Chit Chat Stocks - Digital Turbine Revisited (APPS) | Not So Deep Dive

Episode Date: July 5, 2022

Digital Turbine operates a mobile growth platform that connects mobile applications to users. The company operates through two segments: On Device Media and In App Media. Listen closely as Brett and Ryan go through the history, financials, and future prospects of Digital Turbine. Enjoy the show! This episode is sponsored by Potential Multibaggers. Multis are looking for stocks that have the potential to go up 10x in 10 years. Check-out the service here: https://seekingalpha.com/checkout?service_id=mp_1308  Want updates on future shows and projects? Follow us on Twitter: https://twitter.com/chitchatmoney  Contact us: [e-mail]  Timestamps  Company Background | (3:00)  Industry | (13:00)  Management & Ownership | (16:32)  Valuation | (21:43)  Earnings | (22:55)  Balance Sheet | (25:22)  Our Analysis | (28:36)  Disclosure: Chit Chat Money hosts and guests are not financial advisors, and nothing they say on this show is formal advice or a recommendation. Brett Schafer and Ryan Henderson are general partners and portfolio managers at Arch Capital. Arch Capital and its partners may hold securities discussed on this show. Learn more about your ad choices.  Learn more about your ad choices. Visit megaphone.fm/adchoices

Welcome to Chit Chat Money. On this show, host Ryan Henderson and Brett Schaefer interview industry experts and riff on the world of investing. As a quick reminder, Chit Chat Money is a CCM Media Group podcast. Ryan and Brett are also general partners at Arch Capital, and Arch Capital may have positions in the securities discussed in this podcast. Anything discussed on Chit Chat Money by Ryan or Brett or any other podcast guests is not formal advice or a recommendation. Now, please enjoy this episode. Welcome in. This is the Tuesday Not-So-Deep-Dive episode on Chit Chat Money. This is the show where we go over the basics of an individual stock in about 40 to 50 minutes. And then on

this week's show, we're going to cover the history, financials, future growth opportunities, bull and bear case, everything you need to know about Digital Turbine, a small cap advertising and mobile solutions company, as they call themselves. They have some great consulting names for a lot of their products, which Ryan will get into, and it can be quite confusing. We're going to try to simplify that process for you. Ryan, how was researching Digital Turbine? Tough, a lot of weird names for all their products. Yeah, they were like in the process of restructuring how they want to think of the business

because they've made acquisitions recently. So it was kind of hard to like construct it in a way that's easily digestible for listeners. But I think I got it. I think I did a decent job. And we got a lot of pro forma results, all that good stuff. I'm gonna let Ryan introduce the company.

But first we need to talk about our sponsor for this Not So Deep Dive episode. and that is Potential Multibaggers. The aim of the Potential Multibaggers service is to find stocks that can go up 10X over the next 10 years or compound at 26% per year. Potential Multibaggers picks high growth stocks to hold them for a long period of time. If this is your style of investing, which I believe overlaps a lot with our show, this is the perfect service to help with your research process. Of course, they had to continue performing to hold them. So Chris and the team behind them continually updates their research on the companies. They're not afraid to admit when

they are wrong. Buy and verify approach. That is what they call it. Exactly. And they do deep research about the companies they hold. For every pick, you get five different articles together at over 20,000 words to spread out and help with your research process in identifying what companies you want to own. So if you want to become a multi and join the potential multibagger service, you can go to Seeking Alpha and look for From Growth to Value. Google it or go to at From Value on Twitter. The link is also in our show notes. All right, Ryan, introduce Digital turbine yeah digital turbine is a software maybe yeah i'll say software provider that essentially sits between device manufacturers or uh mobile phone carriers so think verizon at&t and then

for some of the little guys it's they they for some of the little carriers they have to focus more on the device the actual oems the original equipment manufacturers which happens to be like the Samsung and the LGs of the world. And so, they sit between them and then brands or app creators. So, there are several ways that they do this, but the overarching goal is to get users of those devices, which is basically everything that's non-iPhone, to download apps thanks to the Digital Turbine recommendation. And obviously, that's something brands are more than willing to pay for. So I'll kind of go through the different products. The first one, this is what they're primarily known for. It's called on-device media. The product that they have is actually called

Ignite. So if it's referred to as either one of those, just think on-device media. This makes up 65% of the company's overall revenue. And it's an advertising platform that comes pre-installed on handheld devices by top carriers and OEMs. And when I say OEMs, Think Samsung's LGs, that's the manufacturers. And it allows users to install relevant apps on their new phones when they first activate them. So in my mind, this is essentially a win-win-win, right? As you're getting ready for the installation process or in the process of installing or activating your phone, users get apps based on different information about that user recommended to them that are relevant apps they might want.

