AppLovin: Reinforcing My Assumptions About A Bullish Business Potential

seekingalpha04-23

AppLovin's 2023 earnings were solid, with revenues up 17% and accelerated growth in the Software Platform Segment.AppLovin is outperforming its competitors in the AdTech industry, with significant ...

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In the article, I describe the market opportunity, strategy, and business model of the company and outline the main challenges. I concluded that there was massive potential with a big market and a good dynamic for the company with network effects. However, I have some doubts about the challenges it faces. Five months after my article about AppLovin, 2023 earnings were released, and the market has been bullish about the company's growth, almost doubling its value. In this article, I will review the 2023 financial overview and check that AppLovin has a sufficient advantage over the competition. After that, I will value the firm with my new assumptions. Solid Financial Results Clearing Doubts 2023 earnings results were solid, especially evolution in 4Q. Revenues were $3.3 billion, up 17%. This revenue growth was accelerated in 4Q, reaching 36% YoY growth. This growth is because the Apps Segment has been losing revenue due to optimizing the Apps in the portfolio. App Segment revenue declined -18% to $1.4 billion. Acceleration in the Software Platform Segment, the other Segment, has been stellar in 4Q, with 88% revenue growth. My interpretation is that this growth confirms that they are capturing the benefits of network effects in its Software Platform. The adjusted EBITDA margin was 46% until $1.5 billion. Almost all of the EBITDA was converted to a free cash flow of $1 billion. This demonstrated the company's good operating dynamics. With a marginal cost, they can capture more than double the revenues with almost no new investment. The business's attractiveness is confirmed to be good. At the time of my last article, there were almost $40 million in insider sales. Later, in 2024, directors and managers bought 842 million shares, balancing a possible massive sell-off from management and directors and clearing some of my previous doubts. Figure 1: AppLovin 2023 Earnings Release Powerhouse Over Competition I will analyze AppLovin's performance relative to that of its competitors in the AdTech industry. We will see that AppLovin is performing much better than its competitors. Figure 2: Seeking Alpha In Figure 2, we can see how AppLoving has grown almost 300% in a year, in contrast to The Trade Desk (TTD), which has grown 26%, and Innovid (CTV), which has grown 118%. We can observe some winners and losers in the industry. I think it is a tough market with economies of scale, and for companies that don't win traction, the market has left them behind. Figure 3: Seeking Alpha This market review is reflected in the ratings (Figure 3), especially Quant ratings. Wall Street analysts are usually too optimistic, which is not a good indicator for a recommendation. SA analysts are more reliable, but it depends on how many analysts cover the stock. SA Quant rating is an excellent indicator to grasp how the company is as an investment. In line with the market, you can see that it doesn't recommend Integral Ad Science (IAS) and Perion Network (PERI), as we'll see later, for lousy performance. The algorithm doubts TTD for being too expensive and Unity (U) for lousy performance. However, my main point is that AppLovins is a lead recommendation for the SA Quant algorithm, SA analysts, and Wall Street analysts. Figure 4: Seeking Alpha Drilling down the Quant algorithm factors (Figure 4), we can see a profitable growth company with the market's tailwind and revisions getting up. Valuation has a mixed rating for the algorithm; later, we will find out why. Figure 5: Seeking Alpha AppLovin's revenue is not stellar at 16.5% YoY, but you must consider that they have been restructuring its Apps Segment, which I expect to stabilize. If you think of the Software Platform Segment, it is growing at a spectacular 58% in 2023, which is not reflected in Figure 5. The company's operating leverage is evident, with the EBITDA growth YoY at 115.8%, another positive attribute of AppLovin. The bottom line, leveraged free cash flow, is solid at 29% but could be better, as you can see in TTD. IAS and PERI stand at 41% and 81%, respectively, but those companies must be explicitly analyzed. Figure 6: Seeking Alpha In Figure 6, you can see that AppLovin is very profitable. The EBITDA margin is 35%, which is an excellent value. Concerning capital, Return on Equity is the best at 22.6%, even with Return on Assets at 12% (AppLovin has a high leverage, 59%). One indicator that I like to observe in a software company is Revenue per employee, and Applovin is a leader in this indicator, too, at $1.9 million per employee. AppLovin is in a solid position concerning competition based on the fundamentals supporting its business model (growth, profitability…). Valuation I will value AppLovin using a discounted cash flow methodology. First, I will project the value drivers: revenue growth, adjusted EBITDA margin, tax savings for non-cash items, and investment in net working capital and CAPEX. Then, I will discount the resulting free cash