What stood out to me from both The Trade Desk and Magnite’s calls was the emphasis placed on Netflix entering the market.
“If I could actually pick up at the end of where Laura's question was on CTV, and you kind of touched on this, the idea that between Netflix, Disney, HBO, Warner coming together, we're going to see a lot of ad-supported content coming into inventory and this next year here.”
“Yes, hey Matt. Great question. And to be played out, but our sense in talking to the big buyers is when there were rumors of the Netflix perhaps coming online this year they purposefully left money out of the up fronts into the spot market to have optionality.” – CEO Of Magnite“Yes, hey Matt. Great question. And to be played out, but our sense in talking to the big buyers is when there were rumors of the Netflix perhaps coming online this year they purposefully left money out of the up fronts into the spot market to have optionality.” – CEO Of Magnite
To me, this means buyers are excited and already planning to allocate to Netflix and didn’t want to tie up their budgets in the upfront season for this reason.
“I also want to talk about Netflix recent moves. I believe they are in a very strong position to be a leader in AVOD and hybrid pricing models, similar to how they led the way for more than a decade in SVOD.” – CEO of The Trade Desk
The Trade Desk’s CEO, Jeff Green, spent a good deal of time talking about Netflix.
There’s risk that Netflix will have a subscriber miss in the near term –Q3 specifically since more time will be spent indoors in Q4 so less risk here. Yet, there is considerably less risk than usual that Netflix will be able to accelerate revenue next year in 2023.
Surprisingly enough, both stocks are down 50% (more or less) YTD and so there is no penalty by moving this position to Netflix. It’s rare to get a juggernaut on sale, and even rarer to have a juggernaut outline a clear path to accelerate revenue over the next 12 months.
We are strong believers in the connected TV trend — and the trend is painfully early right now. Eventually, all traditional broadcast and cable will be phased out and about 1-3 years after this we will have a mature market. Magnite is not a CTV pureplay right now and we prefer to allocate to those that are.
Magnite’s CTV ad revenue growth is not an issue yet other segments weigh on this company, such as DV+ (desktop video) and mobile. The company will see some tailwinds from political ad spend in Q3, but overall, the revenue mix is weighed by underperforming segments.
We prefer to move this over to Netflix soon given the company’s discount in price.
Closing Magnite:
All numbers are stated in ex-TAC, which means revenue minus acquisition costs.
The chances are high that Magnite provided a conservate guide and will have a sizable beat next quarter. Political campaign spend is expected to exceed 2020’s ad spend levels and Magnite will see tailwinds here.
In the current quarter, Magnite reported 23% YoY growth for revenue of $123.3 million, or up 7% on a proforma basis. Out of an abundance of caution, Magnite guided for flat sequential growth from $123 million ex-TAC in the current quarter to $124 million, at the midpoint, for next quarter.
CTV revenue continues to be strong as a result of the SpotX acquisition. The segment was up 52% year-over-year, or 19% on a proforma basis, for revenue of $52.1 million. In the year ago quarter, the company reported revenue of $34 million. Last year’s comp includes two months of the SpotX acquisition.
The company is guiding for similar revenue next quarter of $53 million at the midpoint. This will be up from $43 million in the year ago quarter. You can see the conservatism here as some political spend will show up in September as the guide implies growth of 23%.
Magnite’s bottom line fluctuates on a GAAP basis due to the amortization of intangible assets from acquisitions. This expense totals $72 million this year and will total $104 million next year. Stock based compensation increased from $16 million to $38 million.
GAAP EPS was ($0.19) and adjusted EPS was $0.14. The company has an adjusted EBITDA margin of 34%. The company has operating cash flow of $30 million and the company has stated their free cash flow for 2022 will be $100 million. The company’s net leverage has improved from 6X to 2.9X with cash of $230 million on the balance sheet and debt of $723 million.
Mobile reported modest growth of 13% with revenue of $44 million compared to $38.8 million in the year ago quarter.
The CTV segment is not an issue but the desktop segment continues to weigh on the company. It was flat year-over-year with $27.2 million this quarter compared to $27.4 million in the previous quarter. You could argue they are seeing the same headwinds as many media properties right now. However, the desktop ad ecosystem also has to overcome Google’s plans to remove cookies on the Chrome browser and the risk here is not present in CTV pure plays.
Perhaps anti-trust measures will prevent Google from moving forward, but Apple certainly was allowed to move forward as the real estate owner, and hoping for a favorable anti-trust outcome is not a risk we care to take on. The reason the deprecation of cookies has been pushed out is not for altruistic reasons by any means, it’s so that Google’s Privacy Sandbox can be tested and roll-out as a stronger product.
It’s true this is delayed until 2024 now but given this segment already weighs on Magnite and we have other CTV pure plays down a similar amount this year (50%-ish), we think it’s prudent to take advantage of the discounts now rather than time this later.
We started our position in Google around the market lows in May and we are now starting a position in Netflix so that we can build with defensible land owners. As stated, it’s rare to get juggernauts on sale. Perhaps they don’t provide the AH pops that high growth does, but the downside is limited and we have clear catalysts (potentially massive catalysts) on the horizon.
Netflix’s announcement to partner with Microsoft confirms our understanding of the value of first-party data as Netflix chose its partner based on Microsoft’s ability to protect its data. As AI/ML builds out, data will move from being the oil of the world to being scarce as diamonds. I believe all of the moves you’re seeing from Apple, Google and Netflix’s choice with Microsoft is to prepare for consumer-driven AI dominance and to protect their large and valuable data sets.
Last week, the team of I/O Fund analysts kicked off Q3’s earning season with a member-only webinar to discuss how they will position their portfolio for Q3 2022 and beyond. In this clip from the premium webinar, Beth Kindig examines ad tech stock valuations and answers important questions for investors searching for ad tech growth opportunities. Watch the clip to find out the answer to three important ad valuation questions:
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This article was originally published on Forbes on Apr 28, 2022,10:45pm EDT
If an investor were to believe market price action this week, it would appear Facebook had strong earnings while Alphabet stumbled. Yet, the opposite is true. Primarily, it was strength in retail ads that led to Alphabet reporting healthy growth of 23%. Meanwhile, Meta Platforms (Facebook) reported revenue growth of 9.7% and is guiding for roughly 0% growth from $28.5 billion in Q2 2021 to $29 billion, at the midpoint for Q2 2022. This analysis looks at why Alphabet is able to provide higher revenue guidance despite 80% of its revenue coming from ads while Facebook is guiding for flat growth.
Notably, Q2 is particularly hard because there are three heavy macro headwinds: supply chain issues, Ukraine-Russia situation, and the transition that Apple has forced with changes to attribution and measurement on iOS. When you add the one-time event of Covid, which plummeted ad spend in Q2 2020, only to lead to a surge in ad spend the following year Q2 2021, the hurdle to clear for revenue growth is at a historic high. We believe those ad-tech stocks that can show top line growth right now are providing important clues for when macro headwinds clear.
BACKGROUND:
The ad-tech industry remains in a whirlwind of changes following iOS privacy changes that limit third-party tracking on Apple mobile devices. I am hyper focused on identifying who the winners and losers will be following these changes, as it will determine who will lead ad-tech going forward. This issue is important because it impacts leading FAANG ad-tech companies, such as Facebook (Meta) and Google (Alphabet). Wall Street particularly likes ad-tech’s bottom line, and will aptly reward those stocks that can capture more ad spend.
In the below analysis, I review Google’s Q1 2022 results and focus on its ad platform (I am ignoring Google Cloud for now) and look for hints if Google is being impacted by the recent iOS changes. You’ll find that Google has held up well relative to other app-based advertising platforms, such as Facebook, following the changes to third-party identifiers. This is because Google has a first-party data advantage, which is critical during a time that attribution and measurement is limited by third parties. I explain why in more detail below.
Google’s Q1 Ad Growth Remains In-Line
While the market is still digesting the macro headwinds previously mentioned – supply chain and Ukraine-Russia; the third headwind of attribution and measurement changes is the headwind that investors should pay most attention to as it leads to a material change in story for ad-tech companies. Meanwhile, the other two headwinds will resolve in time.
Q1 earnings are provide valuable data of who is most and least impacted. Two critical data points will be Facebook’s and Google’s Q1 results, as most of their sales come from mobile ads. Google recently reported that sales grew 23% YoY to $68 billion, which were in-line with estimates. Furthermore, Google’s Search business slightly outperformed and grew 24% YoY to $40 billion. This follows the outperformance in Q4 as Search sales grew 36% YoY in Q4 while total Q4 sales grew 32% on a year-over-year basis. It may appear that Alphabet’s search revenue is slowing from 30% in the year-ago quarter, but the deceleration in search revenue is due to the tough comps, and relative to Facebook, is outperforming.
The strength in Search highlights the advantage that having first-party data provides. This is because Search is primarily done on a browser, allowing Google to capture valuable first party data from ownership of Google Chrome, Google Search and also from Android OS. Moreover, Google is releasing new products, such as Topics API, which enables behavioral targeting. This is a direct shot at Meta Platforms, who is known to be quite competitive on behavioral targeting through taxonomies.
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However, while Search remained strong, both YouTube and Google Network sales underperformed during the quarter. For instance, YouTube grew sales just 14% YoY to $7 billion, a steep slowdown from the 25% and 49% YoY growth rates from last quarter in Q4 and Q1 2021, respectively. Google Network sales increased 20% YoY to $8 billion. This also represented a deacceleration from the 26% YoY growth rate in the prior quarter.
In aggregate, total ad sales increased 22% YoY to $55 billion, a deacceleration from the 33% YoY growth rate in the prior quarter. It is notable that despite the headwinds in YouTube and Google Network, Google’s sales vastly outpaced Facebook’s Q1 revenue growth. As shown below, Google’s ad sales grew nearly 3x faster than Facebook’s 7% growth.
I/O Fund
I believe this outperformance was driven by Google’s first-party data advantage. Moreover, YouTube revenue was the biggest laggard during the quarter and YouTube sales grew 14% YoY to $7 billion during the last three-months (fun fact: YouTube is larger than Google Cloud). The slowdown in YouTube may suggest that ads have been impacted by iOS changes, but its important to consider that YouTube grew sales 49% YoY in the year-ago quarter, leading to a tougher comparable base period.
During the Q1 call, Google’s management team explained that the tough comp and “modest” growth from direct response advertising had also impacted the segment, but noted that brand advertising remained an area of strength. The diversification across content types and ability to offer at true omnichannel strategy across mobile, browsers and CTV likely contributed and suggests that brands have shifted ad budgets to YouTube, likely due to its ability to measure ROI at the expense of competing platforms.
Google also reiterated this point during their Q1 Conference Call when CBO Philipp Schindler explained that being able to fully measure what users do after they click on an ad is critical to measuring ROI. He added that “Measurement is also obviously a key component to success [in CTV], and we want to make sure that advertisers can fully measure their YouTube CTV video investments across YouTube and YouTube TV for an accurate view of true incremental reach and frequency and so on”.