Digital Turbine gets paid by the app owner once a user installs or clicks on that app. There's different ways that they get paid for that. And then Digital Turbine pays out a portion of that money to the service provider. So, service provider wins, Digital Turbine wins, brand or the app provider wins, and so does the user. Now, explaining what is the service provider, because I think some people might be confused if they're listening to this. The carrier. Okay. Or in some cases, it also goes to the manufacturer.

So that was a part that I had a little bit of difficulty understanding because the relationships vary depending on who sort of has negotiating power. So some of the small carriers don't have as much negotiating power. So Digital Turbine goes through the OEMs. I think simplifying it, think revenue share with all their partners that they're trying to provide value to. Well, except for the advertisers, obviously the advertisers are paying them. Right. And so when Digital Turbine recommends a relevant app to a user, they can make money in a few different ways, but there's basically three ways. So one, just a straight up fee for installs. So if the user installs it, Digital Turbine collects a fee from the app. Two, revenue when a user clicks on the app. So that's more targeted, probably more costly. And then the third one is a fee for some sort of action within the app.

So think they had to deal with Netflix where every time there's a subscriber or a new subscriber through them, they get a portion of that. So that's the various ways that they can collect revenue. However, they've been trying to become more integrated. They've been trying to diversify away the revenue streams purely from that one process or product to being more integrated within the software of the phone on other services. and they call this part the in-app media. So this goes beyond the activation phase and essentially into two other products, single tap and folder. So single tap is a feature and they talk about this a lot. Single tap is a feature that allows users to install an app from an in-app link. Let's say there's like a banner ad or something like that. You can click on the banner ad.

You can instantly install that app without having to go through the app store. And so these work for display ads banner ads video ads basically it's integratable i don't know if integratable is a word but it can be integrated into various different places on in-app media if that is that am i describing that in a way that makes sense it just i think you just need to simplify and say it's advertising in-app and they're trying to go from less one-time revenue from install like setting up phones to more recurring revenue with their customers um both the users of phones advertisers and publishers who want to either find more customers or monetize their stuff they want to increase that relationship and especially because they already have a lot of relationships

with these publishers like a zynga like uh well any other app you can think of that wants to monetize through advertising and all right another part of the value in this is let's say you're starbucks and you want to run an ad with digital turbine where it's single tap and it's maybe me a display ad and someone's, let's use not Zynga, but maybe a Washington Post or something like that. It's a display ad in a newspaper. You can get with single tap, they don't go to the app store and see all the other alternatives. They instantly install it without having to explore. So it's kind of more, there's just less steps in that process, which makes the advertising inventory more valuable. And then the other product that they work on is called

folders so this is where and i'm sure a lot of iphone or any anyone's smartphone users probably do this they group their apps together digital turbine is able to offer on a few of their different carriers is able to offer recommendations for new apps to be included in that folder so let's say you've put together a streaming folder they can offer you hulu if you don't have that yet something like that um and then they're so those are the well they have like 12 products but that's the you know they in the last conference call he said uh bill stone said they're trying to groove it into three two different categories or categories sure sure but they said they have just not too confusing they have a lot like dozen plus different products

for customers and the uh but they've also been acquiring just ad marketplaces lately so it's not just they that's i guess another pillar of their strategy so the two that they i guess the three that they recently acquired are fiber ad colony and appreciate um and they all run fairly similar models their basic mobile programmatic advertising marketplaces so they connect um either demand either uh other demand side platforms or advertisers with publishers like brett mentioned as Zynga, something like that. And they are essentially acquiring them and using or leveraging single tap to kind of enhance the value that they would provide to an advertiser. That seems to be the strategy right now. Well, yeah. And just, I forget even which one of these was just a DSP

and one was with an advertising marketplace, but think there's when, when someone's advertising on mobile, they want to connect the advertiser to the publisher beforehand, digital turbine had to go to third-party marketplaces, some of them, these acquisitions that they've made, now they're trying to make it so basically if you want to go from advertising all the way to the publishing part, publishing the ad on a mobile app, you just have to go through Digital Turbine. And in fact, some of the other ad tech players like the Trade Desk and Pubmatic will be using in a small part because Digital Turbine is very, very small, the marketplace.

place. So I think hopefully that gives a good illustration of what the business basically provides. But the history was really hard to get any sort of a grasp on. And I actually found it a little bit suspicious. So from what I could find, the original group was founded in 1998 and they were called eB2B Commerce Incorporated, which sounds like the most typical dot-com name I've ever heard. But the company tried to reinvent itself several times after that. They changed their name to Mandalay Digital Group. They may have even had a name change in between there as well. But around 2012 is when things started to pick up. So they hired Bill Stone. He became the CEO in 2014. And at the time they were basically just a typical advertising, just another advertising

marketplace. However, in 2014, they signed a deal with Verizon, which allowed them to pre-install apps on its phones. And that's really when things picked up. The stock pretty much doubled, I believe in like the matter of two weeks. There were a lot of skeptical articles written at this time that i could find uh and but it worked a lot of equity the only gripe with the only gripe i have with their history is that they would try to reinvent themselves and then issue equity which feels sort of like a grab for money so the share count has uh increased 1400 percent since 2012. It's that's been also obviously attributable to a lot of the acquisitions. They made one in 2014, 2015 for 33% of the company. And then they've obviously made other ones since a lot

