Magnite provided a stark reminder that the bottom line is more important than the top line in current market conditions as the stock moved 80% off the earnings report with low revenue growth yet the small cap has rare strength with its improving bottom line and 20% cash flow margin.
Low Growth; Strong Bottom Line
The company reported Q3 revenue of $127 million, which grew 12%, and beat estimates by 2.8%. This is down from 23% last quarter.
For Q4, management is expecting revenue to be $154 million for growth of 8.3%. Perhaps Magnite also benefited by being the last to report as many ad-tech companies guided lower than 8.37%. Analysts were expecting growth of 8.25% for Q4.
CTV ad revenue grew 29% year-over-year to $55.8 million, and represents 44% of revenue. Management is guiding for 10% CTV ad revenue growth next quarter for $64 million in revenue, at the midpoint.
Mobile weighs on the company’s growth with 7% this quarter for $44 million, compared to 14% last quarter for $44 million. The segment was flat sequentially. Mobile represents 35% of revenue.
Desktop is the weakest segment at (7%) growth this quarter for revenue of $27 million compared to 1% drop last quarter for revenue of $27 million. This segment was also flat sequentially. Desktop represents 21% of revenue.
Magnite breaks down United States and International growth with both regions growing YoY. The United States represents 78% of GAAP revenue.
The United States region GAAP revenue grew 9% YoY to $114 million, up from $106 million last quarter. International grew 18% YoY to $32 million, and was flat sequentially, with $31.2 million last quarter.
The company reported GAAP EPS of ($0.18) and Non-GAAP EPS of $0.18. This is an improvement from Q2 and also an improvement from the year ago quarter. In fact, this was the strongest EPS on GAAP and Non-GAAP basis over the past five quarters excluding the holiday quarter.
Analyst estimates for adjusted EPS next quarter are $0.32. Assuming the company reports this EPS, it will exceed last year’s holiday season with adjusted EPS of $0.26 and it will also beat Q4 2020 with adjusted EPS of $0.19.
This improvement is important to note and to continue to track as few companies are able to improve bottom lines right now let alone a small cap.
Pictured Above: Magnite stands out for its improving bottom line.
The GAAP gross margin was down from 53% in Q2 to 51%. However, the GAAP operating margin has improved to (15%) in Q3 from (17%) in Q2. The improvement is more evident when you compare to Q1 at (34%) and the year ago quarter at (18%). Excluding the holiday period, Q3 2022 had the strongest GAAP operating margin from the past five quarters.
Down the income statement, the GAAP net margin of (17%) mirrored the operating margin with a 1 point improvement sequentially and YoY. This resulted in $24.4 million in net losses.
On an adjusted basis, the company reported a profit of $25.6 million, up from $20 million last quarter and up from $20 million in the year ago quarter.
Where Magnite shines is the cash flow margins. Operating cash flow of $28.6 million represents a margin of 20% on GAAP revenue. The company stated that it will have free cash flow of “over $105 million” which is up from the previous guide of $100 million. This will represent a FCF margin of 20.5%
Please note the following I/O Fund internal note on Magnite’s FCF calculations which deduct cash interest payments from operating cash flow.
“Some companies calculate FCF in a different manner. If the company does not provide FCF, we can calculate using operating cash flows minus capex from the cash flow statement. In this case, the operating cash flow calculation itself is different which is a rare case. The operating cash flow is adjusted EBITDA less Capex. The FCF involved the deduction of cash interest payments which is available in the supplemental disclosures of other cash flow information as the recent earnings call provided the interest payments for this quarter, however, they did not provide cash interest separately.”
The company has $253 million on the balance sheet and $725 million in debt. The debt is less of a concern as long as the company is FCF positiveas long as the company is FCF positive and doesn’t pursue anymore acquisitions. The debt includes $400 million in convertible senior notes and a term loan of $355 million due to the SpotX acquisition.
The company’s net leverage has greatly improved from 6.2X in Q2 2021 to 2.6X in Q3 2022. This also improved from 3.1X in Q1 to 2.8X in Q2.
Magnite reported stock based compensation of $17.4 million, or 13.7% of revenue.
Magnite Proves the Valuation Trade is Alive and Well
Despite Magnite being comfortably profitable on an adjusted basis and free cash flow positive with a 20% margin, the stock was priced for bankruptcy or another fatal risk at 1.5 forward P/S going into earnings. I believe the stock rallied because the risk/reward didn’t reflect the valuation, rather reflected the broader “small cap” bucket where most small caps have serious profitability issues.
The low valuation coupled with clear evidence Magnite is unlikely to go out of business anytime led to the stock rallying.
Magnite helps to illustrate that 2022 market conditions continue to be more favorable for stocks with strong bottom lines. This is a critical adjustment for growth investors as Magnite’s top line does not fall into a growth definition at 12% this quarter and 8% next quarter.
Note: All numbers quoted ex-TAC unless otherwise stated. GAAP margin is calculated on the GAAP revenue of $145.8 million. Please note, we do not own Magnite at time of writing but plan to enter if we can find the right technical setup.