$APPS: Prime Digital Real Estate At a Discount
Deep Dive
Hello! This month, I bring you my deep dive on Digital Turbine Inc. I decided to dig deeper into the company after Rob´s original recommendation. I hope you enjoy it and as always, feel free to skip to any section of your interest.
1.0 The Opportunity
2.0 Understanding APPS 0.00%↑
2.1 Δ(Devices): Digital Turbine is Essential to Carriers and OEMs
2.2 Δ(Revenue per Device): Effective and Troublesome Acquisitions
2.3 Moat and (Supply Side) Customer Concentration
3.0 Accounting Changes, Narratives and Financials
4.0 Conclusion and Valuation
1.0 The Opportunity
Digital Turbine has a bright future ahead, whilst the stock is trading today as if the opposite were true.
All throughout the tech-growth space there is a fine thread that is becoming increasingly visible as we continue to move forward post crash and that very much concerns APPS 0.00%↑ . Essentially, Mr. Market was previously over-excited and is now over-depressed about fundamental dynamics that nevertheless continue to evolve favorably and perhaps exponentially in the future.
Technology continues to propel humanity (and our economy) ahead, no matter what Mr. Market thinks of it now. In fact, technology is the basis for humanity´s core wealth generation process and time and time again, money resumes its perennial gravitation towards the field, no matter the degree and magnitude of the latest round of disappointment.
Looking at APPS 0.00%↑ from a high plane of abstraction, this is a business riding one fundamental trend which is only getting stronger: people do more and more things online as time goes by, which gives way to more online advertising. We are only just scratching the surface in this sense and in a few decades, people will do things online that today are unimaginable.
Accordingly, the online advertising space will continue to grow exponentially and APPS 0.00%↑ seems well positioned to be a key player in the space. Incidentally, I have brought together some disparate data points that suggest the latter is actually quite likely - which I think you will really enjoy learning about 2.1.
Whilst indeed the fact that overall space that the company inhabits seems set for growth is no guarantee of its future performance, it is on this occasion a very necessary realization to explore the opportunity under the adequate light - and one thing is intellectually grasping the idea and another is integrally doing so.
In my research, I have found the company to be a solid one (although it is not exempt of undesirable particularities) and the opportunity does not quite arise from seeing something in the company that others do not, but from understanding that the company will likely do fine despite the pervasive pessimism that surrounds it, which is reflected in its current valuation.
APPS 0.00%↑ is currently focused on the mobile (smartphone) ad space. However, as more and more devices get connected to the internet (such as cars, read my Blackberry deep dive to learn more), if it manages to carry over its ability to serve smartphones into these new devices, its TAM can expand by orders of magnitude.
Most people think of devices as something that exist in the physical space, but as we go deeper into the virtual realm, virtual devices will become common place and we may see a near infinite number of them being instantiated through time. You currently hold your phone in your physical hand, but how many phones will you operated when you have 20 virtual avatars running around doing work for you?
2.0 Understanding APPS 0.00%↑
Digital Turbine operates prime internet real estate. For the stock to go up, it needs to keep acquiring new smartphones and increase the revenue per smartphone. So far, doing both very well.
Digital Turbine is essentially the partial gatekeeper of what is arguably the modern world´s most valuable real estate: smartphone screens. When you buy a phone from a carrier like T 0.00%↑ or VZ 0.00%↑ or directly from an OEM like Samsung, it comes with a series of pre-loaded apps. In most cases, the software that enables these apps to be pre-loaded is facilitated and operated by Digital Turbine. Naturally, this real estate is highly monetizable and so the company rents it out to brands, so that they can get new eye balls on their products and pays carriers / OEMs a fee.
Digital Turbine started off by enabling app creators to pay for their apps to be included in phones and since, it has acquired a range of companies with the objective to increase the monetization per acquired smartphone. Perhaps more importantly, the acquisitions are gradually enabling the company to shift from a business model based on monetizing the real estate once (activation, getting the app into the phone) to doing so recurrently, by delivering services that stakeholders can leverage through time.
Fundamentally, for the stock to go up meaningfully, the company has to explode its earnings over the next 5-10 years by:
1. acquiring a lot more devices
2. and figuring out ways to continuously obtain a higher revenue per device.
These two metrics in fact summarize the overall health of the company and a thorough analysis of the two naturally leads to a functionally complete understanding of the company.
2.1 Δ(Devices): Digital Turbine is Essential to Carriers and OEMs
Digital Turbine continues to grow its number of devices very healthily and the underlying drivers are sound.