of those are stock deals. So we'll get to not recently. We'll get to that. I think later in the show, maybe some gripes with the credit facility, but, but yeah, sorry. Anything else? No, that's about it. I think they went, it was hard to get a timeline on the IPO, but they officially became Digital Turbine in 2014. Yeah, essentially Bill Stone is the founder and you can see why he decided to go in that direction. He was kind of a perfect fit when it gets to management and ownership, but let's hit industry competition. Digital Turbine operates in the mobile advertising industry. There are wide range of estimates on how large this industry is. I don't know really how they can have these wide of ranges, but that just shows us third-party marketing statistic places are not that reliable. We can give you a vague grasp of how large an

industry is, but we're going to go off their investor presentation. In 2021, mobile advertising was estimated to be at just under $400 billion. I think the big takeaway is that it's a huge industry. And by 2025, this is expected to grow to over $600 billion in annual advertising spend. Now, don't put that in the bank because if we go into recession through the next few years, I doubt mobile advertising will be $600 billion. But either way, when the economy is growing, it is typically over the last, say, 15 to 20 years grown at a much quicker pace than overall GDP. Now, Digital Turbine itself expects its TAN to be about $500 billion by 2025. So their total addressable market, $500 billion.

Again, that's just really, really large. And given the size of their business right now, which we'll get to in the earnings, you don't really need to worry about the market opportunity. It's all about winning the spend from advertisers. Now, that comes into the competition. And when looking at them, it's a bit weird because they have some frenemies. They have some competitors that they actually work with. so i put them into three sets first are the legacy walled gardens and google and facebook

plus anything else google and facebook own now these are the vast majority of mobile advertising spend as we know by the giant top lines of these companies and given its important relationship now it i mean digital turbines important relationship with android google this frenemy dynamic will be important to watch out for now they did sign a long-term agreement with Google back in late 2021. So that is a good sign. But still, the relationship with Android, who is owned by someone they compete with for mobile ad dollars, is something to, I think, consider maybe before making an investment. Now, second group are other applications where people might want to spend on mobile advertising. This would include Snap, Twitter, Spotify, etc. Lots

lots of other smaller ones. However, given their expansion into the DSP, which is demand side platform and the marketplace stuff that they acquired, they actually want to work with a lot of these applications now to improve their advertising capabilities and get a cut of that action. So again, it's a bit of a frenemy dynamic. They're just trying to get a revenue share of a lot of that ad spend. And then third, their other set of competitors are other advertising technology companies that are not Walt Gardens. This would be the Trade Desk, Pubmatic, Magnite, even Unity, I guess, is big for monetizing mobile games for their developers, the people that use their platform. All of those companies can be included here. Essentially, any company that is working

with advertisers or publishers to make mobile advertising work is a competitor to Digital Turbine. But like we mentioned before, some of these companies have to work with some of Digital turbines products, um, like their marketplace, uh, DSP, a demand side platform might be working with that. So it can be a bit confusing, but I think, um, it's a very competitive industry with lots and lots of large, well-capitalized companies. Now let me move to management and ownership CEO, as Ryan mentioned was Bill Stone. He's been there since 2012 and has been the CEO since 2014. Now why I mentioned that he was kind of a perfect fit is he has many decades working in the telecom and mobile applications market. So you can see why they chose him as an outsider to run the

business. And you can see why they pivoted to these mobile app installs, because I think he had a great grasp of what Verizon and AT&T couldn't do and what sort of value they could provide with their software and getting that advantage of having that software installed on the manufactured devices. He is 53 years old. His base salary was a relatively, I'd say, average $575,000. And then he had $2.23 million in total compensation that has been rising quite quickly since 2019. However, I think that makes sense given how fast Digital Turbine has grown. CFO is Barrett Garrison. He has been the CFO since 2016, overseeing gross profit per share increase from less than $0.25 to $3.57 today. So very impressive growth overseen by Garrison here.

And then let's look through. I want to hit on their executive compensation philosophy. It's pretty standard, although there is some things in here that we ourselves do not like. And I'm looking at last year's proxy because their fiscal year ends in March and the proxy is not out yet. They have a fixed base salary, not tied to any performance. That's that $575,000 for Stone. They have a focus on long-term equity awards instead of cash bonuses. And their equity awards are based on revenue and non-gap adjusted EBITDA. Now that's the big thing. And it's very common, but equity awards based on non-gap adjusted EBITDA, where you're X-ing out the stock-based compensation can be a bit of a loophole for executives to get paid a lot of stock when

they're not actually creating true value for shareholders. But that's a whole conversation for another day. Either way, they're not getting paid too much here where it's a big deal. Now, here's a quote from the proxy statement to kind of get a grasp on how they do it. Performance investing stock units are to be contingent on achievement of three-year revenue and adjusted EBITDA goals. So fairly long-term goals. They're not just getting paid willy-nilly here. But again, adjusted EBITDA is not the best performance metric.

