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.

Growth adjusted EV/Fwd Revenue (EV/Fwd Rev/Fwd Growth)

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.

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Disclaimer: This is not financial advice. Please consult with your financial advisor in regards to any stocks you buy.