I first thought of Digital Turbine as a lucky servant of carriers and OEMs, which if true would make the company un-investable, since its value emerges from the inventory it manages to secure. Upon further investigation, I found some very interesting insights which have led me to evolve towards thinking that the company is in fact essential for its supply side customers.
Firstly, what strikes me is the large volume of phones that DT software is implemented in. This alone suggests some kind of growing consensus on behalf of carriers and OEMs that implementing DT software on their phone makes sense, as well as some pretty solid execution. As of its last reported quarter (Q4 2022), the company is currently operating 800m+ devices, suggesting no slowdown in this sense despite the recent price action. However, this alone is not enough for me to develop a conviction: I need to understand the underlying mechanics that are propelling this trend.
Whilst I have never gone near a phone carrier´s office, I have spotted the one fundamental trend which seems to explain DT´s device growth: carriers cannot do advertising. Whilst it is true that historically carriers have made money by:
1. charging you for bandwidth
2. and by selling your data (advertising),
two key data-points are highly indicative of their suboptimal ability to perform #2:
1. VZ 0.00%↑ sold its media division to Apollo in 2021 (source).
2. T 0.00%↑ sold its media division Xandr to MSFT 0.00%↑ in late 2021.
“Microsoft’s acquisition of Xandr (from AT&T), announced in late 2021 and just completed, makes this feasible. Xandr (née AppNexus) was an early, dominant player in the programmatic display ad space and, when acquired by AT&T back in 2018, began to hang its hat on the TV/video ad opportunity.” - Why Netflix chose $MSFT to be its ad partner
So the two largest carriers in the US sell their advertising business and in turn, NFLX 0.00%↑, one of the world´s best companies, has recently chosen Microsoft as its ad partner to leverage the power of AT&T´s (Xandr) ex-programatic ad platform, which it had to sell. Expressed in algebraic terms,
x = carriers need someone to run the advertising for them even if they have an awesome platform, which seems to correlate and indeed be the causation of the graph at the beginning of this section.
As it refers to OEMs, I have not found such a fun trail of crumbs to follow and decypher other than the fact that the world´s largest smartphone OEM (Samsung) has gone from doing a few million devices with DT to “tens of millions of devices today”.
“…so when we think about our Samsung relationship now, a year ago, we were doing millions of devices and now we're doing many, many, tens of millions of devices with them globally right now in I think about 75 different countries around the world right now.” - Bill Stone, CEO @ Q4 2022 ER CC
Overall, I get the impression that DT´s platform is good enough for world-class smartphone players to feel compelled to hand over very valuable real estate to the company for a fee and to continue doing so through time. If there an any carrier / smartphone OEM specialists reading this, feel free to illustrate us with your knowledge and to correct me if I am wrong.
2.2 Δ(Revenue per Device): Effective and Troublesome Acquisitions
Revenue per device is growing impressively and recurrent revenue is exploding, although the integration of the acquisitions seems to not be going so well.
Revenue per device continues to grow really fast and per the current state of the synergy revenues, I would say it could go up exponentially over the next coming years:
In the United States, our revenue per device was $2.10 in fiscal '20, $3.30 in fiscal '21, and $4.70 for fiscal ’22 (quite a healthy dynamic). Internationally, we're still not where we aspire to be, but we have doubled our RPDs from $0.10 in fiscal '20 to $0.20 in fiscal '21 to over $0.40 in fiscal '22. - Bill Stone, CEO @ Q4 2022 ER CC.
To add to the above, the company makes most of its money in the US:
However, the company has performed a total of 3 acquisitions in 2021 and this merits some careful analysis:
Appreciate (March 1, 2021): a programmatic DSP (demand-side platform). It enables customers to easily buy ads and track performance.
AdColony (April 29, 2021): enables in-app monetization.
Fyber (May 25, 2021): the platform provides publishers with a set of customized ad management software tools that enable them to extract the yield for their ad inventory. Also offers mediation, exchange, user acquisition, analytics, and ad formats solutions.
Since DT is effectively an SSP (supply-side platform), these acquisitions enable the company to move further up along the value chain. Customers that pay to have their apps included in smartphones can now monetize their apps via AdColony and can really optimize the performance of their content with Fyber. Together with Appreciated DSP (demand-side platform), this is now a fully integrated ad-tech ecosystem which should over time play out into meaningful synergies:
The acquisitions make sense because now DT can really improve its financials by monetizing its customers recurrently and for a long time. There has been an impressive jump in recurrent revenue as a % of overall revenue, from 50% to 85% in just one year:
“Our revenues that occur over the lifetime of a device now represent approximately 85% of our total revenues compared to just about 50% last year. Diversifying away from revenues only attributable to first boot and monetizing over the life of the device has been a strategic priority for our business, and this progress is material.” - Bill Stone, CEO @ Q3 2022 ER CC
However, at this stage, the integration of these acquisitions is nowhere near complete, both for the good and for the bad. Starting with the good, the revenue per device and recurrent revenue delta emerges from synergy revenues at low levels, which begs the question, what does the business looks like once synergies come to full fruition?