And now I want to give in a new stat here that I think I'm going to use for management and ownership, and that is gross profit as a percentage. or sorry, executive compensation as a percentage of gross profit. I think this is a great measure to see how much a company is paying its executives as a percentage of, say, the profits it could be generating. And digital turbines in 2021, fiscal year 2021, which ended last March, was 3.3%. So fair amount, but not an egregious one. And then lastly, share count has gone from around 86 million at the end of 2019 to 98 million today. And they have 7.1 million options outstanding as of end of year 2022. That's March 2022 compared to 98 million shares outstanding. So definitely

expect share count to continue to rise. Any comments or questions, Ryan, on management and ownership? Well, not on the management and ownership, but it's a good time to talk about the shares outstanding because they have had a combination of not all their acquisitions are the same they don't necessarily have like a blueprint for choosing to do it in all stock deals or all cash deals but they also have um like so their fiber one was really big it was a 600 million dollar deal 400 million of which came in stock in the form was it are you sure i'm looking at it right now 400 million dollars in payable payable in shares of digital turbine and $150 million in cash additional earn-out payment.

And they also, that is a big feature of their acquisition is they have earn-out clauses. The one that they did with Ad Colony was a $150 million to $175 million earn-out on a $350 million acquisition. So they incentivize them to stick around and continue to perform after they're around because they give them these giant bonuses

if they're able to do that. And that one was cash, right? That one was cash, but the bigger one, which was fiber, was essentially $450 million in stock. Okay. All right. Yeah, that makes sense. But at the time, Digital Turbine stock had gone into that bubble phase of the small cap kind of growth market. And it's honestly, it's great that they use their stock to acquire.

For shareholders, maybe that bought then, it's not great, But I think it's great that they use their stock a little bit aggressively, but given we'll hit the balance sheet with Ryan, but given that they took out a lot of debt to do some of the acquisitions, I maybe would have some gripes with them not using their stock when it was trading in like, I believe, 50 times gross profit. It's for you. Credentials to advance, confidence to stand out in your career. At Regent University, you'll join more than 30,000 world changers making a difference in high demand fields. pursue your bachelor's master's or doctorate online or on campus in virginia beach your degree from top ranked regent university is waiting so is the world you will elevate say yes to your purpose and position yourself for a brighter future visit regent.edu learn more regent.edu learn more but either way let's move into valuation now market cap 1.77 billion dollars

ticker is APPS, so apps. Enterprise value, $2.18 billion, given their high debt load. And I just have two metrics here that I think are the most important ones to track for Digital Turbine, and that is trailing 12-month enterprise value to gross profit and trailing 12-month enterprise value to free cash flow. Enterprise value to gross profit is 6.3, and enterprise value to free cashflow is 35.5. From their analyst day, which was in November, 2021, their long-term target is for 25% to 30% revenue growth with EBITDA margins expanding to 25%. Given their business model, this could probably translate to about 15% to 20% free cashflow margins because they are capital light. I just want to give that reference there. You can watch

the investor presentation if you want all the details, but that was one of the main takeaways besides that vertically integrated stuff that they're working on. And they really expect themselves to continue growing revenue, gross profit at a high rate, along with getting solid operating leverage. All right, Ryan, you want to hit earnings? Yeah. And I'll also say they're on the all ticker team. Apps is top notch ticker. Maybe one of the best I've seen. Well, Wolf. Wolf is good. Yeah, Wolf started to beat. Yeah, I'll hit the earnings.

So their full year revenue for 2022 was $748 million. That was up 138% year over year, but that was inorganic. So on a pro forma basis, that means all the businesses, what their actual growth was individually, well, in aggregate. If the acquisition started at the beginning of the fiscal year. Right, was 41%. So that's sort of the organic growth figure. And then 46% gross margins. Like I said, there's a large chunk of their revenue that has to get paid out to the service providers, those carriers that I was talking about. And then they had on

that $748 million in revenue, they had $92 million in operating income. So that came out to about 12.3% operating margin. Their earnings before taxes was about 44 million. So 6% earnings before taxes margin, which is about half of their operating margin. The majority of the difference there was a $41 million change in fair value consideration associated with an earn out as part of the fiber acquisition. So they do their financial statements. And I think you'll hear it in how we throughout the rest of this episode, they get tricky because of all the different acquisition clauses and all the different earnouts. Watch out for those non-cash charges and watch out for those liabilities on the balance sheet. Those, you know, just watch out for them,

see where they change. But they generated about $85 million in operating cash flow for the year. So they do generate cash on an operating basis. However, they've used a lot of that cash to make acquisitions and their operating cash flow for reference was up 35% year over year. Typically they don't have a lot of capital expenditures, like true capital expenditures in the form of like property and equipment purchases, because they are a fairly asset-like business. But they spent, they paid about $150 million to acquire the two businesses that I mentioned before, or the three businesses. And then they also had a line in their cashflow statement that said $303 million charge for payment of deferred business acquisition consideration.

