Category: Tech Stocks

Meta: Fastest Revenue Growth since 2021, Ad Metrics Strong 

Posted on by io-fund

Meta reported its fastest topline growth since late 2021, with Q1 revenue up 33% YoY, more than double Q1 2025’s 16% YoY growth, an impressive feat at this scale. Meta is also executing quite well with strong growth in engagement across Instagram and Facebook, while advertising key metrics were quite robust with ARPP notably seeing a meaningful step-up in growth.  

The underlying message from Meta this quarter is that it will continue to work on improving model capabilities to increase engagement and ROI for advertisers, keeping its ad engine and growth flywheel strong, while laying the foundation for personalized consumer and enterprise AI agents at scale as the long-term vision (with an ultimate goal of monetizing these in the future). Meta believes that there is ‘massive upside’ for delivering superintelligence via personal agents, but this also goes for the ad side to deliver increasingly relevant content and ads, keeping growth strong. 

However, the one key message Meta sent to the industry was a subtle but critical shift in its stance on future capex. Executives continue to emphasize that compute needs continue to be underestimated and increasing capex gives the flexibility to meet future compute needs, yet this quarter Meta hinted at possibly reducing capex in future years if needed. 

Double Clicking on Capex – Subtle but Critical Shift in Future Commentary 

Meta raised its FY26 capex by $10 billion, now projecting $125 to $145 billion versus its prior view for $115 to $135 billion. Management explained that the majority of the increase is due to higher component costs, particularly on the memory side. While Meta reemphasized its stance that they continue to underestimate their compute needs, the bombshell, if you will, was CFO Susan Li’s discussion on future capex needs:  

“We have continued to underestimate our compute needs even as we have been ramping capacity significantly as the advances in AI have continued and our teams continue to identify compelling new projects and initiatives. And now, too, there are very compelling internal use cases. So our expectation is that compute will become even more central to the business going forward. And it will be critical to determining the quality of the models we develop, the types of products we can introduce, how productive we can be as an organization. So we're going to continue building out our infrastructure with flexibility in mind. And if we end up not needing as much as we anticipate, we can choose to bring it online more slowly or reduce our spending in future years as we grow into the capacity that we're building now.” as the advances in AI have continued and our teams continue to identify compelling new projects and initiatives. And now, too, there are very compelling internal use cases. So our expectation is that compute will become even more central to the business going forward. And it will be critical to determining the quality of the models we develop, the types of products we can introduce, how productive we can be as an organization. So we're going to continue building out our infrastructure with flexibility in mind. And if we end up not needing as much as we anticipate, we can choose to bring it online more slowly or reduce our spending in future years as we grow into the capacity that we're building now.” 

This commentary here is relatively the same as it has been over the past few quarters. Compute needs continue to be underestimated, requiring higher levels of capex to build to meet demand, and Meta wishes to remain flexible to adapt to long-term compute needs. However, the change here is that Li has now put a potential capex reduction on the table, in the future, where prior quarters’ commentary regarding flexibility was generally taken as preparing to meet even higher capacity needs in 2027-28. 

At the moment, though, Meta’s infrastructure-related spending shows no sign of slowing, evident not just in the capex raise but also within its contractual commitments, up $107 billion this quarter. Meta said this was both for third-party cloud capacity agreements, such as its deals with CoreWeave and Nebius, and infrastructure, such as its chip agreements with Broadcom or Amazon. On the chip side, Meta is remaining diverse, rolling out >1GW of its custom silicon developed with Broadcom and a “significant amount” of AMD GPUs to complement its Nvidia systems, helping drive down costs across its workloads. 

There was one other key discussion on capex, with CEO Mark Zuckerberg detailing Meta’s framework for evaluating returns on capex, and hints that FCF could dip negative. Morgan Stanley’s Brian Nowak question what factors Meta tracks to justify its spending and how it will ensure it generates healthy ROIC:  

“So if you could just sort of let us know some of the key factors you're watching over the next 12 to 24 months, whether it's Meta AI, Muse advances, core algorithm, what are you sort of watching foremost just to make sure that you're on the right path to generating healthy ROIC on all this CapEx and infrastructure spend?” 

CEO Mark Zuckerberg 

“The formula for our company has always been build experiences that can get to billions of people and focus on monetizing them once you get to scale. I think we're seeing a little bit of that here where basically we invest in advance to build leading models, and we convert that into leading products. And then we think that these are going to be some of the most important products that get built over the next decade. So I think just like anything else that we've done over time, the basic milestones that I look at are around, first, technically, are we delivering the quality to enable a great product; then second, when you have the product, how is it scaling; and then third, you look at the monetization and then you drive up the efficiency of it towards increasing profitability. 

I mean like I don't think we have a very precise plan for exactly how each product is going to scale month-over-month or anything like that. But I think we have a sense of the shape of where these things need to be.”   

Much of the work that Meta is doing on the R&R optimization side likely lands in that third bucket of increasing monetization and profitability, while its personal and business AI agents mostly remain in square 1, working towards scaling and eventually longer-term monetization models in the future.    

CFO Susan Li also clarified that Meta is not optimizing for a specific cash flow level this year, suggesting that there is a high chance free cash flows dip negative, potentially as early as next quarter. Q1 capex was $19.8 billion, leaving nearly $115 billion still to spend over the next three quarters to meet the midpoint of the new range. While unlikely, splitting this evenly across those quarters projects spending of ~$38.7 billion each quarter, ~20% above Q1’s operating cash flow and well ahead of estimates for $31.8 billion in operating cash flow in Q2 and Q3. 

Personalized AI Agents and Improving Engagement  

We touched on this part in our Q4 earnings write-up, Meta Q4 Earnings: A New Era Driven by AI Agents, that Meta is moving away from pattern and behavior-driven algorithms driving its feed to LLMs. These LLMs offer reasoning for a level of personalization not possible in the current pattern recognition-based approach, helping drive both engagement and ROI higher. Meta is uniquely positioned to benefit from this personalized-agent approach due to its treasure trove of contextual and behavioral data it has gathered from its 3.65 billion active users. 

While we look forward to this pivot to LLMs and increased personalization to drive higher engagement and advertising dollar growth, it’s important to note that this shift will not happen overnight. Meta explained that because its “recommendation systems are operating at such a large scale, we'll phase in this new research and technology over time,” and the focus for 2026 is “validating the model architectures and techniques in these domains before we scale them out in future years.” This was described as part of the longer-term roadmap, including foundation models for organic content and ads recommendation, as well as the LLM-based recommendation models to increase personalization.    

Going back to the present and the current model improvements Meta is making, CFO Susan Li explained that Meta “doubled the length of user interaction sequences we use for training on Instagram in Q1 and increase the richness of how each user interaction is described, enabling our systems to develop a deeper understanding of user interests.” Meta also improved model indexing speeds so new posts can be recommended sooner after publishing, as well as content understanding techniques allowing LLMs to identify posts that could spark user interest even if prior engagement on similar content was minimal.  

This is driving strong growth in engagement – Meta noted that ranking improvements made in Q1 helped drive a 10% increase in Reel time spent on Instagram, and a 9% increase in video watch time on Facebook in the US & Canada. Meta also recorded its largest QoQ increase in total video watch time on Facebook in Q1, up more than 8% QoQ globally. This was likely aided in part by increased diversity and recency of content with same-day posts representing more than 30% of recommended Reels on Facebook and Instagram, more than double the level from a year ago. 

CFO Susan Li sees that there is “a lot of room to continue improving recommendations over the rest of the year, and we expect we'll be able to do that to drive additional engagement on both Facebook and Instagram.” This will be done from training on more data, more detail and more history of content users have engaged with, and increasing personalization of recommendations. Meta also mentioned using Muse Spark, the first model from its Superintelligence Labs team, to improve R&R models for better personalization of feeds and ads. 

Improving ROAS For Advertisers via Conversion Gains 

For Meta, the equation for growth can often be seen as simple on paper — increase engagement and time spent on its apps, serve more relevant and effective ads, improve conversion rates for advertisers, and drive more ad spending with higher pricing.  

Meta is executing very well on the engagement side per the stats above with the highest QoQ growth in video time in four years, but the company is arguably executing just as well with increasing conversions. This all ties together within the strength across Meta’s three key ad metrics – impressions, pricing, and ARRP – which all accelerated this quarter (discussed more in the Financials below).  

Meta revealed that enhancements it made to Lattice’s modeling and learning along with its GEM architecture helped drive a 6% increase in conversion rates for landing page-view ads. Additionally, advertisers using Meta’s genAI video generation features saw a >3% increase in conversion rates during tests. 

Meta also shared more details on its adaptive ranking model that that began to roll out in the second half of 2025, leveraging LLM-scale complexity of 1T parameters while maintaining millisecond speeds to serve ads at scale. In Q1, Meta expanded coverage of the model to support off-site conversions, driving a 1.6% increase in conversion rates on major surfaces on Facebook and Instagram.  

Stemming from this ability to increase conversion rates via a variety of different AI models or features, Meta is seeing strong momentum in its ‘value optimization suite’, which it says helps advertisers maximize ROAS by “prioritizing the highest value conversions rather than optimizing solely for the most conversions at the lowest cost.” The annual run rate of this suite has now surpassed $20 billion, more than doubling YoY.  

Financials 

Revenue Accelerates to 33.1% YoY — Fastest Growth Since Late 2021   

Meta's Q1 2026 revenue came in at $56.31 billion, beating estimates by 1.4% and accelerating sharply to 33.1% YoY from 23.8% YoY in Q4 2025, representing the company’s fastest top-line growth since Q3 2021. On a sequential basis, revenue declined (6%) QoQ, which is typical seasonal softness after the holiday-heavy Q4. The strong print was driven almost entirely by Meta's advertising business, which continues to benefit from AI-powered improvements to its ad delivery systems and accelerating ad impressions and pricing.   

Looking ahead, management guided Q2 2026 revenue of $58 to $61 billion, implying YoY growth of 25.2% and sequential growth of 5.7% QoQ at the midpoint, in line with the estimates. Meta provided some insight into factors affecting the guide – the first being some headwinds from less personalized ads in the EU related to its December 2025 alignment with the EC over data consent, with this change starting in Q1 with Q2 and future quarters seeing full quarter impacts. Second, Meta said that the guide also “embeds a range of possible macro outcomes, ranging from continued improvement to macro deceleration” related to the Iran conflict, though current trends slow slight improvement in the Middle East and around the world (US and Western Europe were said to see softer spending trends in Q1). 

Analysts expect revenue to grow by 22.5% YoY to $62.75 billion in Q3 and 21.8% YoY to $72.94 billion in Q4.  

Ad Metrics: Ad Impressions Accelerate 14 points YoY 

Advertising revenue reached $55 billion in Q1 2026, up 32.9% YoY — an acceleration from 24.3% in Q4 and 25.6% in Q3 2025. The dual drivers of this growth — ad impressions and ad pricing — both strengthened concurrently.  

Ad impressions rose 19% YoY in the quarter, a slight one point acceleration from 18% in Q4; it should also be noted that this does come against the weakest comp at 5% growth in the year ago quarter. Regionally, US & Canada impressions were stable at 13% YoY, while Europe and Rest of World both accelerated four and three points to 17% YoY. Meta explained that impressions growth was primarily driven by growth in engagement and users, while increases in ad load and new ad availability, such as ads on Threads in more markets, aided growth as well.  

