Explosive Growth and a Wide Moat
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Digital Turbine (APPS) is becoming a mobile advertising powerhouse. With a reach of 1.5bn people monthly and partnerships with social media firms and telecom giants worldwide, the company has a great opportunity to steal market share from competition. The business’ restructuring to One Digital Turbine is creating an end-to-end advertiser with recurring revenue and monumental growth. Having fallen 60% from its recent high of $91, the company is low-hanging fruit at current prices.
Summary of my thesis:
Direct on-device advertising means a huge total addressable market for APPS customers
Patented single tap software experiencing explosive growth and provides a moat
Strategic acquisitions mitigate concentration risk and create a recurring revenue business model
The Business
Initially, Digital Turbine was paid one-time lump sums by advertisers to preinstall its apps on a user’s smartphone based on their interests. The main issue with this is that revenue was not recurring, and the market didn’t like that. The shares went nowhere from 2010 to 2019. Today the business has transformed. Having spent $1bn acquiring several businesses, APPS now has the capacity for monetisation and recurring revenue through its business partnerships.
Digital Turbine is restructuring into two segments, ‘on device’ and ‘in-app’ media, which is creating increased synergies and a totally integrated end-to-end advertising platform. On-device software, through ‘Ignite’, accounted for $134m of revenue (35% of total) for the three months to December 2021, an increase of 43% year over year (YoY). The Ignite platform comes preinstalled on over 800m Android phones thanks to the company’s partnership with Google and other mobile carriers, giving Digital Turbine’s customers a huge audience to advertise its products to. In-App Media accounts for the other 65% of revenue, including $157m coming from Fyber and $94m coming from AdColony – two companies acquired by APPS during 2021.
Digital Turbine has a wide range of product offering now, Source: Digital Turbine Investor Relations
APPS acquisition spree through the purchase of both aforementioned companies, as well as Appreciate, has boosted revenue tremendously, and these businesses allow APPS to offer products throughout the entire advertising supply chain (see below – APPS presence before and after acquisitions). Appreciate’s platform allows advertisers to create campaigns, tailoring to specific audiences, and then allows the advertiser to track and optimise ads in order to maximise return on investment. On the other side of the advertising chain, Fyber offers a platform for ad publishers like ESPN which has advertising space it would like to sell (commercial breaks etc). These publishers can post available ad space on Fyber, and advertisers buy this space much like we would buy a product from eBay. Finally, AdColony is a software development platform helping advertisers create video content and interactive advertising for their products.
The acquisition of Appreciate delivers valuable ad-tech and algorithmic expertise to help Digital Turbine execute on its broader, longer-term vision. Deploying Appreciate's technology across Digital Turbine’s global reach should further benefit partners and advertisers that are a part of the combined Company’s platform. Once fully integrated, all three acquired companies should contribute significantly to revenue and margin growth, with the most recent quarter being a great example as revenue has grown 324% compared with 2020.
APPS advertising supply chain presence pre-acquisitions, Source: Canaccord
APPS advertising supply chain presence after acquisitions, Source: Canaccord
Digital Turbine is used by Meta Platforms, Snapchat, Walmart, EA Sports, BBC, and many more. APPS partnership with Google for preinstalls on its Android phones saves on costs, with SG&A accounting for only 14% of sales – a small figure for a scaling business. Not only are Digital Turbine’s platforms installed on over 800m Android devices, but new partnerships with Telefonica (Spain), Jio (India), and TMobile mean that the business is gaining a global reach. Expansion into Asia-Pacific is proving to be a huge success so far, with 15% of revenue now coming from this area. Furthermore, the business is continuing to innovate, adding new products to its range of offerings, further driving organic growth… and it’s working. Revenue per device (RPD) has risen 50%, showing the value of Digital Turbine’s platform to publishers and advertisers.
Mobile Advertising is only heating up
As I touched upon last week, there is huge scope for compound growth in the mobile advertising space in the future. Rising smartphone affordability in emerging markets, where favourable demographics and better growth rates are present, should lead to continued growth for companies such as Meta Platforms and Digital Turbine in the future. The global mobile advertising market is expected to grow to more than $540bn by 2025 (see below), and Digital Turbine has a great opportunity to steal the remaining market share behind Meta and Google.
Digital Turbines TAM, Source: Digital Turbine Investor Relations
An attractive valuation with a strong moat
APPS is in a strong financial position with $150m in cash alongside a revenue growth rate of 33% per year expected into 2026 (see below). The company issued $385m in debt to fund the acquisitions previously highlighted, but APPS is expected to make $400bn in free cash flow by the end of 2023, so will have no problem reducing debt levels. Even accounting for this growth and strength, as well as net income margins of 13%, the company is priced at only 25x earnings before interest and tax (EBIT), or 15x free cash flow. A fair multiple for a company growing revenue at 30% per year would be anything north of 25x free cash flow, which shows the extremely negative sentiment toward technology companies today. How times have changed from 2020! Alongside this, one measure used by many venture capitalists to assess the attractiveness of a tech stock is the ‘rule of 40’. This adds the percentage revenue growth rate with the free cash flow rate or EBIT margin, with a sum greater than 40 suggesting an attractively valued tech company. Digital Turbine has a score of 52.