That leads me right into the balance sheet. On April 29th of 2021, which was this fiscal year, Digital Turbine amended their credit agreement that it had with Bank of America, which allowed them to access $400 million worth of additional credit on top of its already existing $300 million. and they eventually added to that another $125 million totaling, sorry, I'm going a little long-winded here, $866 million of available credit to withdraw. Simplifying it, I think they use their credit facility to fund the growth they want to do. I think that's the big takeaway, right? Right. And for anyone who isn't familiar with the terminology and we're not the best experts at it, but this is your revolving credit line. If you see that, I always find it funny when people say they pulled their revolver, like it sounds like a Western shootout. But this is a revolving credit line that they have with a bank or a group of lenders. And the interest rate on

the line of credit is variable. So there are some different interest rates that they can ultimately pick from, but it'll likely be the LIBOR rate. So the London Interchange, I'm blanking on what the acronym is for. It's LIBOR what? LIBOR plus what? Plus one and a half to two and a quarter. And it depends on their leverage ratio. So it's a little bit of a complicated variable rate. But basically if interest rates rise, their payments are likely going to rise. Sorry, their interest expense will rise all else equal. Yes. And this year it came out to their interest rate was about 2.6% when you include their fees associated with your undrawn credit line. So if you don't draw it, you have to pay a fee annually. So that plus their interest rate ended up being

about 2.6%. Yeah, that rate's going up for sure. That's the thing is with these variable rates, as the rates rise for the banks, you're going to have a higher rate as the borrower. So right now they have about $533 million in total debt on the balance sheet. 98% of that is long term. So not a lot was due over the next 12 months, but the credit line matures in 2026. So $533 million due in 2026, they are not earning a ton of cashflow. Well, I mean, it's not a bad ratio. It's not a bad ratio, but they got to keep generating cash. But they only have $127 million in cash and equivalents. So they are in a pretty, I guess you would call it, it's roughly, I'm doing this math in my head,

but about four times their total net debt to annual operating cash flow would be my guess. It's around that. Yeah. It's like, it's not a tight situation, but it's not a conservative situation. Basically, the majority of their cash flow is going to be paid back to the debt holders over the next four or five years. There's a chance that they roll that debt. I would hope that they don't have to do that if rates continue to rise. Yeah, I would hope they pay it down.

Like that would be my goal. That would be a good positive indicator for me if they continue to pay that down because, yes, those interest expenses. This episode is brought to you by La Quinta by Wyndham. Here you are miles from home and ready to start your vacation. Good thing you're staying at La Quinta by Wyndham. They have free high-speed Wi-Fi to stream all your favorite movies. and in the morning get fresh waffles with their free bright side breakfast or squeeze in a workout at their fitness center either way you're ready to conquer the day

tonight la quinta tomorrow you triumph book your stay at lq.com it doesn't seem to be rising for the time being yes exactly all right anecdotal evidence ryan anything here i know you're an iphone user so i got more of the anecdotal evidence i'm an iphone user they well they're moving into iphones a bit with the mobile advertising slightly so a few of the ad marketplaces that they've acquired have some uh collect some of the revenue on the iphone so the idfa changes they talked about that on the conference call they said they didn't and it did not impact their overall business that much which is kind of nice compared to a lot of the other advertising players i am an iphone user though so i don't get to experience uh their actual products much at all

or are there the core ones yeah um i have read some blogs online that described it as bloatware so that's a bit harsh i think that's harsh what what's your experience been with them because they seem fun i mean i have android it seems fine to me like the preload stuff is slightly spammy but it's not i mean you probably watch those videos outlining how it works it's not that bad i mean if it shows you to download uber spotify and amazon i don't think that's a huge it's not how that's spammy to me. And everything else is very, very standard internet stuff. However, I think on another note, in-app mobile game monetization. So I'll say that again, because that was a bit of a word sound. In-app mobile game monetization could really use some

improvement because a lot of those, I don't know if anyone's played mobile games or any other sort of app that uses these type of advertising services, that's not a Facebook property or maybe a snap or whatever you get like the same ad 10 times in a row so i think there's a big way to improve these non-google these non-facebook uh these non-social media um mobile advertising like uh not what am i trying to say just the strategy the way get them more effective yeah i do like being able to bypass the app store in those sort of apps or not apps, ads, where you've got a video ad.

