#31: Q3 2022 Portfolio Rundown
Portfolio rebound (for now); Trade Desk keeps it moving; 52-week highs coming down; Adtech market below IPO prices; Transcript buzzwords
Today is Fibonacci Day! It celebrates Leonardo Bonacci’s massive invention — a pattern of counting that continues to influence math and technology today. It’s made of numbers that sum the previous two numbers before them — 1, 1, 2, 3, 5, 8, 13 — and so on. The sequence is used in computing, stock trading, architecture, design, and DNA sequencing. It must be used in Programmatic Land somewhere… even if it’s not it just sounds good in a sales pitch! 🤣 🤣 🤣 .
Reading Time: 9 minutes
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Where do they stand?
Had you bet $100 in January 2018 when our Quo Vadis portfolio started, you’d be up $270 today.
Looking in the rearview mirror (bad idea), you’d be up 1000%+ if you had sold the entire portfolio in February 2021 when it climaxed.
But you can still feel good about holding onto the programmatic dream. The NASDAQ is only up 49% over the same time period, so you’d still be doing quite well betting on programmatic adtech.
Then again, if you had only bought The Trade Desk in January 2018 to get exposure to programmatic advertising and forgot about all the other players, you’d be up 896%.
How does TTD do it? Well, they get two out of three things really right on a consistent basis.
Thing #1: They consistently attract ad budgets to their platform, mostly through tight relationships with media agencies. TTD attracted $6.2B in gross ad spend last year and will rake in ~$8.3B this year.
Thing #2: They consistently extract ~20% take rates from those growing ad budget flows and manage to get buyers to believe in whatever value is purportedly added (e.g., frequency management, targeted reach, etc.)
Thing #3: The odd part for Quo Vadis is how investors are somehow not looking at TTD’s not-so-great track record when it comes to delivering stellar economic profits (aka economic value add (EVA), free cash flow, etc).
Why does EVA matter? Mainly because producing profits is the entire point of being a for-profit business. For adtech, after extracting take rates from ad flows, these businesses need to do so at the lowest operating expense and on the least amount of invested capital.
What does that mean for The Trade Desk (the biggest player in our portfolio)?
Looking back at the past 11 quarters for TTD, we see the following:
Rising gross ad spend, but increasing at a decreasing rate (it gets harder to reach max penetration over time)
Consistent take rates (albeit decreasing ever so slightly on a CAGR basis), therefore net revenue is also consistently growling in line with gross ad spend.
Operating expenses as a % of net revenue have always been high and have increased over the past few quarters (mainly due to increases in stock-based compensation)
Invested capital for TTD goes up with gross ad spend (as expected) while capital efficiency (net revenue generated from $1.00 in invested capital) is going up little by little (it’s a good thing to squeeze more juice from the orange you’ve already invested in).
For TTD, beta has been increasing over the past few quarters (similar to the sector) while the risk-free rate has increased for everyone.
Putting all together means that TTD has not demonstrated an ability to generate returns above its cost of capital (ROIC > WACC). That means all the machinery in play is actually value-destructive.
If you’re growing the topline on a business that cannot create positive returns, then you’re going the wrong way. The best way to flip this scenario is by reducing operating costs such that they grow less than net revenue growth (assuming take rates remain healthy).
Quick Thought Experiment: Let’s say TTD manages to attract a whopping $100B in gross ad spend by 2032. That’s crazy growth, hence management’s CTV story (see below). Assuming total global spending grows at 5% per year, it will be $1.35 trillion in 2032. That means TTD will have a 7% share compared to the sub-1% share it has today. If take rates remain at 19% (odds say they decrease over time to access CTV inventory), and operating costs do not dramatically decrease (even after adjusting for hefty stock-based compensation expense), there is no way TTD will generate enough economic profits to justify its current share price. Something has to give. That’s something to think about for investors and advertisers alike.
Let’s unfold these nested bets you’d be making if you buy that scenario. Not only would you be making a giant bet on massive ad flows coming TTD’s way (unlocking CTV inventory from the grip of content owners), but you’d also have to bet that operating costs as a percentage of net revenue (gross ad spend x take-rate) come way down from where they have been — from 90%+ in recent quarters to less than 65%. Those are really big bets. Go for it!
Quo Vadis Portfolio Trend
Even though TTD has not proven it can generate enough economic profits to justify its current price ($48.32 closing price on November 21), it still dominates our adtech portfolio in terms of contributing most of the 270% gains to date (TTD contributes 65% of the gains).
The real question for both TTD and the overall portfolio is where is the bottom? Are we there yet or is there more downward movement to come? We think the bottom is wherever our portfolio meets NASDAQ returns.
Fibonacci Use Case: Technical stock traders use a technique called Fibonacci Retracement to find resistance and support for stock prices. Let’s give it a shot on our Quo Vadis portfolio.
We first take two the difference between extreme points (usually a peak and a trough) and divide the vertical distance into the key Fibonacci ratios of 23.6%, 38.2%, 61.8%, and 100%. Once these levels are identified, we draw horizontal lines to identify possible support and resistance levels.
In our case, we’ll use the recent high in February 2022 and the recent low in July 2022. As you can see, our adtech players are trading in the lower band. If our portfolio retraces above the 78.6% level and continues to rise, we could be in “buying” territory.
On the other hand, if our portfolio dips below the lower boundary “support” line, we’ll be in a whole new territory and likely head lower.
52-Week Lows Spell M&A Next Year?