“Our synergy revenue run rate approached 10% of overall revenues as we exited the quarter.” - Bill Stone, CEO @ Q3 2022 ER CC
Moving on with the bad, if you have been reading me for some time, you will know that I have different levels of abstraction at which I look at a company at. One of them is that a company is just a bunch of people working together and that how they work (culture) often determines the fate of a company. In turn, the reason most acquisitions fail is that:
They are strategically inadequate.
The people from the acquired firm cannot be succesfully integrated into the acquiring firm.
An acquisition is an anthropological challenge of considerable magnitude and exponentially more so when we are dealing with 3 acquisitions in under 12 months. Below, you can see that this seems to have taken quite a toll on the company´s employees, per the sharp decline of the company´s overall rating on Glassdoor over the last few months. This menaces to damage the company for the long term and must be fixed as soon as possible.
2.3 (Supply Side) Customer Concentration and the Moat
The supply side has been great de-risked over the past few years and the company is building a strong moat.
Digital Turbine is a platform, in that it brings supply and demand together. To effectively function, it needs to not rely on any single customer too much on either side of the platform and until recently, but in this case specifically so on the supply side - the demand will continue flowing to the very valuable real estate. Until recently, there was a heavy reliance on supply side customers (partners).
“During the fiscal year ended March 31, 2022, no single partner represented more than 10% of our net revenue.
During the fiscal year ended March 31, 2021, T-Mobile US Inc., including Sprint and other subsidiaries, a carrier partner, generated 26.4% of our net revenue; AT&T Inc., including its Cricket subsidiary, a carrier partner, generated 22.3% of our net revenue; Verizon Wireless, a subsidiary of Verizon Communications, a carrier partner, generated 18.5% of our net revenue; and America Movil, primarily through its subsidiary Tracfone Wireless Inc., a carrier partner, generated 10.8% of our net revenue.
During the fiscal year ended March 31, 2020, Verizon Wireless, a subsidiary of Verizon Communications, a carrier partner, generated 37.3% of our net revenue, while AT&T Inc., including its Cricket subsidiary, a carrier partner, generated 30.0% of our net revenue.” - 10-K, top of page 10
In just a few fiscal years, the situation has been considerably de-risked and I think this speaks very positively of management´s skills. Incidentally, I have been looking at TTD 0.00%↑ ( a DSP) amongst other companies in the ad-tech space, and the stock has managed to 10X (20X before the crash) tracking the evolution in fundamentals over the last 5 years, with a similar supply side customer density than DT exhibits today. <10% of revenue dependence per customer seems to be the standard in the B2B space and per TradeDesk´s track record, it works.
Following the succesful de-risking of the supply side, a natural question is where is the moat? Firstly, as discussed in section 2.1 it is in the service provided itself. Beyond that, I express it the following way (Δ means increase):
Δmoat = Δ (S,D) * Δ( ad supply chain complexity abstraction)
The more supply and demand participants the platform incorporates and the more DT abstracts the complexity of the ad supply chain away from participants, the more indispensable the platform will become to customers and hence the larger the moat will be. Basically, if you need to monetize some ad inventory or if you need to hire cost-effective ads, the more options (liquidity) you have and the less headaches you get the more likely you are to stick around in the platform.
In this sense, APPS 0.00%↑ is advancing notably. It continues to bring in more partners, a lot more devices and thanks to its acquisitions, it is well on its way to abstracting complexities away for its customers. Unless the human resources issue outlined in section 2.2 derails the company, fundamentals are likely to evolve well.
3.0 Accounting Changes, Narratives and Financials
The market has been spooked by the recent accounting change and notable slowdown in revenue growth, whilst the financials are positively surprising for a business undergoing such a degree of expansion / transformation.
The market was very confused by the company´s accounting changes. In Q4 2022, DT changed from reporting gross revenue (all the money the ad inventories make) to net revenue (the part they actually keep, after paying carriers and OEMs). The market was shocked when the company reported a fraction of the “expected” revenues and the stock dropped nearly 20%, contributing to the existential sense of this analysis. As you will read below, nonetheless, the financials are just fine.
