Opportunities in a market dominated by tech giants and plagued by ad-blocking & ad-fraud
Companies: ADGRF, RTHM, TRMR
Digital advertising is a massive and increasingly important sector of the economy. It's currently estimated to be worth around $225bn (£173bn) per year and is growing at 15-20% annually. Despite this growth, the sector and companies that operate in it are facing increasing challenges from the duopoly of Facebook and Google, ad-fraud, ad-blocking, and a squeeze on funding.
In this article, we explore some of the AdTech companies that are listed in the UK and what challenges and opportunities may lie ahead in the sector.
The global digital ad market is colossal; it accounted for more than 30% of the total media spend in 2016, which works out at roughly $225bn. According to eMarketer, the market has a forecast compound growth rate of 15% per year to 2020, by which time it will account for nearly 50% of the total ad spend.
This figure is quite staggering considering that in 2001 it accounted for a mere 3%, before rising to 16% in 2010, and 31% for 2016, with growth rates steady over the last five years. For 2017, eMarketer is forecasting continued growth of 16%!
GroupM (WPP) has said that digital "absorbed" nearly 75% of global ad growth between 2010-15 and that this could rise to 95% between 2015-17. It's hardly surprising, then, that Google (Alphabet) and Facebook shares have performed very well in the last year, up 33% and 25% respectively.
However, despite the astonishing growth of digital advertising, the industry that exists around it has its fair share of challenges.
Ad-Fraud, Blocking, and other industry challenges
One of the major factors that the AdTech industry needs to overcome is ad-blocking. According to eMarketer, 30% of internet users will block ads by 2017, that's double the 15% that did it in 2014. Estimates vary, but this looks to have cost the global ad industry $22bn in revenue during 2015.
Publishers can lose between 10% and 50% of income from ad-blockers, depending on the demographic and region they target. RhythmOne recently said Ad-blocking doesn't affect them as they don't sell access to users that blocks ads, but it could have long-term impacts on its advertiser network if those businesses change business models or go out of business altogether.
"Publishers can lose between 10% and 50% of income from ad-blockers..."
While Ad-blocking is a concern, it is more worrying for publishers than advertisers, but it is still something that is a growing threat to the entire web. It fundamentally challenges the core revenue model of the internet.
Perhaps more dangerous to AdTech firms than the growing use of Ad-blocking worldwide is Ad Fraud, also known as Invalid Traffic, (an umbrella term for traffic, click, and conversion fraud) which is costing advertisers billions of dollars worldwide.
Ad fraud is the intentional, or unintentional, representation of false online ad impressions, clicks, conversion or data events. It can be from scams or just general internet use by bots. One of the stocks covered in this article, RhythmOne, has a black mark on its record for a 2014 Adware Controversy, but more on that later.
According to comScore in 2013, around half of all online ads aren't actually seen by humans, which is due to the sheer volume of internet traffic that is, in fact, bots. These bot networks pretend to be human web users generating fake traffic to fake websites and reporting fake clicks. Some bot networks are unintended side effects of the modern web, but many are deliberate scams.
Way back in 2004, Google CFO George Reyes said ad fraud was the internet economy's biggest threat. In 2016, the World Federation of Advertisers began advising its members on how to combat Ad fraud, which some have estimated costs advertisers and ad budgets between $7-20bn per year, and that figure is growing.
The opportunity for systemic abuse (deliberate or not) was highlighted at the end of last year with the highly-sophisticated Methbot campaign, which faked domain registrations and tricked algorithms into buying fraudulent web space. It is estimated that the Russian AFK13 group that perpetrated the attack were raking in $5m a day from unaware ad buyers/advertisers around the World.
On top of these issues, the wider AdTech sector faces difficulties with higher than ever barriers to entry, increasing funding challenges, and a constant need to develop and keep up with Facebook and Google. Taptica CEO Hagai Tai said in a recent interview with mobyaffiliates.com:
"The barrier to entry is already very high, and it will continue to rise. New entrants to the market can’t bring in more of the same."