When our portfolio peaked in February 2021, rising from our original $100 investment to $1151, the 52-week high trendline started to creep downward. That means the price tag to do M&A deals was too expensive up to the peak, but adtech asset prices are now heading toward a place where private investor activity will likely pick up.
Not Unimaginable Acquirer Themes
Magnite and Pubmatic get married to push combined marginal costs downward aiming to squeeze out more economic profit for shareholders.
Could we see Taboola and Outbrain or IAS and DV do the same?
How about all the smaller DSPs banding together to try to match TTD’s scale?
And the crême de la crême deal…how about Trade Desk buying Criteo? That could be interesting too.
Trade Desk works mainly with agencies, but Criteo mostly does not.
Trade Desk is used by upper-funnel advertisers, while Criteo is dominated by lower-funnel performance campaigns.
CRTO is far ahead of TTD when it comes to retail media.
TTD is busy promoting UID2.0, CRTO has its own solution.
CRTO has gobs of purchase and conversion data.
Unlike TTD, CRTO is well-diversified outside of the US so TTD gets faster growth exposure in new markets.
Both players have proven management teams, top development teams, and they both know how to attract talent.
And perhaps most importantly, CRTO has demonstrated a steady ability to turn ad flows into free cash flow.
And what about private equity coming back to the adtech game? The more the 52-week highs come down to current share prices, the closer private equity will look at some of the better assets in the space and bring their discipline playbook to bear (creating and capturing free cash flow).
Luma Partners talks about this convergence in their Q3 market report. Check it out.
15 out of 18 Below IPO Price
Only 3 out of 18 stocks in our portfolio are still trading above their IPO price: Trade Desk, Roku, and S4 Capital.
10 out of 18 are trading at -50% or more compared to their IPO price — ouch! 🤕
If Q4 ad spending comes in lower than expected (hoping is not a strategy), then new lows will show up in February 2023 when adtech reports Q4 and full-year results.
Ctrl F on Earnings Transcript Buzzwords
Quo Vadis subscribers are a curious bunch, so we wanted to check the frequency of five buzzwords that adtech management likes to throw around when they talk about the prospects for growth in their earnings transcripts.
1. CTV / Connected TV: The grand majority of adtech players are all loving CTV, but TTD takes first prize for throwing it around the most. 🏆
Funny thing about CTV — the more we ask, “Where is all this CTV coming from?” the less we get a satisfying answer. For instance, if marketers ask any of these players for hardcore data as proof of CTV inventory they probably hear crickets. And if CTV is supposedly the big future growth driver of ad flows and free cash flow, observers and investors alike would love to know more about it and what kind of take rates can be expected.
2. Programmatic: The word “programmatic” shows up as expected, but not nearly as much as CTV. A few players don’t even mention it at all. Considering what happened in P&G’s earnings call, we find that a bit odd.
Jason English (Managing Director of Equity Research at Goldman Sachs) asked: “how do we think about the right investment posture when it comes to advertising and media?”
Andre Schulten (CFO of P&G) answered: “On the media investment, I think we really need to shift focus. It is difficult to describe media sufficiency in dollars, especially when we are actively shifting our spending from linear non-targeted TV into programmatic and into digital spend, that is a lot more targeted and a lot more precise in terms of delivering reach and quality of reach where we need it. What we need to understand is what are our reach objectives and are we sufficient and spending to achieve those reach objectives, what are our objectives in terms of number of weeks on air achieving that reach. And that's how we'll measure sufficiency.” (See Thing #1 above).
3. UID2.0: Trade Desk talked about UID2.0 the most because they “own” it. It was also mentioned in passing by RAMP and IAS.
What Quo Vadis would love to know?
If 100 campaigns were chosen at random during Q3, we wonder how many had UID2.0 in play for audience targeting?
4. Identity: Surprisingly, you’d think the word “identity” would be the center of attention given all the “sky is falling” nervousness around third-party cookie deprecation, but it was hardly mentioned. Unsurprisingly, Liveramp mentioned it the most — identity is their business, after all.
5. Retail Media: This buzzword was the third most mentioned out of the five. Interestingly, Criteo had zero mentions of anything but “Retail Media." We like that kind of focus!
To put a finer point on Criteo’s focus, check out AdExchanger’s October 18 interview with CRO Brian Gleason.
Question: “Does Criteo consider agencies and holdcos to be competitors?”
Great Answer: “Absolutely not. Our number one focus is to enable agencies for commerce media. It’s a three-step process. The first is education. We launched what we call “Retail Media University” earlier this year, and we’ve already given over 6,000 certifications.”
For all you up-and-coming adtechies, that’s how you sell. Inbound swirl vis-a-vis tangible content pays off at multiples of outbound sales efforts. Why? Because it creates magnetic urgency and friendship like nothing else.
Perhaps most interesting of all, Taboola, along with its brother from another mother, Outbrain, did not utter any of the five buzzwords at all. Neither did S4 Capital (aka Media.Monks).
If you’re wondering what S4 did talk about on its Q3 earnings call, it looks like this.
If this isn’t an example of knowing your home base message map, then nothing is! Masterful!
Perhaps that kind of financial focus is why S4 is up 50% since hitting a July low (better than every other player in our portfolio) and one out of five in our eighteen-company portfolio with positive returns.
Ask Us Anything (About Programmatic)
If you are confused about something, a bunch of other folks are probably confused about the same exact thing. So here’s a no-judgment way to learn more about the programmatic ad world. Ask us anything about the wide world of programmatic, and we’ll select a few questions to answer in our next newsletter.
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