Ad pricing saw a more pronounced acceleration, up six points from 6% in Q4 to 12% in Q1, marking its second fastest YoY growth since 2022. All of Meta’s regions witnessed growth, with US & Canada accelerating five points to 14% YoY, Europe and APAC accelerating seven points to 19% and 5% respectively, and Rest of World accelerating three points to 18%. Meta said growth was driven by ad performance improvements, hinting at better ROI for advertisers via R&R optimizations, macro improvements and some FX tailwinds, with impressions growth in lower monetizing regions partially offsetting this.  

This combination of volume and pricing uplift underscores the effectiveness of Meta's AI-driven ad stack, including tools such as Advantage+, Andromeda, and GEM, in delivering measurable ROI improvements for advertisers.  

Family Daily Active People (DAP) came in at 3.56 billion, up 3.8% YoY, a slight deceleration from 6.9% in Q4; DAP decreased slightly sequentially due to Internet disruptions in Iran and WhatsApp restrictions in Russia. Family Average Revenue Per Person (ARPP) surged to $15.66, up 26.7% YoY, a meaningful acceleration from 16.2% in Q4, reflecting how AI monetization gains are rapidly translating into higher per-user economics at scale.  

Margins  

Gross margin was 81.9%, effectively flat with Q4 2025 and in the same period last year, reflecting consistent unit economics in Meta's advertising-dominant business. Q1 gross profits grew by 32.7% YoY to $46.1 billion.  

Operating margin came in at 40.6%, a modest decline from 41.3% in Q4 2025 and 41.5% in the same period last year. Operating income was $22.87 billion, up 30.3% YoY. Meta's management has committed that operating income will grow in FY2026, even as total expenses are guided to $162–$169 billion for full-year 2026.  

Net income was $26.8 billion or 47.5% of revenue compared to $16.6 billion or 39.3% of revenue in the same period last year. Net income included a one-time tax benefit of $8 billion in the recent quarter and excluding the benefit net income would be $18.7 billion, up 12.4% YoY.  

EPS 

Meta reported Q1 2026 GAAP EPS of $10.44 and included a one-time tax benefit $3.13. Excluding that benefit, GAAP EPS would be $7.31, beating estimates by 9.8% — a healthy beat that reflects the strength of underlying operating performance.  

Looking ahead 2026 GAAP EPS is expected to grow by 26.2% YoY to $29.64 in 2026 and 16.1% YoY to $34.42 in 2027.  

Cash Flow & Balance Sheet 

Q1 operating cash flow was $32.23 billion or 57.2% of revenue compared to $24 billion or 56.8% of revenue in the same period last year. However, the increase in cash flows were due to one-time tax benefit.   

Q1 free cash flow was $12.39 billion or 22% of revenue compared to $10.33 billion or 24.4% of revenue in the same period last year. Capex in Q1 2026 was $19.84 billion, up 44.9% YoY.  

As discussed above, management increased the FY2026 capex guide to $125 billion to $145 billion from the previous range of $115–$135 billion, implying a YoY growth of 86.9% at the midpoint. The increase was primarily due to higher component costs, primarily memory prices.  

The company had cash & marketable securities of $81.2 billion and debt of $58.8 billion at the end of Q1 2026. 

Conclusion 

Meta reported quite a strong Q1 despite the market’s reaction, with revenue growth the fastest since late 2021 at 33% YoY, ad impressions and pricing both accelerating in the quarter and ARPP seeing a notable step-up to nearly 27% YoY growth. Meta also saw strength in engagement in video and Reels stemming from model improvements across Instagram and Facebook, while also increasing conversions and ROAS for advertisers.  

Meta is progressing with its pivot to LLM and personalized agent based recommendation systems in a complete overhaul of its pattern-recognition based approach, a move that should further strengthen its ads flywheel from increasing engagement, delivering more relevant content and ads, and driving higher ROAS. 

On the capex front, Meta raised its forecast for the year by $10 billion to $135 billion at midpoint, suggesting significantly higher spending through the rest of the year versus Q1’s $19.8 billion; more importantly, Meta hinted that they may reduce capex in future years if needed, a notable shift in commentary that will need to be watched closely.

Damien Robbins, Equity Analyst at I/O Fund contributed to this analysis.

Please note: The I/O Fund conducts research and draws conclusions for the company’s portfolio. We then share that information with our readers and offer real-time trade notifications. This is not a guarantee of a stock’s performance and it is not financial advice. Please consult your personal financial advisor before buying any stock in the companies mentioned in this analysis. Beth Kindig and the I/O Fund own shares in META at the time of writing and may own stocks pictured in the charts.

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AppLovin Q3: Flexes Bottom Line Muscle; AXON Self-Service Platform is Ramping 

Posted on by io-fund

AppLovin beat on the top line with revenue growth of 68.2% YoY and 11.6% QoQ. Management guidance is for a slight acceleration for QoQ growth of 12.8% in Q4. Growth on the top line is disproportionately flowing to the bottom line with EPS growth of 91.2% this quarter and growth expected to be 65% next quarter. As a reminder, they divested their Apps business in Q2 2025. 

Just when you thought AppLovin’s Adjusted EBITDA could not get any better, it expands again 100 basis points QoQ to 82% and is expected to expand 50 basis points next quarter to 82.5% at the midpoint. As we’ve pointed out, this is the best EBITDA margin in the market (that I’m aware of). The cherry on top was free cash flow growing 92% YoY. 

The earnings call Q&A was focused on the AXON ads manager self-service platform that launched October 1st.  The goal is to quickly scale by offering a self-service interface for Applovin’s 1 billion reach and also help expand Applovin’ from gaming inventory only to also include e-commerce. Previously, Applovin was limited to the number of advertisers the company could manually on board.

Applovin operates in sharky waters as one of the only contenders over the past decade to challenge the walled fortresses of Meta and Google. There is a current SEC probe, which is detailed below. Although the fundamentals are exceptional, this stock is not for the faint of heart with wild swings in both directions.  

We look at this and more below!  

High Growth AXON Ad Engine Expands with Self-Service Feature 

Although very early and based on small numbers, management stated AXON’s self-serve feature is seeing strong traction with advertiser spend growing 50% week-over-week since the launch October 1st. This is invite-only, referral based demand in the e-commerce vertical with the platform expected to open up more broadly in early 2026. 

“While it takes a while for new customers to get going, to integrate, to learn how to use our system and to ramp spend, we're already seeing spend from these self-service advertisers grow around roughly 50% week-over-week. It's too soon to be significant, but this type of early growth gives us even more confidence that our platform will excel at being an open platform to any type of advertiser.” 

The company uses AI to increase conversion rates; this can be considered a catalyst for future growth if the company expands conversion rates for advertisers compared to competitors. According to management, the model continually learns for better behavior targeting and ad personalization. Generative-AI based creatives are also a feature being built out to generate more effective ads (also leading to higher conversion rates). An area where Applovin sets themselves apart is the 35 second ad creatives compared to 7 seconds on social, which could (presumably) also lead to higher conversions.  

According to management, improving conversion rates is a path to sustained growth: “We believe that giving our powerful recommendation engine, a more diverse set of advertisers to recommend will dramatically improve conversion rates, paving the way for elevated growth rates for years to come.” 

Overall, it’s important to remember that Applovin is demand constrained rather than supply constrained as they reach over 1 billion users. Therefore, opening up the AXON ad manager to more demand is the primary catalyst for the next few quarters.  

According to data from eMarketer shows encouraging signs from the e-commerce sector: clients including Wayfair, Ashley Furniture and Dr. Squatch are scaling six-figure daily budgets. eMarketer adds that early Axon adopters see “strong click-through and conversion rates,” with one brand increasing spend by >500% after testing Axon. 

Regarding the size of the AXON ad manager, APP has not disclosed customer count, yet management said they have hundreds of gaming and hundreds of e-commerce customers, or a “platform that might have 1,500 advertisers,” yet opening the platform up could help them scale to “hundreds of thousands of customers” in the long run.  

On the call, the following information was shared regarding AXON’s current size: “I think it was in Q1 was $11 billion plus of ad spend. And then the disclosures we've given you across web advertisers and gaming advertisers puts it in the low thousands. So you've got such a high amount of spend for such a low amount of advertisers across over 1 billion daily active users.” 

20% to 30% Annual Growth Baseline Hinges on Two Factors 

At Goldman Sachs’ Communacopia conference, APP executives dove deeper into the long-term growth framework provided in Q2, calling for a baseline 20% to 30% annual growth. Management explained that this hinges on two primary factors: reinforcement learning and continuous improvement on the ad engine, and opening the recommendation engine up to e-commerce and exposing it to a wealth of new demand.  

The update regarding 20% to 30% growth is the self-service platform could help exceed this baseline: “We're still believing very confidently in this 20% to 30% long-term growth rate in our core category. But even in the core, we're beating that. And then now you're layering on, on top of that, all this opportunity with the self-service platform” 

Management also hinted that the public launch of Axon and expanding to the e-comm vertical could help drive significant customer growth leading to a flywheel. This was expanded on during the earnings call: “And so you're building up a data set that doesn't just limit itself to the shopping category or the website advertising category. It helps enable better advertising for the gaming customers as well. So you put all those pieces together, and I'm really confident that we're not going to squeeze anyone in our platform. We're probably going to have expansion across the board as we add more demand density and get more data into the system.” 

AppLovin Facing SEC Probe 

AppLovin dropped ~14% last month on reports of an SEC probe into its data practices, following short-seller and whistleblower allegations that APP used “unauthorized” tracking—such as device fingerprinting—to support targeted ads in ways that may conflict with platform rules (e.g., Apple). These remain allegations; no findings have been announced. AppLovin declined to comment, stating it does not discuss potential regulatory issues. 

Financials: 

Revenue beat by 4.7% 

AppLovin reported strong revenue of $1.405 billion, beating analysts' estimates by a solid 4.7%. The company’s revenue grew by 68.2% YoY and 11.6% QoQ. The growth was primarily driven by the strong gaming advertising revenue, with management stating: 

“Our teams delivered multiple incremental lifts in our core models this quarter. And our MAX supply-side platform, one of the best indicators of our end market growth continues to grow at very healthy rates. We also opened up international traffic for advertisers promoting websites or shops in Q3 ahead of schedule.” 

Management has guided for a strong Q4 guide of $1.57 billion to $1.60 billion, representing a YoY growth of 58.6% and 12.8% QoQ. The Q4 guide beat the analysts' estimates by 2.3%. Looking forward, analysts expect revenue to grow 33.5% YoY to $7.45 billion in 2026 and 28.2% YoY to $9.56 billion in 2027. 

Management highlighted that the priorities include improving the models, onboarding flows, and continued AI integration, positioning the company to acquire a large volume of new advertisers in the future. “Our focus for Q4 and 2026 will be the following, with priority always given to improving our models for all advertisers. We'll continue tuning our onboarding flows and ramping more AI agents into the workflow to support a seamless experience for new advertisers. Once we're satisfied with the quality and experience, we'll open the platform broadly beyond referral basis. We'll be testing generative AI-based ad creatives.” 

Advertising Revenue Grew by 68% 

The company’s Q3 advertising revenue grew by 68.3% YoY to $1.405 billion. The ad revenue exceeded the management guidance by a solid 5.6%, primarily driven by strong gaming advertising revenue.  

