Description

Pubmatic, Inc. (Ticker: PUBM) is a technology company operating a sell-side advertising platform that matches digital content creators with ad buyers. Before getting into the details of PUBM’s business, we’ll briefly discuss the company’s recent revenue growth, and market growth rates.

REVENUE GROWTH & MARKET GROWTH

PUBM grew revenues at strong rate of 31% in 2020, and by and even stronger rate of 53% in 2021. The company estimates that in 2021, its total addressable digital advertising market grew at 31%, so it outperformed market growth substantially. The company increased its market share from approximately 2%-3% in 2020, to approximately 3%-4% in 2021, representing an increase in market share of approximately 1% during the past year, a big move off a small base, reflecting its outperformance.

In late 2021, a surge in the omicron variant created some headwinds within some specific digital ad market verticals, including in-person activities, such as food and drink, and health and fitness. This slowdown appears to be persisting for early 2022. The company expects the current TAM will grow at double digit rates in 2022, and we believe the company will grow revenues in 2022 by approximately 25%, and by a similar amount in 2023. Zenith has projected global retail media ad spend to increase at a 23% over the next three years.

So that’s the basic backdrop for industry and company growth. We see this market continuing to grow quickly and the company being able to match or exceed that growth.

DIGITAL ADVERTISING

In order to understand PUBM’s business, we offer a brief background on the basic structure of the digital advertising industry.

A lot has been written on this, and we note that agentcooper2120 wrote up a competitor, Magnite, in May of 2021, and provided an excellent overview of issues surrounding the markets for digital advertising and for Supply-Side Platforms (SSPs).

We’re going to make our own attempt to explain in simple terms how we see the industry.

BUY SIDE

On the one side of the digital ad market, there are buyers of advertising space. These are traditional media buyers, who want to identify and purchase ad space that is relevant to their target audience, and they include advertisers and ad agencies. For example, Procter & Gamble has the largest ad budget in the world, while WPP is the largest ad agency. These groups want to buy ad space.

SELL SIDE

On the other side, there are sellers of advertising space. These are publishers, content creators, and app developers that have ad space inventory they want to sell to monetize their business. Publishers include firms like Yahoo, and News Corp., while app developers are firms like Zynga and Electronic Arts.

In simplistic terms, consider a generic news web site that has news content for consumers, with adjacent space available for advertisements. They want to sell that ad space. It’s the same basic advertising dynamic as existed with newspapers 50 years ago.

SELL SIDE PLATFORMS

PUBM sits between these two groups of 1) buyers and 2) sellers. The company is focused on the sellers of advertising space and earns its revenues from them. The company has created a “sell side platform” (SSP) whose purpose is to monetize advertising inventory for the sellers. As consumers navigate websites and apps, they see ads, which are sold to buyers programmatically in real-time. The company is aligned with the sellers, as it is independent and agnostic with respect to which specific advertisers or agencies might purchase specific advertisement space. The buyers can access the sell side platform, review seller ad space inventory available on it, and bid on and purchase space that best aligns with their goals. This is PUBM’s basic model, as an SSP.

DEMAND SIDE PLATFORMS

There’s one more wrinkle. The buyers of advertising space also have their own platforms, known as “demand side platforms” (DSPs). A DSP is the inverse of an SSP. While an SSP lets publishers sell their ad inventory through a platform exchange, with a DSP, advertisers might buy across several different SSP ad platform / exchanges at the same time. DSPs are demand aggregators. Thus, to expand on the above, SSPs sell ad space not only to advertisers, and ad agencies, but also to DSPs.

PUBLISHERS AND ADVERTISERS

The company has a stable of strong publishers, including Forbes, The Guardian, the New York Times, the Washington Post, WebMD, Zillow, Ebay, Draft Kings, ABC and many more.

During 2021, PUBM added approximately 250 new publishing partners, and served approximately 1,450 publishers and app developers representing over 87k domains and apps. Verticals included news, e-commerce, gaming media, weather, fashion, technology and more.

In 2021 there were 72,000 advertisers per month who placed ads on the company’s platform, with a 50% ad spend growth in the top 10 ad verticals.

FORMATS

The company’s platform covers a wide range of formats and device types, including mobile app, mobile web, desktop, display, digital video, and fast-growing OTT/CTV.

