Integral Ad Science: New Product Offerings Drive Continued Profitable Growth

seekingalpha10-05

Shares have struggled this year, despite solid momentum in the underlying business.Guidance for the year suggests a 14% year-over-year growth, with an adjusted EBITDA margin of 34%.The primary risks I...

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Thanakorn Lappattaranan/iStock via Getty Images Investment thesis Integral Ad Science (NASDAQ:IAS) offers a competitive product lineup for the digital ad verification market, with its newer offerings in the social media segment gaining significant traction and providing strong cross-sell opportunities to its existing customer base. Additionally, this year’s growth is supported by the influx of new customers resulting from the recent closure of Oracle's (ORCL) advertising business. Adjusted EBITDA margins remain strong at 34%, despite some pressure from lower gross margins and recent hiring increases. With a valuation of 14 times FCF, I consider the company to be fairly valued. While I find its growth and margins attractive, the substantial risks posed by competition and the increasing adoption of AI lead me to maintain a Hold rating on IAS shares. Key insights into the business The company's core products are designed for measurement and optimization within the digital advertising market. The global market for ad verification solutions is valued at over $10 billion and is projected to grow at a rate exceeding 16%. The company collaborates with over 2,000 advertisers to ensure that their ads are viewed by real humans rather than bots, while also guaranteeing that they are placed alongside brand-suitable content. Q2 Investor presentation As shown above, the company derives a majority of its revenue from its optimization and measurement products. Although its publisher revenue is much smaller, it is positioned to benefit from the growing Connected TV (CTV) market. The measurement product segment in particular has performed strongly in recent quarters, growing 17% year over year in Q2. This is mainly due to the growth of IAS's offerings in social media such as its AI-driven Total Media Quality (TMQ), a brand safety and suitability measurement product for video content on platforms such as TikTok and Meta's (META) Facebook and Instagram. IAS consistently introduces new products to the market, including its latest Misinformation product, which ensures that brand ads are not placed alongside content that spreads misinformation. The ongoing release of new offerings aimed at meeting its customer needs has been a key driver of the 116% Net Revenue Retention (NRR) achieved last quarter. The company's success in cross-selling is evident, with an average customer spend increasing by 55% in the second year following the signing of a new contract. Looking ahead: What can investors expect As I stated previously, I continue to expect the company's growth to be driven by the traction gained from cross-selling its newer products, especially in the social media segment. During this quarter, its products have now been adopted for content even on the Pinterest (PINS) and Reddit (RDDT) platforms. Additionally IAS continues to benefit from an inflow of new customers following the closure of Oracle's Ad business, Moat last month. This represents a significant opportunity for IAS, given Moat generated around $300 million in revenue in its latest fiscal year. Investors should closely monitor management's commentary during the Q3 earnings call to gauge IAS's ability to capitalize on these opportunities, as this would serve as a strong indicator of their competitive position in the market. Notably, unlike many of its advertising peers, IAS does not anticipate a meaningful contribution from political spending related to the upcoming U.S. elections. As stated by its CEO at a recent investor conference: We often get asked a question about political advertising, how meaningful is that for your business. It's not material to our revenue. It's actually small from a revenue contribution. In addition to receiving some of Moat's customers, IAS has also hired as many as 20 employees from Moat including Marc Grabowski as Chief Operating Officer (COO), who was previously Global Vice President of Oracle Advertising. This increase in hiring is expected to have a negative impact on adjusted EBITDA margins this year, as guidance implies an adjusted EBITDA margin of 34%, which is the same as last year despite the 14% in year over year revenue growth expected. Another factor affecting adjusted EBITDA margins is the decline in gross margins, projected to be around 78% this year, down from approximately 83% two years ago. This decrease has been driven by increased hosting costs associated with video-related products. Nevertheless, I expect adjusted EBITDA margins to improve by at least 100 basis points next year, driven by my expectation for low double-digit revenue growth and the operating leverage in the business. Given that the company has a low net debt level of $24 million, I expect the FCF generated to be allocated towards share repurchases, mainly to offset the impact due to stock-based compensation (SBC). Valuation At the current share price of $10.4, IAS has a market cap of $1.68 billion, assuming 161 million shares outstanding. With a net debt position of just $24 million, the company's enterprise value is approximately equal to its market cap. Based on management's latest full year adjusted EBITDA guidance of $182 million, shares are valued at an EV/adjusted EBITDA multiple of 9.2. While this valuation may seem attractive given its double-digit growth and strong profitability, I prefer to assess the business based on its FCF generation. Q2 Investor Presentation I arrive at the expected FCF for this year by deducting the annual capex spend from the adjusted EBITDA figure. As shown in the image above, with capex running at close to $62 million on an annual basis, FCF should be approximately $120 million, assuming no impact changes in working capital. Accordingly, shares are valued at a Price/FCF multiple of 14. Its main competitor, DoubleVerify (DV), which is both larger and growing slightly faster, is valued at a Price/FCF multiple of nearly 16. As a result, I believe IAS shares are close to being fairly valued. Furthermore, with annual SBC expenses of $60 million, the valuation becomes much more expensive on a GAAP basis. Risks to consider Competition IAS operates in a highly competitive AdTech landscape, with DoubleVerify as its closest competitor, providing a similar suite of products. As mentioned earlier, Oracle's Moat exiting the market is set to significantly benefit IAS. However, the company continues to rely on revenue-sharing partnerships with major demand-side platforms (DSPs) such as The Trade Desk (TTD), which could itself potentially offer similar services as IAS, bundled with its own platform. Threat from AI The rapid adoption of AI could disrupt the ad verification and measurement products offered by IAS. As advertisers increasingly turn to self-service platforms powered by AI, IAS may encounter significant challenges in maintaining its market position. Macroeconomic weakness Its revenue is influenced by fixed cost per mile (CPM) rates and the volume of impressions. If macroeconomic conditions turn unfavorable, revenue may decline due to reduced impression volumes. However, since a portion of its revenue is based on fixed CPMs, the business is likely to retain some level of resilience. Conclusion  IAS is set to see healthy double-digit growth in the coming years, primarily driven by cross-selling its newer product offerings to its existing customer base. However I find shares fairly valued at a Price/FCF of 14, particularly given the high level of SBC expenses. As a result, I am rating IAS shares as a Hold.","kind":null,"is_publish_news":true,"is_publish_highlight":false,"is_publish_live":false,"is_publish_wemedia":null,"editions":null,"column":"","sentiment":"0","news_tag":"analysis","news_rank":0,"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":"4.29.1","shortVersion":"4.29.1","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/2473923635"}