TBLA - Outbrain Faces Further Revenue Decline Amid Advertiser Pullbacks

2023-12-04 15:45:39 ET

Summary

• Outbrain Inc. reported Q3 2023 financial results, missing revenue but beating earnings estimates.
• The company faces demand headwinds as advertisers avoid war-related web pages and tighten advertising budgets.
• Revenue has been declining, so I remain Bearish [Sell] on Outbrain.

A Quick Take On Outbrain

Outbrain Inc. ( OB ) reported its Q3 2023 financial results on November 7, 2023, missing revenue but beating consensus earnings estimates.

The firm operates an advertising recommendation delivery system for websites and advertisers on the Internet.

I previously wrote about OB with a Sell outlook amid a softening online advertising outlook.

OB continues to face demand headwinds as advertisers avoid an increasing number of war-related web pages and tighten their advertising budgets.

With revenue continuing to decline, I remain Bearish [Sell] on OB.

Outbrain Overview And Market

New York-based Outbrain has developed a system to provide recommendations of stories, products and videos that are relevant to the content they are displayed next to and relevant to readers' potential interests.

The firm is led by co-founder, Chairman and CEO Yaron Galai, who was previously the co-founder of Quigo Technologies, a provider of performance-based marketing solutions for advertisers and publishers.

The company’s primary offerings include:

• Engage

• Smartfeed

• Native Ads.

OB targets business relationships with media agencies and brand advertisers.

According to a 2021 market research report by Transparency Market Research, the market for digital ad spending is estimated to reach $1.4 trillion in 2031.

If achieved, this would represent a CAGR (Compound Annual Growth Rate) of approximately 14% from 2021 to 2031.

The primary reason for this forecasted growth is shifting consumer preferences toward consumption of social media and digital video, increasing the demand for display advertising.

Additionally, after the pandemic, travel, hospitality and automotive industries have represented significant demand growth opportunities, although the three industries are trending toward their pre-pandemic level of activities.

Major competitive or other industry participants include:

• Taboola

• Facebook

• Google

• LinkedIn

• Twitter

• Amazon

• Criteo

• Magnite

• PubMatic

• Xandr.

Outbrain’s Recent Financial Trends

Total revenue by quarter (blue columns) has barely grown year-over-year; Operating income by quarter (red line) rose past breakeven in the most recent quarter, as the chart shows below:

Gross profit margin by quarter (green line) has trended lower since 2022; Selling and G&A expenses as a percentage of total revenue by quarter (amber line) have dipped in the most recent quarter:

Earnings per share (Diluted) have remained positive in the two most recent quarters:

(All data in the above charts is GAAP.)

In the past 12 months, OB’s stock price has risen 2.59% vs. that of Taboola.com Ltd.’s ( TBLA ) rise of 24.83%:

For balance sheet results, the firm ended the quarter with $168.6 million in cash, equivalents and short-term investments and $118.0 million in total debt, all of which was categorized as long term.

Over the trailing twelve months, free cash used was $5.1 million, during which capital expenditures were $10.4 million. The company paid $12.0 million in stock-based compensation in the last four quarters.

Valuation And Other Metrics For Outbrain

Below is a table of relevant capitalization and valuation figures for the company:

(Source - Seeking Alpha.)

Below is an estimated DCF (Discounted Cash Flow) analysis of the firm’s projected growth and earnings:

Based on the DCF, the firm’s shares would be valued at approximately $3.57 versus the current price of $3.96, indicating they are potentially currently overvalued.

As a reference, a relevant public comparable would be Taboola:

(Source - Seeking Alpha.)

OB’s most recent unadjusted Rule of 40 calculation was negative (6.5%) as of Q3 2023’s results, so the firm has performed poorly in this regard, per the table below:

(Source - Seeking Alpha.)

Commentary On Outbrain

In its last earnings call (Source - Seeking Alpha ), covering Q3 2023’s results, management’s prepared remarks highlighted the current regional unrest in Israel and the greater Middle East.

The company has employees distributed in many locations worldwide but has 380 in Israel, of which 30 have been called up.

On the business side, management is more cautious due to ‘brand budget cuts and delays’ due, in part, to an increase in war-related news pages, which are more difficult to monetize as brands seek to avoid showing their advertisements on such pages.

The company is continuing to invest in AI initiatives to improve its algorithmic performance as well as automate ad variety.

In the earnings call, I tracked the frequency of various keywords and terms used by management and analysts:

The chart illustrates that macroeconomic uncertainties are weighing on the firm’s client base and are the reason why it has widened its guidance range for Q4.

Analysts asked leadership about its 2024 expectations, its Onyx system performance and its free cash flow and cost management efforts.

Management said it is focused on leveraging AI for optimization as part of its efforts to scale new and existing supply of inventory.

The Onyx system was successfully launched, with positive feedback and an increasing number of campaigns utilizing it.

Leadership said the company returned to positive cash flow in the most recent quarter and plans to focus on efficiency and generating positive cash flow in 2024.

For the quarter’s results, total revenue for Q3 2023 rose by only 0.4% YoY while gross profit margin increased by 1.9%.

Selling and G&A expenses as a percentage of revenue fell by 1.8%, a positive signal, and operating income turned positive, reaching $2.6 million.

The company's financial position is solid, with ample liquidity, some long-term debt and a small amount of free cash used in the trailing twelve-month period.

OB’s Rule of 40 performance has been poor, with revenue contraction combined with slight operating profit.

The net revenue retention rate for publishers was 95%, indicating ‘a continued headwind and the impact of the demand environment on pricing and yields, which is the primary factor driving retention to be below 100%.’

Looking ahead, consensus full-year 2023 revenue expects a decline of 5.3% versus 2022.

If achieved, this would represent a growing contraction in revenue versus 2022’s decline rate of 2.3% versus 2021.

In the past twelve months, the firm's EV/Sales valuation multiple has fluctuated materially, as the chart from Seeking Alpha shows below:

A potential upside catalyst to the stock could include improving results from its AI integration initiatives, from further adoption of its Onyx system and from the start of a presidential election cycle in the U.S.

However, given the growing incidence of conflict worldwide combined with brands tightening their advertising budgets, I’m not optimistic in the near term.

With revenue continuing to decline, I remain Bearish [Sell] on OB.

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