CBO Schindler’s comments highlight the importance of measurement, a key aspect of digital advertising that has been challenged following the changes to iOS cookies. If advertisers cannot measure ROI, they tend to limit their ad expenditures, so its critical that ad platforms find solutions to measure ROI in order to sustain growth.
Perhaps the most important comment during the Q1 Conference Call was a statement by management that Google continues to see strength in Retail, reiterating comments made during the Q4 2021 Earnings Call that retail (e-commerce) continues to be strong.
This brief statement is very important, as it adds support that Google will not be as impacted by the iOS changes. Given the signal loss from iOS changes, e-commerce has been one of the hardest hit verticals. Google’s strength here is likely due to its first-party data advantage.
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Here is what Facebook CFO David Wehner said about Google’s strength in the retail vertical during Facebook’s Q4 2021 Conference Call:
“e-commerce was an area where we saw a meaningful slowdown in growth in Q4. … But on e-commerce, it's quite noticeable — notable that Google called out, seeing strength in that very same vertical. And so given that we know that e-commerce is one of the most impacted verticals from iOS restrictions, it makes sense that those restrictions are probably part of the explanation for the difference between what they were seeing and what we were seeing.”And so given that we know that e-commerce is one of the most impacted verticals from iOS restrictions, it makes sense that those restrictions are probably part of the explanation for the difference between what they were seeing and what we were seeing.”
Google’s statement that it continues to see strength in retail suggests that it is not as impacted from the iOS changes relative to app-based peers such as Facebook. Importantly, Search is often based on a web browser (Google Chrome), allowing Google to capture first party data and limiting the signal loss from the removal of cookies on mobile based apps.
Our thesis is that in this new cookie-less world, owners of first-party data will outperform going forward. We expect that Google will remain strong given its ownership of first-party data on both its Search platform and also its YouTube platform. However, Facebook will likely continue to struggle here due to its reliance on third-party data and not owning “the real estate,” or essentially the device and/or operating system while needing to collect data from this device in order to support its high ARPU. We wrote about this for Forbes recently: Facebook Stock: A Permanent Change to the Business Model
Two weeks ago, I held a webinar that discussed Facebook’s business model change and why I believe there will be meaningful erosion to ARPU. This is a thesis we first published four years ago in 2018 when we warned this FAANG faced considerable headwinds. In the webinar below, we discuss why we believe Meta Platforms (Facebook) will continue to underperform and who the winners will be from this shift, including first-party data owners, supply side platforms, and contextual advertising publishers and platforms.
Conclusion
Notably, Q2 is particularly hard because there are three heavy macro headwinds: supply chain issues, Ukraine-Russia situation, and the transition that Apple has forced with changes to attribution and measurement on iOS. When you add that the one-time event of Covid, which plummeted ad spend in Q2 2020, and later led to a surge in ad spend the following year Q2 2021, the hurdle to clear for revenue growth is at a historic high. We believe those ad-tech stocks that can show top line growth right now are providing important clues for when macro headwinds clear.
Magnite offers an opportunity to have exposure to a higher mix of CTV ads from an independent SSP than what is currently on the market. What is most interesting about Magnite as of late is the company’s programmatic strategy for Live TV and also programmatic SSP products for bids on CTV ad inventory. We discuss this more below.
Similar to Roku, The Trade Desk, PubMatic and other ad-tech companies, Magnite faces the double whammy of enduring eight quarters of high Covid comps at a time when macro headwinds are affecting the ad industry. Magnite has even more whammies, which is being a small cap during a historic small cap selloff, and having financials that are tough to analyze due to a string of acquisitions/mergers.
Bradley wrote about the financials in the Q2 earnings write-up: “While the SpotX acquisition positions the company to succeed in the CTV ad market, it also unfortunately complicates MGNI’s accounting. For example, SpotX recognizes sales on a gross basis, while MGNI had previously recognized most of its sales on a net basis (net of TAC). As a result, the company has reported an adjusted pro-forma growth rate to help investors better gauge MGNI true topline growth rate.
Moreover, since SpotX recognizes sales on a gross basis, this can artificially dampen MGNI’s reported gross margins, as the topline is inflated while gross profit remains static. As well, accounts receivables are accrued on a gross basis, which makes MGNI receivables balance appear severely outsized relative to sales. A ballooning receivables balance can signal that a company is pulling forward sales, which is a negative trend and something investors tend to avoid. We suspect that MGNI’s complex accounting is having a temporary negative impact on MGNI share price, due to a subdued gross margin and an inflated receivables balance. However, these concerns will likely dissipate as MGNI’s results start to annualize and the Street gains a better understanding of MGNI’s future growth prospects. At the moment, the Street is dependent on management’s adjusted, pro-forma metrics.”
To illustrate that SpotX was a merger and not really an acquisition, consider that Magnite paid $1.2 billion for the company meanwhile Magnite reported $221 million in revenue in 2020, around the time the acquisition was announced. This acquisition combined two CTV players to create scale and efficiencies. Magnite has stated the company expects to realize $35 million in annualized cost savings from its mergers and acquisitions: "We expect some of those increases to be offset by cost saving activities that began in the second quarter of 2021 and continue to be in process. We are targeting in excess of $35 million in run-rate operating cost synergies over a two year period. As of December 31, 2021, we have achieved more than half of our cost synergy target on a run-rate basis.” However, Magnite also reported $20 million in interest and so the high debt levels are technically a risk.
We see softer growth in Q4 compared to Q3 but it would be tough to say this is reflective of the company. The next few guides on Q2 and Q3 are more important for Magnite than what we’ve seen during the winter months. This is because ad spend is expected to rebound in H2 and by Q3 the company will be fully past the one-year mark for the SpotX acquisition (which was almost more of a merger), which will help normalize the year-over-year comparisons.
On the earnings call, management discussed a product that can help differentiate Magnite, which is Live Stream Acceleration (LSA). The product was announced in February and has been tested with Sling by serving programmatic ads for five weeks to help increase fill rates. Live sports are expected to account for 22% of ad spend and this product helps publishers deal with large spikes in traffic, sporadic time-outs or play reviews by referees by lowering the throttle and increasing fill. LSA helped Sling see a 47% lift in ad conversions during the trial period by filling ad slots that would have normally timed out.
The company also launched BidLink to help publishers improve ad rates and yield by creating a real-time auction. The programmatic features of link to 22 SSPs to increase bids regardless of what ad server publishers use. This is key because Magnite is going to full leverage the Telaria and SpotX acquisitions to potentially help drive publishers to its platform. By using CTV as the anchor, Magnite can expand its footprint and leverage its positioning as the largest independent SSP by being full-featured and competitive in its product R&D. We’ve seen a slew of announcements on Magnite being chosen as a preferred SSP and/or omnichannel partnerships, including from Fubo/Molotov, Samsung Ads, Plex, CH Media and GroupM.
That is a lot of product and partnership movement for a small cap with a seasoned management team although currently the forward revenue guide isn’t reflecting this with “more than 20% revenue growth this year” (see below). I think it’s clear to see Magnite is not a momentum play for us in terms of top line growth, rather it’s a strong choice for those who think CTV ads are going to rip over the next few years (I am in this group).
We also covered private marketplaces in the past and why CTV inventory is unique in terms of how many SSPs a publisher will work with. These newer products help differentiate the private marketplace deals and also any upfront contracts that Magnite might see with more tools for Live TV publishers. Essentially, private marketplace inventory is more premium and this helps edge a (marginal) defense for Magnite against other independent ad-tech companies. Magnite must still compete against heavyweights like FreeWheel and Roku, especially for upfront contracts, yet medium-sized publishers who see working with these two as cannibalistic will likely prefer Magnite.
On the call, the company discussed The Trade Desk’s OpenPath product which is attempting to pull more direct publishers to the DSP. The announcement came with a list of media companies that plan to utilize OpenPath, such as The New York Times, Conde Nast, etcetera. This does not prevent those media companies from also working with a SSP to procure higher bids and so TTD will need to be competitive with SSPs in order for this to succeed. Magnite argues in the earnings call it may not drive higher ad rates for publishers who will prefer to stay with a SSP because the tools are more optimized for publishers.
“In the end, most publishers find it insufficient to rely solely on a direct connection versus the breadth and depth of what a full-featured SSP like Magnite offers. I'm not just talking about capabilities like yield management, inventory curation, ad quality tools, billing and reconciliation or access to seasoned monetization experts, though, all of that is critical. Magnite also facilitates demand for publishers across all formats, in many cases, directly from brands and agencies.”
The company is stating it may be more advantageous in the long run if advertisers to go direct to SSPs: “For select publishers that want a direct connection to buyers, the approach can be additive to the unified auction, potentially lifting of publishers revenue. Demand Manager, our header bidding software based on prebid, makes it easy for publishers to activate direct connections to buyers such as the Trade Desk.”
The management also stated The Trade Desk moving away from Google’s Open Bid was a slight tailwind for them: “But I'm also going to move outside that action with a direct connection and compete against those auctions, sometimes compete against ourselves. And a publisher's way of thinking is that could just be increased bid density and it could lift yield. And so therefore, the only reason why I wouldn't want to do it is if Trade Desk came in and said, "I don't want to participate in a unified auction. I want to be put as a tag in the server, and I want to be first look on everything and then everyone else gets to look at everything." That's the world of nonheader-bidding that used to exist in the SSP world.
And so publishers have spoken. They want it as part of a unified process. Interestingly enough, a lot of publishers, as you know, through our Demand Manager product don't have the wherewithal to even manage a unified auction in prebid. And so in — weird way economically Trade Desk moving outside of moving as another source of demand in the head helps us economically from Demand Manager, because, as you know, we get paid on every successful auction, whether it's a Magnite auction or not. And so if it's more demand inside the header and it's going through Demand Manager, it actually — it works out well for us.And so in — weird way economically Trade Desk moving outside of moving as another source of demand in the head helps us economically from Demand Manager, because, as you know, we get paid on every successful auction, whether it's a Magnite auction or not. And so if it's more demand inside the header and it's going through Demand Manager, it actually — it works out well for us.
Typically, if publishers go direct to the demand side successfully, it’s because the DSP has some kind of rich first-party data that the publishers can gain from (Facebook/Audience Network, Google/AdMob). I’m not sure The Trade Desk has enough leverage in terms of data for this strategy to successfully recruit publishers in terms of offering an advantage on higher ad rates for publishers, but let’s see/monitor this. Instead, it could be a defensive move from The Trade Desk in terms of third-party data becoming weaker. I suspect Google is not going to work with Universal Ad ID 2.0 as there is little incentive to invite a new ID after getting rid of cookies. My educated guess is Google will want to protect their properties. I’ll try to write more about Google’s changes on Android as it unfolds in a separate analysis.
You’ve probably heard the term walled garden. Well, we are now going to have fortified stone walled gardens in terms of Google protecting their properties and data and not allowing cookies/IDs. Apple is doing the same. This is under the guise of privacy but given that Google sells fire alarms that spy on people in their personal residence, I doubt ethics or privacy is driving the decision.
