Summary
- Despite substantial revenue growth post-2020 due to acquisitions, Digital Turbine Inc.’s (NASDAQ:APPS) profitability metrics have declined. Its 2024 revenue was lower than expected and there were declining returns.
- This is despite growing worldwide advertising spend indicating challenges for APPS to reverse its revenue trend. Its high operating leverage meant a significant impact on profits when revenue declined.
- The company is undergoing a turnaround but there is no margin of safety at the current market price based on an optimistic turnaround scenario.
Investment Thesis
APPS’s triple-digit revenue growth in 2021 and 2022 was due to its acquisitions. Since then, revenue has declined despite increasing worldwide advertising spend. Not surprisingly, its return has been declining with negative returns for 2024. The company is undergoing a turnaround that would not be a walkover for the company. My valuation based on an optimistic turnaround scenario did not provide any margin of safety.
Company background
APPS operates in the mobile platform business. The company provides end-to-end products and solutions for various participants in the mobile application ecosystem. These included advertisers, publishers, carriers, and device original equipment manufacturers (OEMs).
The company enables its customers to monetize mobile content and generate higher-value user acquisition. Their products and services are currently reported under two segments:
- On Device Solutions: This segment simplifies the discovery and delivery of mobile apps and content media for end-users.
- App Growth Platform: This segment consists of Advertising Solutions and Ad Monetization Solutions, catering to both app developers and brands/agencies.
Over the past 2 years, the On Device Solutions segment accounted for about 2/3 of the revenue.
In looking at the company’s performance, it is useful to categorize it into 2 groups – pre-2020 and post-2020. This is because from 2021 to 2024, the company grew substantially due to acquisitions.
As such the company today is bigger and different from that in 2017. For example, the 2023 revenue was 17 larger than that in 2017. In terms of business focus:
- In 2017, the company had a narrower focus on advertising and content-related services.
- In 2023, the company had a broader scope and positioning within the mobile industry. Its offerings have expanded to cater not only to mobile operators, advertisers, and device OEMs but also to publishers, carriers, and application developers.
Operating trends
I looked at 2 groups of metrics to get a picture of the operating trends over the past 8 years.
- The left part of Chart 1 shows the trends for 3 metrics – revenue, PAT, and gross profitability (gross profits / total assets).
- The right part of Chart 1 shows the returns – Operating return (NOPAT/Total Capital Employed), ROE, and ROA.
There was a substantial jump in revenue in 2022 following the completion of several acquisitions. Unfortunately, this did not lead to a jump in PAT. While the revenue in 2024 was significantly higher than in 2017, the PAT in 2024 was lower than in 2017.
The only positive sign was the improvement in gross profitability from 11% in 2017 to 23 % in 2024. Furthermore, since peaking in 2021, returns have been on a downtrend. The average returns from 2021 to 2024 were:
- 15% for the Operating return
- 1% for the ROE
- 2 % for the ROA
As seen from the right part of Chart 1, these low returns were due to the negative results for all three 3 metrics for 2024. The surprising thing was the Operating return of negative 2% for 2024.
Notes
- Performance Index chart. To plot the various metrics on one chart, I have converted the various metrics into indices. The respective index was created by dividing the annual values by the respective 2017 values.
- The 2024 values were based on the Dec 2023 LTM values.
To get a better understanding of the 2024 performance, I broke down the operating profits into fixed and variable components. Refer to Chart 2.
- The company has improved its contribution margin post-2021 and this margin seems to have leveled off at a high of 59%.
- Over the past 3 years, fixed cost is about half of the total cost. Given this high operating leverage, you can understand why the drop in revenue has a high impact on profits.
Unfortunately, revenue dropped drastically in 2024 compared to that in 2022. The company attributed the lower revenue to:
- The end of a carrier partnership and lower device volumes for the On Device Solutions segment.
- Weaker demand and the impact of the consolidation of the business lines in the App Growth Platform segment.
Notes: I broke down the operating profits into fixed and variable costs.
- Fixed cost = SGA, Depreciation & Amortization and Others.
