Rubicon Project: Quick Turnaround Story With No Debt And Strong Downside Protection

| About: The Rubicon (RUBI)
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Summary

Rubicon trades at $5.50/share with $3.84/share in cash and zero debt, wide discount to peer group and downside protection.

In the middle of time lag after which revenue stream will stabilize.

Has scale and built-in relationships in sector as an advantage.

Introduction

Rubicon Project (NYSE:RUBI) is a technology company in the ad tech industry that automates the purchase and sale of advertisements on the internet.

The advertisement can be of different types: desktop display (the usual banner on the internet), mobile display (advertising in a mobile application) or video (video advertising).

Rubicon stands between supply and demand, offering its platform on which transactions occur, like an exchange. That type of business is called SSP (supply side platform). The publisher is on supply side. It has an inventory and a contract with Rubicon for the sale of its inventory for 10%-15% commission. The DSP (demand side platform) company is on demand side. It is an intermediary on the buyer's side, and also pays Rubicon a commission.

The market share structure is about 80% for giants like Google (GOOG/GOOGL) and Facebook (NASDAQ:FB). These are the largest players in the digital ad space, the rest is distributed between Rubicon, AppNexus, Taboola, OpenX, PubMatic, Criteo (NASDAQ:CRTO), Rocket Fuel (NASDAQ:FUEL), etc. Rubicon has always been one of the leaders in this sector, working with the best publishers and premium inventory, and one of the largest by revenue.

Rubicon has several sales channels for inventory. The first type is direct transactions or orders, where the buyer, using Rubicon's technologies, directly contacts a particular publisher. The second type is auctions in real time or RTB (real-time bidding).

Until recently, Rubicon had contracts with publishers and their inventory was being sold via the techniques of "waterfalling." Publishers start by selling impressions with one SSP (say, Google's AdX) at a high price floor. If the impressions don't get picked up, publishers push them to second (Rubicon Project) or sometimes third SSPs (PubMatic) at lower price floors until they do. Such a system was not effective, because the buyer from the third exchange, for example, could pay more for the inventory than the buyer from the first exchange, but did not have this opportunity because this inventory simply did not reach him.

More than two years ago headder bidding technology came to the market, which allows all the demand companies at the same time bid for inventory. Thus, the last bid became more expensive and the publisher's revenue began to grow. This technology in 2016 was the hottest topic in the ad tech sector. All publishers want their inventory to be sold through headder bidding, showing revenue growth of up to 50%.

"Header bidding, also known as advance bidding or pre-bidding, is an advanced programmatic technique wherein publishers offer inventory to multiple ad exchanges simultaneously before making calls to their ad servers (mostly DoubleClick for Publishers). The idea is that by letting multiple demand sources bid on the same inventory at the same time, publishers increase their yield and make more money. Header bidding isn't that different to a waterfall (many publishers are already working with multiple SSPs), except that all demand sources are given the same opportunity to bid and win. This gives buyers better access to the valuable inventory. Poor inventory will still perform poorly." (AdExchanger.com)

Rubicon was late with the introduction of this technology and completed its implementation in early 2016. Because of the tech delay, and time lag, revenue at the end of 2016 began to fall sharply, so in 4Q 2016 revenue fell 23% YoY, and the forecast for 1Q 2017 is a 40% decline YoY. Additionally there was the closure of the Canadian business Chango, which Rubicon bought in 2015 for $122 million and which did not meet management expectations. The company finally wrote off Chango in the fourth quarter.

Due to problems, the company began restructuring and laid off 19% of its workforce (mostly associated with the Chango business) and part of the top management. Industry veteran Michael Barrett had been appointed the new CEO of Rubicon.

After all the developments mentioned above the stock price collapsed from $20/share in April 2016 to $5.50 in April 2017 which is an all-time low for the stock.

Investment Thesis

In 2016, global advertising spend totaled $652 billion of which display varies from $55 to $90 billion (according to IDC and eMarketer). According to Magna Global, $19 billion of that was sold via programmatic with an expected growth of up to $42 billion by 2020 showing a 22% CAGR.

Rubicon back in 2016 was the sector leader with more than 1,300 customers, contracts with the best publishers for premium inventory, which means built-in relationships and scale. Already today, 300 customers out of 1,300 are connected to FastLane (the company's own headder bidding solution), and the volume of transactions increased from zero to $129 million in less than a year. Given the 25% average commission rate it generates $32 million of net revenue.

"...you take something that was a challenge for us and if you look at the rate that we have been able to turn that around from a customer implementation standpoint and a product implementation stand point, you're pretty much coming from a cold start. We launched a product in the market, you get 300 deployments, go from zero to $129 million of ad spend in just over three quarters. I think that illustrates the strength of our market position, it illustrates the strength of our customer relationships." (March 2017 conference call transcript)

The main concern is whether Rubicon will stabilize its revenue and return to growth. With headder bidding proliferation, pricing has become a key competitive differentiator since the same inventory is available through multiple exchanges, which means that it has to be balanced by volume. Given the scale of Rubicon's client base and rapid development of headder bidding technology, Rubicon has all chances to get back into the leader's seat of the SSP market and return to high rates of revenue growth.

"What really drives that revenue growth given that we are a marketplace business is the access to supply. In header bidding, it's ad requests, and ad requests overall in our platform grew 50% on a year-over-year basis even though we had a challenging 2016 year. Reconnecting that supply is critical for us in reconnecting that revenue growth.