Regardless of what Big Tech’s motivation is, I believe there is alpha in some of our ad-tech stocks because this shift is so little understood. The reason Snap and Facebook’s earnings were important for us is that it provided a nod that we are on the right track – as the publisher (Snap) is guiding strong while the third-party data exchange (Facebook) is expecting top line erosion in ads. Given the opaque backdrop on macro/supply chain, this at least provided a glimpse of the longer-term picture, which should become clearer when macro/supply chain clears up. I think I’ve been pretty clear that my money is on first-party data and on the publisher/supply side. I do want to emphasize that I don’t expect the first-party data thesis to materialize overnight, the shift will be gradual. However, despite the shift being gradual, I believe it will be permanent and that’s most important to us investors in terms of a material change to the advertising industry.
Review of Q4 Earnings Report
By Bradley Cipriano
Magnite reported revenue of $142.1 million for proforma growth of 10% and revenue ex-TAC growth of 76%. CTV revenue growth continues to be a strength, up 23% proforma and up 252% on an ex-Tac basis to $54 million.
The adjusted EBITDA was $68 million during the quarter, or 48% of ex-TAC revenues, which was an improvement from the 37% EBITDA margin in the year-ago quarter, driven by the SpotX acquisition and organic growth. This led to EPS of $0.26 in Q4 and operating cash flow of $60 million.
In 2021, Magnite reported total revenue of $416 million. CTV revenue grew 52% on a proforma basis and accounted for roughly 40% of revenue. Magnite stated they reach 80 million households every month (similar to Roku) and they estimate this to be 20% market share. The company’s mobile revenue was low at 6% growth and desktop was very thin at 1% growth.
The company is guiding for ex-TAC revenue of “well above $500 million” for 2022, or at least 20% growth. The first quarter ex-TAC revenue is expected to be $107.5 million, at the midpoint. The company expects CTV revenue growth to be similar to Q4 although a lower amount at $41 million due to the seasonality of Q1. Management stated that Q1 adjusted EBITDA margin will be in the low 20s on a percentage basis primarily due to the timing of annual raises, which were pulled forward from April to January, general increase in wages to improve retention and increased costs related to returning to the office. As a result, the path to 35% to 40% adjusted EBITDA margins has been extended, but management nonetheless reiterated the guide. CFO David Day stated during the Q4 call that “we don't see any changes in the long-term trajectory to our 35% to 40% [adjusted EBITDA] margin targets”.
The company’s current mix is 38% CTV / 36% mobile / 26% desktop. This is up from a mix of 19% CTV exposure in Q4 2020, highlighting the rapid repositioning Magnite has made in one year.
Adjusted EBITDA margin for the year was 35.7% with adjusted EPS of $0.55. The company has $230 million in cash and $720 million in long-term debt, or about $500 million in net debt. With $148 million in annual adjusted EBITDA, Magnite’s net leverage ratio is 3.3x as of Q4, down from 4.1x as of Q2 2021 and management explained on the Q4 call that they aim to reduce their leverage to 2x over time. The company’s strong cash flows will help reduce debt, and Magnite guided that its free cash flow (defined by the company as Adj. EBITDA less capex less intertest expense) will be over $100 million during the year, and will grow faster than adjusted EBITDA over time. The company is currently in compliance with its debt covenants as well.
Magnite offers an opportunity to have exposure to a higher mix of CTV ads from an independent SSP than what is currently on the market. What is most interesting about Magnite as of late is the company’s programmatic strategy for Live TV and also programmatic SSP products for bids on CTV ad inventory. We discuss this more below.
Similar to Roku, The Trade Desk, PubMatic and other ad-tech companies, Magnite faces the double whammy of enduring eight quarters of high Covid comps at a time when macro headwinds are affecting the ad industry. Magnite has even more whammies, which is being a small cap during a historic small cap selloff, and having financials that are tough to analyze due to a string of acquisitions/mergers.
Bradley wrote about the financials in the Q2 earnings write-up: “While the SpotX acquisition positions the company to succeed in the CTV ad market, it also unfortunately complicates MGNI’s accounting. For example, SpotX recognizes sales on a gross basis, while MGNI had previously recognized most of its sales on a net basis (net of TAC). As a result, the company has reported an adjusted pro-forma growth rate to help investors better gauge MGNI true topline growth rate.
Moreover, since SpotX recognizes sales on a gross basis, this can artificially dampen MGNI’s reported gross margins, as the topline is inflated while gross profit remains static. As well, accounts receivables are accrued on a gross basis, which makes MGNI receivables balance appear severely outsized relative to sales. A ballooning receivables balance can signal that a company is pulling forward sales, which is a negative trend and something investors tend to avoid. We suspect that MGNI’s complex accounting is having a temporary negative impact on MGNI share price, due to a subdued gross margin and an inflated receivables balance. However, these concerns will likely dissipate as MGNI’s results start to annualize and the Street gains a better understanding of MGNI’s future growth prospects. At the moment, the Street is dependent on management’s adjusted, pro-forma metrics.”
To illustrate that SpotX was a merger and not really an acquisition, consider that Magnite paid $1.2 billion for the company meanwhile Magnite reported $221 million in revenue in 2020, around the time the acquisition was announced. This acquisition combined two CTV players to create scale and efficiencies. Magnite has stated the company expects to realize $35 million in annualized cost savings from its mergers and acquisitions: "We expect some of those increases to be offset by cost saving activities that began in the second quarter of 2021 and continue to be in process. We are targeting in excess of $35 million in run-rate operating cost synergies over a two year period. As of December 31, 2021, we have achieved more than half of our cost synergy target on a run-rate basis.” However, Magnite also reported $20 million in interest and so the high debt levels are technically a risk.
We see softer growth in Q4 compared to Q3 but it would be tough to say this is reflective of the company. The next few guides on Q2 and Q3 are more important for Magnite than what we’ve seen during the winter months. This is because ad spend is expected to rebound in H2 and by Q3 the company will be fully past the one-year mark for the SpotX acquisition (which was almost more of a merger), which will help normalize the year-over-year comparisons.
On the earnings call, management discussed a product that can help differentiate Magnite, which is Live Stream Acceleration (LSA). The product was announced in February and has been tested with Sling by serving programmatic ads for five weeks to help increase fill rates. Live sports are expected to account for 22% of ad spend and this product helps publishers deal with large spikes in traffic, sporadic time-outs or play reviews by referees by lowering the throttle and increasing fill. LSA helped Sling see a 47% lift in ad conversions during the trial period by filling ad slots that would have normally timed out.
The company also launched BidLink to help publishers improve ad rates and yield by creating a real-time auction. The programmatic features of link to 22 SSPs to increase bids regardless of what ad server publishers use. This is key because Magnite is going to full leverage the Telaria and SpotX acquisitions to potentially help drive publishers to its platform. By using CTV as the anchor, Magnite can expand its footprint and leverage its positioning as the largest independent SSP by being full-featured and competitive in its product R&D. We’ve seen a slew of announcements on Magnite being chosen as a preferred SSP and/or omnichannel partnerships, including from Fubo/Molotov, Samsung Ads, Plex, CH Media and GroupM.
That is a lot of product and partnership movement for a small cap with a seasoned management team although currently the forward revenue guide isn’t reflecting this with “more than 20% revenue growth this year” (see below). I think it’s clear to see Magnite is not a momentum play for us in terms of top line growth, rather it’s a strong choice for those who think CTV ads are going to rip over the next few years (I am in this group).
We also covered private marketplaces in the past and why CTV inventory is unique in terms of how many SSPs a publisher will work with. These newer products help differentiate the private marketplace deals and also any upfront contracts that Magnite might see with more tools for Live TV publishers. Essentially, private marketplace inventory is more premium and this helps edge a (marginal) defense for Magnite against other independent ad-tech companies. Magnite must still compete against heavyweights like FreeWheel and Roku, especially for upfront contracts, yet medium-sized publishers who see working with these two as cannibalistic will likely prefer Magnite.
On the call, the company discussed The Trade Desk’s OpenPath product which is attempting to pull more direct publishers to the DSP. The announcement came with a list of media companies that plan to utilize OpenPath, such as The New York Times, Conde Nast, etcetera. This does not prevent those media companies from also working with a SSP to procure higher bids and so TTD will need to be competitive with SSPs in order for this to succeed. Magnite argues in the earnings call it may not drive higher ad rates for publishers who will prefer to stay with a SSP because the tools are more optimized for publishers.
“In the end, most publishers find it insufficient to rely solely on a direct connection versus the breadth and depth of what a full-featured SSP like Magnite offers. I'm not just talking about capabilities like yield management, inventory curation, ad quality tools, billing and reconciliation or access to seasoned monetization experts, though, all of that is critical. Magnite also facilitates demand for publishers across all formats, in many cases, directly from brands and agencies.”
The company is stating it may be more advantageous in the long run if advertisers to go direct to SSPs: “For select publishers that want a direct connection to buyers, the approach can be additive to the unified auction, potentially lifting of publishers revenue. Demand Manager, our header bidding software based on prebid, makes it easy for publishers to activate direct connections to buyers such as the Trade Desk.”
The management also stated The Trade Desk moving away from Google’s Open Bid was a slight tailwind for them: “But I'm also going to move outside that action with a direct connection and compete against those auctions, sometimes compete against ourselves. And a publisher's way of thinking is that could just be increased bid density and it could lift yield. And so therefore, the only reason why I wouldn't want to do it is if Trade Desk came in and said, "I don't want to participate in a unified auction. I want to be put as a tag in the server, and I want to be first look on everything and then everyone else gets to look at everything." That's the world of nonheader-bidding that used to exist in the SSP world.
And so publishers have spoken. They want it as part of a unified process. Interestingly enough, a lot of publishers, as you know, through our Demand Manager product don't have the wherewithal to even manage a unified auction in prebid. And so in — weird way economically Trade Desk moving outside of moving as another source of demand in the head helps us economically from Demand Manager, because, as you know, we get paid on every successful auction, whether it's a Magnite auction or not. And so if it's more demand inside the header and it's going through Demand Manager, it actually — it works out well for us.And so in — weird way economically Trade Desk moving outside of moving as another source of demand in the head helps us economically from Demand Manager, because, as you know, we get paid on every successful auction, whether it's a Magnite auction or not. And so if it's more demand inside the header and it's going through Demand Manager, it actually — it works out well for us.
Typically, if publishers go direct to the demand side successfully, it’s because the DSP has some kind of rich first-party data that the publishers can gain from (Facebook/Audience Network, Google/AdMob). I’m not sure The Trade Desk has enough leverage in terms of data for this strategy to successfully recruit publishers in terms of offering an advantage on higher ad rates for publishers, but let’s see/monitor this. Instead, it could be a defensive move from The Trade Desk in terms of third-party data becoming weaker. I suspect Google is not going to work with Universal Ad ID 2.0 as there is little incentive to invite a new ID after getting rid of cookies. My educated guess is Google will want to protect their properties. I’ll try to write more about Google’s changes on Android as it unfolds in a separate analysis.
