Intro
AppLovin is an ad-tech company that saw a strong acceleration in growth and margins this past year driven by AXON 2.0, an AI-powered advertising engine that efficiently acquires users for mobile game publishers.
At IPO in 2021, AppLovin made most of its revenue from its Apps segment, a portfolio of free-to-play mobile games. This was historically seen as a cost center as AppLovin could gain a valuable trove of first-party data to feed into improving its user acquisition algorithms. However, management has since made an important pivot to grow its Software Platform segment, composed of MAX, its supply side platform (SSP) and AppDiscovery, its demand side platform (DSP).
This was because as MAX grew, AppLovin had a better source of data and gradually restructured its Apps business to focus on maximizing profitability. This transition made sense given the drastically different margin profile of the two segments, with a 15% long-term adjusted EBITDA margin profile for Apps compared to the over 73% adjusted EBITDA margin of the Software Platform segment.
After Apple announced its App Tracking Transparency (ATT) policy in 2021 which limited advertisers’ ability to track users across apps, AppLovin’s data became even more valuable as advertisers sought out AppDiscovery’s user acquisition algorithms to acquire high value users cost-effectively.
Furthermore, AppLovin’s CEO has repeatedly made clear that its AI recommendation engine has applications far beyond mobile gaming. It acquired Wurl, a Connected TV (CTV) SSP, in 2022 as an initial foray into CTV.
With a mobile ad network significantly larger than others in the market, AppLovin’s end-to-end advertising stack gives it a unique data advantage which enables superior algorithms that deliver better ad conversion rates, leading to higher return on ad spend to advertisers and higher spending, which attracts more inventory, leading to even better algorithms and so on.
Provided we can get the stock at a reasonable valuation, due to a durable data advantage, we believe AppLovin will be well-positioned to outperform.
Business Overview
AppLovin’s business consists of two segments: a fast-growing, high margin Software Platform and a slower-growing, lower margin (but still profitable) Apps segment consisting of its portfolio free-to-play mobile games. Our focus is on the software segment as it continues to drive top-line growth, powered by its AXON 2.0 AI-engine which we will discuss below.
Software Platform Segment (66% of Revenue, 87% of Adjusted EBITDA in Q2’24)
AppLovin’s software platform enables mobile gaming publishers to monetize their ad inventory, acquire new users more cost-effectively, and optimize their ad spend through three solutions:
MAX is AppLovin’s mediation platform, a type of supply-side platform (SSP) which is used by publishers to maximize the value they’re able to sell advertising inventory for by running real-time auctions across a wide range of ad networks. The service is free to use for publishers, with MAX charging advertisers a fee of 5% of header bidding. AppLovin acquired MoPub from Twitter for $1.05 billion in cash in 2022, turning MAX into by far the largest mediation platform for mobile gaming today.
AppLovin’s largest competitor in this segment is Unity Software, which has its own “Grow” segment where it offers tools to monetize and acquire mobile gaming users. It completed a $4.4 billion merger with ironSource in 2022, which was intended to remedy Unity’s own troubled mediation software as ironSource had its own leading mediation platform and tools for creating and managing ad campaigns.
AppLovin actually offered to acquire Unity at $58.85 per share in August 2022 before its planned merger with ironSource. Unity turned down the offer and continued with the merger, which has not proven successful. In January 2024, Unity cut 25% of the combined company’s employees and the ironSource founders left shortly afterwards. In its recent Q2’24 earnings report, Unity’s Grow solutions revenue was $296 million, down 9% YoY and up 1% QoQ after two quarters of QoQ declines. This was a far cry from AppLovin’s own Q2’24 result of 75% YoY and 4.9% QoQ growth for its software segment to $711 million.
AppDiscovery, the majority of the software platform’s revenue, is AppLovin’s demand side platform (DSP) that leverages machine learning to identify high value users that are mostly likely to download and engage with an app and help game publishers to earn the highest return on ad spend. Advertisers pay AppLovin, typically on a cost-per-install performance-basis, who passes on the spend to publishers on a cost per impression model.
Adjust is a SaaS solution that provides analytics to optimize ad performance. It generates revenue mainly through an annual software subscription fee.
Finally, Wurl, a company that AppLovin acquired in 2022, essentially does what APP does but for the connected TV industry. It helps video content creators distribute, monetize, and acquire new users. Wurl generates revenue primarily from content companies which typically pay Wurl on a usage-basis.
Apps Segment (34% of Revenue, 13% of Adjusted EBITDA in Q2’24)
AppLovin’s other main business segment is Apps. AppLovin owns or partners with ten studios worldwide which have published over 200 free-to-play mobile games – mostly in casual and card game genres which are more predictable and target a wider audience.
