. We develop outstanding leaders who team to deliver on our promises to all of our stakeholders. In so doing, we play a critical role in building a better working world for our people, for our clients and for our communities. EY refers to the global organization, and may refer to one or more, of the member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited, a UK company limited by guarantee, does not provide services to clients. For more information about our organization, please visit ey.com. Ernst & Young LLP is a client-serving member firm of Ernst & Young Global Limited operating in the US. Ernst & Young Capital Advisors, LLC (EYCA) is a registered broker-dealer and member of FINRA ( providing sector-specific advice on M&A, debt capital markets, equity capital markets and capital restructuring transactions. It is an affiliate of Ernst & Young LLP serving clients in the US. This material has been prepared for general informational purposes only and is not intended to be relied upon as accounting, tax, or other professional advice. Please refer to your advisors for specific advice. Some of the materials contained herein are copyright 2016, S&P Capital IQ (S&P). Reproduction and distribution of referenced S&P data in any form is prohibited except with the prior written permission of S&P. Use of S&P information is intended for the recipient s internal use purposes only. None of S&P, its affiliates or their suppliers (together, S&P parties) guarantee the accuracy, adequacy, completeness or availability of any information nor are responsible for any errors or omission, regardless of the cause or for the results obtained from the use of such information. In no event shall any S&P party be liable for any damages, costs, expenses, legal fees or losses (including lost income or profit or opportunity costs) in connection with any use of S&P information. ey.com 2016 EYGM Limited. All Rights Reserved. EYG no Gbl ED None 6 P age