You’ve probably heard the term walled garden. Well, we are now going to have fortified stone walled gardens in terms of Google protecting their properties and data and not allowing cookies/IDs. Apple is doing the same. This is under the guise of privacy but given that Google sells fire alarms that spy on people in their personal residence, I doubt ethics or privacy is driving the decision.
Regardless of what Big Tech’s motivation is, I believe there is alpha in some of our ad-tech stocks because this shift is so little understood. The reason Snap and Facebook’s earnings were important for us is that it provided a nod that we are on the right track – as the publisher (Snap) is guiding strong while the third-party data exchange (Facebook) is expecting top line erosion in ads. Given the opaque backdrop on macro/supply chain, this at least provided a glimpse of the longer-term picture, which should become clearer when macro/supply chain clears up. I think I’ve been pretty clear that my money is on first-party data and on the publisher/supply side. I do want to emphasize that I don’t expect the first-party data thesis to materialize overnight, the shift will be gradual. However, despite the shift being gradual, I believe it will be permanent and that’s most important to us investors in terms of a material change to the advertising industry.
Review of Q4 Earnings Report
By Bradley Cipriano
Magnite reported revenue of $142.1 million for proforma growth of 10% and revenue ex-TAC growth of 76%. CTV revenue growth continues to be a strength, up 23% proforma and up 252% on an ex-Tac basis to $54 million.
The adjusted EBITDA was $68 million during the quarter, or 48% of ex-TAC revenues, which was an improvement from the 37% EBITDA margin in the year-ago quarter, driven by the SpotX acquisition and organic growth. This led to EPS of $0.26 in Q4 and operating cash flow of $60 million.
In 2021, Magnite reported total revenue of $416 million. CTV revenue grew 52% on a proforma basis and accounted for roughly 40% of revenue. Magnite stated they reach 80 million households every month (similar to Roku) and they estimate this to be 20% market share. The company’s mobile revenue was low at 6% growth and desktop was very thin at 1% growth.
The company is guiding for ex-TAC revenue of “well above $500 million” for 2022, or at least 20% growth. The first quarter ex-TAC revenue is expected to be $107.5 million, at the midpoint. The company expects CTV revenue growth to be similar to Q4 although a lower amount at $41 million due to the seasonality of Q1. Management stated that Q1 adjusted EBITDA margin will be in the low 20s on a percentage basis primarily due to the timing of annual raises, which were pulled forward from April to January, general increase in wages to improve retention and increased costs related to returning to the office. As a result, the path to 35% to 40% adjusted EBITDA margins has been extended, but management nonetheless reiterated the guide. CFO David Day stated during the Q4 call that “we don't see any changes in the long-term trajectory to our 35% to 40% [adjusted EBITDA] margin targets”.
The company’s current mix is 38% CTV / 36% mobile / 26% desktop. This is up from a mix of 19% CTV exposure in Q4 2020, highlighting the rapid repositioning Magnite has made in one year.
Adjusted EBITDA margin for the year was 35.7% with adjusted EPS of $0.55. The company has $230 million in cash and $720 million in long-term debt, or about $500 million in net debt. With $148 million in annual adjusted EBITDA, Magnite’s net leverage ratio is 3.3x as of Q4, down from 4.1x as of Q2 2021 and management explained on the Q4 call that they aim to reduce their leverage to 2x over time. The company’s strong cash flows will help reduce debt, and Magnite guided that its free cash flow (defined by the company as Adj. EBITDA less capex less intertest expense) will be over $100 million during the year, and will grow faster than adjusted EBITDA over time. The company is currently in compliance with its debt covenants as well.
Google parent Alphabet’s results have further renewed optimism in the stock market as the company beat analysts’ revenue estimates by 4.9% and EPS by 13%. It was led by the growth in advertising and cloud revenues. Advertising revenue grew by 33% to $61.24 billion. The company also announced the 20-for-1 stock split.
On the other hand, Facebook’s results disappointed as it missed analysts' EPS estimates by 4% and only managed to beat revenue estimates by 0.7%. The revenue outlook for the next quarter also disappointed the Street since it only expects revenue to grow in the range of 3-11% YoY. Revenue in Q4 grew by 20% to $33.67 billion. We have stayed away from the stock due to the various privacy issues and failed efforts to enter new markets like stable coins and dating. Not to mention the Cambridge Analytical data scandal.
Snap Inc. reported on February 3rd and results came in relatively stronger than Meta’s. Snap guided for sales to grow 36% YoY next quarter, well above Meta’s guide for 7% YoY growth at the mid-point. The large disparity between Snap and Meta’s forward guide highlights that Apple’s changes to iOS will have varying degrees of impacts on companies in the ad-tech space. The stock is up 59% after hours following the positive report while Facebook is down 28% following its report.
In this earnings preview, we cover Digital Turbine, Twitter, HubSpot, Trade Desk, Roku, Magnite, and PubMatic. To understand valuations across the Ad-Tech companies and how the sector is positioned moving into earnings, please reference our analysis, “I/O Fund’s Ad-Tech Q4 2021 Earnings Overview.”
The company’s revenue grew 338% YoY to $310.2 million. However, the company’s results include AdColony and Fyber results which were acquired earlier this year. For better comparison, the management provides pro forma revenue growth i.e. 63% YoY. The analyst’s consensus estimates suggest revenue to grow 299% to $353.21 million in the next quarter.
The management believes that the company’s current Total Addressable Market has significantly increased from about $96 billion to about $369 billion due to the various acquisitions.
Macquarie analyst Tim Nollen has an outperform rating and a price target of $80. He is bullish on the company due to “Industry and macro tailwinds (secular growth in mobile gaming and digital ads, alongside lower app store fees); an expansion into brand advertising (a $400 billion-plus total addressable market); upside to current estimates; and the attractive valuation.”
Roth Capital Partners analyst Darren Aftahi has a price target of $90. He is positive on the +25% revenue growth, the SingleTap feature, and also on the company’s various partnerships. “Therefore, not only can [Digital Turbine] expand its wallet share on existing devices, it can capture additional upside and long-tail revenues on new devices as well, especially with market expansion outside the U.S. given various partnerships with Samsung, Telefonica and others.”
Please note that the I/O Fund may or may not agree with the above financial analysts, yet we objectively report what the Street is saying. You may view our previous analysis of the company below:
The company’s revenue grew 37% in Q3 and the consensus forecast suggests revenue to grow 22% to $1.57 billion in the next quarter. It will be the first earnings call for the new CEO, Parag Agrawal. In the Barclays Tech Conference, he mentioned his priorities include smooth transition to all the stakeholders and improving the execution to deliver great products and results.
Truist analyst Youssef Squali has a buy rating and a $50 price target. He believes, “The company's Q4 revenue growth should decelerate sequentially to 22% from 37% in Q3, reflecting tough Y/Y comps, and normalization from peak engagement on the platform due to COVID.” However, he still expects over 20% growth, led by healthy ad budgets, new monetization tools, and mDAU growth.
Mizuho analyst James Lee lowered the company’s price target to $56 from $70. He has a neutral rating on the stock. In his view, “While the management changes are necessary to enable Twitter to accelerate the development, introduction, and update of its products, it could take time for the new strategy to take shape for users and revenues to reach the company's long term targets.”
HubSpot’s Q3 revenue grew 49% to $339.2 million. The company’s total number of customers increased 34% to 128,144. The consensus analysts’ estimates suggest revenue to grow 42% in the next quarter. The company’s revenue growth has been good since it grew at a compound annual growth rate of 41% from its IPO in October 2014 till Q3 2021.
Mizuho analyst Siti Panigrahi has lowered the company’s price target to $500 from $790 and has a buy rating on the stock. In his view, “Software-as-a-service momentum has stalled thus far in 2022 amid concerns over rising interest rates.” However, the analyst does not see any deterioration of fundamentals despite the market sell-off. On the other hand, Barclays has also lowered the price target to $550 from $800.
Goldman Sachs analyst Gabriel Borges has a buy rating and a $953 price target. The analyst notes that the company responded positively during the early days of the Covid-19 pandemic. He points out that the company lowered the starter package price and introduced a freemium product, which led to the increase of the customers. Over a period of time, he sees a potential for its customers to move to a higher-priced plan.
The Trade Desk Inc – Tentative Earnings Date is February 18th
The company's Q3 revenue grew 39% YoY to $301.1 million, excluding the political spend related to the previous year's U.S. elections; the growth was about 47%. The consensus analysts' estimates suggest revenue to grow 22% to $389.82 million. The management expects Q4 revenue to be about $388 million. It did not give specific guidance and mentioned about the uncertainty to the advertising industry due to rising Covid-19 cases. In the earnings call, founder and CEO Jeff Green mentioned that the IOS changes did not have any material impact on the company's business.
Jefferies has upgraded the stock to a buy rating and has a price target of $105. In his view, "Broadening adoption of connected TV viewership is driving more dollars toward programmatic advertising, from linear TV; the Solimar product launch is the biggest since Next Wave, which drove an acceleration in rev growth following its mid-2018 launch; and TTD is in a relatively better position to weather the privacy changes from Apple's iOS 14, compared to Walled Garden names like FB and SNAP."
On the other hand, Stifel analyst Mark Kelley has resumed coverage on the stock with a hold rating and a price target of $68. He says that the feedback he heard about the stock is positive. He also believes that Connected TV advertising still has room to improve. However, he sees the company's shares are "stretched at current levels."
Roku Inc – Tentative Earnings Date is February 18th
The company’s Q3 revenue grew 51% to $680 million and the analysts' consensus estimate suggests revenue to grow 38% to $897.65 million in the next quarter. The management expects revenue in the range of $885 million to $900 million and adjusted EBITDA of $65 million to $75 million. The company’s active accounts at the end of Q3 were 56.4 million, a net addition of 1.3 million in Q3.
According to the NPD's Weekly Retail Tracking Service, the company has been the top-selling smart TV operating system for the second consecutive year in the U.S. Also, according to the study conducted by Hypothesis Group, Roku is Canada's number 1 streaming platform. On other recent news, Fox News International announced that it is expanding distribution on Roku, which should supplement Roku’s international growth.
Deutsche Bank analyst Jeffrey Rand has lowered the company’s price target to $300 from $400 and has kept the buy rating on the stock. He believes that the company is well-positioned in the rapidly growing connected TV market and the recent sell-off is overdone. Q4 earnings could be a positive catalyst for the stock. His checks indicate that the advertising market remained strong in Q4 despite some initial concerns about brands reducing ad spending due to supply chain issues.
The company completed the acquisitions of SpotX and SpringServe this year. Revenue excluding traffic acquisition cost (TAC) was $114.1 million, up 89% and up 26% on a pro forma basis (SpotX and SpringServe included in Q3 20 for comparisons). The consensus analysts’ estimates suggest revenue ex-TAC to grow 71% to $139.85 million. Management expects revenue ex-TAC in the range of $138 million to $142 million.
Truist analyst Matthew Thornton has a price target of $23 and a Buy rating. The analyst believes that the setup could be interesting into the second half of the year on easing supply chain issues and the stock trading 13-times and 11-times expected FY22 and FY23 adjusted EBITDA. He further notes that the Q4 consensus expectations are reasonable but a bit cautious on Q1.
