AppLovin has done the unthinkable, which is to awaken a low-growth mobile gaming ads industry with an AI engine that is showing demonstrable results. The market is loving this stock as it has doubled its margins, more than doubled its cash flow and has a surging AI segment due to its AXON 2.0 AI advertising engine.
Our near-term plan is to trade this stock, while our medium-term plan is to build a longer-term position. Both require an active stance rather than guessing on the buys. However, we think App is setting up for a longer-term trajectory and our firm plans to participate.
Update on Investment Thesis:
There are a few key points to the investment thesis that I’d like to bookmark here for future reference.
APP has User Data from 1.4 Billion Mobile Users
The first point to the longer-term investment thesis is that AppLovin has data from 1.4 billion mobile gamers. We’ve seen the razor-razor blade model with hardware, to where a company will own the hardware market to get recurring software revenue. AppLovin has a different variation of this, which is they own mobile gaming apps and a supply-side platform to mix both first-party data and third-party data, which in turn, fuels their AI engine to help them capitalize on the broader mobile gaming market.
The word moat is overused in tech stocks, yet AppLovin has an enviable advantage in the era of AI. Off the top of my head, I cannot think of another company with this level of user data for advertising purposes that is not a Big Tech company and in the Mag 7.
Catalyst: E-commerce and more Web-based Advertising Categories in 2025
AppLovin’s success has been entirely based on gaming companies advertising to mobile gamers.
The company is planning to introduce new advertising segments to the 1.4 billion users they serve in 2025, which is likely to help the company grow into the foreseeable future. The catalyst for 2025 is expected to broaden to also include a self-service platform for all types of web-based advertising. According to management, the pilot for introducing e-commerce demand is going quite well: “E-commerce, on the other hand, is looking so strong that it's something that we think will be impactful to the business financially '25 and then for the long term.”
Product Differentiation:
The ad engine AXON 2.0 offers a monumental advantage to AppLovin as the company is ahead in the race for AI-driven advertising. Part of this is the user data from 1.4 billion users, which cannot be overemphasized, and it’s also due to the company owning both a supply-side platform MAX and demand-side platform, App Discovery. 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. 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.
AppLovin is also an arbitrage advertising platform, which means they can quantify the impact of their reach for advertisers by returning back to the advertiser what was spent or more within 30 days. If an advertiser spends $10,000 (or multiples of this), AppLovin is able to return that or more to the advertiser. The company is also unique in that it offers performance marketing for brands and direct-to-consumer. The Trade Desk primarily works with agencies, whereas AppLovin is attracting smaller and medium sized businesses that rely on performance.
Most importantly, AXON 2.0 is an AI-powered advertising engine that is continuously improving. Every quarter and every year, AXON becomes more effective by ingesting more data that improves the model through self-learning. The management has been quite clear they believe these step-ups in model efficiency can help to maintain a 20% to 30% growth rate in gaming alone, and not accounting for the new web-based advertising catalysts expected in 2025.
“Last quarter, I shared our confidence in achieving 20% to 30% year-over-year growth for the foreseeable future. We continue to expect 4% to 5% quarterly growth through self-learning and market growth, with occasional step changes resulting from enhancements to our AXON algorithm.”
Strong Bottom Line and Cash Flows:
On top of the growth potential, APP has a strong bottom line and cash flows, which we review in more detail below. The adjusted EBITDA margin is at 60% and the GAAP operating margin has doubled YoY from 21.6% to 44.6%. The free cash flow margin of 45.5% has also doubled from 22.4%. Notably, the company carries $3.5 billion in debt, yet at this cash flow margin is not a concern.
You can read more about AppLovin here.about AppLovin here.
Q3 Earnings: Software/Advertising Segment up 16% QoQ
In addition to reporting growth on the bottom line, AppLovin’s primary AI segment inflected 17% QoQ to $835 million, up from $711 million last quarter. The software/advertising platform has a high adjusted EBITDA of 78%, easily making this one of the more profitable hypergrowth companies the market has ever seen. This is not exactly a secret, as AppLovin is up over 600% YTD but what is important to look at it, is whether AppLovin can continue this winning streak.