Management guided advertising revenue of $1.57 billion to $1.60 billion, representing a YoY growth of 58.6% at the midpoint. Management stated that the guidance incorporates optimism around the e-commerce referral program, continued model enhancements, and the normal holiday seasonality.  

Operating Margin of 76.8% 

AppLovin’s margin expansion is truly outstanding, primarily driven by strong operating leverage. The company’s AI-powered advertising engine, AXON 2.0, launched in Q2 2023, serving as a game-changer that drove strong revenue and profits. The company’s operating margin has increased from 17.5% in Q2 2023 to a remarkable 76.8% in the recent quarter. 

During the Goldman Sachs Communacopia conference, management highlighted that additional costs can be expected with the e-commerce push. They stated: “So as we push into things like e-commerce, where we are going to see new costs that investors should be aware of are for things like API calls as we use LOMs for agentic customer support, campaign analytics and management.” 

  • Gross profits grew by a solid 72.2% YoY to $1.23 billion, with a gross profit margin of 87.6%. The gross profit margin was up 210 basis points YoY and down 10 basis points sequentially. 
  • Operating profits grew by 102% YoY to $1.08 billion, driven by solid operating leverage. The operating margin improved by 12.8 percentage points YoY to 76.8%. 
  • The net profits grew by 92.3% YoY to $835.55 million or a net profit margin of 59.5% compared to 52% in the same period last year and 65.1% in the previous quarter. 
  • Adjusted EBITDA grew by 79% YoY to $1.16 billion. The adjusted EBITDA margin was 82%, beating management guidance by 100 basis points. Management also guided a strong Q4 adjusted EBITDA margin of 82.5% at the midpoint. 

GAAP EPS grew by 91% 

The company’s Q3 GAAP EPS grew by 91.2% YoY to $2.45, primarily driven by strong operating leverage. The EPS beat the analysts' estimates by 2.6%. Analysts expect strong EPS growth to continue as they expect it to grow 65.3% YoY to $2.86 in Q4 and 85.2% YoY to $3.09 in Q1 2026. 

Looking forward, analysts expect EPS to grow 51.2% YoY to $13.80 in 2026 and 31.4% YoY to $18.12 in 2027. 

Free Cash Flow Grew by 92% 

The company has an exceptionally strong cash flow margin profile, primarily driven by strong profits.  

  • Q3 operating cash flows grew by 91.3% YoY to $1.05 billion with a margin of 75%, up 9.1 percentage points YoY. 
  • Q3 free cash flows grew by 92.4% YoY to $1.049 billion with a free cash flow margin of 74.7%, up 9.4 percentage points YoY. 
  • The company’s cash improved to $1.67 billion, up from $1.19 billion at the end of the previous quarter. While debt remained the same at $3.51 billion.  
  • The company repurchased and withheld approximately 1.3 million shares worth $571 million in Q3, which was funded by free cash flows. Over the last 3 quarters, the company has been able to reduce the outstanding shares from 346 million in Q4 2024 to 341 million this quarter. During the quarter, the Board of Directors increased the share repurchase authorization by an incremental $3.2 billion. The total outstanding authorization is $3.3 billion as of the end of October. 

Conclusion: 

The management team has accomplished an unimaginable feat over the past 1-2 years, yet their success has also attracted short seller scrutiny. What keeps us coming back on this stock is the exceptional fundamentals and the understanding that Applovin is disrupting a massive industry. Thus, the reward could outweigh the risk given management’s strong history of execution.   

Equity Analysts Damien Robbins and Royston Roche contributed to this analysis. 

Please note: The I/O Fund conducts research and draws conclusions for the company’s portfolio. We then share that information with our readers and offer real-time trade notifications. This is not a guarantee of a stock’s performance and it is not financial advice. Please consult your personal financial advisor before buying any stock in the companies mentioned in this analysis. Beth Kindig and the I/O Fund own shares in APP at the time of writing.

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AppLovin Q2: Operating Margin doubles; H2 commentary is strong 

Posted on by io-fund

Applovin reported revenue of $1.26 billion compared to consensus of $1.28 billion according to some sources yet others reflect the consensus we had of $1.22 billion, thereby it’s debatable if the top line beat. Our notes show App beat, although narrowly.  

Management had guided last quarter for revenue of $1.195B to $1.215B, representing YoY growth of 69.5% at the midpoint. By this standard, as well, Applovin beat with growth of 77%.  

On the bottom line, the company had a large beat with EPS of $2.39 compared to $1.99 EPS expected, representing growth of 169%. This was a 45 point beat on growth rate for the bottom line. Adjusted EBITDA doubled to $1.02 billion, up from $943 million last quarter. This represents an adjusted EBITDA margin of 81%.  

As management alluded to on the earnings call, the company “prints cash” with a 61.3% operating cash flow margin and a 61% free cash flow margin.  

The Q&A was primarily focused on when Applovin plans to launch its self-serve ad platform, as this should create a boost for growth. Management was encouraging saying “as soon as possible” yet the tone on the earnings call was particularly optimistic about Q4 being a bigger quarter for the company. Details on why management had the confidence to call out Q4 specifically are noted below. 

Revenue  

Regardless of a nominal decimal point that caused a beat (or miss), the quants may have quickly sold the report after hours from mistakenly pricing Applovin for a deceleration from the March quarter to the June quarter.  

  • Overall revenue last quarter was $1.48B versus this quarter at $1.26B. As we covered in the past, this is due to Applovin divesting its mobile gaming “Apps” business, with the sale completed on June 30th. Therefore, if you adjust for this sale, revenue for the ads business in Q1 was $1.15B for QoQ growth of 8.7%. 
  • The current quarter marks an acceleration from 71% YoY growth yet QoQ growth is slowing.  
  • For next quarter, Applovin expects to see $1.33 billion in revenue, slightly above estimates for $1.31 billion. This represents 59% YoY growth and QoQ growth of 5.5%.  

As stated, Applovin divested its Apps business, which was weighing on both growth and margins. For example, Applovin had been reporting low growth in this segment of (13%) growth in the March quarter leading up to the sale.  

Margins and EPS: Operating margin doubled to 76% … what?! 

Applovin’s revenue growth is only part of the story, whereas the bottom line is what sets Applovin apart. I can count on one hand (or maybe even one finger) the number of tech companies that have reported a 76% GAAP operating margin.  

It may be common for tech companies to be in hypergrowth stage at times, yet very few ever reach the quality margins that App is reporting quite early in its company history.  

The bottom line presented below is a thing of beauty. The margins have clearly benefited from divesting the Apps business, which had been weighing on the margins.  

  • Gross margin of 88% compares to last quarter at 81.7% and the year ago quarter at 73.85.  
  • Operating margin of 76% expanded from 44.7% last quarter and more than doubled from the year ago quarter at 36.2%. Wow!! 
  • Net margin of 65% expanded from 38.8% last quarter and doubled from 28.7% in the year ago quarter. Wow!! 

Earnings per share of $2.39 beat estimates for EPS of $1.99, representing growth of 169%. This was a large beat as growth was expected to be 123.5% on the bottom line.  

Cash Flow Margin of 61% 

In yet another impressive bottom-line number, Applovin reported a 61% free cash flow margin for free cash flow of $768 million. The company has been strong on cash for sometime, yet this still represents a 540 bps expansion QoQ and 20-point expansion YoY.  

The operating cash flow margin of 61.3% is up from 56% last quarter for operating cash of $772M. The company has $1.2 billion in cash on the balance sheet including $425M from the sale of the Apps business. The company has $3.7B in debt.  

Applovin does share buybacks with 900,000 shares repurchased in the last quarter for a total of $341 million funded through free cash flow. This lowered share count form 346M to 342M last quarter.  

Earnings Q&A: 

Self-Serve platform set to launch October 1st 

Management has repeatedly stated that gaming alone can sustain growth of 20% to 30% YoY. Therefore, the catalyst for the next few years is securing additional supply, such as e-commerce, as well as opening up the AXON ad platform to more advertisers.  

The AXON ads manager recently became self-service, which means it can scale at levels not previously seen by offering self-service interface for Applovin’s 1 billion reach. As of now, Applovin is limited in the number of advertisers it can manually on board. According to the opening remarks: “With the rollout going smoothly, we are ready to widen access. On October 1, 2025, we plan to open the AXON ads manager on a referral basis, perfectly timed for the holiday season. Feedback from these partners will guide our global public launch in the first half of 2026. To date, web advertising campaigns have been limited to the United States. On October 1, we plan to open our platform to most major international markets.” 

When it comes to e-commerce, Applovin explained they limited the number of advertisers initially in order to make sure the tools were working properly, and they are now satisfied with the results and ready to launch self-serve on an invite basis to start. 

Per the Q&A: 

“And then the last point to remember is another one of my prepared remarks highlighted the fact that we have constrained the advertisers we even have live today by not allowing them to buy our audience that's international. The vast majority of our user audience is outside the U.S. We will be releasing almost all markets once we go into this October 1 release.” 

Looking longer-term, by matching categories such as e-commerce with a self-serve platform, Applovin discussed a flywheel effect: “So in terms of opportunity for us, not only does opening up the platform get us more demand, which is going to be massively accretive and incremental to our business. It gets us more data. And so every single quarter, you're going to have that flywheel effect that, that then paired with our engineers' ability to take added data and improve the technology and its interpretation of that data creates a real strong foundation for growth for a long time to come.” 

Commentary that Q4 will be strong: 

During the Q&A, there were a few mentions that Q4 should be strong along with mention of upside to the numbers come 2026.  

I want to make money in 2026 about as much as I want to make money in 2025, so this kind of discussion is my favorite moment during an earnings call (…and is the reason I take the time to listen to these calls and not run the transcript through Chat-GPT, like many, many research sites do these days!)  

Here’s one example: 

“We expect that will increase the advertiser count quite quickly and also allow us to go through live examples of advertisers coming in self-service all the way to scale on our product. Assuming all that goes well, then we talked about opening up the platform entirely to the world in first half of next year. We think as advertiser count grows on our business, especially in categories outside of gaming, you're going to see a lot of upside in the numbers that we're able to report.” 

Here was a more specific mention to Q4: 

“As we go into Q4, that's a huge holiday shopping season. So not only are you going to see the cohort that we have live spend a lot more. You're also going to have new onboarding happening for the first time in our history at a rate that's much higher than we will have ever seen before. So we fully expect that e-commerce will see a pretty substantial ramp-up through that, what you can call a soft launch period and then, obviously, as we go into a broader global release, the impact from that.” 

It was repeated again with more details around the compounding effect of onboarding the many new advertisers for existing gaming inventory and also new categories: 

“Now it's not necessarily true that we're going to take our queue that's built over the last year and just say, everyone you're in. They're still going to have to get invited to get into the platform. So it will be still curated onboarding. The reality is like Q4 is going to end up being a fun quarter. You've got the advertiser cohort that we didn't have last Q4 that was growing in the quarter to the point where we reported huge numbers and then had huge numbers in Q1. But we're going to have those advertisers primed and ready to go for the full Q4. We're going to have advertisers inviting their friends onto our platform in Q4, and we're going to be opening up international all at the same time. 

So there's going to be a lot of fun moment — moments for us and our customers in this e-commerce or web-based category that will set sort of a new baseline for that business. And then obviously, then we will go through hopefully another inflection when we really truly open up the platform and try to get into a state where we're more stable long term.” 

