AcuityAds: This Fallen Angel Has Fallen Far Too Far

seekingalpha2023-05-10

nespix AcuityAds (NASDAQ:ILLM) consists of two major businesses: A Programmatic Marketing Platform that allows advertisers to manage their purchase of online display ads in real time A journey ...

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YCLim
2023-05-11
YCLim
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For 2022, AcuityAds reported a (1%) decrease in revenue year over year to $121 million. That doesn't smell like rot, but it's far from the expectations of investors circa 2021. If you had invested in AcuityAds when they went public in 2017 and held until February 2021, you would have notched a meteoric 700% total return relative to the seemingly paltry return of the S&P 500 at 59.77%. 2021 ILLM vs SPY (Yahoo Finance) The well seasoned among you may have winced at the timing of this - Feb 2021. This was the peak for many a growth stock and the road since has been incredibly rocky. Stocks, at this point, had far outrun even the rosiest projections. Naturally, reality set in. ILLM is down 94.5% from the highs (Yahoo Finance) Since the peak at $25.60 per share, the stock has taken a vertiginous plunge to $1.46 at the time of writing. This story is not unusual. The graveyard for growth stocks of yesteryear is increasingly crowded. So, what? Why should we expect AcuityAds to reverse the ever-present force of downward momentum? The answer is that fundamentals eventually matter. Acuity's core business in AdTech has become subject to the slings and arrows of the broader economy and economic downturns can really harm advertising businesses. Advertising is viewed as a discretionary spend for some businesses and as budgets tighten, ad dollars are one of the first to go. Throughout its life, Acuity has built and acquired a panoply of advertising business which are mostly being dragged down by the economic situation. AcuityAds Significant Events (acuityads.com) Being down 1% should be a badge of honor for a business in this industry right now. It would be hyperbole to say that the core business is rotting. However, the non-illumin adTech businesses of AcuityAds are in a stark decline year over year. The rebirth of AcuityAds all comes from their newest product illumin. Background - What is illumin? illumin can most simply be described as a Journey Advertising Platform (JAP). As a marketer, it can be incredibly difficult to ensure that the right messaging is being sent to your target customers at the right point in the customer journey. The messaging that you want to display differs based on where the customer is in the marketing funnel. For a brand new target customer, I want to display advertisements that create awareness for the product/service that I am offering. Ideally, as the customer becomes more aware of my product/service, I would be able to send them additional ads and push them down the funnel from awareness to interest to purchase intent and even post-purchase re-engagement. The problem for many businesses is that they do not have the scale and sophistication to track these user journeys. This is the gap that illumin solves. Imagine mapping out every possible pathway that a user could take down the marketing funnel and create relevant messaging for each unique part of that journey. By delivering relevant and engaging ads at each stage of the customer journey, illumin allows its customers to establish a stronger connection with their target audience. The product is compelling value proposition for marketers and the company believes that this product is a game-changer for the industry. illumin sales growth (ILLM - 2022 Investor Presentation) This business has been growing and has kept the overall sales at AcuityAds flat despite the headwinds in advertising. As we head into 2023, the revenue mix will shift decidedly towards illumin as it has eclipsed 50% of the business's revenue. Shifting Sales Mix (ILLM - 2022 Investor Presentation) Growing Self-Serve Channel The illumin team has continuously highlighted the progress that they have made through their self-service channel. The company differentiates between two revenue streams: (1) Managed Service and (2) Self-service. Self-service revenue can be more desirable for the business because it does not come with all of the added overhead expense of managed service advertising campaigns. Further, self-service revenues can scale much faster than managed service. To grow revenue in the managed service line of business, additional hiring must be done to grow the team and provide said service. With a self-service approach, revenue can double tomorrow without meaningful overhead expense. “I am most excited by the tremendous momentum of illumin’s growing self-serve component. Fourth quarter self-serve revenue grew 100% sequentially with an 86% increase in new self-serve customers. This rapid revenue and customer growth, our strong self-serve demo pipeline and high rate of conversion to contract, speaks to illumin’s incredible potential. In addition, we recently began an initiative to pursue long-term self-serve contracts, with terms greater than one year and guaranteed revenue minimums. We look forward to sharing our progress on this front as we continue to advance this initiative. - Tal Hayek, Co-Founder and CEO. Growing Serf-Serve Revenue (ILLM - 2022 Investor Presentation) This channel is still relatively small for illumin, but is growing very quickly and is critical to the overall thesis of AcuityAds returning to growth and eventually reaching sustainable profitability. Am I Catching