Standards, Certificates, and Consolidation
To combat the issue of Ad-Fraud there is an increasing push from industry players to standardise their inventories, processes, and auditing - this will hopefully prevent them losing the confidence of their buyers.
Just this week, RTHM became the first AdTech organisation to receive the Internet Advertising Tech Lab Seal and OpenRTB Certification for its unified programmatic platform, RhythmMax. It appears RTHM is the first out of the block on this, and time will tell if others follow suit and buy into the framework.
As Hybridan wrote in their Small Cap Report this week:
"[This is] part of RhythmOne's commitment to working internally & with external standard-setting partners to create transparency within the advertising ecosystem. Having met the criteria for certification, RhythmOne ’s customers can enjoy a common framework which is established, verified and validated - reducing supply chain friction, enabling easier onboarding."
While Panmure Gordon recently argued that while it was challenging, Ad fraud wasn't as severe as some might believe as the problems were fixable, with the extra functionality which digital advertising delivers likely to keep evolving and improving:
"Viewability and ad fraud issues have always been present too in traditional media, and should improve over time for digital as the industry matures."
In that report, Panmure also argued that evolution and "intense consolidation" were likely as a result of high fragmentation, increasing standards, the need to keep up with Facebook/Google, increasing funding challenges, and strategic interest from other sectors like ad agencies, publishers, and telcos.
"Powerful consolidation forces are now at work in the ad tech sector... funding for the sector from PE groups and the stockmarket has increasingly dried up. And on top of this, industry participants - ad agencies, IT groups, telcos and publishers – all have strategic reasons for wanting to own ad tech. We expect a period of violent M&A for the sector, as hundreds of ad tech groups today consolidate to perhaps as few as 5-10 full service groups in the future."
In this M&A environment, there will be winners and losers, with those who can consolidate potentially able to carve larger pieces of their small (non-Facebook & Google) pie.
(The platform formerly known as Blinkx)
Founded as: Blinkx in 2004, acquired Burst Media in 2011
Headquarters: Burlington, Massachusetts
Key People: CEO S. Brian Mukherjee, and CFO Richard O'Connor
RhythmOne (formerly Blinkx) is an online advertising platform that connects digital audiences/users with brands/advertisers with content across devices. It began as video platform Blinkx before rebranding following a malware controversy two years ago and now focuses on online advertising.
Primarily, RTHM operates through RhythmMax, its integrated programmatic trading platform. Through this, it works with advertisers, publishers and content providers offering integrated, cross-screen advertising solutions.
RTHM has good exposure to mobile, video, and programmatic sectors, as well as a flexible tech stack, stable financing, and growing scale. Recently, the business has enjoyed growing momentum, with programmatic revenue jumping 28% in the first quarter of this year, rising 63% in Q2, and 73% in Q3.
The group has a strong balance sheet (£58m net cash), an increasing share price, and a management team with M&A experience, which bodes well for industry consolidation. This was shown with its recent acquisition of Perk ($43m, all stock).
As previously mentioned, Panmure Gordon recently argued that there will be "profound consolidation" of the independent AdTech sector going forwards and that RhythmOne would be a winner in this market:
"We initiate on RhythmOne which we see as a potential winner in this space, with a strong organic growth opportunity (following a complete rebuild of its tech stack) plus a strong inorganic one (as the sector consolidates)."
On its current valuation of 0.9x revenues, there could be substantial potential upside if the company can deliver. However, the Adware controversy and share price collapse in 2014 could weigh down the share price potential.
RTHM said recently that the industry had taken critical steps to "self-correct" this issue, which cost advertisers $7.2B in 2016. And, this week it became the first AdTech organisation to receive the Internet Advertising Tech Lab Seal and OpenRTB Certification for its unified programmatic platform, RhythmMax.
Conclusion: its share price has increased 120% in the past year to 45p, and net profit looks to be on the horizon (Consensus: $6.5m 2018). It is potentially well positioned for M&A activities, and it has Broker target prices of 52p, 65p, and 75p in the next twelve months.