Quick Note on 2026-2027: 

Although further out, there was talk that lower fees on the App Store should become a tailwind for Applovin 4-8 quarters out: “So no impact yet. And I would guess it will probably take 2 to 4 quarters from some impact. And by 4 to 8 quarters, you're going to get pretty material impact in pricing on our platform.” 

Conclusion: 

I’ve never been one that needs the market to agree with me, and I am afraid on this one the market and I will have to agree to disagree as the price is down after hours. This was a stellar report with all fundamental boxes ticked, a team that has proven to execute, and incoming catalysts that are quite well-timed to where the market is selling the stock while we maybe have two quarters (or less) to wait for an inflection. 

Of course, this requires some speculation as consensus will not reflect management commentary until there are material results. But after all, that’s where the real money is made. Let's hope the formula of "believe what you see" works for us again as the growth, historic margins and the ability to print cash all point toward a solid stock while management hints they have more in store for shareholders around year-end.

Please note: The I/O Fund conducts research and draws conclusions for the company’s portfolio. We then share that information with our readers and offer real-time trade notifications. This is not a guarantee of a stock’s performance and it is not financial advice. Please consult your personal financial advisor before buying any stock in the companies mentioned in this analysis. Beth Kindig and the I/O Fund own shares in APP at the time of writing and may own stocks pictured in the charts.

Recommended Reading:

AppLovin Q2: Operating Margin doubles; H2 commentary is strong 

Posted on by io-fund

Applovin reported revenue of $1.26 billion compared to consensus of $1.28 billion according to some sources yet others reflect the consensus we had of $1.22 billion, thereby it’s debatable if the top line beat. Our notes show App beat, although narrowly.  

Management had guided last quarter for revenue of $1.195B to $1.215B, representing YoY growth of 69.5% at the midpoint. By this standard, as well, Applovin beat with growth of 77%.  

On the bottom line, the company had a large beat with EPS of $2.39 compared to $1.99 EPS expected, representing growth of 169%. This was a 45 point beat on growth rate for the bottom line. Adjusted EBITDA doubled to $1.02 billion, up from $943 million last quarter. This represents an adjusted EBITDA margin of 81%.  

As management alluded to on the earnings call, the company “prints cash” with a 61.3% operating cash flow margin and a 61% free cash flow margin.  

The Q&A was primarily focused on when Applovin plans to launch its self-serve ad platform, as this should create a boost for growth. Management was encouraging saying “as soon as possible” yet the tone on the earnings call was particularly optimistic about Q4 being a bigger quarter for the company. Details on why management had the confidence to call out Q4 specifically are noted below. 

Revenue  

Regardless of a nominal decimal point that caused a beat (or miss), the quants may have quickly sold the report after hours from mistakenly pricing Applovin for a deceleration from the March quarter to the June quarter.  

  • Overall revenue last quarter was $1.48B versus this quarter at $1.26B. As we covered in the past, this is due to Applovin divesting its mobile gaming “Apps” business, with the sale completed on June 30th. Therefore, if you adjust for this sale, revenue for the ads business in Q1 was $1.15B for QoQ growth of 8.7%. 
  • The current quarter marks an acceleration from 71% YoY growth yet QoQ growth is slowing.  
  • For next quarter, Applovin expects to see $1.33 billion in revenue, slightly above estimates for $1.31 billion. This represents 59% YoY growth and QoQ growth of 5.5%.  

As stated, Applovin divested its Apps business, which was weighing on both growth and margins. For example, Applovin had been reporting low growth in this segment of (13%) growth in the March quarter leading up to the sale.  

Margins and EPS: Operating margin doubled to 76% … what?! 

Applovin’s revenue growth is only part of the story, whereas the bottom line is what sets Applovin apart. I can count on one hand (or maybe even one finger) the number of tech companies that have reported a 76% GAAP operating margin.  

It may be common for tech companies to be in hypergrowth stage at times, yet very few ever reach the quality margins that App is reporting quite early in its company history.  

The bottom line presented below is a thing of beauty. The margins have clearly benefited from divesting the Apps business, which had been weighing on the margins.  

  • Gross margin of 88% compares to last quarter at 81.7% and the year ago quarter at 73.85.  
  • Operating margin of 76% expanded from 44.7% last quarter and more than doubled from the year ago quarter at 36.2%. Wow!! 
  • Net margin of 65% expanded from 38.8% last quarter and doubled from 28.7% in the year ago quarter. Wow!! 

Earnings per share of $2.39 beat estimates for EPS of $1.99, representing growth of 169%. This was a large beat as growth was expected to be 123.5% on the bottom line.  

Cash Flow Margin of 61% 

In yet another impressive bottom-line number, Applovin reported a 61% free cash flow margin for free cash flow of $768 million. The company has been strong on cash for sometime, yet this still represents a 540 bps expansion QoQ and 20-point expansion YoY.  

The operating cash flow margin of 61.3% is up from 56% last quarter for operating cash of $772M. The company has $1.2 billion in cash on the balance sheet including $425M from the sale of the Apps business. The company has $3.7B in debt.  

Applovin does share buybacks with 900,000 shares repurchased in the last quarter for a total of $341 million funded through free cash flow. This lowered share count form 346M to 342M last quarter.  

Earnings Q&A: 

Self-Serve platform set to launch October 1st 

Management has repeatedly stated that gaming alone can sustain growth of 20% to 30% YoY. Therefore, the catalyst for the next few years is securing additional supply, such as e-commerce, as well as opening up the AXON ad platform to more advertisers.  

The AXON ads manager recently became self-service, which means it can scale at levels not previously seen by offering self-service interface for Applovin’s 1 billion reach. As of now, Applovin is limited in the number of advertisers it can manually on board. According to the opening remarks: “With the rollout going smoothly, we are ready to widen access. On October 1, 2025, we plan to open the AXON ads manager on a referral basis, perfectly timed for the holiday season. Feedback from these partners will guide our global public launch in the first half of 2026. To date, web advertising campaigns have been limited to the United States. On October 1, we plan to open our platform to most major international markets.” 

When it comes to e-commerce, Applovin explained they limited the number of advertisers initially in order to make sure the tools were working properly, and they are now satisfied with the results and ready to launch self-serve on an invite basis to start. 

Per the Q&A: 

“And then the last point to remember is another one of my prepared remarks highlighted the fact that we have constrained the advertisers we even have live today by not allowing them to buy our audience that's international. The vast majority of our user audience is outside the U.S. We will be releasing almost all markets once we go into this October 1 release.” 

Looking longer-term, by matching categories such as e-commerce with a self-serve platform, Applovin discussed a flywheel effect: “So in terms of opportunity for us, not only does opening up the platform get us more demand, which is going to be massively accretive and incremental to our business. It gets us more data. And so every single quarter, you're going to have that flywheel effect that, that then paired with our engineers' ability to take added data and improve the technology and its interpretation of that data creates a real strong foundation for growth for a long time to come.” 

Commentary that Q4 will be strong: 

During the Q&A, there were a few mentions that Q4 should be strong along with mention of upside to the numbers come 2026.  

I want to make money in 2026 about as much as I want to make money in 2025, so this kind of discussion is my favorite moment during an earnings call (…and is the reason I take the time to listen to these calls and not run the transcript through Chat-GPT, like many, many research sites do these days!)  

Here’s one example: 

“We expect that will increase the advertiser count quite quickly and also allow us to go through live examples of advertisers coming in self-service all the way to scale on our product. Assuming all that goes well, then we talked about opening up the platform entirely to the world in first half of next year. We think as advertiser count grows on our business, especially in categories outside of gaming, you're going to see a lot of upside in the numbers that we're able to report.” 

Here was a more specific mention to Q4: 

“As we go into Q4, that's a huge holiday shopping season. So not only are you going to see the cohort that we have live spend a lot more. You're also going to have new onboarding happening for the first time in our history at a rate that's much higher than we will have ever seen before. So we fully expect that e-commerce will see a pretty substantial ramp-up through that, what you can call a soft launch period and then, obviously, as we go into a broader global release, the impact from that.” 

It was repeated again with more details around the compounding effect of onboarding the many new advertisers for existing gaming inventory and also new categories: 

“Now it's not necessarily true that we're going to take our queue that's built over the last year and just say, everyone you're in. They're still going to have to get invited to get into the platform. So it will be still curated onboarding. The reality is like Q4 is going to end up being a fun quarter. You've got the advertiser cohort that we didn't have last Q4 that was growing in the quarter to the point where we reported huge numbers and then had huge numbers in Q1. But we're going to have those advertisers primed and ready to go for the full Q4. We're going to have advertisers inviting their friends onto our platform in Q4, and we're going to be opening up international all at the same time. 

So there's going to be a lot of fun moment — moments for us and our customers in this e-commerce or web-based category that will set sort of a new baseline for that business. And then obviously, then we will go through hopefully another inflection when we really truly open up the platform and try to get into a state where we're more stable long term.” 

Quick Note on 2026-2027: 

Although further out, there was talk that lower fees on the App Store should become a tailwind for Applovin 4-8 quarters out: “So no impact yet. And I would guess it will probably take 2 to 4 quarters from some impact. And by 4 to 8 quarters, you're going to get pretty material impact in pricing on our platform.” 

Conclusion: 

I’ve never been one that needs the market to agree with me, and I am afraid on this one the market and I will have to agree to disagree as the price is down after hours. This was a stellar report with all fundamental boxes ticked, a team that has proven to execute, and incoming catalysts that are quite well-timed to where the market is selling the stock while we maybe have two quarters (or less) to wait for an inflection. 

Of course, this requires some speculation as consensus will not reflect management commentary until there are material results. But after all, that’s where the real money is made. Let's hope the formula of "believe what you see" works for us again as the growth, historic margins and the ability to print cash all point toward a solid stock while management hints they have more in store for shareholders around year-end.

Please note: The I/O Fund conducts research and draws conclusions for the company’s portfolio. We then share that information with our readers and offer real-time trade notifications. This is not a guarantee of a stock’s performance and it is not financial advice. Please consult your personal financial advisor before buying any stock in the companies mentioned in this analysis. Beth Kindig and the I/O Fund own shares in APP at the time of writing and may own stocks pictured in the charts.

Recommended Reading:

AppLovin Q1: Web-Based Catalyst 2025-2026; Apps Segment Divested is a Major Plus 

Posted on by io-fund

AppLovin easily topped revenue and EPS estimates in Q1, but more importantly, the company is setting up for an additional under-reported catalyst with its web-based ad platform expected to launch its self-serve feature and scale with a wider pool of advertisers as the year progresses.  

In addition, the company divested its App segment, which is the gaming assets portfolio, and is now a pureplay ad-tech stock. The high-growth and high-margin advertising business that ignited AppLovin’s strong returns over the past few years is now the company’s sole focus.  

You’d be hard pressed to find a stronger stock in terms of fundamentals on the market today. There is plenty of runway left for this stock should the growth of 30%+ coupled with 80%+ gross margins and nearly 40% net margin continue. Consider that EPS grew triple digits this quarter and FY2026 EPS estimates are being revised higher by an astonishing $3.50 in incremental EPS. 

In analysis below, we turn our focus to ways the company can sustain this growth on the top line and bottom line as we look at 2025 and beyond.  

Ad Growth of 71% YoY 

AppLovin reported 40.3% YoY revenue growth to $1.48 billion in the first quarter, beating consensus estimates by $100 million. This was AppLovin’s sixth consecutive quarter with revenue growth >35% YoY.  

