2023-08-10 06:09:21 ET
Summary
- AppLovin delivers strong earnings report, with Q3 guidance pointing to $800 million in revenues.
- The Software segment is the key driver of AppLovin's growth, with high EBITDA margins and ample cash flow.
- Despite challenges in the Apps segment, AppLovin's profitability and potential for $1.2 billion in free cash flow make it an attractive investment.
Investment Thesis
AppLovin (APP) delivers a strong earnings report. There's a lot of nuance under the hood, but I cut through the noise and explain the key moving parts that investors need to know.
All in all, I believe AppLovin will probably end up reporting about $1.2 billion of free cash flow in 2023. This is a very conservative estimate, which leaves the stock priced at 10x this year's free cash flow.
Here's what you need to know.
Rapid Recap
In my previous analysis titled, Inflection Quarter, Get in Now , I explained that AppLovin has two main segments. I explained that investors shouldn't be put off by its Apps segment, because the bull case for this investment is found in its Software segment.
I proceeded to remark that AppLovin's Software segment oozes free cash flows and holds high EBITDA margins and that this provides AppLovin with ample cash that allows it to improve its balance sheet, making its debt profile very manageable.
On the back of its latest quarterly result, I stand by those insights.
AppLovin's Guidance Impresses
Analysts expected to see AppLovin's Q3 guidance point to approximately $745 million. Not much more. What did AppLovin's Q3 guidance actually point at the high end? $800 million in revenues. This dramatically changes the tone of this investment thesis. Why?
Previously, AppLovin looked to many investors and analysts as an ailing adtech company. And I could quite easily understand why. Firstly, as I discussed in my previous analysis, and I'll repeat now, its Apps business was in the gutter.
But as I made the case in my previous analysis, and I'll repeat now, the Apps side of the business is becoming a smaller part of the overall story.
And yet, for their part, investors weren't too interested to look under AppLovin's hood towards the different moving aspects of its business. Why would they?
This brings me to my second point, advertising has been in massive turmoil, and that has been impacting AppLovin's Apps segment.
Case in point, PubMatic (PUBM), Magnite (MGNI), and Digital Turbine (APPS) all paint the same story. There is tremendous appetite amongst ad agencies to deploy advertising dollars, provided ad agencies get access to high-quality identifier data.
Put more simply, advertisers want, more than ever before, access to data that can deliver them measurable data with high ROI. They want to be able to iterate their ad campaign quickly to know what is working and what's not. The times of spending on an ad without data to inform advertisers of the success of an ad are done and dusted.
And this takes me to discuss AppLovin's software. Here's a question, why do you think we've seen Meta (META) and Alphabet (GOOG)(GOOGL) report such strong guides? The Trade Desk (TTD) is another example. Although The Trade Desk is very richly priced, the fundamentals echo what I'm describing here.
The message is clear, if there's a way to measure advertising ROI and provide analytics on that ad data, advertisers will gladly spend to gain market share in an uncertain market.
All that being said, even though investors like a simple story, and I have no doubts that AppLovin's Software segment will carry the bull case in full simplicity, and admittedly AppLovin's Apps segment is clearly delivering unappetizing growths rates, with revenues down 25% y/y, but somehow this segment remains remarkably profitable.
As you can see above, despite having to operate with substantially less scale, and a significantly smaller revenue base, AppLovin's Apps business is still delivering 18% EBITDA margins.
APP Stock Valuation -- 10x This Year's Free Cash Flow
In the graphic that follows, you see illustrated the message that I'm driving home:
APP Q2 2023
You see that AppLovin's Software business oozes high margins. Q2 2023 delivered 67% adjusted EBITDA margins. Given that I believe this segment will soon make up 70% of AppLovin's overall business, this will mean that AppLovin's free cash flow margins will improve further.
Now, here's further context. We know that AppLovin's capex is minuscule. Here I estimate that AppLovin's capex for 2023 will be around $25 million.
On the other hand, I estimate that AppLovin's 2023 will reach around $1.3 billion of EBITDA. Note, advertising is very seasonal, with Q4 being the strongest quarter.
Given that, for the first 9 months of 2023, AppLovin is likely to make $980 million EBITDA, I believe my estimate of $1.3 billion of adjusted EBITDA to be conservative.
But operating with a margin of safety is ok. In sum, I see AppLovin on a path to $1.2 billion of free cash flow. Leaving the stock priced at approximately 9x-10x this year's free cash flow.
The Bottom Line
After analyzing AppLovin's robust earnings report, it's clear that beneath the intricacies lies a promising story.
Amidst the details, I've distilled the key elements that investors should focus on. In my assessment, I anticipate that AppLovin is likely to generate around $1.2 billion in free cash flow for 2023, a cautiously conservative projection.
This valuation places the stock at a mere 10x multiple of this year's free cash flow, suggesting strong potential. The recent Q3 guidance also impresses, as it signals a shift in perception.
Despite challenges in its Apps segment and industry-wide turmoil, AppLovin's Software segment stands out, holding high EBITDA margins and bolstering its financial position.
This insight aligns with the broader trend seen in companies like Meta, Alphabet, and The Trade Desk, where the ability to measure advertising ROI and offer analytics has become paramount.
While AppLovin's Apps business exhibits unimpressive growth rates, its continued profitability is noteworthy, with EBITDA margins at 18%. Considering the trajectory of its Software segment and free cash flow margins, AppLovin appears poised for a future with significant potential, marked by a valuation of 10x this year's free cash flow.
For further details see:
AppLovin Q2 Earnings: Why Now Is The Time To Buy Into Future Success