Given commentary on the most recent earnings call, we think analyst estimates are too low for next year. There’s also a valuation case being made by institutional analysts following the last earnings report that APP should be valued by EV/EBITDA, which creates room in the valuation that traditional top line and bottom-line metrics are not showing.
Revenue
APP reported $1.2 billion in revenue in Q3, beating estimates by nearly 6% after missing slightly in Q2. Revenue growth continued to decelerate from its peak of 47.9% YoY in Q1, with Q3 revenue growth of 38.6% YoY.
For Q4, APP guided for revenue between $1.24 to $1.26 billion, or 31.1% YoY growth at the midpoint, pointing to growth decelerating once more as comps get tougher. Moving through the first half of 2025, growth is expected to hover in the low-20% range, up from the mid-teens before the report.
The reason the market is ignoring the deceleration is that the key AI segment is growing QoQ and re-accelerated in the most recent quarter. This hints at a re-acceleration potentially in the top line in the coming quarters.
For FY24, APP is expected to see revenue rise 39.9% YoY to $4.59 billion, before slowing to 18.9% YoY growth to $5.46 billion in FY25.
Our firm is tracking the 2025 catalysts of e-commerce and other web-based advertising segments as offering strong potential that analyst estimates are too low, especially when coupled with management comments that gaming alone will drive 20% to 30% revenue growth into the foreseeable future.
Margins:
APP’s margin strengths have been an underlying driver of the surge in the stock price, with increased operating leverage driving a strong expansion on the bottom line.
- Gross margin in Q3 was 77.5%, improving from 73.8% in Q2 and 69.3% a year ago.
- Operating margin in Q3 was 44.6%, a significant improvement from 36.2% in Q2 and more than double the 21.6% operating margin in the year ago quarter. This degree of operating leverage is ridiculous! Especially while seeing revenue growth rates above 30% — essentially, APP has been able to drive this revenue growth with barely any change to its operating expenses, even as it continues to improves its AXON AI engine. Wow.
- Net margin in Q3 was 36.3%, improving from 28.7% in Q2 and nearly triple the 12.6% margin in the year ago quarter, due to that substantial operating leverage. Again, wow.
- Adjusted EBITDA margin was 60% in Q3, up from 56% in Q2 and 49% in the year ago quarter. For Q4, APP guided adjusted EBITDA margin to remain flat QoQ at 60%.
EPS
Given the dramatic improvement in operating and net margins, APP’s net income and EPS has followed suit, rising over 300% YoY in Q3.
Q3’s GAAP EPS of $1.25 increased 317% YoY, and easily beat estimates for $0.93. This accelerated slightly from Q2’s 304% YoY growth. Looking ahead, GAAP EPS is expected to remain flat QoQ in Q4 at $1.25, before advancing slightly in the first half of 2025 to the mid-$1.30 range.
Through Q3, APP’s GAAP EPS has risen 462% YoY to $2.81. Using Q4’s guide, FY24’s EPS would be estimated at $4.06, or YoY growth of 314%.
For FY25 and FY26, EPS growth is expected to remain robust even after this surge, with growth projected currently at >30% in both years: analysts estimate 37% YoY growth to $5.57 in FY25, and 31% YoY growth to $7.26 in FY26.
Cash and Balance Sheet:
Operating cash flow and free cash flow growth has also been remarkably strong, with margins quickly approaching 50%.
- Operating cash flow was $550.7 million in Q3, increasing 177% YoY. OCF margin was 46%, improving from 42.1% in Q2 and doubling from 23% in the year ago quarter.
- Free cash flow was $545.1 million in Q3, rising 182% YoY. FCF margin was 45.5%, improving from 41.2% last quarter and 22.4% in the year ago quarter.
- Cash and equivalents totaled $567.6 million.
- Debt totaled $3.51 billion.
What’s of note here is that APP carries a high debt load, with the first $1.5 billion tranche of senior secured term loans due in 2028, with the remaining $2.1 billion senior secured loan due in 2030.
Key Segments and Metrics
APP’s Software segment (soon to be reclassified as Advertising) and its AXON AI engine has been the primary growth driver over the course of the past six quarters, with Software Platform revenue rising from 50% of total revenue at the beginning of 2023 to 70% in Q3 2024.