Right now, in my experience, I have to click into the app store that I kind of get if I look through the reviews or I see other products, I can get to turn from downloading it. So from an advertiser's perspective, I would see that why that's more valuable. And it's nice that Google signed that long-term deal

and it seems like they're okay with the single tap stuff. Now, I don't think Apple would be good with this, but Android's large enough for a company of digital turbine size of only $2 billion enterprise value. And that leads us into future growth opportunities. So, Ryan, what do you got? Let's say you got DSP stuff. Yeah. So, I use the Appreciate acquisition. And if you look it up, the other name they go by is Triapati Limited.

So, Appreciate's a little easier, but it's an Israeli-based demand-side platform. So this is essentially another one of their ad marketplaces that they're gobbling up. And it's not big relative to like Fiverr or Ad Colony. It was only $22.5 million deal that was paid for in cash. But I like that strategy of buying the ad marketplaces for their customer relationships and then being able to license or not license because it's owned by you, but leverage your single tap technology to kind of enhance the value that they provide to their customers. It seems like a big sort of step change in value provided.

And just the, so say you're, okay, well, what type of app? If Pandora is a long time, a long time customer, if Pandora was using them for the pre-install stuff through the core digital turbine business, you'd go to them and say, look, they're spending with us here. why don't we help you actually monetize your app and you can use us as the ad marketplace and we can bring advertisers to you in a highly effective manner because we have this vertically integrated marketplace now that's competing a lot with you know a company like the trade desk or whatever but seems like a very sound strategy my question is why if single tap is this very useful i guess

feature that they have and provide why are they trying they're also getting a lot of interest to license it oh i didn't see that i didn't see that when did you see that they talked about on the conference call they talked about all the demand they're getting to license the single tap technology i would hope they don't do that yeah my thought would be keep it proprietary especially if you're going to buy the ad marketplaces because it enhances the value of your own marketplaces exactly so i don't know i i guess maybe they're are they describing yeah are they describing as bringing single tap onto these publishers or having other advertisers because that could have just been weird wording was it specifically for other advertising technology

companies yeah so even appreciate was using them prior well i think that's i again these are complicated so hard to get the back end but i think that's just because they had to connect you have to connect to the end customer if you get what i mean so i don't think they're giving up that proprietary stuff because no one they ha no one can no one else has the software on device not the software on device but if you're letting the other ad marketplaces use single tap yeah but no one else can copy them without you because they don't have the software on the on the Oh, yeah. Sorry, the whatever the actual device, I guess I don't follow because the what value how much more valuable is an ad marketplace as owned? So you own it now. If there isn't any difference, if there is any difference between you owning it and it being its own, and you're just licensing the single tap? Well, yeah, it's a give and take. So you're going to be earning revenue if you have Singletap going in through these other third party marketplaces. But if it's proprietary, then they have to go through you. So they're making money either way and no one can copy them without partnering with them. Sorry, no one can copy them or use Singletap without going through Digital Turbine, at least at this moment.

so i think both situations are solid but it's hard to see what would be the best strategy long term all right what's your i mean well i said single tap yeah i mean i had single tap this is the most hyped up product uh we already described what it is and it is that you know i mean it's proprietary because given their relationship with the software on the mobile devices, it's very unlikely that an ad tech company can copy that. And they did sign that multi-year agreement with Google, which is really nice to see, like I mentioned. And why we've been talking about single tap so much is because they believe it is going to be on its own, a $1 billion revenue opportunity. And that is larger than their trailing to a

month revenue today. So a lot of the growth is going to come from there. All right. Highlights, lowlights, Ryan, what'd you like and dislike about this business? The click-to-install rate is higher with Digital Turbine than other advertising locations. That's something that they really talk about, kind of brag about, as they should, if it's true, because theoretically that means it's way more valuable to advertisers than other ad spots. The other thing that I like about that is if we enter a recession, and I guess we're already in a recession, so I should stop saying that. Um, well, most likely given the GDP numbers that are coming out. Yeah. But I mean, some recessions aren't that meaningful. Okay. Even in a bear market, let's say the advertisers might be pulling back on their marketing budgets. I would think if they're getting a higher click to install rate here, and this is the more valuable one, they would,

this would be one of the last to go in terms of ad spots. So that I like, um, low lights though, they are very dependent on the relationship with the big carriers that's not necessarily it's kind of like what else could they do essentially because that's just a function of being in a market where you're providing services to the big mobile operators or the mobile carriers because verizon and at&t take up such a big chunk of that um but they highlight it as a risk factor yeah and hopefully they're diversifying out of this as they move more internationally, because as a lot of people, well, maybe people don't know this, but a lot, you know, AT&T and Verizon have a huge market share in the United States. And I guess they

signed T-Mobile too. So hopefully that will diversify it a bit, but as they move internationally where Android is way more prominent, hopefully they'll diversify to a lot more telco providers. Yeah. I believe they have 40 different partners overall, but the majority of, or as they say, a significant portion of our revenue are currently being derived from a limited number of wireless carriers customers um it's just a risk that you have to take well yeah most important relationships are what samsung android verizon at&t right now yeah and then the other things and these are maybe small ones but i just got a few yellow flags listening to management and reading the conference call um the ceo at one point did during his basically his prepared remarks basically said