Advertising revenue increased 70.9% YoY to $1.16 billion, slowing slightly from 91% in the year-ago quarter. Management said growth was driven by continued enhancements in its AI ad engine, as well as the full quarter impact of its web-based ad solution even coming off the seasonally high e-commerce quarter in Q4.  

For Q2, management guided Advertising revenue of $1.195 to $1.215 billion, pointing to 69.5% YoY growth at midpoint, maintaining its hypergrowth phase.   

Management is still looking to explore CTV as a future growth channel, following its recent push into e-commerce, while the upcoming launch of its AI-powered self-service campaign management platform is expected to be both a catalyst for revenue and margins.  

Given the Apps business is being divested, AppLovin will be reporting headline growth in the 60% range that is aligned with its Ads business rather than a mix of both. Consensus revenue growth estimates are much lower and show a sharp deceleration, as these comps still take into account revenue from the Apps segment . Thus, growth rates such as 20% in Q3 do not reflect the true performance of the business.  

Apps revenue declined (14.4%) YoY to $325 million. AppLovin announced that it entered a definitive agreement to sell the segment to Tripledot Studios for $400 million in cash ($150 million at closing and a $250 million promissory note) and a 20% stake in Tripledot’s equity. The transaction is expected to close in Q2. This will transition AppLovin into an advertising pure-play.  

Margins Show Continued Strength 

Though AppLovin’s top-line growth is quite impressive, margins are where it shines, with gross margin surpassing 80% and operating margin reaching a new high. This combination of strong revenue growth and strong margins is driving exceptional operating leverage with triple-digit earnings growth. 

Per management on the call: “Total revenue soared 40% from the same period last year to $1.5 billion, and adjusted EBITDA increased a remarkable 83% to an impressive $1 billion, achieving a fantastic 68% adjusted EBITDA margin […] Shifting to the Advertising business, we generated $1.16 billion in revenue and $943 million in adjusted EBITDA, achieving an incredible 81% margin.” 

Gross margin expanded 5 points sequentially and more than 9 points YoY to 81.7%. Notably, AppLovin cut its cost of revenue by nearly (9%) YoY, from $294.1 million to $272.2 million, while still driving 40% total revenue growth and 70% advertising growth. 

Operating margin remained above 44% for a third straight quarter at 44.7%.  To put in perspective how strong these margins are, AppLovin would have a Rule of 40 score of 85% based on Palantir’s definition of revenue growth + operating margin, while Palantir had a score of 83%.  

Post-divestment, AppLovin’s operating margin will look much different, given that Advertising’s current operating margin is likely much closer to 70%. Management talked about the Rule of 150 on the earnings call, reflecting the new fundamental structure of the company, with ~70% revenue growth and 70% operating margins:  

“I don't know of any other tech company with the financial profile that we have and scale growing the way we are. I think it's on a Rule of 150 or something. And what we're focused on when we talk about priorities is how's 2026 going to be? How's '27 going to be?” 

Net margin in Q1 was 38.8%, up more than 16 points YoY. AppLovin’s business model sees a high percentage of its operating income flow through to the bottom line, driving tremendous EPS growth as margins expand.  

Adjusted EBITDA margin was 68%, well ahead of guidance for 63% to 64%, as adjusted EBITDA surpassed $1 billion. Advertising adjusted EBITDA margin expanded 8 points YoY and 3 points QoQ to 81%, with adjusted EBITDA of $943 million coming in nearly 16% ahead of guidance. Apps adjusted EBITDA margin was 19%, flat QoQ but up 4 points YoY.  

For Q2, management guided for adjusted EBITDA of $970-990 million for an 81% margin. 

EPS Grows Triple-Digits in Q1 

AppLovin reported massive 149% YoY growth in GAAP EPS to $1.67, outpacing revenue growth by more than 3x. Looking ahead, EPS estimates have been revised significantly higher since our latest update in February, AppLovin: Expanding from Gaming to E-Commerce (and Beyond)AppLovin: Expanding from Gaming to E-Commerce (and Beyond). 

Q2 EPS is now seen growing 125% YoY to $2.00, before rising to $2.16 in Q3 and exiting the year at $2.46.  

This compares to February’s estimates for 60% growth to $1.43 in Q2, $1.66 in Q3 and $1.78 in Q4. This is a significant >38% increase for Q2 and Q4’s EPS, as AppLovin will benefit from a much leaner business model as an ad-tech pure play, with operating margins set to expand post-divestment to nearly 70%, aided by prudent cost management – sales & marketing expenses were down nearly (20%) YoY, R&D was down nearly (21%), and data center costs rose by just $30 million YoY on a $480 million increase in revenue.  

For FY25, analysts now estimate AppLovin will generate $7.80 in EPS, up 72.3% YoY, with FY26 EPS rising 42% to $11.80. This is more than a $3.50 increase for FY26 since February’s $8.27 estimate.  

Cash Flows and Balance Sheet 

AppLovin’s cash flows are exceptional, with operating and free cash flow margins expanding to new records in Q1. Per the opening remarks: “In the first quarter, we generated $826 million in free cash flow, up a staggering 113% year-over-year. Quarter-over-quarter, our free cash flow grew 19%, representing an impressive 82% flow-through from adjusted EBITDA to free cash flow.” 

  • Operating cash flow rose 112% YoY to $831.7 million for a 56% margin, expanding from a 51.1% margin in Q4 and nearly 19 points higher than 37.1% in the year ago quarter. 
  • Free cash flow rose 113% YoY to $825.7 million for a 55.6% margin, expanding from 50.6% in Q4 and 36.6% in the year ago quarter. 
  • Cash and cash equivalents decreased to $551 million from $741.4 million in Q4, though the closing of the Apps sale should help restrengthen its cash position. AppLovin also repurchased and withheld 3.4 million shares in Q1 for a total cost of $1.2 billion, funded primarily via free cash flow and a temporary draw on its revolving credit facility, which was already repaid. 
  • Debt totaled $3.71 billion, and debt-to-equity ratio has surged from 3.4x last quarter to nearly 6.5x now, as AppLovin is now more highly levered due to the decrease in cash and increase in total liabilities from $4.78 billion to $5.13 billion. 

Analyst Estimates Do Not Represent the Full Picture 

Analyst estimates show very low growth because these are taking the combined business of gaming and ads, and basing growth on this whereas organic growth will be much higher. 

While Q2 will still have five weeks’ revenue impact from gaming, Q3 and Q4 will be AppLovin’s first two quarters post-divestment, with consensus revenue growth of 20-23%.  

However, organic growth for Advertising was guided at just under 70% in Q2, and expected to be 65% YoY in Q3 based on the current estimate for $1.38 billion in revenue, which aligns with trends for 15% QoQ growth from Q2’s guide. Revenue is expected to decelerate to 52% in Q4, though this comes against a 73% growth comp.  

Looking at just the Advertising business, full-year revenue growth is projected at ~63.2% YoY to $5.26 billion, based on current guidance and estimates for 2H. This would value AppLovin at a rather pricey 23x PS for 2025, and if revenue grows 30% YoY in 2026 to ~$6.83 billion, AppLovin would be valued at 17.7x forward PS.  

If AppLovin can lever strong execution, expansions into web-advertising and further into e-commerce, and better optimizations to its AI ad engine to drive 50% YoY growth in 2026, revenue would project out to $7.89 billion, or ~15.3x forward PS 

On the bottom line, AppLovin is currently operating near a 40% net margin with some quarterly fluctuations, and Advertising’s strong operating margin profile will likely pull net margins to the high-50% to 60% range. Looking out to 2026, AppLovin could generate earnings of $11.85 on the 30% growth forecast, assuming a 58% net margin with ~10 million share buybacks. This would value it slightly above 30x forward PE. Based on the 50% growth forecast and similar net margin and buyback assumptions, earnings would project to $13.70, or growth of >72% YoY based on current FY25 estimates, valuing AppLovin at 26.1x forward PE. 

Growth Catalysts for 2025 and Beyond: 

In terms of executing a successful pivot, Applovin’s management team does not get enough credit. Mobile games are a business that has plateaued (that’s putting it nicely – it’s actually a market that has tanked). Applovin aggressively acquired mobile games and leveraged their mobile IP portfolio to build a formidable database of 1.4 billion users. By building an ad-tech business and acquiring AI engineering talent, the company was early to AI with its AXON 2.0 platform. The pivot is one of the boldest I’ve seen in a 15-year career in tech; on par with Lisa Su’s move to overtake Intel. 

Here is a summary of AXON 2.0 from our previous analysis: 

“The ad engine AXON 2.0 offers a monumental advantage to AppLovin as the company is ahead in the race for AI-driven advertising. 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.” 

Looking into the future, however, the management team cannot rest on their laurels as gaming eventually hits its limit in inventory. Although 1.4 billion daily active users is impressive, at about half of what Meta has with its family of apps at 3 billion users, one could argue that gamers are only worth so much to a marketer as the demographic is narrower and more limited.  

Applovin’s next moves are the following: 

  • Branch out to e-commerce — This plays nicely into the restrictions AppLovin has with a cookie window to convert within 24 hours. Meaning, if a user converts beyond 24 hours, it is hard for AppLovin to verify attribution. Therefore, the company is less appealing to an auto advertiser where the buying decision is quite long compared to a T-shirt company. 
  • Web-based advertising – mobile games are an app-based business, hence the name AppLovin. The company came to market in the mobile era, yet the company is not capitalizing on websites at this time.  
  • Self-service Platform – although this goes hand-in-hand with the web-based advertising catalyst, it’s important to look at this feature separately as the onboarding of advertisers can scale more quickly once this feature launches. Given AppLovin’s ideal advertisers convert within 24 hours for products that are less than $250, self-serve platform is the only way forward that makes sense. 
  • Go Global – this is not on the near-term product road map yet is a lever AppLovin can pull when the timing is right. The company is focused on the United States market, which is by far the most lucrative. 

E-commerce Apps: 

According to the CEO’s response to short sellers in February, the initial launch of the e-commerce platform has seen 600 advertisers with an annual run rate of $1 billion. In terms of increasing TAM (which is also related to the information below in the web-based advertising section), the company stated they are “sub-0.1% penetration in the market,” signifying a long runway.  

Where the TAM is a bit constrained is Applovin has 24 hours on the attribution side to convert and this tends to perform best with products priced under $250. 

“On web, we built the product to be self-attributing, so our own attribution platform. And it's not high turnover products. I mean, like, most products in the world are not selling something greater than $250. Our product — our models can go deliver something that's a couple hundred dollars within a few minutes of the ad being seen, and it it's happening quite often. I mean, obviously, scaled at the $1 billion run rate that I mentioned.” 

You can read more about the e-commerce platform in our previous analysis here. 

Web-Based Advertising and Self-Serve Platform 

The breakdown of mobile versus web-based advertising in terms of ad spend is as follows. 

  • Total Ad Spend in the United States: $309B per year 
  • In-app advertising represents $165.9B per year 
  • Mobile Web advertising represents $36.7B per year 
  • Desktop advertising represents $106.B per year 

Applovin is effectively increasing their TAM by 40% by adding web-based advertising. This will take time to scale yet given the strong start we’ve seen on the in-apps ad business, to increase TAM by 40% is certainly something that catches our attention.  