Needham analyst Laura Martin has a buy rating on the stock but has lowered the price target from $70 to $25. The analyst highlights broader short-term concerns like tougher comps, supply chain concerns, and omicron variant slowing digital ad growth for companies under her Streaming and AdTech coverage that drove multiple compression last year and in 2022-to-date.
PubMatic’s revenue grew by 54% in Q3 and is expected to grow 34% in the next quarter to $75.55 million. The company’s revenue grew at over 50% in the previous four quarters. It also has an excellent net-dollar retention rate (NRR) of 157% for the trailing twelve months ended September 2021.
In the words of the company’s CEO, “We use a land and expand approach, coupled with a usage-based revenue model. When we deliver incremental value to our customers, we participate in their upside which further accelerates our profitable business model and enables us to invest for future growth. This flywheel positions us well for sustained and profitable growth and market share gains.”
The management expects revenue in the range of $74 million to $76 million, representing a growth of about 34%. It had raised the full-year 2021 guidance from the range of $205 million-$209 million to the range of $225 million-$227 million, representing a growth of about 52%. It also expects the full-year 2022 revenue to be at least $281 million.
Jefferies has been positive about the company as they believe that the recent iOS changes will not have much impact on the company. They also point out that the company has been trading below its historical averages.
The I/O Fund is a team of analysts who share their research publicly as they build a portfolio of 20 stocks. Our team has record results for a retail Fund and we also have four-digit gains on some of our free newsletter coverage. You can learn more about our premium service by clicking here or sign up for our free newsletter here.by clicking here or sign up for our free newsletter here.
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Ad-tech is a cash efficient industry with a healthy rebound when economic activity recovers. Ad-tech earnings will be critical for the broader tech landscape, and major players such as Google, Facebook and Snap Inc. have reported this week. Google was the first to report, and sales grew 32% during the quarter, which “reflected broad-based strength in advertiser spend and strong consumer online activity” according to Google CFO Ruth Porat. Google’s strong results suggest that ad-tech could show resilience with individual companies despite sector wide headwinds.
However, Meta Platforms (Facebook) reported notably weaker results than Google, driven by changes in Apple’s iOS related to mobile tracking and privacy. The company guided for weak growth in the first half of 2022 and expects sales to rise just 3% to 10% YoY in Q1 2022. Furthermore, management estimated that changes in iOS will be a $10 billion headwind during the year. While changes to iOS will impact most mobile advertising companies, we suspect that Facebook will be most impacted due to its heavy reliance on mobile tracking via its Audience Network. Furthermore, some companies may actually experience a net benefit from the changes.
Snap Inc. reported on February 3rd and results came in relatively stronger than Meta’s. Snap guided for sales to grow 36% YoY next quarter, well above Meta’s guide for 7% YoY growth at the mid-point. The large disparity between Snap and Meta’s forward guide highlights that Apple’s changes to iOS will have varying degrees of impacts on companies in the ad-tech space.
In the analysis that follows, I give a brief overview of the ad-tech industry and discuss key metrics that investors should be aware of heading into Q4 earnings.
Ad-tech: Top 10 EV/FWD Revenue Multiples
Below we ranked ad-tech stocks based on their EV/NTM sales multiples. The Trade Desk (TTD) has the highest multiple in the ad-tech sector, as the ad platform reported that sales increased 39% YoY in Q3 coupled with a robust 41% adjusted EBITDA margin. The Trade Desk also has strong partnerships, and Founder-CEO Jeff Green explained on the company’s Q3 call that “the world's leading advertisers are standardizing on our platform”, a trend that is likely contributing to its premium multiple.
Unity also sports a premium multiple, driven by the company’s dominate position in mobile gaming ads. Over 70% of the world’s mobile games are built in Unity, and the company also has exposure to other growth markets such as 3D modeling and augmented/virtual reality. Unity’s software tools are also useful for many applications beyond gaming, such as Industrial Applications and A.I. and machine learning.
It is noteworthy that ad-tech valuations have compressed in 2022 following the heightened volatility in financial markets. Nonetheless, ad-tech is a very cash efficient industry, evident by the robust free cashflow (FCF) margins shown below. We expect that ad-tech will see a rebound before or around H2 2022 as supply shortages are expected to ease, which can lead to an increased demand for advertising.
Ad-tech: Top 10 Three-month Forward YoY Growth Rates
Below is a chart of ad-tech stocks that are expected to grow sales the fastest in the upcoming quarter. Looking forward, Digital Turbine (APPS) is expected to grow the fastest, mostly due to its recent acquisition of AdColony and Fyber. Magnite’s (MGNI) growth rate is also skewed due to its acquisition of SpotX.
FuboTV (FUBO) is expected to grow sales YoY by triple digits in Q4, driven by a ramp in subscriber growth. The company had preannounced Q4 revenue and subscriber growth, which came in above its initial guide. Specifically, subscribers increased 100% YoY to 1.1 million and Q4 sales are expected to rise by 107% YoY to $217 million at the mid-point. The preannouncement of results was ahead of a Needham Conference, where FUBO CEO David Gandler highlighted that “[in 2022] we're going to be heavily focused on ad-tech, because we want to unlock a lot of that value that's going to drive margins”.
As mentioned above, ad-tech is a highly cash efficient industry and FuboTv’s rapid expansion of ad sales will help drive margin improvements at the firm.
Top 10 Weekly Share Price Movements
Below is a table of the weekly change in share price for our universe of ad-tech stocks (week ended 01/28). Markets have been volatile recently, however there are signs that ad-tech is beginning to bubble under the surface.
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For example, ironSource (IS) staged a double-digit rally last week as its share increased 11%, while The Trade Desk (TTD) and HubSpot (HUBS) increased 7% last week. ironSource reported strong results in Q3, as sales increased 60% YoY and its dollar based net expansion ratio was robust at 170% during the quarter. On the Q3 call, CEO Tomer Zeev stated that Apple’s recent iOS IDFA changes will be a net positive for the company. It is also noteworthy that over the last three-months, The Trade Desk has outperformed most ad-tech stocks. This trend, coupled with its premium multiple outlined above, likely signals that the market believes that The Trade Desk is one of the leading ad-tech platforms heading into Q4 earnings.
Top 10 Changes in sales growth estimates – last 90 days
The table below ranks ad-tech stocks by their topline revisions over the last 90 days. An increase in topline revisions signals that the Street believes that the company will grow faster than initially believed, which can result in outperformance. As mentioned above, FuboTv (FUBO) preannounced Q4 topline results, which came in ahead of its initial guidance and contributed to the rise in sales estimates recently. PubMatic (PUBM) had beaten its Q3 topline guide by 12% and also raised its FY2021 guide by 11%, which contributed to the higher sales estimate for the company. During its Q3 call, PubMatic’s Founder-CEO Rajeev Goel explained that the company has limited exposure to IDFA and added that demand for the company’s solutions will grow as third-party cookies and IDFA are phased out.
Update on EV/Fwd revenue multiples:
Overall stats:
Overall ad-tech forward median: 3x
Top 5 ad-tech forward median: 10x
Overall ad-tech forward average: 5x
EV/FWD SALES:
As shown below, the median and average ad-tech EV/NTM sales multiple had been relatively static throughout 2021 and has since compressed meaningful in 2022. Given ad-tech’s reliance on a strong economy, the market may be pricing in slowing growth, which has led to a reduction in ad-tech valuations. Furthermore, Apple’s changes to IDFA and third-party tracking have introduced uncertainty into the market, which has likely had a near term impact on valuations. However, if sentiment and the outlook for economic growth improves, then ad-tech valuations could quickly recover.
Top 5 EV/FWD SALES:
In the chart below, we can more clearly see the large dispersion in ad-tech valuations, as the top 5 premium valued ad-tech stocks have had their EV/Fwd sales multiples rapidly expand since 2020. However, the top 5 valued ad-tech stocks have had their valuations materially compress since November, falling from a median of 23x in early November to a low of 10x as of January. The median ad-tech stock has also experienced a multiple compression in recent weeks, falling from a multiple of 6x to a median multiple of 3x over the same time period.
EV TO FWD Sales Growth Buckets:
We can further dissect the change in ad-tech valuations by breaking up the group into high growth (>30%), mid growth (>15% and <30%) and low growth (<15%). The below chart shows the historical valuations for stocks in various growth buckets. Each growth bucket has had their valuations compress since November, with the high growth bucket experiencing the steepest decline and falling slightly beneath the mid growth median valuation.
The market likely expects growth to decline in the near term and has adjusted valuations accordingly. However, there are signs that advertising growth is stable within specific earnings reports. For instance, Microsoft stated during its most recent Conference Call (01/25/22) that search and advertising revenues increased 32% YoY, which were better than expected and benefitted “from a strong advertising market”.
Top EV TO FWD SALES:
The below chart provides a more holistic view of the ad-tech landscape heading into Q4 earnings, sorted by EV to NTM revenue multiples. As mentioned above, The Trade Desk (TTD) sports a premium multiple and has outperformed the majority of its peers during the recent market sell-off. Unity (U) and HubSpot (HUBS) are closely behind, and are expected to grow faster than The Trade Desk in the near term.
The last chart is based on EV to FWD sales but also takes into account forward growth expectations. By scaling valuation relative to forward growth, we can more clearly see which companies are cheapest relative to forward growth. A low value in the below chart means that a company is cheap relative to growth.
Note that some names may be skewed due to acquisitions such as Digital Turbine (APPS). Both HubSpot and ironSource look relatively cheaper after accounting for their relatively stronger growth rates. The Trade Desk looks relatively more expensive after considering its topline growth rate, as it is expected to grow slower than the median ad-tech company.
Finally, the last table we will be discussing includes aggregate ad-tech operating metrics. The below table illustrates the median topline growth, margins and FCF generation for the ad-tech industry. The median growth rate was 47%, and the market expects the median ad-tech stock to grow sales by 22% YoY in Q4. Gross margins remained robust at 64% and cashflows were strong at 18% of three-month sales for the median ad-tech company.
Ad-tech is a highly cash efficient industry that is dependent on a strong economy. If economic growth is sustained, then ad-tech valuations will likely quickly rebound. The I/O fund will be watching this industry closely heading into Q4 earnings. Find out what the Street is saying about ad-tech stocks headed into Q4 earnings in our I/O Fund’s preview of 7 Ad-Tech stocks for Q4 Earnings.
The I/O Fund is a team of analysts that share their research publicly as they build a portfolio of 30 stocks. Our team has record results for a retail Fund and we also have four-digit gains on some of our free newsletter coverage. You can learn more about our premium service by clicking here or sign up for our free newsletter here.by clicking here or sign up for our free newsletter here.
Disclaimer: This is not financial advice. Please consult with your financial advisor in regards to any stocks you buy.