Headquarters: Tel Aviv, Israel
Key People: CEO Hagai Tai, CFO Yaniv Carmi, VP Marketing Sharon Reisner
Taptica International is an American-founded, Israeli-based, UK-listed AdTech Demand-Side Platform. The Company’s tech is based on artificial intelligence, machine learning, and big data.
It has an impressive list of clients, working with more than 600 advertisers, including Disney, Amazon, Facebook, Twitter, Starbucks, King.com, Lyft, HBO, Sony, Expedia, Zynga, EA, GREE, ngmoco, Hotel Tonight, Playtika and Game Insight. It also works with more than 50,000 supply and publishing partners worldwide.
The company uses AI (artificial intelligence), Machine Learning, and Big Data to target users with very specific ads suited to them based on a broad range of criteria. TAP handles a massive 22 billion requests per day in 15 countries. It uses user's data from 17,000 campaigns, 600 clients, and has profiles on 220m users to help target people with effective messaging.
Taptica has been gaining lots of attention in the past twelve months after enjoying a stonking 363% rise from its 63p lows last July. In that time, Brokers raised EPS forecasts four times, from 12.72p to 26.71p (an impressive 109% increase).
Despite that rally, its P/E is still relatively modest for a growing tech company, but this could be because of the uncertainty in earnings that has hampered the AdTech industry in the past, as well as the discount that non-UK companies can sometimes be subject to on the AIM market.
The Group is trading at a slight discount to its peers on a P/E 10x compared to the sector-wide average of 12.5, which drops to 9.7x 2018e EPS.
The Company's shift towards focusing heavily on mobile services follows trends across the internet, and it is well positioned to benefit from a growing digital ad market. Its ROE, ROCE, and Operating Margin are all strong compared to the market and its sector, and its current assets of £51m (£21.5m in cash) comfortably cover its liabilities of £31.9m.
Conclusion: It has an impressive list of clients, a healthy return on equity, and has proven itself a serious player in its shifts towards mobile. It could certainly be a player in any M&A activity, but is self-funded and generates enough cash to fund future growth. Its current P/E is lower than its sector and seems low for a profitable and growing tech company.
Headquarters: Tel Aviv, Israel
Key People: CEO Or Shani, CFO Yoram Freund
Adgorithms claims to have created the first-ever artificial intelligence marketing platform, Albert. ADGO is quite different to RTHM and TAP, and it has some impressive clients, including Harley Davidson, Evisu and Made.com.
Albert is supposedly able to perform many of the manual, time-consuming tasks that exist throughout a marketing campaign – from digital media buying to execution to optimisation, and analysis.
It uses its software and data to access display, video, mobile and social advertising inventory through ad exchanges and offers ongoing insights and recommendations on information it has learned.
October 2015: 60% share price drop
In October 2015, shares in Adgorithms fell 60% in one day after it downgraded expectations for its full-year earnings, citing severe disruption in online advertising that it said had led to a loss of supply and a drop in demand from major media buyers.
It was a major blow to investors as it came just months after the group had floated on AIM to raise £27m to fund growth.
Following its share price drop, the business said it intended to shift its activities to a cloud-based Saas model, that it has now completed. Adgorithms evolved its business away from providing a managed service from ADGO employees to a Saas model where the in-house marketing team used the software for a subscription fee.
This model is more scalable and offers greater visibility of earnings and recurring revenue. As Liberum wrote in April:
"The online advertising eco system is still very volatile but the recent major contract wins highlight the momentum of SaaS and the validation and ROI of Albert. Management is confident that the company can leverage a growing pipeline into meaningful recurring revenues, implying material upside in equity value if it is successful."
Despite the lack of consensus forecasts for future years, it appears confidence is returning slowly to ADGO, with the stock making 115% gains in the past twelve months. Which, despite being -70% lower than its pre-October 2015 price, is progress.
It's currently trading at just 1.24x revenue and has quite a high net debt, but if this speculative stock can make its new Saas model work and utilise its artificial intelligence technology efficiently, it could offer riskier investors opportunity for decent upside.