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.

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

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%.

The ad-tech market appears well positioned to continue to do well going forward. Find out which stocks the I/O Fund will be watching heading into Q3 earnings in our Q3 Stock Earnings Preview - What to Expect for 7 Ad Tech Stocks.

Bradley Cipriano and Royston Roche contributed to this article.

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