we've been he bragged that we've been growing at a compounded annual growth rate of 180 percent of the last four years and did not mention acquisitions in that sentence well i mean no reason to sell on that but no i find them but i don't like when i i kind of hate that like look how big our growth has been but you know it's not organic yeah yeah i don't know not a deal to me but i can see why you're upset by it also uh they had to restate their financial results in may they're currently being investigated for it um they overstated the revenue the net revenue from the companies they were acquiring and a big chunk of their or not a big chunk but a portion of their cost of goods sold those those other the companies they had acquired put into their

uh product development costs so maybe it's just a little bit of accounting i don't think this was a big deal reading into it like gross profit per share is still compound at a great rate and it was just the revenue share stuff being this classified the businesses aren't like fraudulent you know it doesn't change the bottom line no no exactly but it's still generating cash yeah they uh i mean just look at gross profit even just ignore revenue just look at gross profit I mean, the gross profit has changed as well, but. Slightly, but a lot of this was the classifying as net, like net instead of. Your gross revenue is net revenue.

Yeah, exactly. Yeah. Yeah, but, you know, if anything materializes from the investigation, that's a problem for me. That's true. That is true. I mean, it's never a good thing. Never a good thing. All right.

My highlights, they locked up that partnership with Google and Android, which is great to see. you know solid unit economics if you're looking at a gross profit basis uh that should really scale with no capex hopefully that should lead to solid margins i do believe they have at least a decent competitive advantage versus other mobile ad tech services you know with their uh oem which the manufacturers again and their carrier relationships management seems to want to stick around a lot of these executives have longer tenures as kind of mercenaries which is great to see. And then the acquisitions make a lot of sense and they really make them, you know, they can now hopefully become competitive with the big dogs in the industry, not Google or Facebook, but kind of

the big dogs in the ad tech market, low lights, customer concentration, like we already talked about. Let's see. We already talked about financing the acquisitions with the variable interest rate debt. I would have loved to see them use their stock when it was at 50 times gross profit, but hindsight 2020 in the past is the past. Surprisingly, I found minimal lowlights here. I was expecting on a small cap to find more, but I really liked their position in the industry. However, when we'll talk about in the bear case, well, no, in more or less interested, this is an industry that is tough to kind of get a grasp on who the winners are, but let's move in. We're running out of time. Let's move into the bull case. Brian.

Well, I'm going to let you put some numbers on it first. Okay, I'll go first. So if they achieve what they outlined during their investor day, they will hit $1 billion in EBITDA within five years. And given their capital expenditures, you know, given that depreciation and amortization are a little overstated interest rate. There'll also be a lot of interest. Interest expense might be higher, but I kind of think that should translate to a good amount of free cash flow, probably in the $600 to $750 million range at least. And that will help them easily pay down their debt. And if they get to, I mean, if they get to a billion dollars in EBITDA, they can generate their entire current market cap in cash within a few years after that.

So yeah, that's the bull case. If they do what they say they're going to do at the investor day, I mean, this is a potential 10-bagger within decades. Yeah. Since you already put some numbers on it, I'm not going to repeat them, but I'll talk about the drivers. Pretty much for me, there's two important factors. Grow the number of devices that their software is on. I'm not just talking about the on-device software, but the tap to install and the folders products. They have to get carriers to, I remember them in their investor day presentation, the number of carriers with three to four products, three to four of digital turbines products on them is significantly lower than the total amount of carrier partners that they have. Yeah, they had like way more, a lot with zero to two, some with three to four, and only a few with like five to 12. You want to see that improving. Yeah. And so if they're able to do that, that means they're going to be able to increase their

revenue per device. So that combination right there, more devices, higher revenue per device, that's probably how they're going to be able to hit those growth figures that they've outlined. Yep. And the operating leverage should kick in if it's from existing customers. All right. Bear case, Ryan, what are your thoughts? What could go wrong here?

Well, if advertising does fall off some sort of a cliff, I guess, in this recession, like everyone seems to be worried about um they might not be as competitively advantaged or immune to that as maybe they've outlined or i feel like they would be so there's that risk also smart we forgot to say smartphone sales too and then write that down those deteriorate a lot you know new unit sales they can offset that with new carrier partners but that's true it's still ahead when they be fighting um the other thing is i'm not so enthusiastic i like the core business of the on-device media i think that's very differentiated um compared to a lot of no one else is able to do that uh however i'm not as enthusiastic about the other elements of their business i know single

taps fairly differentiated but i think it's very well it is it's slightly better it's not like a It's not as much of a help. Going through the app store is not that big of a friction. And frankly, a lot of people like the process of going through the app store. I like seeing the reviews before I install something. Good point. So, and they're allocating a lot of capital there. So, if they pour a lot of capital into that side of their business, or they make a lot of acquisitions on that side, it could potentially be at risk if it isn't that differentiated.

