CDLX - Cardlytics: Running Out Of Time For A Turnaround

Summary

• Cardlytics has a unique and seemingly promising advertising platform.
• However, it has struggled to transform this asset into a profitable business model.
• I fear that the company may be running out of time to turn things around.
• Looking at the price of the company's bonds should give pause to any potential investors in the company's common stock.

Cardlytics ( CDLX ) is an online advertising company that offers targeted ads to banking customers. It's no secret that online advertising has been a tough industry to be in over the past year. Even by sector standards, however, Cardlytics' stock performance has been putrid over the past 24 months or so:

Shares climbed from $40 at the Covid lows to more than $150 in early 2021. Since then, the stock is down 97%. What's gone wrong for Cardlytics and is there any hope of a comeback?

A Promising Story

Cardlytics has been in business for more than a decade and has been building its business and banking connections for a long time. After proof of concept with smaller banks, Cardlytics has brought on bigger partner banks such as JPMorgan ( JPM ) and Wells Fargo ( WFC ) in more recent years.

The idea is that Cardlytics provides a value-added marketing service to a partner banks' account holders.

And, in theory, Cardlytics has the best possible data. It knows what customers are actually buying from their bank account transactions. That is potentially much more useful information than simply what people are looking at or searching for. Browsing could just be window shopping, whereas purchase data should be highly indicative of potential future purchase intent.

Also, advertisers should be able to achieve more certainty in terms of whether their ads are working. Suppose, say, Starbucks ( SBUX ) advertises on Cardlytics. It should be able to see whether targeted customers end up buying from Starbucks more frequently after running Cardlytics offers. This measurability should give advertisers more confidence in using the platform and tying offers directly to return on incremental advertising spend.

The thinking was that Cardlytics had shown poor financial results over the years since it was primarily assembling its bank connections and building trust with key partners. Now that the company has developed sufficient operating scale, it could turn on more monetization efforts and really unlock the profit potential of the business. With the Covid-19 outbreak, people were more open to online shopping and digital offers. This could have been Cardlytics' moment to shine. It all looked good, and CDLX stock skyrocketed.

Some bulls even labeled Cardlytics as the third-largest advertising platform, as measured by monthly active users, in the United States. Currently, Cardlytics has nearly 200 million active users by at least one count. However, the issue with that metric is that people logging into a participating online bank account are counted as a Cardlytics user even if their usership of the membership rewards program is limited.

You can see this reflected in the average revenue per user "ARPU" which for Cardlytics was just $0.36 in Q3 '22. I'd argue this is quite possibly the major flaw with the business model.

The company has access to a ton of users, sure, but there's been very little ability to monetize this potentially massive client base. So far, it would seem, the company hasn't hit on the right formula to create a workable value-added strategy out of this banking opportunity. That's clearly reflected when looking at the firm's results to date.

Troubling Financial Results

Despite the company's potential, it has failed to turn this into profitability as of yet. Indeed, the company has failed to generate positive operating income in any year to date. Here are the results over the years on an operating income basis:

• 2015: -$40 million
• 2016: -$30 million
• 2017: -$17 million
• 2018: -$41 million
• 2019: -$17 million
• 2020: -$54 million
• 2021: -$97 million

In 2019, it seemed the company might be turning the corner, as it got relatively closer to profitability. However, since then, things have gone from bad to worse, with operating losses exploding to record highs in 2020 and even further in 2021. Trailing twelve-month results have further deteriorated this year, as the company has seen a sharp rise in operating expenses without generating an equivalent increase in revenues.

This was highlighted in the company's latest quarterly results , where revenues and earnings both fell well short of expectations. Things have reached the point that Cardlytics is well into red ink on even an adjusted EBITDA level. You know a company is struggling when it can't break even on that most forgiving of metrics.

The company also guided down its results for Q4, which is seasonally its best of the year. Anyone hoping for a turnaround at the end of the year had those expectations dashed. Shares plunged another 34% on these sour Q3 results.