Software’s growth remained strong in Q3, with revenue rising 66% YoY to $835 million. This marked the fifth straight quarter of YoY growth >60% for the segment, with growth also reaccelerating sequentially, with QoQ of 17.4% in Q3 versus 4.8% in Q2.
Software’s adjusted EBITDA increased 79% YoY to $653 million, outpacing revenue growth as a result of increased operating leverage. Adjusted EBITDA margin in the segment was 78%, expanding from 73% last quarter and 72% in the year ago quarter.
On the other hand, App revenue was relatively unchanged, rising just 1% YoY to $363 million, and decelerating from 7% growth in the prior quarter. App’s revenue has not yet rebounded after a trough in early 2023.
App’s adjusted EBITDA rose nearly 24% YoY to $68 million, or a 19% margin. This contracted slightly from 22% in Q2 but had improved from 15% in the year ago quarter; however, segment performance remains slightly challenged as APP continues to optimize the segment’s cost structure.
Monthly Active Payers, Average Revenue:
APP’s monthly active payers were 1.6 million, flat sequentially but down from 1.8 million last year. On the other hand, average revenue per monthly active payer (ARPMAP) was $52, flat sequentially but improving from $46 last year.
Earnings Call Discussion:
Bull Case: 20% to 30%+ Growth into Next Year
As stated, the comments that gaming alone can drive 20% to 30% growth, in addition to the important catalyst of expanding into e-commerce and web-based advertising is why AppLovin can continue on a strong growth trajectory. Analysts currently have FY2025 estimates at 19.6%:
Here is the tone from the earnings call:
“While we remain confident in 20% to 30% growth for mobile gaming advertisers alone, we're also exploring new areas, as shown by our recent e-commerce pilot. Early data has exceeded our expectations, with the advertisers in the pilot seeing substantial returns, often surpassing those from other media channels, and in many cases, experiencing nearly a 100% incrementality from our traffic.”
The Scale + AI Engine is Why AppLovin is Just Getting Started
AppLovin’s 1.4 billion users is key to why this company’s trajectory may just be getting started. The company has stated even if they release the code and algorithm for AXON 2.0, competitors cannot mimic what they’ve built due to the data they own.
Here is what was stated on the call:
“[Our customers] care about optimization and automated advertising to a revenue goal. And that's really like what our system is predicated on is that. We take all the risk on the media side. We have to deliver really compelling performance on the technology side. And I guess, like what's most exciting for me on what we've built and where we are in terms of, like you said, market cap and scale as a business today is we're on top of 1.4 billion daily actives. So it's really easy to forget the scale of the audience reach that we have on our platform. We've got the largest mediation solution in the sector, and our teams built maybe the most innovative advertising technology that the world has yet seen.”
Valuation:
EV/EBITDA Valuation Shows Room
No doubt, AppLovin is richly valued on the top line and bottom line. The top line is trading at 21X Fwd PS compared to ad-tech peer The Trade Desk at 26X Fwd PS. On the bottom line, AppLovin is trading at 52 Fwd PE Ratio compared to a Fwd PE Ratio of 79 for TTD.
However, where there is more room is seen in the EV/EBITDA valuation, which institutional analysts are making the case should be the correct valuation. Per current data, there is nearly 100% upside to APP on this valuation.
Here is what analysts are saying: “(11/07) Macquarie raised the firm's price target on AppLovin to $270 from $150 and keeps an Outperform rating on the shares after the company's beat and raise Q3 report. The firm, which raised its 2024 adjusted EBITDA estimate to $2.6B from $2.4B and its 2025 estimate to $3.2B from $2.9B, notes that it shifted its valuation method to "straight EV/EBITDA, given the predominance of the Software Platform now."
Source: YCharts
Conclusion:
Our firm is preparing to participate in AppLovin in two ways — first, a quicker momentum play to see if we can capture any remaining upside presented in the EV/EBITDA valuation that institutional analysts are favoring for this stock. Knox’s technical analysis is showing a potential move, and this is supported by fundamentals. However, for our longer-term position, we will look to close the momentum trade and participate again come 2025. Stay tuned!
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