These apps are monetized through in-app purchases by users (68% of apps revenue in H1’24) as well as advertising (32% of apps revenue in H1’24), with in-app advertising growing slightly more at 8.8% YoY compared to in-app purchases growing at 5.1% YoY.
This segment has become a secondary focus for AppLovin, and they’ve stated their openness to divestitures though they are waiting for the market to improve. The number of studios they partner with has also dropped from 14 in Q2’21 to ten today.
AppLovin competes against other publishers like Activision, Tencent, and Zynga. Notably, many of these companies are also customers for the software segment, with the CEO noting on the Q2’24 call:
“At this point, our platform is so successful in mobile gaming, it's very, very hard for any publisher to look the other way. And so we've gotten a lot more adoption across even those publishers. There isn't really a customer that I know of in mobile gaming that does not find success — scalable success on our platform at this point today.”There isn't really a customer that I know of in mobile gaming that does not find success — scalable success on our platform at this point today.”
Acceleration from AI-Powered Platform
AppLovin’s revenue growth saw a dramatic acceleration over the last four quarters, improving from -3.36% YoY growth in Q2’23 to 44% YoY growth in Q2’24, driven by the Software Platform which rose from 54% of revenue to 64% over the same period.
Management accredited a large part of this acceleration to the launch of AXON 2.0 in early 2023, with growth from this pivot first showing up in the numbers in Q2’23. AXON leverages data from its MAX mediation software to train AXON, an AI-powered advertising engine that drives AppLovin’s AppDiscovery product.
MAX gives AppLovin data on what different ad networks are willing to bid for ad placements, allowing AXON to competitively bid for ad placements to maximize return-on-ad-spend.
Management effectively encapsulates why the combination of their algorithm and their data gives them a first mover advantage in the Q1’24 call:
“We built cutting-edge AI technologies. It's a multi-year effort for anyone to be able to look at that and go be able to replicate that. And I don't even think it's conceivable that it's something that can be replicated. So, by the time there's anyone that's actually going to be able to compete against our technology, we will be years advanced from where we are today because we're continuing to evolve the technology.multi-year effort for anyone to be able to look at that and go be able to replicate that. And I don't even think it's conceivable that it's something that can be replicated. So, by the time there's anyone that's actually going to be able to compete against our technology, we will be years advanced from where we are today because we're continuing to evolve the technology.
Second piece is, we can open-source our code tomorrow. We can hand-out the code to competition. It still won't matter because these technologies need data that they're achieving in the marketplace to be able to drive themselves. So, if you think about like AI models, like what makes an AI model impactful? Well, they're utilized and that data feedback that they get from human behavior retrains the model and allows the model to continue to improve itself.”We can hand-out the code to competition. It still won't matter because these technologies need data that they're achieving in the marketplace to be able to drive themselves. So, if you think about like AI models, like what makes an AI model impactful? Well, they're utilized and that data feedback that they get from human behavior retrains the model and allows the model to continue to improve itself.”
Given AppLovin’s reliance on user tracking to feed its algorithms and how its apps business was impacted by IDFA changes in the past, one of the largest risks are privacy initiatives by Apple and Alphabet to limit user tracking. The CEO responded to this by noting on the Q3’23 call:
“Look, we’ve dealt with privacy changes probably since 2014. Every time there’s a change on platform or with regulators, you’ve changed something in your stock, but we’re a nimble company, we’ve rewritten our core technology multiple times over the years, and we are always able to adapt and perform in the face of any of those kinds of changes.”
Management has also hinted at possible applications outside of gaming, with AppLovin launching its first web advertising campaigns for e-commerce in Q2’24 and noting its early success, with material contributions expected as soon as 2025.
“In the quarter, Q2, we launched pilot of our web advertising program…This allows an e-commerce shop that has a website to buy on our in-app inventory, the billion-plus daily active users we see in mobile gaming, a video advertisement routes that user to their shop and purchase that user in the same way that mobile game companies like purchasing users on our platform.
…Results are looking really promising, materially better than what we would have expected this early in our progression in trying to get into web advertising. So this product, we think is something that we're going to invest heavily behind, start scaling out and hopefully will show a material impact in '25 and beyond. And it is not limited to just e-commerce. It opens the door to advertising for any website of any type that wants to drive transactions that are measurable on a performance basis on our platform.”hopefully will show a material impact in '25 and beyond. And it is not limited to just e-commerce. It opens the door to advertising for any website of any type that wants to drive transactions that are measurable on a performance basis on our platform.”
In the Q2’24 call, management expanded on how improving the algorithm both as a function of more data and model improvements can lead to 20 to 30% long-term software segment growth, compared to industry growth in the low-single-digits, without accounting for expansion into new verticals.
