Outbrain - Pioneer of the Native Advertising
If you're looking for "early signs of muscle atrophy" or "how this stay at home mom makes $10k a month," then you're in luck! Outbrain is officially a public company as of today. Before you see the name and write the company off completely, let's take a look at what it is, what it does, and if you should invest. Let's examine the king of the chumbox that is Outbrain:
Top-line Numbers
Market Capitalization based on IPO terms: $1.39 billion
Full Year 2020 Revenue: $767 million
Q1 2021 Revenue: $228 million
Q1 2021 Profit: $10.7 million (vs $4.4 million for full-year 2020)
How Did Outbrain Get Started?
Outbrain was founded in 2006 by co-founders Yaron Galai and Ori Lahav, who met while serving as officers in the Israeli Navy. Both had experience in the digital start-up space, with Galai selling his first business, Quigo, to AOL in 2007. Lahav worked at Shopping.com up until it was acquired in 2005.
Galai's original venture in Quigo was a pioneering foray into the digital contextual advertising space, using search engine queries to serve targeted ads to users, which should sound familiar if you've been on the internet at all in your life as this is the cornerstone upon which online advertising is built. It directly competed with the duopoly of Google Adsense (still crushing it) and Yahoo! Ads (not crushing it so much anymore). In a stunning, M. Night Shyamalan-style plot twist, AOL made a solid business decision and purchased the company from Galai and his business partner for $363 million in 2007. He turned around and used that money, combined with private equity funding, to start Outbrain.
What's Is Outbrain?
Outbrain is a native advertising company that generates revenue based on a user clicking one of their ads.
Outbrain likely wins the award for the company you've interacted with the most, but had no idea. You know when you read an article on a news or sports site and you reach the bottom where all those other suggested posts are for you to click on? The ones with the really clickbait-y titles like "9 out of 10 doctors say you should have this in your pantry" or "single cougars in your area?" That's Outbrain at work.
They are a different type of contextual advertising on the internet, in a niche that's now commonly referred to as "Content Discovery," where every view and click on an ad is money in the pocket of Outbrain and their advertising platform partners. But while Outbrain might be the pioneer for this type of advertising, they're not alone in the space anymore. Taboola and Dianomi are proving to be their biggest competitors, with the U.K-based Dianomi actually beating Outbrain to the public markets with their direct listing last month. So that's two clickbait companies in the space of 60 days sprinting to the public markets? Why?
2020, as I've discussed many times on this site, changed pretty much everything. With people shut in their homes and bored out of their minds, many turned to online content. What ensued was consumers the world over, well, consuming. Podcasts, blogs and general news sites saw heavily increased traffic. Ad rates on YouTube skyrocketed, rewarding content creators with enormous paychecks. And finally, advertisers took notice. Despite slow spend in the early part of the year as uncertainty gripped the planet, digital ad spend accelerated to new levels during the back half of 2020, leading to a 12.2% increase in total digital ad spend from 2019, according to the Interactive Advertising Bureau who commissioned the study alongside Price Waterhouse Cooper, resulting in a gross ad spend of $139.8 billion. This is even despite the release of iOS 14, Apple's new mobile operating system that allows users to disable activity tracking, leading to potentially less effective digital ads.
What you have to remember is: an increase in digital spending is a "rising tides" situation. The Apple issue I mentioned a minute ago was also coupled with Google announcing they are changing the way cookies and tracking are implemented, causing a mini-crisis among digital advertisers. Not to mention, numerous big advertisers pulled spend from Facebook last year over issues of censorship and social justice. So where did all this pulled money go? This is why a marketer's favorite word is "reallocation." The money was moved to "less traditional" digital advertising platforms! Instead of Google, companies were now shifting into connected TV giant The Trade Desk. Don't want to advertise on Facebook but still want to hit an affluent millennial target? Pinterest is here to pick up the pieces, and you can see the evidence of this in their rocketing share price through 2020. As companies looked for places to direct their massive digital advertising budgets, "out-of-the-box" companies like Outbrain were the direct beneficiaries.