In terms of how this plays out, Applovin’s goal is to see 10% of revenue from the web-based business once the self-service platform goes live: 

“After we launched the self-serve model, that business could grow quite significantly and outpace that 10% metric that we provided previously. So, it's quite likely that it could represent a larger than 10% portion of the revenue this year.” 

Once the self-serve platform goes live, Applovin’s ambition is to see a market penetration in web-based advertising on par with their penetration in mobile games. The following was stated regarding the roll-out happening toward the back half of the year: “And then, even more exciting, I touched on this in the talk script, we're finally going to be releasing our new dashboard to some select advertisers for feedback this quarter. That's a huge catalyzing effect. When we do go to a full self-service state, we're going to open up our platform from a very small amount of advertiser penetration to the entirety of the world being able to come on to our platform.” 

The company also clarified that until the self-service platform launches, they will not see meaningful revenue in the web-based business, yet in the meantime, there is “a line out the door.”

“We've got a line out the door of customers that have been waiting to come on to the platform, and then we've onboarded, I think I said, in a blog, hundreds of advertisers, but our team is small. So, when I say we're not looking to push, we're looking to push over time, but we need to get the self-service tools into the market so that we can pair that with the team to automate a lot more of the processes.” 

Short Reports: 

The CEO responded to the short seller reports here and here. These are worth a read as the CEO makes the explanation quite simple in terms of how their pixel is not unique and is aligned with industry standards.

Conclusion: 

There are no guarantees in tech investing. Stick around long enough and you will see a bulletproof company fall flat (pick any high-flying best-of-breed cloud company – Zoom, Snowflake, Datadog, MongoDB), while others surprise the market for a decade or longer (Meta, Google, etc.). 

Applovin gushes margins, has many catalysts to continue its growth trajectory and perhaps most importantly, is an underdog of sorts to where the market often (mistakenly)- affords a better entry in time. I won’t get any originality points for writing an analysis on Applovin after an 800% run in the markets in eighteen months, yet perhaps I can help by saying that from what I can see today, this run is not over yet.  

The I/O Fund is closely monitoring Microsoft for a potential entry point. Join us Thursdays at 4:30 p.m. in our Advanced Market webinars, where we’ll outline our strategy for initiating a position with maximum upside in mind. Learn more here.Learn more hereLearn more here.

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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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Meta Platforms: Quietly the Strongest Mag 7 Stock with Meta AI App Launching Soon 

Posted on by io-fund

Meta is the strongest Mag 7 stock YTD with its peers down as much as 40%, Meta’s (13%) decline since the first of the year is strong on a relative basis and provides some important clues. 

It may be easy to lump the Mag 7 together, yet this cohort is different in key aspects that matter. For example, we’ve been cautioning on Tesla’s margins for years, Nvidia continues has an AI lead that appears insurmountable, while the others have open pocketbooks for AI chips without much visibility to offer in terms of how that capex will be paid back and when.  

It’s this last piece that Meta has a better handle on.  The company is not offering data center infrastructure for developers and R&D departments to create AI applications, who in turn, must find a path to monetization for a virtuous cycle of demand. With what we know today from earnings disclosures, Azure is leading with a $13 billion annual run rate in revenue among the cloud providers (Amazon, Google, Microsoft). Yet, consider that Meta has a new ad product driven by AI that is already on a $20 billion run rate, and this does not include incremental revenue AI is driving across their other ad products, evidenced by an inflection in Meta’s key metric on ad prices. 

There are other areas that Meta is quietly leading. The company is releasing a standalone AI app in Q2, powered by Llama 4, with projections for 1 billion monthly active users by year’s end. That’s up from 700 million users today on the embedded AI features it sees in its popular “family of apps” such as Facebook, Whatsapp and Instagram. To compare, Chat-GPT's standalone app has 500 million. While it remains to be seen if Meta AI will reach the company’s lofty goals, there’s certainly a viable path with 3.35 billion currently using its popular apps today. 

Lastly, whereas other big tech companies ramped capex 1-2 years ago, Meta is only now moving into large capex spending from $30B in 2023, to $40B last year to $62 billion this year, up 59.4% YoY. This past quarter, capex was up an astonishing 88% YoY. Meta is in the enviable position to increase this capex once they’ve found product market fit within their own platform rather than pre-emptively building for future AI development. I suspect this new trajectory in capex spending means Meta is ready to scale its AI tools on the ad platform side.  

Meta’s AI-Powered Ad Tools 

Meta is unique in that its customer base has an unusually high incentive to use AI tools. You could argue developers for cloud IaaS also have a high incentive, yet they must in turn monetize to drive scale for their AI apps. Meanwhile, advertisers see an immediate ROI using AI tools and are then incentivized to spend more.  

Evidence of this is visible in the stubbornly high ad revenue growth last quarter of 20.6%, which has sustained even as Meta recently lapped tough comp as the average ad price grew 14% YoY.  

Advantage+ has $20B Run Rate:

Advantage+ is an automation tool that uses machine learning to match customers to ads. Similar to Google’s Performance Max, the tool uses AI and machine learning to help with optimize bids/budgets, create and find audiences, and to produce ad creatives. Up to this point, Advantage+ has been used for ecommerce and manually turned on, yet Meta is now going to have the tool turned on automatically and roll it out to other verticals soon.  

“In this new setup, all campaigns optimizing for sales, app or lead objectives will have Advantage+ turned on from the beginning. This will allow more advertisers to take advantage of the performance Advantage+ offers, while still having the ability to further customize aspects of their campaigns when they need to. We plan to expand to more advertisers in the coming months before fully rolling it out later in the year.” 

According to the recent earnings report, over 1 million advertisers used Meta's gen AI tools to create 15 million ads in December 2024.  

  • Advantage+ shopping campaigns surpassed a $20 billion annual run rate, up 70% YoY.  
  • Advantage+ users are seeing a return on ad spend (ROAS) improvement of up to 22%. 
  • Advantage+ Creative is seeing over 4 million advertisers using at least 1 generative AI ad creative tool, up 1 million just six months ago.  

Andromeda has 10,000X increase in Model Capacity: 

In H2 2024, Meta revealed a new machine learning system built on Nvidia Hopper chips called Andromeda. Per the earnings call: “This more efficient system enabled a 10,000 times increase in the complexity of models we use for ads retrieval, which is the part of the ranking process where we narrow down a pool of tens of millions of ads to the few thousand we consider showing someone.” 

Consider that with AI, an advertiser can make 5,000 creatives rather than 5 creatives, changing the game in personalization. Andromeda is aimed at the new frontier of AI advertising, with an emphasis on retrieval as the first step. This first stage in the ad serving process is to retrieve the ads that are most personalized to a user, resulting in thousands of ads before the final ads are selected.  

Due to AI, these ads can now be chosen based on learned associations rather than categories or keywords. By offering a 10,0000X increase in model capacity, Andromeda processes large amounts of data to accurately predict which ads will resonate with which users. This leads to more relevance, which in turn, leads to higher conversions. The deep neural network is considered "hierarchal structured” to where it can handle a much larger volume of ads at a much higher accuracy, improving on the previous structure known as “two-tower.” 

Meta AI to See 1 Billion Users in 2025 

In a recent conference, Chief Product Officer Chris Cox, described Meta’s AI features as Search 2.0. Instead of visiting a search engine, users engage with Meta AI in-app and on the newsfeed. Meta’s standalone app is expected to be announced in late April at the developers conference.   

During the conference, Zuckerberg said, “Meta AI differentiates itself in this category by not just offering state-of-the-art AI models, but also unlimited access to those models for free, integrated easily into our different products and apps. So Meta AI is on track to being the most used AI assistant in the world by the end of this year. In fact, it’s probably already there. We’re almost at 500 million monthly actives, and we haven’t even launched in some of the bigger countries yet.” While this version was on Llama 3.2, the new rollout of its standalone Meta AI app will be using Llama 4.0 (detailed below).  

Since then, Meta AI has reported 700 million users on a monthly basis while Chat-GPT is at 500 million weekly active users. This is not comparable, however, since Meta AI is not a standalone app yet. The release will be closely watched as Meta will likely push hard on its large social media base to download the app. 

Chatbot to Aid in Personalization of Content and Ads: 

Meta’s chatbot will also help to aid in further personalization of ads. The data from its chatbot will be stored in memory to help target users. 

“We'll be able to remember certain details that people share in one-on-one chats, for example, and use those details to personalize its responses and then really increasing its ability to deliver great content recommendations and enhance really what makes Facebook and Instagram, so valuable for people today.” 

CFO Susan Li described the Meta AI roadmap in 2025 during the Q4 2024 conference call, stating something similar as to the strengths of Meta’s app over other AI chatbots in terms of personalization and a large context window: 

“And as we look forward to 2025 in our Meta AI road map, we are really focused on doing more to make it feel more personalized. So, I would say some of the most exciting features we're working on include improving sort of the memory dimension of the Meta AI experience. We'll be able to remember certain details that people share in one-on-one chats, for example, and use those details to personalize its responses and then really increase its ability to deliver great content recommendations and enhance what makes Facebook and Instagram so valuable for people today.” 

Notably, it’s unlikely Meta AI is monetized this year, although in future years there are plans for a premium tier similar to Chat-GPT. 

Llama 4 Models Released Last week 

Llama 4 Scout and Llama 4 Maverick were released last week, while Llama Behemoth at 2 trillion parameters is expected to be released soon. These multi-modal LLMs are trained on text, images and video with a mixture of experts (MoE) architecture. MoE distributes a computational load across “multiple experts” (or neural networks) and trains across thousands of GPUs using what is called model and pipeline parallelism. This enables more compute-efficient pretraining, yet the parameters still need to be loaded in RAM, so the memory requirements remain high. 

For Llama 4 Maverick, 400B parameters are stored in memory while only 17B parameters are activated during model deployment, which greatly improves inference efficiency by lowering costs and latency.  

This is similar to the breakthrough we saw with DeepSeek R1, which was a MoE model that was trained on 671 billion parameters stored in memory, yet when the model is served, only 37 billion parameters are active. The overall result is computational efficiency as only the most relevant parameters are activated for a specific task. 

  • Llama Maverick can be run on a single H100 DGX system (8 GPUs) or can be run distributed for inference purposes. The inference cost for Llama 4 Maverick is $0.19 to $0.49 per 1 million tokens compared to Chat-GPT4o at $4.38 per million tokens.  
  • Groq has verified the upper end of this inference cost estimate with Maverick at $0.53. The model leverages 128 experts. According to Meta, Maverick exceeds “comparable models like GPT-4o and Gemini 2.0 on coding, reasoning, multilingual, long-context, and image benchmarks, and it’s competitive with the much larger DeepSeek v3.1 on coding and reasoning.” 
  • Llama 4 Scout is cheap at $0.13 per million tokens according to Groq and can be deployed on a single H100 GPU, leveraging 16 experts. Scout can remember long threads and documents of up to 10 million tokens. This is the largest context window across LLMs available today. 
  • Llama 4 Behemoth is a teacher model that is still being trained with 288B active parameters and 2 trillion total parameters, leveraging 16 experts. Llama 4 Behemoth helped train Maverick and Scout and ranks high on internalinternal benchmarks such as MATH-500, MMLU Pro, GPQA Diamond, Multilingual MMU and image reasoning MMMU. According to MetaAccording to Meta, Chat-GPT 4.5 ranks lower on these benchmarks although this will not be officially verifiedwill not be officially verified until Behemoth is released. For reference, an engineer estimates Chat-GPT 4.5 has 5-7 trillion parameters and 600B active parameters. 

