Description

I believe CDLX is a good short here.  While there are certain aspects of the business to like, as Thistle recently outlined, I think that there are some negative aspects that are being overlooked, that there is significant short-term risk from COVID-19 disruption, and that bulls are overestimating CDLX’s profitability at maturity (specifically with respect to ARPU).

Positive aspects of the business:

1)     Contributory data businesses are hard to build and very defensible – VRSK’s core P&C data business is a good example of this, and I always thought that ID Analytics was an underappreciated aspect of Lifelock.

2)     Closed-loop / walled-garden ecosystem is attractive to advertisers – advertisers consistently call out CDLX’s ability to map spend to offers / i.e. show a high conviction ROI on spend as unique vs nearly every other channel that requires unreliable third-party validation.

3)     Strong value proposition to all constituents that it serves – CDLX has three constituents, 1) financial institutions, 2) financial institution customers and 3) advertisers, with a clear value proposition to each: 1) revenue generation for financial institutions with increased customer spend and retention, 2) attractive offers for customers, and 3) attractive and high-conviction ROI to advertisers.

However, I think there are some key negative aspects to the business that the market is not appreciating:

1)     The visibility in this business is extremely low – this a short-cycle advertising business that has seen volatility in a normal environment (3Q18), and based on the last earnings call it sounds like ad budgets started off the year weak, before COVID-19 was on the scene, driving very disappointing 1Q20 guidance.

2)     Numbers will likely have to take another considerable step down even after the 4Q19 report disappointment – given that this is a short cycle advertising business, and that a lot of the offers drive foot traffic (Starbucks, etc.), I believe there is a high likelihood that Q2 and Q3 estimates will have to come down materially.

3)     Future growth relies heavily on management’s ability to build an automated offering – campaigns right now are “white glove” with dedicated staff building custom campaigns, analytics, etc.  In order to scale the business and attract the longer tail of advertisers and ad agencies, the company needs to build a more automated platform.  The two founders are ex-Capital One execs and I think their expertise is clearly more in the building of the financial institution partner network than the building of an automated advertising platform.  Furthermore, I think that the recent announcement that current CEO Scott Grimes will be moving to Exec Chairman, and current COO Lynne Laube will be moving to CEO is indicative of this challenge.

4)     Automated platform build-out will require significant investment – while the Street is calling for a fairly steady build in EBITDA, management has even called out the possibility for profit volatility due to the investment required to successfully build out an automated solution.

5)     Future ARPU levels are highly dependent on financial institution partner cooperation to help drive engagement – while management does not disclose ARPU by financial institution partner, based on industry sources and management commentary it sounds like ARPU by partner varies widely depending on the UI, the level of marketing the financial institution is putting behind the offers with their customers, etc.  I don’t think that building a sleek tech solution for these offers is a) a competency or b) a priority for the tech teams of most financial institutions.  Indicative of this, Citi was actually once a partner but it sounds like CDLX basically fired them because they wouldn’t commit enough effort to the platform / offering.

6)     Engagement on the CDLX platform is likely inherently much lower than other social media advertising platforms, and could thus translate into much lower end-state ARPU – bulls value CDLX by putting an end-state ARPU on an MAU base (Thistle had a well-articulated bull thesis that pegged ARPU at $10).  The problem I see with this is that the ARPU comps people are using are for platforms with significantly higher levels of engagement (Snapchat, Pintrest, etc.).  Furthermore, from what I can gather, the best performing partner is perhaps BofA which from what I can ascertain has ARPU around ~$4.  If your best partners are going to peak around there and then you have customers more towards the Citi end of the spectrum, getting ARPU back beyond the 2018 levels is going to be very difficult in my opinion.

Today CDLX trades at an enterprise value of $1.4bn, and even in an optimistic scenario where ARPU is able to get back to prior peak levels on >150 (post WFC and US Bank) MAUs, and incremental margins similar to this year, all of which I think carries very high execution risk, the stock is still trading at >30x 2022 EBITDA (45-80x if you were to value it off of either of the next two years).  While it is a unique platform, I think that is a very heady valuation for a company with limited visibility, high execution risk, and what I see as a likely best-case 3-5yr revenue growth CAGR of ~20%.  Hard to put a valuation target on this one, but the stock traded in the $15-30 range in the last twelve months.

Catalyst

Catalysts:

1)     Another large reduction in estimates from COVID-19 ad budget impact.

2)     Choppy financial performance from investment in automated ad campaign platform.

3)     Disappointing growth from lack of execution on automated ad campaign platform.

4)     Disappointing ARPU growth due to point #3 and low engagement limiting the ability to reach ARPU levels of other ad platforms.