For the first time since going public on September 20th, Rocket Fuel (NASDAQ:FUEL) reported quarterly results. Up until now, potential investors had only the company's prospectus to use for financial analysis purposes. As such, these third quarter results are going to be highly scrutinized.
Now that the report is out, in my opinion investors couldn't have asked for much better results than what they got - especially in terms of revenue and client growth. Here are some highlights (you can find more details here):
- Third quarter revenue increased 132 % from Q3 2012 to $62.5 million
- Active customers climbed to 938 from 406 at this time last year and up from 784 as of June 30th of this year
- Non-display channels more than tripled as a percentage of revenues (more on this later)
- Q4 revenue is projected between $74 and $77 million
I'm only highlighting a few major points as the purpose of this article is to analyze why the impressive growth can continue. I'm going to explain why I believe the company can sustain growth, fend off its competitors, and manage its key risks.
Rocket Fuel's predictive modeling and automated decision-making platform is used for navigating the billions of trades occurring daily on digital advertising exchanges. The ability to get the right ad, in the right place, at the right time, in front of the right person is the value the company's products bring to clients.
I'm not going to cover the specific products and services offered by FUEL as I prefer to focus on the big picture. However, there is absolutely no doubt about the value the company's products and services bring to clients.
As a matter of fact, the company's revenue retention rates speak for themselves. According to the prospectus, the revenue retention rate was 134% in 2011, 175% in 2012, and 180% for the 12 months ending June 30th, 2013. That means even without a single new customer, revenue growth rates would be impressive. Throw in new customers, and you can easily see why FUEL's growth potential is off the charts.
Nevertheless, the company isn't going to have to rely on revenue retention to continue posting impressive growth. In fact, there are plenty of reasons to believe robust external growth is a very distinct possibility.
First off, Rocket Fuel's business breaks down into four major channels: display, video, mobile, and social. Display is your typical Internet advertisement, such as a banner ad and the like. Video is of course, video ads. Mobile includes ads you see on your smartphone or tablet. And, social is advertising on social media sites, such as Facebook (NASDAQ:FB).
Historically, FUEL's primary business has been display, providing roughly 85% of the company's revenue. That's simply a case of the display market being more mature than the others. Display inventory was made available on digital exchanges first.
However, management believes (per the prospectus) Rocket Fuel's proprietary AI and computational infrastructure should work just as effectively on the other channels. As the company penetrates more into those markets, there's a significant growth opportunity.
In fact, according to this week's earnings, the company more than tripled the percent of revenue coming from mobile, social, and video. That number jumped to 26% of total revenue (which means display dropped to 74%). So far, it appears the company's belief it can be just as effective in other channels is completely justified.
Perhaps more importantly, the entire digital advertising space has massive growth potential. According to Magna Global (via Rocket Fuel's prospectus), digital advertising is forecasted to grow from $42 billion in2012 to $73 billion globally in 2016. However, all advertising revenue globally reached $472 billion in 2012. In other words, there's plenty of room for broad digital advertising growth as the advertising market changes and adapts.
After all, it will quickly become apparent - if it's not already - the benefits of AI-driven, digital advertising far outweigh the familiarity of old-school marketing methods.
FUEL lists a variety of competitors in its prospectus, from Google (NASDAQ:GOOG) and Facebook to advertising agencies and digital advertising networks. But in many cases, these competitors are just as likely to be partners. Moreover, I believe the industry giants such as Google are more likely to acquire a company like Rocket Fuel rather than develop a similar business in house.
The most similar companies to FUEL are primarily companies that have gone public recently. Here's a breakdown of who I see as the main competition and how they differ from FUEL:
- Millennial Media (NYSE:MM): One of the first companies in this space to go public; its focus is on mobile advertising. The company did recently acquire Jumptap, a more direct competitor to FUEL. Recent market cap: approx. $600 million
- YuMe (NYSE:YUME): focuses on the video advertising channel. Recent market cap: approx. $200 million
- Tremor Video (NYSE:TRMR) - also focuses on video advertising. Recent market cap: approx. $250 million
- Marin Software (NYSE:MRIN) - a closer competitor to FUEL, but provides more of a marketing enterprise solution. Recent market cap: approx. $350 million
- Criteo (NASDAQ:CRTO) - the closest competitor to FUEL just went public last week. The company is based in Europe and so has a larger focus on overseas markets. Recent market cap: approx. $1.5 billion
So as you can see, Rocket Fuel has already differentiated itself from the competition to some extent. The closest competitor is Criteo but FUEL has the geographic advantage in North America. More importantly, the company doesn't believe it needs to specialize on a particular channel - its products are highly scalable and can work just as well in each of the major areas, as evident in the recent earnings report.
Any company in a relatively new industry is going to face its share of risks. Of course, maintaining growth, both in terms of revenues and clients, is always a primary concern. Plus, there's certainly intense competition in digital advertising if you include the Internet giants and ad agencies in the pool.
FUEL's main competitive advantage is its AI and computational infrastructure. The company needs to be a step ahead of its competitors from a technology standpoint for it to continue to grow at a rapid rate. Judging by the increase in number of active clients, FUEL has so far been successful at turning its proprietary technology into results, but the company still has to prove it can show the same results within the other channels (besides display).
It's my opinion that the biggest risk in the industry comes from Google. The Internet powerhouse is talking openly about getting rid of cookies (used to track people's online movements) and replacing them with advertiser-specific identifiers.
This would be a huge deal for the industry. Rocket Fuel (and everyone else in the industry) relies on cookies for its technology to work. Any change to this method of tracking would require a significant change in the underlying technology - and likely cost a fair amount of time and money to modify.
Now, Google isn't likely to just flip a switch and make the change. It's simply too important of a change to do overnight. What's more, everyone in the industry would be impacted equally - so essentially, everyone would be on the same playing field.
Furthermore, cookies do have their limitations. Advertiser-specific identifiers would provide more useful data about customers. Over the long term, the industry would benefit from the change. It's just the transition period which could be challenging as companies scramble to update their technology.
Rocket Fuel has shown impressive growth through its history and has started off strong as a public company. The growth of the digital advertising industry should provide ample opportunities for revenue growth, as well as penetrating non-display channels. Additionally, FUEL's cutting edge technology should allow the company to fend off competitors.
As I write this, FUEL shares are down big in sympathy with the ad-tech industry. Tremor Video posted disappointing earnings with lower Q4 guidance. Keep in mind, FUEL expects to generate record Q4 revenues. This dip could provide a good buying opportunity for FUEL shares.
With the current price of around $40 per share ($1.3 billion market cap), FUEL is priced at 5.7x revenues. For an aggressive growth company, that strikes me as very cheap. Twitter (NYSE:TWTR), which operates in a similar space, is trading at over 40x revenues. Facebook trades at 17x revenues.
Given the company's growth potential, I believe Rocket Fuel makes a compelling case for those wanting to invest in the digital advertising industry.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.