Will I Invest In Outbrain?
I'm going to be very upfront about this: I was ready to HATE this company. Warren Buffett says he looks at a company's financials first, does his own valuation math and then compares it against the math of others to determine his opinion without going in with pre-conceived notions. I violated that rule here. My 9-5 is in digital marketing, so I'm pretty familiar with Outbrain and I strongly dislike the way they serve ads. However, I'm a realist, and I don't have to agree with the company in order to like the company if its fundamentals or future opportunities blow me away, so let's get into it.
The first thing I look at here is the revenue. An S-1 document is a company's chance to spit-shine the financials and put themselves in the shop window for institutional and retail investors alike. What I see from the initial prospectus is...pretty good. Full year revenue of $767 million at a $1.39 billion valuation is actually an absurdly affordable ratio for an ad-tech company in the digital space. If they're building billboards and have to employ people to wallpaper Viagra ads to the side of an interstate, then we're having a different conversation. This is a low-overhead digital ads company with some tailwinds, the first of which is the non-stop growth of the digital advertising sector.
Remember that $139.8 billion number I threw out earlier, which was the total ad spend for 2020? That number is going to look incredibly cheap in the coming years, with some research firms positing that it could even be blown completely out of the water by 2021 numbers. A report by eMarketer is proposing that 2021 ad spend could reach over $400 billion, split fairly evenly between "search" advertising and "display" advertising. If this number is anywhere close to correct, Outbrain could stand to be a big winner just by virtue of participating in the space. But let's project a few years out:
As illustrated above, the compounding effect of digital ad spend is unlikely to continue accelerating, but it really doesn't need to. The simple power of compounding spend looks to drive digital ad spend over $600 billion by 2023, which could serve to be a powerful multiplier for a company like Outbrain.
The second tailwind this company has behind them is the gaining of efficiency in their financials. 2019, as published in the company's S-1 filing, saw a loss of $20.5 million in net income (net income = revenue - spend). Numbers like this can be rooted in a variety of factors, including: marketing and advertising, building infrastructure and customer acquisition. When we look at the company's 2020 revenue, what we end up seeing is a profit of $4.36 million. A tech company with a profit! That's astounding. What's even more astounding is the net profit from Q1 of 2021, which is over $10 million. The company is getting more efficient and effective at capital allocation and profitability with each successive period, coupled with an ironic decrease in Sales and Marketing figures which provides it with greater free cash flow moving forward.
Business Risks
The chief business risk I see on the horizon is the competition in the space. Now that they are a somewhat major player in the digital ad universe, they are now competing with: Google, Amazon, Facebook, Twitter, Pinterest, Microsoft (via LinkedIn), The Trade Desk, Magnite, Dianomi, Snap and many others. According to the earlier referenced IAB study, the top 10 companies in this space account for over 78% of the market share in the category, though they were unspecific to which companies had what percentage. The remaining 22% is not a lot to scrap for, as the top companies are unlikely to release their stranglehold on the market share they currently have. Despite this, though, the digital ad spend growth rates stated earlier means that 22% of spend in 2024 could be around $140 billion, leaving plenty of meat on the bone for Outbrain.
The Bottom Line
OK Outbrain, you got me. I'm interested. The ridiculous growth of the overall industry, coupled with the pretty efficient capital allocation and frankly impressive free cash flow of the company could be a winning formula. It's hard to look past the actual business itself though. To me, this is the digital equivalent of investing in a tobacco company. Tobacco is a low-quality business that actively makes people sick (allegedly), but you invest because the business model is set up for success. That's exactly where Outbrain falls. It's the digital ad tobacco with no filter. It could be pure profit for those that jump in, but you won't smell great when you emerge.
Short-term: Neutral
Long-term: Long
The following article is for informational and entertainment purposes only, and should not be consumed as investment advice. Do your own research and do not buy or sell based on the content of this article. The author has no monetary involvement with Outbrain, and is not planning on opening a position in the next 72 hours.
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