And that is a really competitive world, the ad marketplaces. Now, I think a bull would argue that given their software-on-device relationship with the wireless carriers and the manufacturers like Samsung, that will potentially give them a competitive advantage within the DSP ad tech world, the more standard ad tech world, compared to a Magnite, Pubmatic, Trade Desk. But that is to be seen. I mean, they're a lot smaller. it though like i think there's more to it because there's got to be a reason that the trade desk and pubmatic and magnite and all those ad marketplaces generate so much more well here's the downside of magnite or sorry digital turbine is their only mobile i mean basically only mobile apps and a little bit home screen stuff on android so i think a lot of other companies

probably want connected tv they want audio they want standard web stuff right i think that could be a downside for digital turbine because if you're a big brand just hand it off to a dsp and let them take care of it yeah but this could be a strategic acquisition i know digital turbine has acquired a lot of companies but this could be a nice little strategic acquisition i don't i think google would make it if they weren't under such regulatory stress um yeah yeah i think so all Right. Yeah. My bear case is similar. I mean, the competitive advantages, quote unquote, that they outlined that we've talked about, given their relationships, do not materialize in market share gains and mobile ad market falls flat, not at the projections of $600 billion in

2025, like everyone is expecting, or at least everyone in the industry touts. Also, interest rate expense risk could impact here. So if we get slower revenue growth combined with headcount increases because they're expecting faster revenue growth, even some margins don't expand, but interest expense rises, free cashflow available to shareholders, you know, might not be there. Here's my thing is I don't think there's a very high floor here because there is a lot of risk now financially where, all right, let's say advertising spend does fall, revenue declines, cashflow to clients. They have their variable rate

also depends on their leverage ratio. So they'll have a higher interest rate on top of potentially higher interest rates to begin with. There's a lot of ways this can go poorly now. Yeah, I don't know how badly they'd be impacted by, like, unless advertising spend falls in half,

which I doubt will happen. I mean, that would be super, super surprising. I think a slight decline, they could still do fine. Do you get what I mean? But, I mean, it's not a tailwind. It is a headwind. I suppose it's a little riskier than Google, I guess. Yeah, yeah.

I mean, yeah, since they're beholden to Android. All right, more or less interested, Ryan? On the fence. It's not that expensive. The stock is not that expensive. True. That you need a free cash flow Outlined

Should come down quickly given the acquisitions Yeah I don't know I really like the on-device media part To me that seems like Really valuable inventory for an app Sticky too And they're the only ones

Yeah but I just have some yellow flags so Oh those aren't go on the fence. I mean, maybe this will sound bad if something happens, but I feel like those yellow flags are like... Investigations are bullshit. No, those are... Come on. Almost every company is

getting sued. Come on. Yeah, but they... I mean, not all of them have to restate their financials and didn't look into whether their net revenue was gross revenue or whether their gross revenue was net revenue on an acquisition. I mean, come on. I think that's not...

That's not a huge deal. What if you painted 25% What if the gross margin was substantially higher reported than it really should have been? I think if you weren't able to calculate that about what net versus gross was as an investor, then you shouldn't be buying the stock anyways. Well, they bought the companies and weren't able to figure it out. No, no. I mean, they just, they knew what the gross profit was. I mean, yeah, there was a small thing.

But it was overstated. No, I mean, majority of this was just, unless I'm reading into it wrong, the majority of it was just net versus gross. But they also put in cost of goods sold into product development. Okay. Well, how much of that was it? I don't know. They didn't say.

I mean, that could be a really yellow flag, but I don't think that's a huge deal. But either way, I think I'm less interested just because I don't know. The ad tech market, I don't know. I don't know who's going to win. um there's a lot of good companies that make compelling pitches about why they should win trade desk magnite pubmatic digital turbine i can envision this a world where this is a compounds at a very high rate i would not be surprised if that happens but i'm not confident it will just because the competitive positioning all right it's also come down pretty quickly

with the organic growth rate here yeah yeah that's true that's true i will it'll be fascinating to watch this over the next few years on the sidelines just as a i'm not i'm not totally out but the uh it is uh not not outside my circle of competence but just a little hard to forecast i don't yeah it's i think i understand the business but i don't understand why advertisers would choose who who whatever company and and that's not facebook or google if you get what i mean? That's kind of the tough one here. All right. Stock for next week. Ryan, it is your choice. What do you got for us? All right. I'll give you two options. Poshmark revisited or Squarespace revisited. Let's do Poshmark. A lot of cash on that balance sheet. That's what people are saying.

Although the product is scammy. I've used it. All right. That's a little teaser for next week. That's going to do it for this episode. Remember to give us a review on Spotify, Apple podcast. We are not financial advisors. Anything we say on this show is not formal advice or recommendation. We are general partners at Arch Capital. Arch Capital clients may hold securities discussed in this podcast. Thank you all for listening. We'll see you next week.