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January 2019

The Trade Desk: An Ad-Tech Survivor


After a 40% post-earnings pop a couple months back, ad-tech software provider, The Trade Desk (TTD), really made a name for itself. However, investors who got in on this one at the ground floor have quintupled their money since the IPO about two years ago.


Investment Thesis


The Trade Desk’s unique value proposition, solid financials, and visionary management make this an interesting stock even with the run-up in the past couple years.


Unique Value Proposition


The Trade Desk sells a software platform that enables advertising agencies to optimize their programmatic advertising among different mediums. In plain English, The Trade Desk helps ad agencies spend their budgets more effectively.


Traditionally, ad-tech companies would act a bit like a black box, profiting from the arbitrage between buying from publishers and selling to agencies. The Trade Desk takes a completely different approach by focusing solely on the buy-side agencies. The value of this is that the company establishes strong, recurring relationships. The metric to watch is the retention rate, measuring customer churn and it has been above 95% for the last 19 quarters.


Clearly, customers are happy with the company’s platform. To drill down deeper on the platform, it is actually quite confusing at first but also quite impressive. At its core, it helps agencies spend more effectively by optimizing real-time bidding. Surprisingly, a lot of modern-day advertising is done through this system. In essence, there are millions of bids going on for every ad space.


Let me put it this way. Let’s say you go on YouTube and find a video to watch. Before the video loads, an ad pops up. Now what goes on behind the scenes? Picture this. A big auction room with a bunch of different Fortune 500 companies represented. Up front, there is an auctioneer from YouTube rapidly announcing prices for each brand to “win” the ad that is shown to you on YouTube. Finally, KIA wins as top-bidder and you end of watching 15 seconds of footage on their new Optima.


This is theoretical but essentially what is happening in real-time bidding. The only difference is computers do the bidding rather than humans. Instead of handling programmatic advertising on their own, big companies usually outsource it to ad agencies. Hence, The Trade Desk’s relationship with them.


To drill down just a little bit more, The Trade Desk’s demand-side platform (DSP) gives ad agencies visibility into which real-time bids will be most profitable.


Now all the technology is good and fun but if it doesn’t translate into solid numbers it doesn’t mean much. Let’s check it out…


By the Numbers


In the latest quarter, revenue grew 50% to nearly $119 million, a huge beat over initial guidance. The company also likes to report adjusted EBITDA numbers for earnings, making a classic value investor cringe. But, in essence, this number is similar to operating cash flow. To the point, adjusted EBITDA rose 50% year-over-year from $24 million to almost $37 in the latest quarter.


You may be scratching your head thinking, “Wow, this company actually makes money!” Surprise, surprise! Especially with SaaS (software-as-a-service) companies these days. But The Trade Desk isn’t SaaS and it does buy advertising inventory so the dynamic is much different. With that said, management has been clear in the past that they believe profitability is important in this industry because a few players have gone bankrupt. Management is being extra cautious since they really want to be the strongest niche player in this space so financial fortitude is a differentiator for them.


At the same time, that doesn’t mean management isn’t innovating.


Visionary Management


Jeff Green, CEO and founder, was a pioneer in ad-tech, founding a company at the ripe age of 26 called AdECN. This company was built the world’s first online ad exchange, the foundation for real-time bidding. AdECN was acquired three years later by Microsoft.


Mr. Green is a charismatic figure, a champion for The Trade Desk. He owns over 6 million shares, worth well over $500 million. His Glassdoor ratings are top-notch. The man can do it all.


For a while now, Green has been harping on the importance of CTV (connected TV) for The Trade Desk. Essentially, he believes that streaming sites like Hulu will eventually use programmatic advertising. Signs indicate he is onto something. Granted from a small, unknown base, CTV revenue grew 10x in the last quarter and CTV ad inventory for the first three months was 78% greater than all of 2017.


Plus, The Trade Desk is focusing on international expansion and omni-channel offerings like audio, search-based, and social media. Both of these areas increased by triple-digits in the last quarter, though, once again, most likely from a small base.


So there is some optionality built into the business, but let’s check out valuation and risks.


Valuation and Risks


The Trade Desk’s market cap is $4.9 billion and it has $139 million in cash. Let’s called it $4.75 billion in enterprise value. I think a realistic estimate for forward sales is somewhere around 40% growth to $587 million in revenues. Guidance for adjusted EBITDA is right around 30% so that would leave us with about $130 million in full year adjusted EBITDA. Doing some division, that comes out to almost 27x forward adjusted EBITDA. But remember, this is essentially operating cash flows so it is certainly not cheap. But if the company can keep posting quarters with 50%+ revenue growth, the valuation is not bad.


Risks play a huge role in the ultimate valuation that a company receives. For The Trade Desk, it has been shrouded in mystery. Before the big pop after last earnings, there was a lot of skepticism surrounding the company’s competitive position, especially against ad behemoths like Facebook (FB) and Alphabet (GOOGL).


The Trade Desk pitches itself as a compelling alternative to these ad kings by keeping data secure. But I view it a little differently. I see TTD having a structural advantage actually. Think about it this way. Facebook and Google aren’t incentivized to help ad agencies make the most of every dollar. Ideally, they would like to keep the bidding somewhat inefficient to make sure ad agencies spend more on their real-time bidding platforms. In my eyes, there are inherent conflicts of interest that TTD can bypass since it focuses solely on ad agencies.


Another risk is customer concentration. The company reports that the three top agencies account for 43% of sales cumulatively (11% Omnicom, 10% WPP, 22% Publicis). However, if you read deeper, these ad agencies are very decentralized so one holdings company like WPP could actually have dozens of independent sub-agencies within it. Therefore, these sub-agencies could be seen as individual clients even though they are under one name like WPP. Still, the concentration is not crystal clear so it could be considered a risk. 


To End


I’ve been following The Trade Desk since a couple months post-IPO. It has been a tough one to understand and I’m still cloudy on a couple things. It’s been a wild ride, but it comes down to the big picture in my opinion. Do you trust Jeff Green as a pioneer and will The Trade Desk be a leader in enabling programmatic advertising as a movement? The financials might be a little wonky at times, but answering the two questions above will give you the intestinal fortitude to hold this one for the long term.

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