flow at an appropriate discount rate. As I have said, revenue grew 17% in 2023 due to a great Software Platform Segment (Figure 7) and an underperforming Apps Segment. Once the Apps Segment is optimized, its overall revenue won't drag in. So, I expect revenue to grow more than 20% over the ten years on which my valuation is based. This expectation is based on the analysis in my former article about AppLovin, which states: \"In practical terms, AppLovin has a reach extending to 3.5 million apps, actually overseeing an ecosystem that includes the management of 140,000 apps. Notably, gaming apps constitute 12.5% of the total market, amounting to 455,000 apps. AppLovin's presence accounts for 4% of the entire App market and holds a significant 30% share in the gaming market. This estimation is based on my assumption that 90% of the apps managed by AppLovin are related to gaming. Digital marketing spending is experiencing a robust growth rate of 21% annually. Additionally, there is a notable shift towards increased programmatic ad placement, with an additional 2 percentage points observed.\" Figure 7: AppLovin 2023 Annual Letter to Shareholders At the same time, the adjusted EBITDA margin will improve as the margin of the Software Platform Segment grows and the margin of the Apps Segment stabilizes. Tax savings will be a stable 26% over revenue, and investment will be -6% for networking capital and 0% in CAPEX. Free cash flows will be discounted at a WACC of 13% due to a beta of 1.9, 12% debt over total capital, and a risk-free rate of 4.5%. As shown in Figure 8, my estimate of value of $131.5 per share is a 97% premium over its current stock price. This valuation means a free cash flow yield of 4.7%; in 5 years, it will be 14%, which is an excellent yield for me if growth expectations are obtained. Figure 8: Author Risks The main risk for AppLovin is TTD competition. As I described in my previous article, AppLovin enjoys the benefit of network effects, but if the ad market is prone to having just one company, the scale of TTD will beat AppLovin. Another risk is that the App Segment could be unmanageable. Currently, AppLovin is managing two different businesses with its two segments. Managing two businesses for a small company such as AppLovin is very hard. If that happens, AppLovin would have to sell the business, worsening the growth trajectory described in the Valuation section. If those risks were to become a reality, not only would revenues be harmed, but margins would suffer as AppLovin would invest more capital to acquire customers, even if it would be hard to attract them as before. So, I model those risks with two variables. The first variable is set at zero and will model percentage point variation over the base revenue in the Valuation section (Figure 9). I will use a Lognormal Distribution with a location of -5% as the representation of the maximum revenue declines. If the Applovin business is threatened, it won't be easy to beat for its current strong position so that the maximum loss will be 5% annually. Over the ten years of the analysis, there will be a stiff decline in revenue, but it won't be too much year over year. Figure 9: Author The other variable is similar but will measure the variation over the Adjusted EBITDA margin. This variable is identical to the former, as shown in Figure 10, but the maximum decline in margin will be 3%. Figure 10: Author Then, I run the DCF model, and the model's output is the stock value. Figure 11 reflects the cumulative probability of the stock value, a sensitivity graph showing the different ranges of stock value based on each of the other growth rates, and an Adjusted EBITDA margin with the variables I have just described. The first conclusion is that the probability of getting a value greater than my base stock value of $131.5 per share is 40.5% (the blue area), so the risks I have described will give a lower chance of getting that value. Figure 11: Author As shown in Figure 12, the probability of getting a value greater than the current stock price at $66.8 per share is 70%, assuming the rest of my above assumptions and inputs for the DCF. Figure 12: Author In conclusion, given my assumptions for the risks that face AppLovin, it would have a value greater than the current stock price, with a probability greater than 70%, and more than the value I have estimated, with a probability greater than 40%. So, AppLovin has a nice risk-return premium that meets my standards. Conclusion  After addressing my concerns, checking for warning signals, and comparing with the competition, I estimate a $131.5 per share, a 97% premium over the current stock price. Modeling the risks AppLovin faces, I foresee a 70% probability of increasing its value, changing my recommendation from hold to strong buy.","kind":null,"is_publish_news":null,"is_publish_highlight":null,"is_publish_live":null,"is_publish_wemedia":null,"editions":null,"symbols":[],"gpt_button":1},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":0,"commentSize":0,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":true,"deviceId":"web-server-community-laohu8-v3","version":"4.22.4","shortVersion":"4.22.4","platform":"web","vendor":"web","appName":"ttm","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/2429979250"}