May 08, 2023 - 12:40pm EST by
2023 2024
Price: 17.75 EPS 0 0
Shares Out. (in M): 300 P/E 0 0
Market Cap (in $M): 6,597 P/FCF 0 0
Net Debt (in $M): 0 EBIT 0 0
TEV (in $M): 0 TEV/EBIT 0 0
Borrow Cost: General Collateral

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Applovin (“APP”) makes marketing and customer acquisition software for mobile gaming studios while also owning several acquired studios themselves.  The company went public in mid-2021 as VC funding poured into mobile gaming developers who spent record amounts acquiring and marketing to customers, to APP’s benefit.  APP’s stock peaked at over $100/share in November 2021, but as technology and gaming stocks declined along with VC funding in 2022, the stock dropped to $14 by December of that year.


As this happened, APP’s CTO sold 70% of his total holdings while the CEO, who had purchased stock at $61/share in May 2021, turned around and sold $30 MM of stock at a large loss of $11/share.  It’s not often you see the CEO do something like that.  While logical to assume our thesis hinges on VC funding evaporating, it does not.  We spoke with a number of industry executives who brought up several unique problems facing APP on the horizon. 


First, industry executives stated that mobile gaming customers have become rightfully skeptical of APP’s inherent conflict of interest, serving as a customer acquisition channel for mobile gaming publishers while owning publishers themselves.  APP’s core software products include AppDiscovery, its customer acquisition / targeting software, and MAX, its ad mediation or “in-app bidding” software.  Note that APP acquired a second ad mediation business from Twitter, MoPub, for $1 BN in January 2022 as well.


The conflict stems primarily from the ad mediation software.  MAX / MoPub embed an SDK (software development kit) inside the customer’s mobile app to track the ads being served / bid on through the apps along with the user responses, which feed into APP’s ad network that monetizes customer ads.  Third party SDKs are painful to remove once installed as the developer must rewrite the code, which inevitably generates bugs.  This ‘spyware’ embedded on the mobile gaming apps leads to superior user insights for monetizing ads and in-app purchases along with increasing customer usage.


To illustrate the value of these SDKs, APP paid $210 MM to the MoPub customers post-acquisition to ensure those studios left the SDKs in their games after the deal closed.  The conflict from these SDKs stems from APP owning studios themselves, enabling APP to translate the user and advertising insights generated by the SDKs on the customer apps to their own mobile gaming apps for improved performance and ad monetization.  With its AppDiscovery software, APP can also funnel the highest quality customer leads to its own studios instead of to the customers. 


According to these industry executives, the gaming customers are very concerned about this and aim to partner with non-conflicted APP competitors.  We see the evidence of this conflict starting to play out with the March 2022 announcement that APP would restructure its Apps business – i.e., the studios they own – to focus strictly on its software business – after years of acquiring studios, after the Apps business started underperforming.


This leads to a second problem, APP’s multi-year, debt financed acquisition spree.  Starting in 2019, APP acquired SafeDK, Samfinaco, Geewa, Redemption Games, Machine Zone, along with other smaller apps and software players.  The deal sizes then increased significantly starting with the $1 BN acquisition of adjust GmbH from Eurazeo in April 2021, followed by the January 2022 MoPub deal for $1 BN, and the $430 MM acquisition of Wurl in April 2022.


This has left APP with net debt of approximately $2.4 BN on real 2022 EBITDA of $600 MM if you count the $192 MM of stock based compensation and $272 MM of other ‘non-recurring’ charges management backs out of its Adjusted EBITDA calculations.  As we will discuss later, we believe the company is heavily overearning and on the brink of a secular decline that will heavily reduce APP’s earnings power.  In that scenario, the leverage likely becomes untenable.


The third issue, according to multiple industry executives we spoke with, relates to APP’s leadership.  According to these executives, APP’s senior management team has intentionally misled both customers and investors alike seeking to create an image of high integrity, telling customers APP does not transfer data or customer leads to its in-house studios while promising investors a bright future ahead when we believe management sees these challenges coming to a headway on the horizon.  The CEO’s $30 MM stock sale in December seems to support that theory.


We believe customers will continue moving away from APP’s customer acquisition and marketing services while the mobile gaming market continues to decline, with APP’s revenue set to decline at double digit rates in the 10%-20% range over the next 1-2 years while margins decline from historically inflated levels by up to 10 points.  These assumptions translate to our projected 2024E revenue of $2,030 MM and Adjusted EBITDA (as defined by management) of $565 MM, a 28% margin.  In contrast, the Street expects revenue growth to accelerate in 2024 to 10% for 2024E revenue of $3,115 MM and Adjusted EBITDA of $1,253 MM, a 40% margin.  Meanwhile, revenue has already turned negative as of Q322 to -2% y/y, widening in Q422 to -11% y/y.


As results underperform expectations and the business begins to sustain significant declines, we expect valuation to move towards those of other customer-acquisition digital marketing businesses, the most closely related comp being CRTO, which trades for 1.4x revenue and 5x EBITDA with a financial profile of 10%+ expected revenue growth and 28% Adjusted EBITDA margins.  Applying 1.5x revenue and 5.0x EBITDA valuations to our 2024E projections translates to fair value of $1.50-$2.00/share, downside of approximately 90% from the current price of $17.75/share. 

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.



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