Recently, Chief Product Officer Chris Cox explained the goals for Llama 4 – it's a long quote but also important to hear what Meta is setting out to achieve with its newest models and also as an open-source leader in LLMs: 

“We've finished pretraining the smaller model. The main thing — first, just from an intelligence perspective, we're trying to pack basically, the intelligence of the large Llama 3 series down into really small models, which can then be used with low latency for low-cost on devices on a single host. So basically getting a lot of the intelligence down into the smaller form factor, that's one of the most important things we can do. 

The second is just the basis of what's expected in a new model today, which is reasoning. Agentic use cases, just meaning tool use, ability to use a browser, ability to use other tools. 

And then the third piece is an omni model. So basically, interacting with image and voice natively. So rather than translating voice into text and then text into LLMs getting text out, turning that back into speech, having speech be native. This is a big deal. I believe it's a huge deal for the interface, the product. The idea that you can talk to the internet and just ask it anything. I think we are still wrapping our heads around how powerful that is.” 

Meta Increases Capex 88% YoY in Q4, will increase 59.4% this Fiscal Year 

Q4 capex was $14.8 billion, driven by servers, data centers and network infrastructure investments. Meta raised its 2025 capex guidance to $60 billion to $65 billion, with a midpoint of $62.5 billion, up 59.4% YoY, driven by investments in AI infrastructure and its core business.  

Meta is also extending the lives of its servers and networking equipment. They will use non-AI and AI servers for longer periods of time before replacing them, which will be 5.5 years, resulting in annual capex savings and depreciation expenses, which is included in its guidance. 

In December 2024, Meta announced plans for its 23rd and largest data center in the United States, a 2GW+ AI data center “so large it would cover a significant part of Manhattan” in Richland Parish, Louisiana. The data center plans to outdo Elon Musk’s xAI’s Colossus supercluster of 1 million NVDA GPUs, with plans for 1.3 million GPUs used to train its Llama AI models.   

The 4 million square foot campus will be set on 2,250 acres on the former Franklin Farm site. They will build up to nine buildings and plan to bring 1 GW online by the end of 2025. The site will total over 2GW at full buildout as construction is scheduled to continue until 2030.    

Meta has a co-location deal with Entergy to develop a 1.5GW natural gas power plant located adjacent to its proposed $10 billion data center. Entergy is investing $6 billion in electric infrastructure, including a 10,000-acre solar farm, three combined-cycle combustion turbines (CCBT) split into two sites totaling 2.26GW and over 100 miles of new transmission lines. Co-location refers to deals where data centers are located next to power plants generating electricity to feed directly to the customer and usually bypassing the electric grid, which would be a back-of-the-meter arrangement.  

Meta is seeking approval from Louisiana OSC to begin construction within 10 months. Meta will be matching its electricity use with 100% clean and renewable energy and has pledged to build or acquire 1.5GW of solar power elsewhere in order to offset emissions from the gas plant. Meta will also contribute to a carbon capture and storage project at the Entergy Lake Charles 994MW gas plant. The gas plant is estimated to open between 2028 to 2029.  

Incidentally, a report by The Information claimed Meta is in talks to build a $200 billion data center. However, Meta has not confirmed the rumor. 

Meta Plans to Increase ASIC Usage 

Meta training and inference accelerator (MTIA) is Meta’s custom silicon and is primarily used for inference today for ads and organic content. The goal is to use MTIA for training next year. According to Tom’s Hardware, the “plan is to gradually increase usage if the chip meets performance and power targets."  

There have been delays in the past on Meta’s custom silicon program with MTIA originally launching in 2020, yet Meta had to halt the program to buy Nvidia’s GPUs over the past few years with MTIA v1 launching in 2023. This year, MTIA v2 was launched using RISC-V cores that lowers the overall cost as there are no licensing fees. You can read more about RISC-V, the open-source competitor to Arm in previous coverage here. 

Regarding DeepSeek, Meta confirmed "that doesn’t mean you need less compute,” going on to explain that a new trend is to apply more compute at inference in order generate a higher level of intelligence and higher quality. “I think that's generally an advantage that we're now going to be able to provide a higher quality of service than others, who don't necessarily have the business model to support it on a sustainable basis. 

Financials:

Average Price Per Ad is Inflecting 

Q4 revenue rose 20.63% YoY to $48.39 billion, beating consensus analyst estimates of $46.99 billion by $1.39 billion or 2.96%. Full year 2024 revenue rose 22% YoY to $164.5 billion. 

Management guided Q1 2025 revenue of $39.5 billion to $41.8 billion, with a midpoint of $40.65 billion representing 11.5% YoY growth at the midpoint. This was in line on a constant currency basis, yet came in under $41.46 billion consensus analyst estimates due to 3% FX headwinds representing 13.72% YoY growth.

Revenue growth in the quarter was driven by 21% YoY revenue growth in its Family of Apps to $47.3 billion, of which ad revenue rose 21% YoY to $46.8 billion, comprising 97.57% of total revenue. Other revenue for its Family of Apps rose 55% to $519 million, driven primarily by WhatsApp Business Platform. 

The number of ad impressions served across its services rose 6% YoY, and the average price per ad rose 14% YoY. Ad revenue growth by geographies was led by the Rest of the World at 27%, Asia-Pacific at 23%, Europe at 22% and North America at 16%.    

The average price per ad was up 14% YoY – which is the most important metric to watch as pricing should increase with the AI advancements described above. Growth in average price per ad is already inflecting when you consider Q3 was 11% growth and Q4 of last year was only up 2%. 

Regarding this inflection, the CFO hinted CPMs (cost per 1,000 impressions) may continue to grow: “Overall, we are seeing healthy cost per action trends for advertisers for whatever is the action that they are optimizing for. And we believe we'll continue to get better at driving conversions for advertisers. And when we do, that will have the effect of continuing to lift CPMs over time, because we're delivering more conversions per impression served, resulting in higher value impressions.” 

The Family of Apps average revenue per person (ARPP) rose 15.6% YoY to $14.25, which was a slight YoY improvement from Q4 ARPP growth of 15.4% — so again, consider this growth is being reported on tough comps. 

EPS Grows YoY and QoQ 

Q4 GAAP EPS rose 50.47% YoY to $8.02, beating consensus analyst estimates for $6.76 by $1.26 or 18.67%. This was a sequential improvement from Q3 GAAP EPS, which rose 37.34% YoY to $6.03, beating consensus analyst estimates of $5.29 by 13.99%.  

It’s no secret that AI agents can write excellent code, which can help drive efficiencies at companies by cutting back on the R&D department overhead. According to the earnings call, Meta expects AI to be as good as mid-level engineer, which will positively impact margins and the bottom line: 

“I also expect that 2025 will be the year when it becomes possible to build an AI engineering agent that has coding and problem-solving abilities of around a good mid-level engineer. And this is going to be a profound milestone and potentially one of the most important innovations in history, as well as over time, potentially a very large market. Whichever company builds this first I think is going to have a meaningful advantage in deploying it to advance their AI research and shape the field. So that's another reason why I think that this year is going to set the course for the future.” 

Margins: 

Meta’s margins and income are impressive at levels not seen since the company was the defacto Wall Street darling in 2017.  

  • Q4 gross margin was 81.7%, falling slightly from Q3 gross margin of 81.8%. 
  • Operating margin steadily climbed to one of its highest levels (ever) at 48.3%. Looking back, it was Q4 of 2017 when Meta last reported a higher operating margin. This is up from an OM of 41% last year. 
  • Net margin of 43.1% is similar – one of Meta’s highest on record, up from a margin of 35% last year. 

Cash and Debt Close 2024 at Their Highest Levels for the Year 

Q4 operating cash flow reached its highest level for 2024 at $27.99 billion with a margin of 58%. This is up from $19.4 billion for a margin of 48.4%.  

 Free cash flow fell sequentially to $13.15 billion compared to last year at $11.5 billion. The roughly $14B difference in OCF and FCF is from high capex spend. 

Q4 cash and cash equivalents rose 9.75% QoQ for $77.81 billion in cash. Debt was $28.82 billion.  

Conclusion: 

Clearly, AI is extremely nascent in terms of what it can do with non-stop development and progress coming from tech’s largest players as well as startups. However, also consider that very few companies have a 3B+ global user base to convert to an AI app.  

Meta is positioning itself to become a dominant player in the AI landscape led by its Llama 4 models and standalone Meta AI assistant app. AI has enhanced its core advertising business with ad pricing reaching an important inflection point. It’s also interesting to consider its AI tool Advantage+ has surpassed Azure in annual run rate at $20B compared to $13B. 

The market is rife with noise, it is hard to know what to pay attention to right now. You can expect us to build a strong pipeline of opportunities to seize when the timing is right.

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.

Recommended Reading:

AppLovin: Expanding from Gaming to E-Commerce (and Beyond)

Posted on by io-fund

AppLovin delivered solid top and bottom line beat in its Q4 2024 earnings release. The company posted 44% YoY and 14.4% QoQ revenue growth to $1.37 billion, beating consensus estimates by 8.7%. GAAP EPS grew for the eighth consecutive quarter, coming in at $1.73, beating consensus estimates by 37.5%. Gross margins were at 76.7%. The Company also raised its forecasts for Q1 2025 and announced an agreement to sell its Apps segment for $900 million in Q1 2025.

The market rewarded its performance with a 24% stock rally. AppLovin has the unique advantage of having a vast dataset of 1.4 billion mobile users. The company has successfully leveraged this data to fuel its AI engine, enabling it to navigate and capitalize on the broader mobile gaming market effectively. AppLovin's data advantage provides a significant competitive edge over its competitors. Very few companies outside of Big Tech possess such a crucial dataset for advertising purposes. This strong moat solidifies the company's future position in the ad-tech industry.

The ad engine AXON 2.0 offers a monumental advantage to AppLovin as the company is ahead in the race for AI-driven advertising. 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.

Incidentally, The Trade Desk reported Q4 2024 EPS of 59 cents, beating consensus estimates by 2 cents; while revenues grew 22.32% YoY to $741.01 million, they still missed consensus estimates by $18.55 million. They issued Q1 revenue guidance of at least $575 million versus $574.16 million with an adjusted EBITDA of around $145 million. The stock gapped down 29%.

Revenue Reach Record Highs in Q4

Q4 revenue grew by 44% YoY and 14.4% QoQ to $1.37 billion, compared to Q3 revenue growth of 38.64% YoY and 10.93% QoQ to $1.198 billion. Q4 revenue of $1.37 billion beat consensus estimates for $1.26 billion by 8.7%, compared to Q3 revenue of $1.98 billion, beating consensus estimates for $1.13 billion by 5.9%.

The Advertising segment revenues grew 73% YoY to $999.49 million, up 73% YoY. The Apps segment revenues fell (1%) YoY to $373,29 million. Revenue strength was attributed to positive early results for its e-commerce advertisers during the holiday season, in addition to its mobile gaming partners. The Company signed an agreement to sell its Apps division to an undisclosed party for $900 million, comprised of $500 million in cash and a minority stake in the combined private entity.