“You've got a mobile gaming category. It's got a few percentage points of growth a year now. So let's call that low-single digits. You've got a business that as these models continue to improve from gathering more data, we think that's an extra 3%, 4% a quarter as well. So, that sort of gets you to the low end.as these models continue to improve from gathering more data, we think that's an extra 3%, 4% a quarter as well. So, that sort of gets you to the low end.
And then we've got a team that's constantly working on improving the models and any improvement that's actually develop or driven enhancement to the models that makes them more accurate, then steps you up into the higher-end of that range. And so we've got a lot of confidence in the growth goal we put out there just on a baseline basis the current business.”any improvement that's actually develop or driven enhancement to the models that makes them more accurate, then steps you up into the higher-end of that range. And so we've got a lot of confidence in the growth goal we put out there just on a baseline basis the current business.”
AppLovin Q2 Financials
AppLovin reported a decent Q2’24, with a bottom-line beat and top-line that was in-line with estimates. Guidance also came ahead of estimates on revenue and adjusted EBITDA.
The software segment again was the driver of growth, reporting 75.1% YoY growth, compared to the overall business at 44% YoY growth, but QoQ growth slowed noticeably from recent quarters.
The highlight of the report was the strong margin improvements, driven by both the continued mix shift towards higher margin software revenue as well as outperformance in apps segment margins due to a reduction in costs.
AppLovin’s Q3’24 guidance also continues to assume strong growth; if the apps segment grows at the same rate YoY as Q2, then the guidance implies a slight re-acceleration in the Software Platform segment from 44% YoY growth to 46.6% YoY growth.
Revenue and EPS
- Q2 revenue grew by 44% YoY to $1.08 billion. It was in-line with expectations
- AppLovin guided for Q3 revenue of $1.125 billion at the midpoint, representing YoY growth of 30.2%, beating $1.10 billion consensus by 2.2% at the midpoint.
- Management remains confident that they can grow their software segment at a 20% to 30% CAGR for the long term after first mentioning the goal last quarter.
Margins
Margins remained strong with gross, operating, adjusted EBITDA, and net margins all expanding YoY and QoQ, driven by a mix shift towards higher Software Platform revenue and cost discipline. Management expects these margin improvements to continue, guiding for QoQ expansion in adjusted EBITDA margin.
- Gross profit rose 62.2% YoY to $797.6 million. Gross margin was 73.8%, up from 65.5% last year and 72.2% last quarter.
- Operating income rose 197.2% YoY to $391 million. Operating margin was 36.2%, up from 17.5% last year and from 32.1% last quarter.
- Net income rose 285.7% YoY to $310 million. Net margin came in at 28.7%, up from 10.7% last year and 22.3% last quarter. GAAP EPS of $0.89 beat estimates by $0.16, representing YoY growth of 304.5%.
- Quarterly EPS growth is expected to level off with GAAP EPS of $1.01 expected for Q3’24 and the same for Q2’25.
- Adjusted EBITDA rose 80% YoY to $601 million, beating guidance by 7.3% at the midpoint. Adjusted EBITDA margin was 55.7%, beating guidance of 52.5% at the midpoint and up from 44% last year and 52% last quarter.
- Management guided for further improvement in adjusted EBITDA margins next quarter, targeting $640 million at the midpoint, representing a 57% margin and beating consensus of $587 million by 9%.
Cash and Debt
Operating cash flow was $454.5 million, up 97.8% YoY. Operating cash flow margin was 42.1%, up from 30.6% last year and 37.1% last quarter.
Free cash flow was $445.5 million, up 101.9% YoY. Free cash flow margin was 41.2%, up from 29.4% last year and 36.6% last quarter. For comparison, analysts expect competitor Unity Software to only earn a 12.7% FCF margin in 2024, compared to 8.2% in 2023. Digital Turbine, another ad tech company that offers user acquisition and monetization services is expected to earn just 4.3% FCF margins for FY’25 (ending March 2025) compared to 0.8% in FY’24. Even The Trade Desk, the leading DSP, is expected to earn 27% FCF margins in 2024, compared to 28% in 2023.
For Q2 2024, the company has $3.52 billion in total debt, up slightly from the $3.50 billion in total debt reported in the previous quarter and $3.2 billion last year. AppLovin reported $460.45 million in cash and marketable securities, down from $876.2 million last year but up from $436.3 million last quarter.
AppLovin repurchased 4.2 million shares for $356 million in the quarter. They currently have $500 million remaining in its $1.25 billion repurchase authorization. AppLovin has taken advantage of the drawdown in its share price to repurchase shares, reducing its share count by 10.6% since the end of 2022.