The chess pieces are being rearranged in ad-tech and I don’t think this quarter is very meaningful in terms of where this will go long-term. These shifts can take a while but our strategy from the beginning has been to stick close to first-party data companies. Magnite is given access to first-party data by representing publishers and the rest of our stocks are firmly cemented in first-party data.
I think it is a false assumption that we have all of the information from 10 days of IDFA changes and iOS 15 being live. The migration towards or away from certain ad platforms can take months, quarters or years. But there is certainly evidence that the shift has begun.
Regarding who will do well long-term, it will be those who work with first party data. There is quite a bit of evidence that this is where the advertising world is headed. Listen to Twilio’s call and you’ll see they are a cloud company banking on this shift.
“Digital growth and digital personalization or how businesses are building their businesses is a tremendous opportunity. And that opportunity is actually accelerated by the [Indiscernible] changes, like on the world of IDFA tags and third-party cookies, and all those things getting change because companies here rely on what's just honestly shenanigans. Like in the changes that have been going on, whether cookies or IDFA tags, these privacy changes are on the right side of history. And so, what Twilio's providing is the antidote to all those changes, which is a personalization and marketing system that starts with first-party data.”like on the world of IDFA tags and third-party cookies, and all those things getting change because companies here rely on what's just honestly shenanigans. Like in the changes that have been going on, whether cookies or IDFA tags, these privacy changes are on the right side of history. And so, what Twilio's providing is the antidote to all those changes, which is a personalization and marketing system that starts with first-party data.”
Here is what Magnite said in their recent call: “It’s been a third-party cookie world with third-party data that has really ruled the ecosystem. And I think publishers are clearly seeing a shift and buyers are starting to acknowledge this is really good information [first-party data]. They have a direct relationship with the consumer.”It’s been a third-party cookie world with third-party data that has really ruled the ecosystem. And I think publishers are clearly seeing a shift and buyers are starting to acknowledge this is really good information [first-party data]. They have a direct relationship with the consumer.” My original thesis on Magnite was centered around first-party data.
Here is what Roku said regarding the shift from third-party data to first-party data in their earnings call, “Yes, as you alluded to and the way you framed up the question, the disruption and the noise around the loss of cookies and device IDs like Apple's IDFA in general is a net benefit to Roku, really for two reasons. First, independent ad tech is very challenged in an environment, where these identifiers are getting more scarce because, they don't have these identifiers. They don't have a direct consumer relationship, whereas Roku does. And so we're always working on our platform with our own first-party data and it's a fundamental advantage for us and ultimately is bringing brands to us.”They don't have a direct consumer relationship, whereas Roku does. And so we're always working on our platform with our own first-party data and it's a fundamental advantage for us and ultimately is bringing brands to us.”
This is what you’ll need to ask yourself – are all of these management teams wrong or is the market wrong? Because clearly the market is penalizing these first-party data companies while rewarding third-party data companies (Snap deeply penalized compared to Facebook which is excessive on third-party data AND Roku penalized vs The Trade Desk which is only third-party data). Granted, the Trade Desk would be more affected by browser cookies being eliminated (this could happen end of 2023) but to have no affects long-term compared to Roku is not the correct outcome.
Hopefully by now, you know we would close a position if we thought the story was materially weaker than we previously estimated. When we close a position, our goal is to move that money into a compounder. However, I also don’t mind standing in front of a train and saying the market is wrong if I think the product isn’t fully understood. How many times will I have to do this with Roku? We can add Q3 2021 to the long string of misunderstood moments in Roku’s history!
We already covered Snap following earnings here, but I will tell you that October 2021 is now branded in my mind as another example of how the market lives in an alternate reality of two extremes. When Snap was experiencing its biggest one day loss, the company was simultaneously launching the most bullish product in the company’s history – Arcadia. This product helps Snap scale AR brand ads beyond its own platform. It’s a critical moment when an advertising company is able to monetize audiences outside of its own feed (or channel), and therefore, it’s bizarre to see a double digit drop during the month of Arcadia’s launch (but will provide a great editorial someday).
Magnite has always been a high flier for us; one where we are counting on the whole being greater than the sum of its two parts. If CTV ads were at saturation like mobile or desktop, then we would not be in Magnite or maybe even Roku. It’s this tailwind that has been able to overcome the current headwinds. Magnite not pictured because a pro-forma was not offered, however, we believe the pro forma growth rate for Magnite is around 25% placing the company between Google and Twitter.
Here is Pay TV ad spend in the United States alone compared to CTV ad spend of $24 billion. When Pay TV ad budgets stars declining like cable TV subscribers has declined, then we know we are finally in the true market for CTV ads.
Roku Earnings
There is a lot to unpack with Roku. Despite headwinds, it’s technically the strongest ad-tech company in terms of forward growth yet the market is going through a serious (and intense) period of doubt. We will need to discuss Player revenue, what supply shortages mean for smart TVs and dongles and competitors such as Google and Amazon and. The supply shortages affect Roku’s active accounts but Netflix also made it clear during Covid that there was a pull forward in terms of subscribers, which is similar to Roku’s situation.
Even despite these near-term risks, Roku is guiding for 37% growth which is the highest of all ad-tech companies above $20 billion in market cap. Notably, Roku is guiding high (comparatively) on a very large revenue base of $890 million at the midpoint for next quarter. Compare this with The Trade Desk, guiding for 21% on revenue of $339 million.
We will quickly go over the financials before breaking down the main issues that the market is concerned about. Then, we revisit our thesis to see if Roku is still on track. The goal is to always figure out where the market is wrong and being inefficient.
Financials:
Roku’s total revenue grew 50% year-over-year to $680 million. Platform revenue increased 82%to $583 million. Gross profit increased 69% and active accounts increased 23% year-over-year. Sequentially, active accounts were low at 1.3 million adds.
Average revenue per user (ARPU) is at $40, representing an increase of 49%. To grow ARPU from $27.00 to $40.00 in roughly a year is unheard of. Here is how Facebook’s ARPU compares with it taking the company 16 years to reach $40 ARPU while it took Roku four years from the launch of its ad exchange to achieve this ARPU. You’ll see the jump from $27.00 ARPU to $40.00 took a few tries between 2017 and 2020 for Facebook while Roku has nailed this incredible monetization growth in one year.
Clearly, Roku does not have billions of users like Facebook but ARPU is a vital sign as to the strength of an ad platform. It’s also helps to elucidate why Roku management is taking it on the chin with Player revenue (see below) and what they mean by flywheel across Roku’s diversified product line, which is an operating system, an ad exchange that extends to mobile and the web, and a publisher.
The $40 ARPU means that Roku can take losses growing its audience and will be able to make up for those losses over time – and that’s exactly what Roku intends to do.
Player revenue is down 26% year-over-year. There are also losses on the player from $20.2 million in profit in the year-ago quarter to $97.4 million in losses in the current quarter. The company stated the following regarding these losses, “While Roku player unit sales were down year-over-year in Q3 2021 (following the extraordinary demand spike we saw in Q3 2020), unit sales were above pre-COVID Q3 2019 levels. Our player unit costs were impacted by the supply chain disruptions. However, we chose to insulate our consumers from these increased costs to prioritize account growth, resulting in Player gross margin decreasing to -15%. We view this Player gross margin erosion as temporary.”
Regardless of transitory issues with player revenue, the substantial increase in ARPU is helping the margins quite a bit with gross margins of 53.5% up from 47.6% in the year-ago quarter and adjusted EBITDA up 132% from $56.2 million to $130.1 million. The gross margins for next quarter are forecast to be weaker at 43% and adjusted EBITDA will be lower between $65 million to $75 million compared to $113 million in Q4 2020. The company explained that the lower EBITDA is from “investing in headcount, product development, and sales & marketing to drive future growth.”
Roku is guiding for quarterly revenue of $885 million to $900 million next quarter or 37% growth, up from $649.9 million in the year-ago quarter. The company is guiding for gross profit of $385 million, or 26% growth year-over-year. To reiterate, what the market doesn’t like is that margin decrease from giving players away at a loss.
Player sales is the main reason that Roku got clobbered. I don’t believe it was over active users as they were up 23% year-over-year, which in the face of declining player sales is quite impressive. It’s important to remember that earnings are relative and Q3 of last year saw very strong Covid tailwinds where users were buying hardware and staying home. Apple is the bellwether on this issue of the electronics and consumer hardware boom that is now tapering off.
Roku management emphasized the fact the growth is stronger this quarter than pre-Covid levels. “Meanwhile Roku player unit sales remained above pre-COVID levels and the average selling price decreased 7% year-over-year as we chose to insulate consumers from higher costs.” However, with player unit sales down 26% in the face of tough Covid comps, the market is concerned.
Logically, analysts and investors know they are not invested in Roku for the player yet the player can weigh on margins. The gross margin in this quarter was strong for Roku at of 53.5% but the guide of 43% is why there was a sell-off (in my opinion). Wall Street has always been worried about Roku’s margins relative to its player revenue.
Roku is a growth machine – comparatively speaking, it’s heads and shoulders above other ad-tech companies in terms of revenue size (roughly $900 million for Q4) with the strongest guide in our universe at 37%. This communicates how management views headwinds or tailwinds – both are an opportunity for a land grab. Here’s one way Roku is seizing the supply shortage: “As mentioned earlier, we chose to insulate our consumers from increased component and logistics costs, resulting in player gross margin decreasing to negative 15% in Q3.” In addition, the company plans to keep dongles stocked so that if smart TVs sell-out or are too expensive for consumers, they can upgrade their current television with a Roku player.
Here's a question from Laura Martin on the call that is important to understand why Roku could come out ahead in light of supply issues: “But if you're going to sell out of those [dongles] anyway because TVs are running out why would you cut price [of the dongles]? Why wouldn't you double price and still sell out and just and still add as many subs, but at a higher price because you've got dongles in stock when all the TVs smart TVs are running out of inventory at the retail level?”
Here was the answer: “So the supply chain — in the case of players we're not — our goal wasn't to not sell out. We are paying more for expedited shipping for — to get chips get in front of the line for chips. So the results of all that is our costs are going up. But we haven't sold out yet. We've just been paying for air shipping and we've been spending money to insulate the retailer and the end customer from pricing issues and supply issues. So far we've been doing that relatively effectively.”
The translation is that they can air ship boxes of dongles and keep them on the shelves because of their small size while TVs sell-out and/or are cost prohibitive for consumers with average of 42% increase in price. “That [TV sales] is down. The market is down 31% year-over-year in part because pricing on U.S. TVs on average is up 42%. And the U.S. TV market is actually down below pre-COVID levels in the corresponding period in 2019.”
When asked why they aren’t doubling the price given the supply constraints (i.e., and appeasing Wall Street on the margins), the answer is that they are actually going to take a hit on the players at about (15%) because they want to keep costs low, which in turn, will grow active accounts. This goes back to the $40 ARPU. Once someone is a Roku user, there are high switching costs and Roku’s advertising flywheel can make up for the loss on hardware.