Management Q1 2025 guide is $1.355 billion to $1.385 billion, representing a YoY growth of 29.5% and flat QoQ, beating estimates by 3.8% at the midpoint of $1.365 billion. The Advertising revenue Q1 guide is $1.03 to $1.05 billion, midpoint at $1.04 billion and the Apps revenue is $325 to $335 million, midpoint at $330 million.

Margins Consistently Expand Through 2024

Q4 gross margin was 76.7%, slightly down from Q3 at 77.5%, while operating margin was 44.3%, slightly down from Q3 at 44.6%.

Its Advertising segment generated a 78% adjusted EBITDA margin from the adjusted EBITDA of $776.7 million on $999.49 million in revenue. Its App segment generated a 19% adjusted EBITDA margin from the $71.3 million of adjusted EBITDA on $373.3 million in revenue. Even though the revenue will come down by divesting the Apps business, the adjusted EBITDA margin of the company is expected to increase to a high 70% from the current low 60% as the Apps business was a drag on the margins.

Management guided Q1 2025 adjusted EBITDA between 63% to 64%, midpoint of 63.5%, or adjusted EBITDA of $855 million to $885 million, midpoint of $870 million.

GAAP EPS Rises for the Eighth Consecutive Quarter

Q4 GAAP EPS was $1.73, beating consensus estimates for $1.26 by $0.47 or 37.5%. An improvement from Q3 EPS of $1.26, beating $0.93 consensus estimates of $0.93 by $0.32 or 34.8%. GAAP EPS has been improving consecutively from a loss of ($0.22) in Q4 2022 to $1.73 in Q4 2024.

Management didn’t provide specific guidance for Q1 2025 EPS. However, they did provide Q1 2025 adjusted EBITDA guidance of $855 to $885 million, midpoint at $870 million, which also include Advertising adjusted EBITDA of $805 to $825 million, midpoint at $815 million and Apps adjusted EBITDA of $50 to $60 million, midpoint at $55 million.

Steady Cash Flow Improvement, But Debt Remains Stagnant  

Operating cash flow has been improving for five consecutive quarters, reaching its highest level in Q4 at $701 million. The same can be said about free cash flow, as it has also improved for five consecutive quarters, reaching a high of $695.16 million in Q4. The accompanying OCF and FCF percentage have also continued to improve in parallel fashion closing Q4 at their highest levels of 51.10% and 50.60%, respectively. However, the debt has grown from $3.1 billion to $3.51 billion in Q4 and has remained stagnant for the past year. The sale of its Apps segment is expected to bring in $500 million in cash, which could be used to pay down some debt.

AppLovin’s debt levels have only grown in the past year to $3.51 billion, and it doesn't seem the company is very concerned about the debt-to-equity ratio of 3.74, whereas The Trade Desk has no debt.

The Apps Segment Will be Sold in Q1 2025

Applovin collects revenues from its Advertising segment, formerly known as the Software Platform revenue, and its Apps segment, which will be sold in Q1 2025. The Advertising segment revenue growth has been stabilizing with 73% YoY growth in Q4. The Apps segment revenue has been falling to (1%) YoY in Q4. Management guided Q1 2025 Advertising revenue growth to 53% and Apps revenue to fall (13%) YoY.

Valuation

Applovin trades at a price/earnings (P/E) ratio of 155.15.
Its forward price-earnings (P/E) of 69.55.
The price/sales (P/S) ratio is 41.49, forward P/S is 30.24.
The company is trading at an EV/EBITDA ratio of 69.6 and a forward EV/EBITDA ratio of 41.7.
However, if we assume a 78% adjusted EBITDA margin after divesting the Apps business, the forward EV/EBITDA will drop to about 35.9.
Debt-to-equity ratio 3.74.
APP stock is up 24% after earnings.

Since AppLovin plans to transform itself into a pure Advertising platform, it may be helpful to see how the leading pure play AdTech platform fares for comparison.

The Trade Desk trades at a price/earnings (P/E) ratio of 135.57.
Its forward price-earnings (P/E) of 42.26.
The price/sales (P/S) ratio is 17.91, forward P/S is 33.61.
Debt-to-equity ratio 0, no-debt.
TTD stock is down (33%) after earnings.

Earnings Call:

AppLovin Moves Beyond Gaming to E-commerce and Beyond

Q4 was the most foundational period since the Axon upgrade in 2023. For the first time, the Company captured “meaningful” holiday shopping advertising dollars beyond solely the gaming category, e-commerce. E-commerce is their new growth driver category. This is bullish as it increases the addressable market.

Applovin reaches over 1 billion people engaged with mobile games daily with engagement times comparable to social media. Applovin transcended beyond advertising for other games as they did historically, but this time included a broader set of advertisers. Applovin's data shows its platform works for all advertisers, not just direct-to-consumer (DTC) brands, which opens up its customer base to the 10 million businesses that advertise online.

The self-service platform is a top priority to meet the overwhelming demand.

“Self-serve and automated tools are going to be really, really helpful. And so, if you look at just the numbers, what gets us really excited is, in a limited pilot of a few customers on the platform, we're driving actually interesting revenue from this category. So, as we start opening up, we think it's going to be really impactful to the businesses of our clients. It's also very, very impactful for the publishers that we work with. All this inventory is mobile games, and it adds variety to the advertising that the customer is getting on a mobile game.”

Divesting the Gaming Apps Business

Applovin will be selling its Apps division for $900 million, comprised of $500 million in cash and a minority equity stake in the combined private company. They did not disclose the name of the acquirer but expect the transaction to close in Q1 2025.

The Apps segment owns over 200 free-to-play games operated by 10 in-house game studios. It will be instrumental in helping them sell their in-game advertising and collect user data. However, they’ve never been a game developer “at heart”. While their games are “free-to-play”, revenue is generated from in-app purchases including virtual items, upgrades and other enhancements. Advertisers bought ads in their gaming apps. Applovin generated $373.3 million from its Apps in Q4 and $1.485 billion in 2024. The Apps segment may be part of the aggregate system that helps the Advertising segment generate its double-digit revenue growth.

They will lose the Apps portion of revenue, which was not a growth engine. Apps revenue dropped (1%) YoY in Q4 and only grew 3% in 2024. While Apps revenue generated nearly 40% of total revenue in Q4 2023, its portion fell to 27% by Q4 2024, as its Advertising revenue soared 73% while Apps revenue lost (1%). Its Apps revenue generated 44% of total revenue in 2023, but due to the 75% YoY growth it ins Advertising revenue versus 3% growth in Apps revenue, that percentage fell to 31.5%.

The new metric moving forward will be adjusted EBITDA per employee (AEPE) as it transitions to a full advertising platform. Q4 generated a $3 million run-rate adjusted per employee, AEPE, in its Advertising segment.

More on the E-commerce Opportunity:

Foroughi stated that his focus has been on streamlining the team and processes. He stated that Applovin is “one of the most financially lucrative businesses to be constantly announcing layoffs.”

Foroughi notes many high-engagement gaming apps that earn most of their revenue through in-app purchases don’t typically run ads—since doing so could hurt their primary revenue stream—but companies like King have shown that introducing non-gaming ads can create extra revenue.

He notes that the traditional mobile gaming ad market has mostly focused on promoting competing games. By bringing in more non-gaming advertisers, the company expects to sell its MAX product and DSP platform to gaming publishers that primarily rely on in-app purchases, thereby opening a new growth opportunity.

“Traditionally, in the mobile gaming mediation market, vast, vast majority of the ads were for games that were competitive to the publisher game. As we execute on bringing on more and more advertisers in non-gaming categories, we think that it's going to be pretty reasonable to sell the MAX product and our DSP platform to these gaming publishers who are monetizing predominantly or exclusively with in-app purchasing, bring on that supply, and that will create another expansion vector.”

When asked about the growth of the e-commerce segment opportunity in 2025 and potential incremental growth to expect from its contribution, Stumpf felt very confident in the ability to contribute a material portion of the revenue from e-commerce activity in 2025.

Foroughi replied, “And the other piece is we've always been a closed-managed platform specifically for mobile games. We now have a lot of proof of life in ecommerce, you've seen it on Twitter, a lot of the noise from customers that are in, but we have not let a lot of customers onto the platform yet as we've been on pilot. As we go more and more open and start attracting thousands and tens of thousands, hundreds of thousands of customers to come on over the coming quarters and years, the business is going to continue to show compelling growth.” He summed it up, “We look at it as one single business and better monetizing the 1 billion-plus daily actives that we see. We don't think about it as revenue from each category matters.”

When asked about the e-commerce solution offering rollout, whether AppLovin is seeing and response from the incumbent competitors.

Foroughi replied, “Yeah. So, I mean, look, we don't look at competition all that much. What I will say is that we're not a platform that's taking the same dollars away from someone else. So, let's compare it to social. If you've got a mattress manufacturer advertising on social today and driving a certain amount of business, and they come on to our platform, what they're seeing are new transactions from customers that they wouldn't have otherwise gotten to respond to their ads. Whether those customers were on social or not might be an issue, but, certainly, there's a lot of overlap. But a lot of customers just won't notice ads in one environment. Now, in our environment, we have a full-screen video ad that captures attention, and they come on to our platform and they're driving incremental sales.”

As e-commerce grows to become a larger portion of revenues, it will be subject to typical seasonality, with holiday periods seeing slightly larger periods of revenue.

When asked about the Apps business sale and whether it would be tranched out rolling off a few studios throughout the year, CFO Stumpf was direct in his response.

“So, we're going to be selling the entirety of the Apps business, Arsenije. So that would all come off of the P&L and the balance sheet all at once. And then timing, as I mentioned, I think, in my talk track that we're targeting for that to close within Q2.”

When asked if the gaming companies are providing any feedback as they move into e-commerce ads, Foroughi responded that the gaming companies are seeing better performance on their platform every quarter since they are a catalyst to their growth. Also, shifting more impressions to e-commerce has its benefits.

“When they start seeing more and more of their impressions shifting to e-commerce, they absolutely love it. If you're a game publisher, your worst nightmare would have been that I'm going to monetize my game with all of my competition's ads. That just sucks as an end product, but that's all they had. And so, we allow all of our MAX publishers to see the advertising list run. Some of those publishers have commented about the number of impressions that are shifting to non-gaming categories. When you see that commentary, they're absolutely excited about it.”

Conclusion:

AppLovin has found a solid niche with in-game advertising due to its own ecosystem of over 200 gaming apps and solid AI engines. Its new e-commerce advertising segment is off to a strong start and looking to be a potentially lucrative source of more advertising revenues. Notably, the Company doesn’t report how much those revenues were in Q4 or will be moving forward. The rollout of its self-service platform will be a key catalyst once it's released. AppLovin also has high hopes of entering the lucrative CTV segment.

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.

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.

The I/O Fund is actively looking for an entry into this stock with a final, multi-year price target that is multiples higher than where it’s trading today. It’s normal for an investor to feel like they’ve missed out; we think that thought will be a distant memory in a few years’ time. Keep an eye on your trade alerts and watch our Thursday webinar replay where Knox recently covered the plan for adding AppLovin to the portfolio.

Jea Yu, Equity Analyst at the I/O Fund, contributed to this article.

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.

Recommended Reading:

AppLovin Q3: Market Leader in AI-Driven Ad-Tech

Posted on by io-fund

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!

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.

Recommended Reading:

AppLovin Q3: Market Leader in AI-Driven Ad-Tech

Posted on by io-fund

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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AppLovin Corporation: Emerging Ad Tech AI Leader

Posted on by io-fund

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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