Not So Deep Dive: Digital Turbine Stock
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Show Notes
(Ryan) What they do: Digital Turbine is a software provider that essentially sits between device manufacturers and brands or app creators. There are several ways that they do this, but the overarching goal is to get non-iPhone users to download apps per their recommendation. And obviously that’s something brands are willing to pay for. Let’s go through their different products:
On Device Media (ODM) - aka Ignite: This is what Digital Turbine is most known for and it accounts for 65% of the company’s overall revenue. This is an advertising platform that comes pre-installed on handheld devices by top carriers and OEMs (Samsung, LG, etc.) and it allows users to install relevant apps on their new phones when they first activate them. So in my mind, this is kind of a win-win-win scenario. Users get easy installation on apps they’d want, Digital Turbine is paid by the app owner once a user installs, and then Digital Turbine pays out a portion of that money to the service provider. There are several ways DT makes money on this (1. Fee for installs, 2. Revenue when a user clicks on the app, or 3. A fee for some sort of action in the app).
In App Media: But DT is also trying to become more integrated into the software on these phones beyond just the activation phase, and they’ve done that through essentially 2 other products, SingleTap and Folders. SingleTap is a feature that allows users to install an app from an in-app link without having to go through the app store. These work on display/banner ads, video ads, or app recommendations (it’s integratable pretty much anywhere). And folders is a product where when users group their apps together, DT is able to offer recommendations for new apps to be included in that folder.
Those are the 3 main products, but they’ve also been acquiring some other businesses lately. In 2021, they acquired both Fyber and AdColony. From what I can tell these two businesses are very similar and they are essentially mobile advertising marketplaces. So they have relationships with say Candy Crush, and advertisers come to them and want to put video ads on candy crush. Fyber or AdColony could make it happen. And now they have the ability to leverage DT’s SingleTap technology.
(Ryan) History: Very limited history on the company and it seems a little suspicious frankly. From what I could find, the original group was founded in 1998 and was called eB2B Commerce Inc, but they eventually changed their name to Mandalay Digital Group. Between ~2000 and 2014, the company tried to reinvent itself several times and would raise equity after it did so successfully. Around 2012, Bill Stone joined the company and in 2014 he was promoted to CEO. At that time the company was essentially just an ad agency business, but the biggest reinvention came in 2014 when they signed a deal with Verizon to pre-install apps on its phone. Since then they’ve stuck with that business struck deals with tons of other carriers. They also have a long history of acquiring companies using their own stock. Share count is up about 1,400% since 2012.
(Brett) Industry/Landscape/Competition:
Digital Turbine operates in the mobile advertising industry. There are wide ranging estimates on how large the industry is (don’t know how that could really be possible), but we’ll go off of the estimates from Digital Turbine’s Investor Presentation
In 2021, mobile advertising was estimated to be at just under $400 billion. By 2025, this is expected to grow to over $600 billion in annual advertising spend
Digital Turbine itself expects its TAM to be $500 billion by 2025. So, given the size of their business, you don’t need to worry about the market opportunity. It is all about winning the spend from advertisers.
Competitors: Three sets
First, are the legacy walled gardens in Google and Facebook (plus anything else they own). Given its important relationship with Android/Google, this frenemy dynamic will be important to watch for.
Second, are the other applications where people might want to spend on mobile advertising. This includes places like Snap, Twitter, Spotify, etc. However, given their expansion into DSP/marketplace, they actually want to work with these applications to improve advertising capabilities and get a cut of the action.
Third, are other advertising technology companies that are not walled gardens. The Trade Desk, Pubmatic, Magnite, Unity, all of these can be included here. Essentially, any company that is working with advertisers/publishers to make mobile advertising work successfully is a competitor to Digital Turbine.
(Brett) Management and Ownership:
CEO: Bill Stone. Been with the company since 2012 and has been CEO since 2014. He has worked many decades in the telco/mobile applications market, so you can see why the company brought him in as an outsider to run this business. He is 53 years old. Base salary $575k, $2.23 million in total compensation that has been rising quickly since 2019.
CFO: Barrett Garrison. Been CFO since 2016, overseeing gross profit per share increase from less than $0.25 to $3.57 today (TTM).
Executive compensation philosophy (from last year’s proxy, this year’s is not out yet)
Fixed base salary not tied to any performance
Focus on long-term equity awards instead of cash bonuses
Equity awards based on revenue and non-GAAP adj. EBITDA
“Performance vesting LTI stock units are to be contingent on achievement of three year revenue and adjusted EBITDA goals”
New stat: Executive compensation was 3.3% of gross profit in 2021
Share count has gone from around 86 million at the end of 2019 to 98 million today. 7.1 million in options outstanding as of EOY 2022. 373k RSUs.