Competitors:
What management said on the call exactly matches my understanding, which is that Roku has always been competing against Google and Amazon. There is no change to the story here. Here is what an analyst asked: “First, just coming back to TVs for a second. Obviously, there's some new kind of incremental competition in market between Google TCL, Amazon Fire TV branded TVs and kind of what Comcast is doing. It remains to be seen how successful that will be. But I guess the question is that that narrative is there and I'm curious what you guys think about to kind of offset that narrative?”, there's some new kind of incremental competition in market between Google TCL, Amazon Fire TV branded TVs and kind of what Comcast is doing. It remains to be seen how successful that will be. But I guess the question is that that narrative is there and I'm curious what you guys think about to kind of offset that narrative?”
Here is what management said, “But we've been competing very successfully with large companies, all the companies you mentioned since the beginning. And if you look at where we are in terms of that competition, we've gone from no market share in TVs to the number one licensed TV OS brand in the US with about a-third of all TVs sold now running the Roku operating system. We've built an incredibly strong brands around streaming. We've achieved large scale with lots I believe lots of scale growth to continue in front of us. Most of our growth is in front of us.
…So we've been competing very effectively. We take competition very seriously. I don't see any particular dramatic change in the competitive landscape, with all the stuff that's going on. It's just more of the same, and we will continue to compete in market share.”I don't see any particular dramatic change in the competitive landscape, with all the stuff that's going on. It's just more of the same, and we will continue to compete in market share.”
They also stated Amazon Prime was not up for negotiation at this time. “As for the — your Amazon question, we have renewal discussions with hundreds of partners each year. It's normal course of business. Our goal in these discussions is always to reach an agreement that's good for our partner, good for our customers, delivers a great user experience. Despite what you may have read, our Amazon agreement is not up for renewal or in negotiations at this time.”
We had a Member post on recent stats on the Wire from Conviva. Here is what Roku’s lead looks like:
Here is how Roku looks on a Global scale – Roku is green, Amazon is white and Samsung is yellow.
That picture is worth a thousand words as to why we are long Roku. Our thesis here is that Roku is the royal flush in terms of its positioning. You can view our webinar here.
Lawsuit with Google:
Who hasn’t Roku fought (and won against?) – Peacock, HBO Max and Fox have all threatened to remove access before eventually folding. Google is especially in a bad position here as they are asking for search data from Roku customers to be shared with them, which Roku does not do for other apps. They also want preferential treatment in search results. Keep in mind, that YouTube TV has been off Roku platform since April and Google created a workaround for YouTube TV to be accessed through the YouTube app. The percentages shown above help illustrate why Roku fights these apps – they are the top dog in this space.
The chances that Google goes up against a well-informed tech CEO in the court of law on data requests and preferential treatment with search results is very low. Roku can expose Google in ways that a Congress Vs. Zuckerberg was not able to as Congress does not know enough about data collection to handle Zuckerberg. Meanwhile, Roku representatives can easily describe the issues with Google. The discovery process will be enough for Google to fold, in my opinion, so let’s see if this prediction turns out to be true. It will also leave Google wide open to have an example made of the company in terms of Big Tech’s overreach. Google tends to play things safe in this regard as there’s a whole lot of data issues lurking beneath the surface; no reason to wake a monster.
CNBC and others are also publishing favorably for Roku, including viewing a 2019 email that shows Google did ask for preferential treatment: “But a 2019 email from Google to Roku that was viewed by CNBC shows Google did ask for preferential treatment for YouTube in Roku’s search results.” And, two members of Congress are already salivating at the idea of taking Big Tech to court.
Let’s Revisit the Thesis:
Now that we’ve dissected why Player revenue is struggling and why Google is small beans in the Connected TV world (and very unlikely to go to court), let’s revisit why we are here. What management said towards the end of the call sums it up: “I mean, if you think about the big picture, we believe all TV is going to be streamed. That means, there's one billion broadband households around the world. They're going to get all their TV through streaming. So, a pretty small percent of those are actually doing that todayThat means, there's one billion broadband households around the world. They're going to get all their TV through streaming. So, a pretty small percent of those are actually doing that today.”
Here's another way to frame the growth that is in front of Roku: “I think if you just think about the drivers of our ad business because some of your questions were about our ad business, the biggest driver of the ad business is not these kinds of details. It's the fact that if you look at TV time in the US today adults 18 to 49 spend 42% of their TV time streaming. But if you look at the amount of ad spend on streaming versus traditional TV, it's only 22% has moved to streaming. So there's this big gap still and that gap is starting to close, but has a long way to go. That — the rate of that closure because they will catch up eventually and the rate of all viewers moving to streaming those are the biggest drivers of our ad business which is a $60 billion opportunity.”It's the fact that if you look at TV time in the US today adults 18 to 49 spend 42% of their TV time streaming. But if you look at the amount of ad spend on streaming versus traditional TV, it's only 22% has moved to streaming. So there's this big gap still and that gap is starting to close, but has a long way to go. That — the rate of that closure because they will catch up eventually and the rate of all viewers moving to streaming those are the biggest drivers of our ad business which is a $60 billion opportunity.”
Magnite Earnings
Magnite has gone through a streak of acquisitions (2020-2021) following a large merger in the previous year (2019) and also a name change. The company uses pro-forma to indicate growth for the combined company of Magnite and SpotX. Ex-TAC refers to revenue that excludes acquisition costs. For our purposes, pro-forma is what the Street will be judging Magnite on moving forward.
If the acquisition comes together nicely then we can reasonably expect this growth to accelerate (assuming the whole is greater than the sum of its two parts). Usually in tech growth, acquisitions are strategic rather than accretive yet financial analysts are only able to model the accretive growth post-acquisition. Magnite’s strategy is to become the strongest supply-side player globally and to circumvent the need to figure out hardware (like Roku) by going direct to publishers.
SpotX was a strong company coming into the acquisition and it almost resembles more of a merger in that regard. This is why pro-forma growth is low in the first year at 26% in Q3 and CTV revenue is up 51% on a pro-forma basis. Compare this to 290% CTV growth if we look at only Magnite last year. SpotX brings about $30 million per quarter to Magnite and this is primarily CTV revenue.
Losses are widening on Magnite to a total of $24.3 million, up from $10.5 million. The adjusted EBITDA margin of 35% is based off ex-TAC revenue, so the comparison to last year pre-SpotX is not as meaningful. Operating cash flow was $34 million in Q3.
Magnite did state in normal conditions, they calculate the growth for CTV ads would have been about 40% year-over-year in the upcoming quarter. “From a comp perspective, if you were to remove political from 2020 Q4, our guide – so our guide straight up is about a 23% year-over-year growth in CTV. If you were to remove the political comp, you get to the low 30s in a year-over-year growth scenario. And if we look at the weakness that Michael mentioned in travel, in automotive, we believe that’s impacting us to perhaps $3 million to $4 million in CTV in Q4. And if you factor that in, we’re at about a 40% year-over-year growth rate.”
For Magnite, the company was more insulated because Android revenue helped make up for any loss on iOS revenue. The company estimates that their exposure is in the single digits and they are seeing a high opt-in rate (likely through the publishers). Magnite’s big risk comes at the end of 2023 when Google will end cookies on Chrome. In the meantime, Magnite plans to build solutions for “first-party publisher segments collected in a privacy compliant manner.” It’s something to monitor but not a concern at this time as it’s two years away.
Magnite’s earnings call is one of my favorites to listen to as the management is often asked industry questions and they give very insightful answers about what they think is going on in the ad industry. Here’s an example of where they were asked about Snap and Facebook.
Analyst: “Hi guys. Obviously, Snap and Facebook felt the brunt of Apple’s privacy changes. And I think you kind of alluded to this and talked about it before, but do you believe ad spend shifted out of social media in totality where you don’t play and into the open Internet or CTV as you talked about earlier? And does that – did that benefit results at all, or it sounds like this could be a long-term issue for social media players. So, is this a catalyst for the open Internet as we push forward?”
Answer: “Yes, Nick, this is Michael. Good question. I believe so long-term, yes. But there is a class of advertisers that really became expert at advertising in the mobile ecosystem and relied heavily upon IDFA that they are not going to be able to shift their spend overnight, right. They are just so used to that ecosystem, the attribution measurements. They have grown to trust their models are based upon from a conversion and lifetime value of the acquisition. All those things have to be reworked not unlike an advertiser that’s lived on Nielsen household ratings and linear TV having to get used to more of the measurement in CTV. And so – so, I think there is no question in the open web will be a beneficiary from that. I just think there will be an evolutionary – an evolution period where these marketers will have to treat their models, get comfortable with new methodology, new attribution and continue from there.”
Here's another explanation:
“We read a lot about the advertisers that have stalled their campaigns or stock spend or decreased spend because they are having a really challenging time working with attribution and customer acquisition costs, etcetera. Those guys are extraordinarily lower funnel. They are extremely sophisticated mobile advertisers. To think that they might jump from that world right into the world of CTV is probably a bit of a stretch. And those are the guys that spend $1,000 a day, $5,000 a day on the Facebook, Instagram, etcetera. But then there is a whole other slew of marketers that do social video advertising, that have much larger campaigns, that also take into account brand attribution, that I think are perfect. And our team is set up for that, Jason.”To think that they might jump from that world right into the world of CTV is probably a bit of a stretch. And those are the guys that spend $1,000 a day, $5,000 a day on the Facebook, Instagram, etcetera. But then there is a whole other slew of marketers that do social video advertising, that have much larger campaigns, that also take into account brand attribution, that I think are perfect. And our team is set up for that, Jason.”
Those quotes are actually bullish for Snap as what Magnite is communicating is that savvy mobile marketers need time to rework measurement and attribution but that doesn’t necessarily mean they will jump ship to CTV ads. They did indicate the push for CTV ads could come from smaller advertisers and we saw this with Roku’s Shopify announcement, as well.
· Regarding Atomera, this story centers around the announcement of the JDA. Until that happens, there’s not much to update. Knox is watching this one closely on technicals.
· Keep an eye on the forum for a Palantir update today/tomorrow and any others that would require a response on what the ER offered. If there’s a beat, we actually de-prioritize these as it means our thesis is playing out and we prefer to spend our time writing analysis on any misses.
ZoomInfo reported 11/1/2021 and beat on both the top and bottom -line. Q3 sales increased 60% YoY to $198 million, which was also 8% above the Q3 consensus estimate of $184 million. The 60% YoY growth rate represented an acceleration from the 57% and 50% YoY growth rates in Q2 and Q1 2021, respectively. However, after adjusting for recent acquisitions, organic sales grew 54% YoY in Q3, which was static to the 54% YoY organic growth rate in Q2. Enterprise customer count and organic bookings growth also deaccelerated during the quarter, which has moved us to the sidelines. I touch on these trends in more detail below.
Continuing down the income statement, gross margin increased 250 bps YoY to 81% while adjusted operating margin fell YoY from 47% to 39%. A rapid 225% YoY increase in research and development expense drove the margin compression, as the company invests in new products such as conversational intelligence. On the Q3 call, CEO-Founder Henry Shuck explained that the company is investing heavily in conversational intelligence, a market that ZoomInfo believes can be an $18 billion opportunity. As shown below, recent acquisitions and expansion into new verticals such as conversational intelligence, recruiting, and training have expanded ZoomInfo’s total addressable market to $70 billion. Finally, adjusted Q3 EPS doubled YoY from $0.07 to $0.14 and also bested the consensus estimate of $0.12 by 2 cents.