Rising Revenue and free cash flow into 2026, Source: TIKR
The company’s preinstalled Ignite software on over 800m phones allows it to place ads directly onto a user’s smartphone. This platform makes the demand for its products extremely sticky and, with the addition of its in-app acquisitions, gives the business a funnel to cross-sell its expanding product range to existing customers. This creates what Warren Buffet would call a ‘moat’ around APPS business, meaning the company is able to maintain a competitive advantage to protect profits and its market share. APPS has a moat because switching costs once the software is plugged into advertising campaigns is high and time-consuming. It’s also the only advertiser with preinstalled software on Android phones. Furthermore, the network effects created by APPS increasing product range across its platform means demand should remain sticky in the future.
In addition, within its In-App Media Division, Digital Turbine has patented ‘Single Tap’ software. As the name suggests, this software allows users to download applications with one click and this is driving organic growth massively for Digital Turbine, with revenue from this segment up a whopping 800%. This patented software makes the demand for APPS’ platform even stickier, which is evident as consumer conversion rates continually improve quarter over quarter. As the business continues to expand its product range, its ability to cross-sell to publishers and advertisers should lead to exponential growth in both sales and profit margins.
Risks
One impact which will weigh on the share price is inflation, which printed at 7.9% last week in the US. With the Russia-Ukraine war continuing, inflation seems likely to remain elevated due to commodity price increases and supply chain problems. Although APPS is a cloud-based business, so exposure to supply chain issues and inflation are relatively low, sentiment toward tech companies will continue to be negative as inflation remains high. In addition, if the economy wavers, businesses will cut advertising costs first, affecting APPS sales. In the medium to long term, this business has so much potential I cannot ignore it at current prices.
Another issue APPS faces is its reliance on the installation of its Ignite software onto Google’s Android devices. However, the astute acquisitions which have taken place during 2021 have diversified revenue streams and today no partner accounts for more than 10% of revenue. Prior to these acquisitions, dynamic installs through Ignite accounted for 70% of revenue. Now it accounts for just 15%, showing the excellent decision by management to acquire these businesses. As Digital Turbine’s product range continues to grow I expect the company’s reliance on Google to diminish significantly.
One ongoing concern which will need to be monitored is that the acquisitions have caused margin compression as integration and expansion of these businesses have led to higher costs. However, EBITDA margins are expected to recover back to 19% by 2025, and with the explosive growth being witnessed across the business, as well as the stickiness of its products, I would not be surprised if APPS margins recover before 2025.
Summary
Federal Reserve (Fed) Chair Jerome Powell confirmed his hawkish stance at this week’s Federal Open Market Committee (FOMC) meeting, raising interest rates by 0.25%. The market has rebounded substantially over the past few days following this meeting, but it feels more like a short-covering rally (as suggested here) rather than a change in trend. It always astounds me how price action determines sentiment, and how quickly investors change tact after a few days of market gains. Investors were heavily hedged going into this meeting and were relieved that a 0.5% rate rise was not announced. Even after a 7% rally, issues on a macroeconomic front have not changed. The labour market is extremely tight, supply chains are fractured due to the ongoing war and as a result of the pandemic, bonds continue to sell off, the yield curve is inverting, growth is slowing, inflation is rising, and the central banks are - somewhat reluctantly in the case of the Bank of England - tightening monetary policy. Therefore, I remain cautious, holding 10-15% of capital in cash and maintaining my holdings in precious metals.
As the saying goes, the cure for a high oil price is a high oil price. As I highlighted a few weeks ago, I believe a lot of the upside in energy is now priced in, so I feel it is prudent to further reduce exposure to this sector. Any resolution of supply issues with western nations who are attempting to cut ties with all Russian oil supply could lead to a significant fall in price. Also, the opportunities elsewhere in the market are plentiful so I have no problem missing the last move upward in commodities if I am wrong. I am therefore selling the remainder of my position in iShares Oil & Gas and rotating into PayPal, Meta Platforms, Digital Turbine, and Transocean. Transocean will benefit should the oil price remain around $70-$80 per barrel longer term, providing the company’s management can secure long-term contracts at higher day rates (how much Transocean is paid per day to use its oil rigs). I have written in recent weeks about my thesis for holding the other three stocks mentioned and I will continue to build out larger positions in these stocks over the coming months.
Action:
Selling 100% of iShares Oil and Gas ETF at $17.32, booking a 44% profit (total profit of £245)
Adding 1% to Transocean ltd (RIG) at $4.26
Adding 1.2% to Digital Turbine (APPS) at $43.04
Adding 0.8% to PayPal (PYPL) at $118.77
Adding 1.5% to Meta Platforms (FB) at $216.49
Portfolio Return Year-To-Date: 7.1% vs S&P500: -7%
Total Return since inception (20/09/21): 13.4% vs S&P500: 2.4%
Let me know your thoughts by emailing me at thesparknewsletter@gmail.com
See you next week!
Peter
Disclaimer
This communication is for informational and educational purposes only and should not be taken nor used as investment advice, as a personal recommendation, or solicitation to buy or sell any financial instrument. This material has been prepared without considering any particular recipient’s investment objectives or financial situation and has not been prepared in accordance with the legal and regulatory requirements to promote independent research. Any references to past or future performance of a financial instrument, index or structured product are not, and should not be taken as, a reliable indicator of future performance. I assume no liability as to the accuracy or completeness of the content of this publication.