Adding to the downbeat news, Cardlytics co-founders Scott Grimes and Lynn Laube both resigned in November following the company's latest earnings whiff. Both of them had served as CEO of the company previously and were key figures at the company.

Poor Earnings Outlook

If Cardlytics were at an inflection point and about to reach profitability, that'd be one thing. But that doesn't appear to be the case. In fact, following the company's latest downbeat earnings report and guidance, have a look at these downright disheartening earnings estimates deck for the company going forward:

The company is expected to lose $2.43 per share in 2022, which can be somewhat excused as 2022 is now drawing to a close. However, things barely improve after that, with analysts forecasting another $2.35 per share loss in 2023 and $2.09 per share more in losses in 2024.

Notably, the company's revenues are hardly growing either, at least not in comparison to the firm's outsized losses.

For 2023 and 2024, analysts expect the firm to lose a combined $4.44 per share. As a reminder, shares are now trading at $4.72 a pop as I'm writing this. Thus, the company is expected to lose nearly its entire remaining market cap in operating losses just over the next two years. This is a grim state of affairs.

Balance Sheet Looks Shaky

As of September 30, 2022, Cardlytics' balance sheet found itself in a rather troublesome situation. The company has more current liabilities ($255 million) than current assets ($249 million), indicating a weak near-term financial position.

The company has very little in the way of tangible long-term assets either, with the vast majority of its long-term assets being goodwill rather than anything that could readily be converted into cash if needed.

However, while assets are limited, the company has a sizable pile of debt to worry about, namely $226 million of senior convertible notes. Speaking of the convertible notes, they are now trading at an alarming 43 cents on the dollar.

At the last trade price, these bonds are now offering a shocking 35.6% yield-to-maturity through their September 2025 maturity date. Simply put, if Cardlytics merely stays in business for the next three years, bondholders will earn annualized returns of more than 35% per year.

You might reasonably wonder why any institutional investors would bother looking at buying CDLX stock, given the potential return on the bonds simply from the company staying afloat. In any case, investors should be exceptionally careful before buying stock in a company whose bonds are trading at such a distressed level.

How Shares Could Rally Despite The Bad News

In the short term, you could build a bullish trade scenario for CDLX stock simply from being wildly oversold and out of favor. Short interest is nearly 20% of the float. This sort of stock is an obvious candidate for a rally after-tax loss selling concludes. Shares are down 48% just over the past quarter and are off more than 10% over the past week. It's not hard to imagine a decent rebound in January simply from being so technically oversold.

The company has avoided some worst-case outcomes as well. Bank of America ( BAC ) ultimately renewed its partnership with Cardlytics despite fears of them leaving. JPMorgan, despite acquiring Cardlytics rival Figg , hasn't left the platform yet either. Those were potential bearish concerns which haven't played out.

There are also some positives, such as a new Cardlytics advertising server which recently rolled out. This could potentially allow for better targeted ads with more images, time-of-day triggered ads, an ads marketplace, and other such features. If this drives much more uptake than analysts are currently projecting, perhaps that could turn things around for Cardlytics.

However, given the problems described in this article, and in particular the balance sheet, any short-term rally would likely be fleeting.

To change my opinion on the longer term, Cardlytics would need to significantly slash costs and/or boost revenues to get much closer to profitability.

Perhaps the co-founders were holding the company back and new leadership can right the ship. Or maybe the layoffs will save more money than expected and Cardlytics can trim enough spending to reach a sustainable operating point. I don't see these possibilities as particularly likely at this point, though.

CDLX Stock Verdict

Cardlytics was certainly a well-liked story stock throughout much of 2020 and 2021. At the end of the day, however, the company hasn't really proven that the business model works yet.

In theory, having access to all that bank data and captive users seems like a slam-dunk. In practice, however, Cardlytics has struggled to turn this promise into tangible financial results. The low ARPU is reflective of that.

I'd remain on the sidelines until the company is able to execute on its original vision. At minimum, potential shareholders should be highly cautious until Cardlytics can shore up its balance sheet, as the current rate of operating losses will put incredible strain on its existing financial resources.

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