OB - Outbrain: A Compelling Opportunity In The Digital Advertising Market

2023-06-16 12:30:34 ET

Summary

• The digital advertising market is forecasted to reach $765 billion by 2025.
• Outbrain Inc. expects strong double-digit YoY growth and improved margins in H2 2023.
• Google's decision to delay Chrome's third-party cookie deprecation until 2024 benefits the ad tech industry.
• I have an end-of-year price target of $8.6 on the stock.

Thesis

The digital advertising market is not only enormous but there is also a subtle shift towards contextual platforms following Apple's recent changes to IDFA. Outbrain Inc.’s ( OB ) gross profit growth is accelerating, and the company is experiencing expanding margins. Furthermore, Google's decision to delay Chrome's third-party cookie deprecation until 2024 provides the ad tech industry with additional time for workarounds, benefiting valuations. Additionally, Outbrain's strong position among news publishers is firmly established, setting it apart from typical supply-side platforms (SSPs). I value OB stock using a 0.4x EV/Sales multiple applied to the FY24 revenue estimates. The target multiple is well below where the peer average currently trades at and results in an end-of-year $8.6 price target.

Recovery on Cards in the Second Half of 2023

Outbrain had a relatively slow Q1, although revenue and EBITDA meeting expectations. Outbrain still anticipates strong double-digit year-on-year growth and improved margins in the second half of 2023, maintaining its gross profit and EBITDA guidance despite the weakness seen in 1Q. This trend is expected to be seen across the digital advertising industry in the second half of 2023, despite concerns of an impending recession. The market has likely already experienced the majority of budget cuts since March 2022. The company is focused on optimizing its cost structure, reducing headcount by approximately 8% since announcing workforce reductions in 3Q22, while continuing to release new product enhancements. OB continues to secure deals with publishers, which positions the company well for future demand growth. The company mentioned that accounts receivables and cash balance returned to normal levels in April after being elevated in 1Q due to connections with SVB.

Operating in a Large Digital Advertising TAM

Outbrain operates exclusively in the digital advertising market, which is a large and rapidly expanding industry. According to eMarketer projections , the digital ad market is expected to reach $765 billion by 2025 at a CAGR of 13.1%. It's important to note that while the digital advertising total addressable ((TAM)) market and CAGRs are significant, they encompass various areas in which Outbrain currently does not participate, such as search, affiliate marketing, and connected TV. However, there is potential for Outbrain to expand its offerings in the future through product development. To determine Outbrain's serviceable addressable market ((SAM)), I believe it is more appropriate to focus on digital advertising outside of China and excluding search. This narrower SAM represents approximately half of the overall TAM mentioned earlier.

Chrome Cookie Deprecation Delayed to 2024

The decision to delay from Google to move away from cookies in Chrome until 2024 came as a pleasant surprise to the ad tech industry. The decision to delay cookie deprecation provides the digital advertising industry with additional time to find solutions and consensus on the various hashed ID approaches being developed by ad tech consortia. While Outbrain has a relatively small direct revenue impact from the deprecation of cookies, it is still a looming negative catalyst. Therefore, any extension that allows the industry to educate advertisers and develop alternatives is seen as beneficial.

For companies like Outbrain, both first-party and third-party cookies play a crucial role in gathering user information for personalized ad targeting. This enhances Outbrain's value proposition by improving targeting and return on ad spend ((ROAS)). The cookie process involves a computer requesting data from a server when accessing a website. The server responds by providing the requested data along with a cookie, which is stored in the device's browser. The next time the computer sends a data request, it includes the previously attached identifying cookie. This stored cookie in the server contains user information like browsing and clicking behaviors. Buyers and sellers of digital advertising use this data to deliver more targeted and higher-priced ads.

Valuation

For valuation purposes, I compare Outbrain vs a primary basket of ad-tech peers with similar growth, margin, and/or revenue profiles. At present, OB stock trades at a discount to the peer group across nearly all metrics. I value Outbrain using a 0.4x EV/Sales multiple applied to the FY24 revenue estimates. The target multiple is well below where the peer average currently trades at and results in an end of year $8.6 price target.

Investment Risks

The ad tech industry has become crowded and commoditized in nature and making it challenging for companies to understand their specific roles and differentiation. Categories like "publisher tools," "exchanges," "ad networks," and "SSPs" alone have several listed companies, with many more smaller players in these areas. The ease of replacing these companies is also a concern, as they can be swiftly substituted by embedding another software developer kit ((SDK)) or a few lines of code. Moreover, ad tech companies operate behind the scenes and are invisible to end users, making it difficult for them to establish strong branding. Outbrain, along with Taboola and other similar companies, faces this dilemma of being in a crowded market with little differentiation. This situation may weigh on investor sentiment if either company faces challenges in the future.

Conclusion

The digital advertising market is enormous and continues to grow. The company is actively developing additional products to enhance its advertising suite, aiming to become the preferred partner for both publishers and advertisers. I view OB stock as a buy at current level and have an end of year $8.6 price target.

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