(Brett) Valuation:
Market cap of $1.77 billion, ticker APPS
Enterprise Value of $2.18 billion given high debt load
TTM EV/GP of 6.3
TTM EV/FCF of 35.5
From analyst day: Long-term target of 25% - 30% revenue growth, with EBITDA margins expanding to 25%. Given their business model, this could translate to ~15% - 20% FCF margins
(Ryan) Earnings:
FY 2022 revenue was ~$748M, up 138% YoY (up 41% YoY)
46% gross margins
$92M in operating income (12.3% operating margin)
Earnings before taxes was about $44M (6% EBT Margins), up slightly YoY
The majority of the difference there was a $41M “change in fair value consideration” associated with an earn-out as part of the Fyber acquisition.
They generated $85M in OCF for the year, up 35% YoY
Typically true capex (purchases of property and equipment) is pretty light. However, they paid out about $150M to acquire the two businesses I mentioned
However, they also had this line in their cash flow statement. $303M charge for payment of deferred business acquisition consideration. Which leads right into the balance sheet
(Ryan) Balance sheet and liquidity: (page 94 of the 10-k)
On Apr. 29th of 2021 (which was in this fiscal year) DT amended a credit agreement that it had with Bank of America, which allows them to access $400M worth of additional credit on top of its already existing $300M. Then they eventually went on to add an additional $125M in December, totalling $866M of available credit to withdraw. “Revolving credit line”
The interest rate on this line of credit is variable. There are some different interest rates they can pick from but it will likely be the LIBOR rate + 1.5%-2.25%. This is risky if rates rise.
Typically, these sit idle unless a company really needs it. But this year, DT drew down a big chunk of it.
DT now has $533M in total debt on its balance sheet, with about 98% as LT. This credit line matures in 2026.
They only have $127M in cash and cash equivalents. So basically, the majority of their cash flow is going to be paid back to debt holders over the next several years
Anecdotal Evidence:
(Ryan) I’ve read some blogs online that referred to Digital Turbine as “bloatware”.
(Brett) Seem like fine services. The pre-load stuff is a bit spammy but besides that everything else feels like standard internet stuff. In-app mobile game monetization could really use some improvement
Future growth opportunities:
(Ryan) Appreciate acquisition. Appreciate (aka Triapodi Ltd.) is a programmatic mobile DSP. So, similar to their other acquisitions, but much smaller. $22.5M in cash. It seems like this is their strategy right now. Buy up a bunch of advertising marketplaces for the relationships they have with different advertisers and leverage their SingleTap tech.
(Brett) SingleTap install. This is a new-ish product where mobile apps can advertise across various places on mobile devices and allow users to “single tap” install. This is prosperity given their relationship and software on the mobile devices, so it is unlikely any other ad-tech company can copy it. Management believes it is a $1 billion revenue opportunity business.
Highlights and lowlights:
(Ryan) Highlights: Their click-to-install rate is higher than other advertising locations, which makes their platform more valuable. I also think this bodes well in a recession as theoretically it should be the last to go on a marketing budget. Lowlights: Very dependent on their relationship with the big carriers. They didn’t give out a specific number, but it’s just a function of being a middleman in the mobile phone market. Per the risk factors, “A significant portion of our revenue are currently being derived from a limited number of wireless carriers and customers”. The CEO also bragged about growing at a 180% CAGR over the last 4 years during the CC, without mentioning all the acquisitions. Also, they had to restate their financial results in May, currently being investigated for it. https://www.otcdynamics.com/apps-digital-turbine-inc-investor-news-robbins-llp-is-investigating-digital-turbine-inc-apps-on-behalf-of-shareholders/?utm_campaign=twitter&utm_medium=twitter&utm_source=twitter
(Brett) Highlights: Locked-up partnership with Google/Android, solid unit economics that should scale + no capex, competitive advantage vs. other mobile ad-tech services with OEM/Telco relationships, management seems to want to stick around, acquisitions make a lot of sense to level-up and become competitive with the big dogs. Lowlights: Customer concentration in a variety of forms (although this could be flipped to positive - DT’s customers cannot do what they do), financing acquisitions with the variable interest rate debt. Surprisingly found minimal lowlights for a smaller business like this.
Bull Case:
(Ryan) Brett already put some numbers on it, but in terms of drivers, there are pretty much two important factors. Grow the number of devices that their software is on, and increase the revenue per device by integrating these additional features with each carrier.
(Brett) They achieve or get close to what was outlined in the Investor Day. If they hit $1 billion in EBITDA that should translate to good amount of free cash flow, they will easily be able to pay down the debt, and they can generate entire current market cap in cash a few years later.
Bear Case:
(Ryan) Advertising budgets falls off a cliff and them with it. Or they make poor acquisitions with the capital at their disposal. There isn’t necessarily a high floor here. Especially now that they’re quite levered.
(Brett) The “competitive advantages” they outlined do not materialize in market share gains, and the mobile ad market falls flat if we hit a consumer-driven recession (less consumer spending = less ad spend). There’s also a smaller interest expense risk if interest rates move materially higher.
More or less interested?
Disclosure: The author and podcast guests are not your financial advisors. Ryan Henderson and Brett Schafer are general partners and portfolio managers at Arch Capital. Clients of Arch Capital may hold securities discussed on this show.