- Variable cost = Cost of Sales – Depreciation & Amortization.
- Contribution = Revenue – Variable Cost.
- Contribution margin = Contribution/Revenue.
Despite the declining revenue, fixed costs did not decline. For example, the SGA margin had increased from 24% in 2022 to 39 % in 2024. As such the improving gross profitability and contribution margin were not translated to a better bottom line.
I also worry about the declining revenue because the company’s performance is opposite that of the global trend for digital advertising spending. Refer to Chart 3. Looking at the chart, I would deduce that the company is losing market share.
Financial position
Despite its poor operating performance, its financial position did not seem too dire. While it had a high debt level, this is manageable.
As of the end of Dec 2023, it has a debt-capital ratio of 0.45. This has come down from its 2022 high of 0.50. According to the Damodaran Jan 2023 dataset, the debt capital ratio was 0.31 for the advertising sector and 0.12 for the information services sector.
Over the past 8 years, it generated about USD 350 million from its cash flow from operations compared to its cumulative loss of USD 160 million. This is a good cash-generation track record. Its CAPEX was relatively low relative to the cash flow from operations suggesting that it has cash cow features.
A big part of the cash flow from operations was spent on acquisitions. Refer to Table 1. Acquisitions are controlled by management and this suggests that the debt level can be brought down.
Valuation
APPS is not a wonderful company from a fundamental perspective. You would only consider this an investment opportunity from a turnaround perspective.
The challenge with valuing a turnaround is projecting the turnaround performance. In this context, I assumed an optimistic scenario where the company would turn around by next year with the following performances:
- The revenue, contribution margin, and capital efficiency would be the same as those for its 2022 peak.
- Its fixed cost would be the 2022 to 2024 average.
On such a basis, I estimated its intrinsic value to be USD 0.71 per share. The market price of APPS as of 26 April 2024 was USD 1.82 per share. There is no margin of safety to consider this a turnaround investment.
Valuation model
I valued the company based on a single-stage Free Cash Flow to the Firm (FCFF) valuation model. Refer to Table 2. I modeled the business along the lines shown in Chart 2.
EBIT = (Revenue X Contribution margin) – Fixed cost
Value of the firm = FCFF X (1+ g) / (WACC – g).
FCFF = EBIT X (1 – tax rate) X (1 – Reinvestment rate).
Reinvestment was derived from the fundamental growth equation and = Growth / Return.
The WACC was based on a Google search for “Digital Turbine WACC” as per Table 3.
Sensitivity analysis
The model is very sensitive to the fixed cost. You should not be surprised as Chart 3 shows that fixed cost is a very large portion of the total cost.
For example, if the fixed cost was assumed to be the 2022 value instead of the average past 3 years value, the intrinsic value increases to USD 8.48 per share. The question is whether you think the company can reduce the fixed cost. Given the increasing fixed cost trend, I would like to think that my assumption is an optimistic one.
The other point is that I assumed that the company would be able to reverse the revenue trend by next year. If it takes a longer time to do so, the discounting process would result in a lower intrinsic value. Turnarounds generally take longer than anticipated so my assumption about next year is an optimistic one. But even with optimistic assumptions, there is no margin of safety.
Conclusion
I would not consider APPS a wonderful company.
- It does not seem to be able to grow its revenue despite the acquisitions and growing worldwide digital advertising spending.
- It had not been able to improve its bottom line despite improving gross profitability. The results are declining return trends post-2021.
The company is undergoing a turnaround and the only positive sign is that it is financially sound to give it time to turn around. Unfortunately, there is no margin of safety assuming that it can return to the 2022 performance next year. This is a challenging turnaround to bet on.
Editor’s Note: The article is from H.C. Eu who blogs at Investing for Value. He is a self-taught value investor and has been investing in Bursa Malaysia and SGX companies for more than 20 years. His value investment experience has been enhanced by both his Board experiences and his contacts with controlling shareholders of many of Bursa Malaysia’s listed companies. These have given him a unique opportunity to be able to analyze and value companies differently from other research houses. If you enjoyed this piece, you can find similar pieces and other value investing tips in his blog.