Income Statement
Regardless of the accounting change, the company has been exhibiting very healthy top line growth since its IPO, although much of the uptick we see in the past year is due to the performance of the acquisitions:
Financially, what strikes me the most about the company is how despite the acquisition activity and the resulting toll on employee morale which I exposed in section 2.2, the I/S and cashflow profile of the company ($127M in free cash flow during FY 2022) remains quite buoyant. Gross margin has ticked up slightly per the evolving nature of the business, coming in at 46.43%
and OPEX as a % of revenues seems to only be reverting to levels seen before the great shopping spree in 2021, coming in at around 30% for FY2022 - it is definitely not going through the roof just yet.
Coupling the above with the aforementioned growth of operational devices and revenue per device, this does not look like an unhealthy business to me. Further and despite being at a relative nascent phase, the business has been posting a positive net income for a few years:
To contextualize what I mean by nascent, consider my Spotify thesis. SPOT 0.00%↑ has been around for almost 20 years now and has not turned a profit since. However, to the trained eye, it is in a nascent phase - it has been building the basic infrastructure to turn into the Google of audio all this time and is only now getting started with implementing the features and verticals that will turn it into a cash machine.
This playbook is very common in our time - it takes a really long time to build out infrastructures that can then be monetized at a marginal cost and it seems that APPS 0.00%↑ is no different. It has taken them a while to become the go-to platform for ad monetization for phone carriers and OEMs and they now seem to be on their way to add new features to the platform that enable them to really make money: Δ(revenue per device) + Δ(recurrent revenue % of total).
Whether this happens or not remains to be seen and I have only been researching the company for a month (whilst it has taken me years to develop the level of conviction I have on SPOT 0.00%↑ ). However, given the current valuation and the potential prospects of the company, this is looking a lot like an asymmetric play to me.
What seems to be spooking the market out is the apparent revenue-growth slow down, which is quite noticeable when looking at quarterly financials. This goes back to what I explained in section 1.0 - the opportunity comes down to whether you believe the quarterly slowdown will just be a little bump in the road in hindsight or not. Per the fundamentals I have outlined thus far, I tend to think it will be.
Balance Sheet + Cashflow Statement
On a similar note of concern, the company has $520.8M in long term debt and just $126.8M cash in hand. On the other hand, cashflow from operations is actually positive and coupled with its $127M in free cashflow during FY2022, it seems like the company will be fine despite the relatively high debt burden:
The green cashflow from operations seems to coincide with a very healthy and growing revenue per device and generally, I believe we are looking at an asset light, cash rich business in the making. The abnormally high revenue per employee supports this view:
4.0 Conclusion and Valuation
An attractive pick, with far more upside than downside.
My conclusion for now is that the business is likely to do fine going forward and it does not have to do exceptionally for the investment to yield some attractive returns, so long as the human resources issue is fixed. At just around 14 times EBITDA and 2.56 time sales, the business is priced very pessimistically.
Further, the key performance indicators of the company are advancing very well, despite the challenges involved around integrating the numerous acquisitions. The number of operational devices continues growing fast and so does the revenue per device. Meanwhile, I believe the overall demand for digital ads will go nowhere but up in the coming decades.
In turn, the successful integration of the acquisitions has a reasonable probability of translating into an exponentially higher revenue, as customers spend more money on the platform and the company goes beyond smartphones, integrating into smart devices in the long term. The scalability that the company exhibits at this stage is likely to bode well in a potentially exponential future.
In all, an assymetric play that I am excited to track going forward.
Until next time!
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Disclosure
These are opinions only of the individual author. The contents of this piece do not contain investment advice and the information provided is for educational purposes only and no discussions constitute an offer to sell or the solicitation of an offer to buy any securities of any company. All content is purely subjective and you should do your own due diligence.
Antonio Linares makes no representation, warranty or undertaking, express or implied, as to the accuracy, reliability, completeness or reasonableness of the information contained in the piece. Any assumptions, opinions and estimates expressed in the piece constitute judgments of the author as of the date thereof and are subject to change without notice. Any projections contained in the Information are based on a number of assumptions as to market conditions and there can be no guarantee that any projected outcomes will be achieved. Antonio Linares does not accept any liability for any direct, consequential or other loss arising from reliance on the contents of this presentation. Antonio Linares is not acting as your financial, legal, accounting, tax or other adviser or in any fiduciary capacity.
⚡ If you enjoyed the post, please feel free to share with friends, drop a like and leave me a comment.
You can also reach me at:
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Any updated thoughts on the APPS thesis?