A Falling Knife? On its precipitous decline over the past two years, many have noted that the stock was underpriced. The stock has experienced significant downward momentum and this trend has not showed many signs of an imminent reversal. However, I think we have reached a tipping point. At $1.46 per share, the market value of the equity of ILLM is currently $81.93 million. If we take a look at the balance sheet, ILLM has $63.5 million in cash and a total book value of equity of $76.2 million. The enterprise value of the business has fallen to the low, low value of $25.85 million. ILLM Capital Structure (Seeking Alpha) ILLM is trading at a very minor premium to their cash position. Markets, always irrationally jittering, could drive the price further down. Still, if the stock declines another 30%, then you would be able to purchase a very high upside business for less than the cash on the books. My belief is that calmer minds will prevail and the painful drawdown will stop here. If you are at all convinced about the downside protection provided by the balance sheet, let's take a look at the upside. Management Is Buying Back Shares The cash position has been dwindling, not because of substantial losses, but because management is capitalizing on the low share price. ILLM Repurchases (ILLM - 2022 Investor Presentation) On average management has been retiring shares at $3.08 and has retired over 14% of shares outstanding. We are a long way away from that valuation and they are not getting any credit for the cash deployed into the buyback which will be very accretive in the long term. Management has expressed that they will be carrying out a balanced approach between investing cash in the growth of illumin and repurchases at depressed prices. What's the Upside? ILLM currently trades at an anemic 0.29xEV/Sales. Since the business is still investing through the income statement to capitalize on their first mover advantage with the illumin product, they have not shown robust profitability. In this current market which seems to have changed from a sales focus to an earnings and cash flow focus, it's not all surprising that ILLM has fallen behind its peers on an EV/Sales basis. However, for a business that should get tremendous economics at scale and a 50% gross margin, the EV/Sales multiple currently on the business strikes us as far too low. Let's look at how some similar businesses are being valued in the market. ILLM Valuation Comps (Seeking Alpha) It's important to caveat that both PubMatic (PUBM) and Digital Turbine (APPS) have reached significant scale and are producing a more stable stream of earnings and free flow. In particular, I think PubMatic had a better business model and has historically produced 20%+ net income margins and 70% gross margins. I think ILLM deserves a mild discount to both PUBM and APPS due to its size and limited profitability to date. So what is the right multiple for this business? Even if you could reasonably contest that ILLM deserves a 50% discount to a business like PubMatic, that would still be a 0.96xEV/Sales multiple which implies an enterprise value of $85.6 million, a market cap of $141.62 million, and a share price of $2.52 - an upside of 73% from today's price. With continued growth in the illumin business, you have growing sales and a EV/Sales multiple that should rerate. Risk - How Can I Lose here? There are of course key execution risks with ILLM even with the robust balance sheet that they have. I think the following risks need to be considered:  It is not entirely clear how much of the growth of the illumin product is a result of the cannibalization of AcuityAds' other revenue streams versus true organic growth. If illumin's growth substantially slows now that the business is greater than 50% of company revenues, I would view this as a red flag. The cash balance for illumin is incredibly robust, but they are currently investing aggressively in their buy back and in the illumin business. As the cash balance is invested, the downside protection may erode as well. Competitive pressure may prevent illumin from producing growth or profits in the future. The business competes against established ad exchanges such as The Trade Desk (TTD) and may not have the necessary resources required to compete effectively. Further deprecation in advertising tracking technology is a key risk. Since Apple implemented App Tracking Transparency two years ago, digital advertising has become less effective. Further changes in fundamental technologies that are used to track users such as Google's pending plan to remove cookies could adversely impact ILLM's future growth and the overall effectiveness of their journey based advertising platform.  Further, it should be noted that any business this small has substantial risk. While I think a lot of the risks can be mitigated if the company executes properly on their strategy, it will be important to keep them in mind as the story develops for illumin and AcuityAds more broadly. Conclusion With the limited downside provided by the balance sheet and the high upside provided by illumin and the large market they are attacking, we see ILLM as a very attractive risk-reward proposition. It's like making a venture capital style investment where you can feel pretty confident that you can get most of your principal make if things do not work out. In my opinion, ILLM is one of the best \"heads I win, tails I don't lose much\" propositions in the market.  Editor's Note: This article covers one or more microcap stocks. 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