During the quarter, management also cleaned up its corporate structure by eliminating its multi-class share structure, resulting in the same economic and voting interest for all shareholders. The improved corporate governance and reduced complexity is expected to enable the company to be included in stock indices, which should increase demand for its shares going forward. This event also created a taxable event as pre-IPO shareholders saw a step up in their cost basis. The company recorded a $4 billion tax asset and $3 billion tax liability as of Q3, with the net $1 billion tax asset lowering future cash taxes over time.
Increased Outlook and Strong Customer Metrics but a Slight Deacceleration in Growth
ZoomInfo’s topline beat also led to a rise in guidance. Management raised their FY2021 sales guide by 4% to $732 million (at the midpoint). The guide implies 54% YoY revenue growth, up from the prior guide of 48% and also implies an organic growth rate of 50%.
Given the recent challenges in the advertising market related to changes to IDFA, it is great to see that ZoomInfo continues to expect robust growth going forward. CEO-Founder Henry Shuck explained during the Q3 call that explained that “our continued investment in privacy is a competitive differentiator.” The company’s roll out of ‘privacy clusters’ in 2020 and its focus on B2B company data, rather than individual level data, has likely helped it navigate the changing market place around data and privacy.
Furthermore, the company’s focus on B2B data is a direct result of its strong growth with enterprise customers. Customers with over $100,000 in annual contract values (a proxy for enterprise customers) grew 74% YoY to 1,250 customers, an acceleration from the 69% YoY growth in Q3 and also outpaced the 60% YoY growth in Q3 sales. The growth was also robust on a sequential basis, as enterprise customers increased 14% QoQ, however this was a slight deceleration from the 16% QoQ increase in Q2, but faster than the 9% QoQ rise in organic sales (shown below).
The acceleration in enterprise customer growth is important as it helps support a premium multiple and highlights how ZoomInfo is increasingly becoming known as a category-defining company in B2B sales and marketing. However, the deacceleration on a sequential basis is something to note and may signal that growth will slowdown in the near term. Dollar based net retention remained static at 108%, which has room to improve as ZoomInfo has made a series of acquisitions that have expanded the amount of products that customers can expand into.
Finally, the company’s revenue quality has also improved, which also supports a premium multiple. We can measure revenue quality by observing trends in both accounts receivables and deferred revenue. Accounts receivables increased just 22% YoY, while deferred revenue increased 63% YoY during Q3, which outpaced the 60% YoY increase in Q3 sales. The relatively faster pace of growth for deferred revenue signals that ZoomInfo is collecting more cash from its sales than in prior years, a sign of strength.
Bookings were also strong during Q3, but did deaccelerate during the quarter. For instance, Q3 organic bookings increased 49% YoY in Q3, a deacceleration from the 71% and 65% growth rates reported in Q2 and Q1, respectively. Bookings can be lumpy, and management stated on the Q3 call that bookings “can be imprecise metrics to assess in-period activity and forward momentum”. Nevertheless, the deacceleration in bookings is something we will need to be mindful of going forward, especially considering ZoomInfo’s premium forward sales multiple of 29x.
The deacceleration in organic growth, sequential enterprise customer growth and organic bookings moved ZoomInfo to the ‘chopping block’ as the company was in our momentum portfolio and we did not want to hold the company if growth starts to slow.
In summary, ZoomInfo beat both top and bottom -line Q3 estimates and also raised its FY21 sales guide. During the quarter, ZoomInfo reorganized its corporate structure, which allows the company to be included in more indices going forward. The company has also been able to navigate the changes to the data privacy landscape well, evident by the robust growth in enterprise customers. The strong growth with enterprise customers provides support for future sales growth. However, organic sales growth slightly deaccelerated during the quarter (growth was static at 54%), as did sequential enterprise customer growth and YoY organic bookings, a trend we will need to be mindful of going forward, especially considering ZoomInfo’s premium multiple. Since we do not want to hold a company in our momentum portfolio that may be slowing down, we decided to cut our ZoomInfo holdings.
In this earnings preview, we review key companies in ad-tech to gauge what to look for in the upcoming Q3 earnings reports. Last quarter, ad-tech saw a rebound in ad spend from Covid yet it’s likely we saw the high-water mark for many companies as the ad industry faced extraordinarily low comps coming out of the historic lows of Q2 2020 when Covid led to reduced spend.
Snapchat will be the first among the ad-tech companies to kick-off the Q3 earnings when it reports on October 21st. In the analysis that follows, we give a brief overview of the ad-tech sector and discuss key trends that investors should be aware of heading into Q3 earnings.
Below is a table of ad-tech stocks ranked by their EV/Fwd sales multiples, along with their most recent YoY growth rate, gross and free-cashflow (FCF) margins. Many Ad-tech names are growing strongly, but M&A activity has inflated some growth rates such as APPS and MGNI. Adjusting for acquisitions, APPS and MGNI reported pro-forma sales growth rates of 104% and 79%, respectively. PINS had the strongest organic topline growth at 125%, as international sales at the company surged 227% YoY during Q2.
Top 10 EV / Fwd Revenue Multiples
However, we can see the high-water mark starts to kick in with the upcoming quarter. Looking forward, Digital Turbine is forecast to grow the strongest in Q3, but this is skewed due to the company’s recent acquisitions. FUBO has high expectations heading into Q3 as subscriber growth from the NFL season which started in Q3 should help fuel sales growth at the company.
Top 10 Three-month Forward YoY Growth Rates
The below table ranks the ad-tech stocks that saw the largest one week change in their share price. With Ad-tech earnings on the horizon, the market may be pricing in which stocks it anticipates to perform strongest. Notably, Digital Turbine and HubSpot have been strong all year and have been some of the strongest Ad-tech stocks recovering from the recent sell off in tech stocks.
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We can also see the market continues to question Fubo per the YTD price action below. We’ve written in detail as to why we think the company is stronger than the market realizes due to tailwinds from OTT live sports specifically and the monetization potential from sports betting. We’ve also recently commented on Twitter that Roku is likely to do even better globally than domestically as ad-supported streaming will be preferred over subscriptions in countries with lower GDPs. Considering that the Roku team created the leading operating system in 2008 and has led in the United States for 13 years over Amazon and Google, we think the team is capable of entering new geographies.
Top 10 Weekly Share Price Movement
In the table below, ad-tech stocks are ranked by percentage of change in their forward sales growth estimates over the last 90 days. A rise in growth estimates can lead to a higher multiple, however the market remains in a “wait and see” stage for names such as FUBO and PUBM, as their stocks have declined despite an increase in forward expectations. FUBO has high expectations as sports streaming from the NFL should boost revenues, while PUBM is a relative newcomer to the Ad-tech market and the Street may be waiting for the company to prove it can compete. In general, PubMatic is in a tough place to compete in the tech stack due to the number of competitors on the supply side.
Top 10 Changes in sales growth estimates – last 90 days
Although ad-tech has seen some double-digit declines over the past three months, we do not think this will last for long. Ad-tech is a robust industry that is cash efficient and tends to outperform other sectors in tech. For instance, two of the FAANGs are ad-tech related and there could be more tailwinds for those who hold first-party data as Facebook and Apple duel over third-party ad tracking and measurement. We covered this here.
At the I/O Fund, we have plenty of exposure to ad-tech and are not concerned with any temporary pullbacks.
Update on multiples
Below, I give an overview of topline multiples for the Ad-tech sector. The multiples shown below are calculated by scaling Enterprise Value (market cap + debt – cash) to forward sales. A higher multiple means the company has a premium valuation.
Overall Ad-tech stats:
Overall Ad-tech forward median 7x
Top 5 Ad-tech forward median 24x
Overall Ad-tech forward average 10x
EV/FWD SALES:
Ad-tech valuations peaked during the beginning of the year and have trended down since. The multiple compression has driven the median Ad-tech EV/Fwd sales multiple to 7x, which is below the median 10x multiple that Ad-tech received heading into Q3 earnings last year (2020). If Ad-tech performs strongly in Q3 2021, then the Street may award Ad-tech a higher multiple.
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The I/O Fund has stated that we see the current market as a buying opportunity with an in-depth macro analysis from Portfolio Manager, Knox Ridley. The valuations illustrate that we are nearing the 6 Median EV to Forward Revenue and the 10 Average EV to Fwd Revenue, which barring a black swan event like March of 2020, is low for ad-tech valuations. We to tend not hunt for bottoms, rather we prefer to trim near tops and add to key positions near bottoms. Therefore, for the style of the I/O Fund, the current valuations are a buying opportunity and we sent a recent Roku buy notification to our I/O Fund Members at $309.30.
By bifurcating the data for the top 5 in the chart below, we see the valuations in some names have largely recovered their multiple compressions since the beginning of the year. Snap, The Trade Desk, Hubspot, Roku and Pinterest have the highest valuations. The recovery in these premium valued names suggests that the market believes that these five stocks will likely outperform the rest of the group going forward.
TOP 5 EV/FWD SALES:
Below, we break the valuations into the following buckets:
Ad-tech High Growth Median EV to Fwd Revenue 10x
Ad-tech Mid Growth Median EV to Fwd Revenue 4x
Ad-tech Low Growth Median EV to Fwd Revenue 4x
We can further dissect the change in ad-tech valuations by breaking up the group into high growth (>30%), mid growth (>15% and <30%) and low growth (<15%). The above chart shows that the high-growth Ad-tech stocks were valued higher earlier in the year, as the market may be anticipating a slowdown in ad spend in the near term.
EV/FWD SALES IN GROWTH BUCKETS:
The chart below highlights the large gap in valuations for ad-tech leaders such as TTD and SNAP and the rest of the sector. SNAP and TTD are valued ~400% higher than the median multiple of 7x, while relatively new entrants PUBM and TRMR are valued below the Ad-tech median, at 6x and 4x, respectively.
EV TO FWD SALES Ad-tech UNIVERSE:
We also include a chart based on EV to Fwd sales but this takes into account forward growth expectations. By scaling valuation relative to forward growth, we can more clearly see which companies are cheapest relative to forward growth. Stocks on the right side of the chart below have the cheapest growth, meaning that they are trading at a bargain. Some standouts are SNAP, which fell from being valued 4x the median to just 2x the median once growth was accounted for. Moreover, FUBO is one of the cheapest Ad-tech stocks when considering their forward growth rates. TTD remains the most expensive and APPS and MGNI are skewed by recent acquisitions, meaning that they appear cheaper because of acquired sales.
Finally, the last table we will be discussing are ad-tech operating metrics. The above table shows that the group as a whole is performing well, as the average median growth in the most recent quarter was a strong 81%, however this should be discounted due to the low base period in the prior year due to Covid (discussed above). Looking forward, the market expects ad-tech to continue to grow strongly as the median growth estimate is 38%.