Revenue Segments
AppLovin’s Software Platform revenue grew 75% YoY and 4.9% QoQ to $711 million, marking the sixth consecutive quarter of QoQ acceleration driven by AXON 2.0, though noticeably by a smaller percentage than previous quarters.
AppLovin’s Software Platform adjusted EBITDA grew by 90.7% YoY and 5.8% QoQ to $520.5 million. Software EBITDA margins were 73.2%, up from 72.6% last quarter and 67.2% last year.
AppLovin’s Apps segment revenue grew 7.2% YoY to $369.1 million, marking the second consecutive quarter of YoY growth.
AppLovin’s Apps segment adjusted EBITDA grew 33.1% YoY and 42.2% QoQ. Apps adjusted EBITDA margins were 21.9%, a significant improvement from 18% last year and 15% last quarter. This quarter was a standout due to a readjustment in user acquisition return goals, resulting in a 11% QoQ decrease in app segment costs. Management expects Apps EBITDA margin to normalize at 15% over the long-term.
Key Metrics
AppLovin logged 1.6 million Monthly Active Payers (MAP) for their Apps segment, a decrease from 1.8 million last quarter and 1.7 million last year. However, Average Revenue per MAP grew to $52, up from $48 last quarter and $46 last year.
Regarding the Software Platform, net revenue per installation increased 7% YoY in Q2’24 while the volume of installations increased 77% YoY, both strong indicators on the effectiveness of its AppDiscovery product.
Valuation
On the top line, AppLovin is trading at the highest it’s traded since the 2021 blowoff top at 6.5X Forward PS. We could see a re-rating of stocks to pre-2022 top line valuations, but this is incredibly speculative. Therefore, a 4X Forward PS is a better target, in our opinion. Unity is trading at a 3.7X Forward PS.
On the bottom line, AppLovin trades at a lower multiple relative to its growth rate at 11x NTM EV/EBITDA and 20.5x LTM EV/FCF. Its closest competitor, Unity, trades at 16x NTM EV/EBITDA and its revenue its projected to fall 16% YoY this year due to backlash from the controversial Unity Runtime Fee last year, poor execution on integrating ironSource, and management turnover, compared to AppLovin’s 33% projected growth.
The reason behind this discount seems to be driven by AppLovin’s shrinking Apps segment. Although it reported 7% YoY growth in Q2’24, it was down 20% from two years ago as AppLovin intentionally divests away from the segment to focus on software. However, this segment continues to be profitable, with adjusted EBITDA margins never falling below management’s 15% long-term target over the last two years.
Even if we assign zero value to the Apps segment, the business still trades at 15x LTM EV/EBITDA for the Software Platform segment alone, which grew revenue 80% YoY over the same period and continues to project 20% to 30% growth.
Another concern could be AppLovin’s period of no-growth in 2022, where revenues stagnated YoY. However, this came after blistering 92% YoY growth in 2021 and before the launch of AXON 2.0 which has driven accelerating Software Platform growth since Q2’23.
While the durability of revenue growth associated with AXON 2.0 remains difficult to predict by management’s own admission, the product is becoming stronger every quarter and that is directly translating to efficiency gains and higher growth.
Conclusion
Ad-tech is one of the industries with the most potential to be transformed by AI and AppLovin is emerging as one of the leaders with its AXON 2.0 engine. AppLovin’s core advantage comes from its superior access to data, leading to better targeting, which leads to more data and so on. We see continued strong growth for the Software Platform segment because of this, driving high growth and an improving margin profile for the company.
We continue to watch AppLovin with interest as it continues to take share within mobile gaming and expand its AI engine to additional industries. Although we are not considering a buy at this time, Knox has a trading plan, which he will share with Advanced Members in this upcoming Thursday webinar.
This analysis is a preview of what you can expect in our upcoming Discovery tier, which will provide additional analysis on new idea generation stocks that are not currently in the I/O Fund portfolio. We look forward to launching this tier late August/early September. There will be no changes to our current service tiers, rather I/O Fund Discovery is a service for those who want more new stock ideas beyond what our service currently provides. Stay tuned for more information!upcoming Discovery tier, which will provide additional analysis on new idea generation stocks that are not currently in the I/O Fund portfolio. We look forward to launching this tier late August/early September. There will be no changes to our current service tiers, rather I/O Fund Discovery is a service for those who want more new stock ideas beyond what our service currently provides. Stay tuned for more information!
Please note: The I/O Fund conducts research and draws conclusions for the Fund’s positions. We then share that information with our readers. This is not a guarantee of a stock’s performance. Please consult your personal financial advisor before buying any stock in the companies mentioned in this analysis.
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