Over the Top (OTT) describes content that is served to viewers streamed over the internet, rather than a private network, as with set-top boxes. This would include services like Netflix, Hulu, and Amazon Prime. A Connected TV (CTV) is a device that connects to or is part of a television to support video content streaming. (e.g., Roku, Apple TV). Ads are served before content, or during commercial breaks.

In Q4 2021, mobile (including mobile video) and video (including OTT/CTV) grew 41% YoY compared to Q4 2020, and accounted for 67% of the company’s 2021 revenue. Notably, CTV revenue growth in Q4 2021 versus the prior year’s quarter was up over 6X.

PRIVATE CLOUD INFRASTRUCTURE

The company owns and operates its own private cloud infrastructure. And the company’s infrastructure Capex in their private cloud is paying dividends, with cost of revenue per impression falling by 28% in 2021 versus 2020, and by 32% in 2020 versus 2019. Put another way, average daily ad impressions have increased by 400% over the three years ending in 2021, while costs to process these impressions have increased by only 90%. During 2021, the company processed 90 trillion impressions, nearly double the prior year, but cost of revenue per million impressions processed declined by 50%.

FRANCHISE VALUE

We believe Pubmatic is creating a sustainable franchise. This is based on several factors, including, 1) owning and operating a private cloud infrastructure that enables continued reductions in costs, combined with 2) increasing scale, and scale economies, and 2) network effects as the company adds more publishers and more advertisers to its platform. This is reflected in the company’s fundamentals.

GROSS MARGINS

The company’s gross margins are high and stable, which is an indication the company has pricing power within its markets. Here are gross margins for the last four years:

2018 69%

2019 68%

2020 72%

2021 74%

We think the company can maintain gross margins in the low 70% range for the next few years.

RETURN ON ASSETS, RETURN ON INVESTED CAPITAL, AND RETURN ON EQUITY

The company boasts high returns on assets, invested capital and on equity, having grown each of these very rapidly over the past 3 years.

ROA was 6% in 2019, 9.2% in 2019, and 12.3% in 2021.

ROIC was 7.5% in 2019, 19.8% in 2020, and 26.2% in 2021.

ROE was 7.1% in 2019, 15.2% in 2020, and 22% in 2021.

We believe these strong and growing returns indicate the company is doing something special, and they are able to use their assets, invested capital, and equity with increasing efficiency.

EBITDA MARGINS

The company’s EBITDA margins have also grown steadily over the past 3 years:

2019 18%

2020 31%

2021 36%

A quick observation here. The “Rule of 40,” usually in a SaaS context, relates to the idea that a software company's combined growth rate and EBITDA margin should be greater than 40%. It’s a high level check that measures the balance of growth versus profitability.

Pubmatic had 2021 revenue growth of 53%, which when added to its 2021 36% EBITDA margin renders it comfortably north of this yardstick. We think for 2022, the company will meet the “Rule of 55,” with 25% revenue growth and low 30% range EBITDA margins.

VALUATION

The company had $82 million in EBITDA in 2021, and an enterprise value of $1.2 billion, which equates to an EBITDA/TEV yield of 6.7% (EV=15X EBITDA). We think this is expensive generally, but cheap for a company growing revenues at such a high rate and with such strong fundamentals. We believe EBITDA could compound at ~17% and top $110 million in 2023, for an 9.1% forward EBITDA/TEV yield on today’s enterprise value.

The company’s P/E (diluted) is 23.6, and ex-cash that is 20.8. Again, that’s expensive generally, but we think not for a firm growing revenues at 25%, which it could do for the next few years. EPS for 2022 and 2023 are very difficult to assess, so this is a risk for the stock, as you could see a significant increase in the P/E in the near-term, at today’s prices.

SUMMARY

Pubmatic is a very rapidly growing small cap firm growing revenues at a CAGR of ~25% and EBITDA at a CAGR of ~17% for the foreseeable future, trading at an EBITDA/TEV yield of 6.7%, and a P/E ex-cash of 20.8X, both of which we think is reasonable for a long-term compounder that will continue to easily beat the “Rule of 40,” with high growth and margins.

The company, with its private cloud platform offering and benefiting from network effects and scale, is showing strong signs it has a viable franchise, with high and stable gross margins in the the low-70s, and strong TTM ROA of 9.2%, ROI of 26.2%, and ROE of 22.0%. It will continue to easily beat the “Rule of 40,” with high growth and strong margins.

Catalyst

-Continued penetration and growth of OTT/CTV market

-Continued growth of digital advertising generally