Pretend that there was a big storm in Manhattan and let's say that Uber had all the Uber drivers in New Jersey and let's say that storm cut off the bridge, so those Uber drivers could not get into Manhattan. That is basically effectively cutting off the supply. Uber is not going to be able to generate revenue because there is a lack of supply or drivers that are in Manhattan. It doesn't mean that revenue is lost forever, but it cannot monetize something if that supply access is not there. So what happened in North America desktop display with us in 2016 is that some of that supply was cut off and wasn't able to make its way to our platform. So it's as though somebody poked a hole in a pipeline that was oil wasn't actually able to get to our system. Once we deployed our own FastLane solution and as we are making those integrations, making sure those integrations are clean and efficient and working well, we have reconnected that supply." (March 2017 conference call transcript)

The publisher has a limit on the number of SSPs that he can connect to his page in order to run headder bidding. With their growth the page starts to load more slowly. The optimal number of SSPs is 3-5, which means that only the largest will have access, Rubicon is one of those with the largest number of clients. That limit will likely lead to consolidation in the industry.

"Beyond being a complicated setup to implement, the biggest issue with header bidding is what it can do to publishers' page load times. Each SSP tag that a publisher plugs into its page is yet another potential source of added page latency. It's a significant risk these days. Publishers are already larding their pages with third-party ad tags, which have slowed down Web pages and forced alienated readers to install ad blockers." (AdExchanger.com)

I had a conversation with a person from the sector who found Roxot, the company partner of AppNexus, which creates the most technologically advanced auction of headder bidding. He believes that Rubicon is in the middle of this time lag and can turn around very quickly.

"One critical point to make there is that because we are a marketplace business, as the supply in the past, some supply was cut off, it took a while for that revenue declined to lag. And now as it is being reconnected, it's got to first, be made available in the marketplace and then it's available again for the bidders to bid on and then those marketplace effects start to reverse." (March 2017 conference call transcript)

Risks

In February 2017, News Corp (NWS/NWSA) sold 3.9 million shares or 8% of Rubicon. Rubicon today is a broken growth story with strategic concerns. The price implies a further decline in revenue with the obsolete business model. Plus, the risks of the sector: i) squeezing margins due to commodification in the sector and pressure from the buyer and seller on non-transparent commissions ii) redistribution of market share between participants iii) the risk of rapid technology change. These are the main reasons why the company lost 75% of its value in 12 months.

Valuation

Rubicon's market capitalization is $273 million, it has no debt and cash and cash equivalents of $190 million, thus the total EV of Rubicon is $83 million. In 2016, the company made $278 million revenue, $71 million adjusted EBITDA and $26 million net cash. The forecast for 2017 revenue is $202 million. I compared Rubicon with competitors in the market. Among them there are both public companies and valuations from the private market. When comparing, it is necessary to take into account the method of calculating revenue. Someone shows a gross value, i.е. together with the cost of the inventory, what Rubicon calls ad spend. To get the right comparison, you need to lead to a net revenue. Rubicon's peers are: Trade Desk (NASDAQ:TTD), Criteo, Tremor Video (NYSE:TRMR), Rocket Fuel as public companies and TubeMogul (NASDAQ:TUBE), Sizmek (NASDAQ:SZMK), LiveRail, BrightRoll, MoPub, Millenial Media (NYSE:MM) as deals in the private market.

The average for a group of peers is EV/revenue х3 with an average gross margin of 68% and EBITDA margin of 17%. At Rubicon the value of EV/revenue х0.4, gross margin 71% of EBITDA margin 15%. I used the expected numbers for 2017. I did not use EV/EBITDA because at the moment it is not possible to calculate the correct EBITDA number for Rubicon, approximately it trades at 3 to 4 times 2017 EBITDA. It is also worth noting that not all competitors are generating positive cash flow. Average P/CF for companies in the group of peers that generate positive cash x41 vs x11 for Rubicon and average EV/CF x38 vs x3.

Triggers

Recovery of operating results. The market will see that the turnaround will be rapid and rerate the company. An example is Rocket Fuel, in which YTD grew more than 150% after a prolonged decline in revenue and a reversal in 4Q 2016 for the first time since 2015 they showed YoY revenue growth.

The possibility of acquisition by a strategic or financial investor. In January, WSJ wrote that Rubicon hired Morgan Stanley to search for a possible buyer. This is confirmed by the contract of the new CEO. He received 1.7 million RSU and options with a $5.7 cost. The contract specifies separately that if Rubicon is sold, the CEO will receive all his bonuses "following a Sale Transaction, 12 months' salary continuation plus target annual bonus, pro-rata bonus at target for time served during the year of termination, 12 months' reimbursement of COBRA expense, and vesting acceleration of all time-based equity awards." Michael Barrett himself is known for having successfully sold AdMeld, Rubicon's direct competitor, to Google in 2011 and Millennial Media to Verizon/AOL (NYSE:VZ) in 2015.

Rubicon can return a portion of its cash on the balance sheet to shareholders. Unlikely, but this option exists.

Downside protection

$5.50/share price today consists of $3.84/share in cash and cash equivalents and $0.77/share in NOL, which means that on the $4 level this stock is well protected, given the slow cash burn rate. According to my estimates, in 1Q17 Rubicon will spend a maximum $8 million in cash. Whether the turnaround happens within next six months or not, the company will not burn much cash, so downside protection will remain in place.

Upside potential

Direct Rubicon competitor AppNexus, which has earned $200 million in revenue in 2016 and today, is the leader in headder bidding, and plans to file S1 form this year to enter into an IPO with an estimated $1.5-2 billion price. To get to the valuation of the least expensive company in the peer group Rubicon has to double.

Conclusion

I believe Rubicon is in the middle of a time lag, and the market misunderstands this, between the start of FastLane deployment and stabilization of its revenue stream. With its built-in relationships in the sector, headder bidding technology in place, experienced management and downside protection at the $4/share level it offers a great risk/reward opportunity. With Rubicon's distressed valuation it also could be an acquisition target for a strategic or financial investor.

Disclosure: I am/we are long RUBI.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.