Cardlytics: A Prime Opportunity In The Digital Advertising Boom

Summary

• As advertising dollars continue their shift online and companies spend more than ever before to attract new business, there is a need for more accurate targeting and in-store data tracking.
• Cardlytics operates its Direct platform which analyzes tens of billion of payment transactions annually and provides actual spending habits data to aid targeted advertising by its clients.
• The company currently leads in the $11 billion direct market and has further expansion opportunities into the $204 billion global digital advertising market.
• Based on the company's market share, sales and net income growth, I conclude the company has roughly 50% upside potential for 2018 as they grow MAUs at double-digit rates.

Investment Thesis

The digital advertising market is exploding with the boom in internet-based social media on desktop and mobile platforms and marketers are more focused than ever on identifying consumer spending habits for targeted advertising.

In an industry where the majority of consumer spending occurs in-store and more than half of all financial transactions are electronic, companies have a limited view into accurate industry wide and individual-specific trends that allow them to effectively target individuals on online advertising platforms.

As this targeted advertising market takes shape, Cardlytics (NASDAQ:CDLX) has offerings specific to U.S. marketers based on consumer purchase patterns by analyzing tens of billions of transactions every year. This is far more accurate than target audiences from mega advertisers like Alphabet's Google (GOOGL) (GOOG) and Facebook (FB) which offer targeted advertising based on search or comment patterns, but fail to provide unique individual prospects to marketers who may want to get a better bang for their advertising buck.

As a result of the boom in these methods of targeted advertising Cardlytics has been growing sales by mid-double digits for the last 3 years and is approaching profitability as it cuts net loss as a percentage of revenues from over 72% in 2014 to 15% in 2017. As the company continues to enjoy the surge in its market, valued at over $11 billion among the $204 billion global digital advertising market, I believe they are at the forefront of the industry's growth and are set to continue and gain market share. (Source: Company 10-K)

Industry Overview

MAGNA research reports show the digital advertising market increasing around 13% to $204 billion in 2017 as more marketers focus on the internet and social media boom. As the majority of current advertising measures focus on key demographics and other criteria based on their online shopping preferences, there is a key issue with accurate purchasing patterns since roughly 90% of consumer spending still happens in store. Specific stores or chains provide details for broad market reports, but individual companies have a limited view of the entire industry regarding specific purchasing and return-shopper patterns, which hurts return on advertising spending.

Many companies have been focusing on improving consumer experiences and analyzing their data for future purchasing patters from large companies like Deloitte, which deploy resources to map consumer spending habits and improve advertising returns all the way to eCommerce startups like Cognilyze which focus on psychological-based consumer spending habits to increase per-visit spending with accurate product recommendation. These types of companies have been working to improve the inaccuracies in targeting and recommendation markets causing major marketers and advertisers to rely on the aforementioned third-party companies for the majority of their needs.

As around 70% of all consumer payments were electronic in the past year, the native bank advertising market has grown steadily alongside digital advertising and is currently valued at over $11 billion in the United States. The amount of data derived from these electronic payments are vast and very useful for targeted advertising in the United States on social media and online in general. There are over 10,000 financial institutions (FIS) and for individual companies to focus on hiring these FIs to create an effective marketing campaign is not realistic. Enter third-party data analytics companies.

Business Overview

Cardlytics purchases information from over 2,000 FIs and analyzes over 18B transactions in the U.S. in 2016 alone. It uses its Carlytics Direct platform to analyze over $1.3 trillion worth of transactions in credit, debit, ACH and bill pay and construct a spending habit profile on customers in exchange for cash-back incentives with its FI's customers. The company paid over $232 million in cash-back incentives in 2017 through the appropriate FI.

The company works primarily with Bank of America (BAC), which provides around 50% of their data and with Lloyds Bank (LYG), which provides an additional 10%. Digital Insights, an NCR Corporation (NCR) company, provides another 13% of data. As 70% of transactions remain electronic in the U.S., Cardlytics's platform can offer valuable insight into in-store spending habits and as a result offers their solutions to 80% of top restaurants, 45% of top retail stores and 75% of top telecommunication companies in the United States.

Based on the company's banking data, the average customer logs in to their online banking account 7.7 times every month and has a 7% click rate on the company's cash-back incentives, which is 9x the average engagement rate banks find with personal and enterprise offers online. As a result, the company saw monthly average users (MAUs) rise over 25% to 53.7M in the first nine months of 2017.

Growth Driving Results

The company's offering, Cardlytics Direct, uses this data for targeted advertising which has a much higher accuracy than the traditional online target audience platform. One of our research team members is an SEO/SEM specialist and as part of his job he interacts with advertising platform like Facebook and Google which offers him target audiences based on factors like recent searches, voice conversations, comments and liked pages but fails to target individuals who actually purchased the item in question in the past which results in a much lower engagement rate between advertisements and customers. Evident to that, Cardlytics has a whopping $30:1 return on ad spend (ROAS) relative to the industry average of $2.87:1. (Author note: See company 10-K for ROAS calculation and see below disclosure for additional team member info).

As a result, sales have increased from their inception in 2008 and grew over 45% in 2016 to $112.8 million. For the first nine months of 2017, the company reports $91.1 million in revenues, up over 19% compared to the same period in 2016. As guidance from the company calls for $129.6 million in revenues for full year 2017, the just under 15% growth rate remains under their CAGR of 44.8% they previously experienced. This is a result of the transfer of business from Aimia EMEA Limited partnership which resulted in a reduction in their "other" sales segment. Excluding this reduction, sales from their Cardlytics Direct platform increased over 25% for the first nine months of 2017.

Net income has increased alongside revenue, but on a adjusted basis has improved dramatically. As they reported $75.7 million in net loss for 2016, they expect full year 2017's net loss to be in the $20 million range. This is because the 2016 net loss was due to a $25.9 million non-cash charge from their Aimia business restructuring and a $10.9 million non-cash charge from the revaluation of convertible notes, bringing 2016's net loss to $38.9 million, down from 2015's net loss of $40.6 million. As the company expects a $20 million net loss for the year, they've reported a net loss of $15.6 million for the first nine months of 2017 which is on par to reduce net loss by almost 50%.

Risk Factors

An initial risk factor for the company is their debt load which stands at just over $55.5 million. As most of its debt is fixed rate, it still has $24.5 million outstanding in an Ally bank facility with a prime plus 3.5% interest rate so its interest expense will increase with each rate hike. A continued rise in interest rates, which is expected according to the Federal Reserve board, may lead the company to refinance their floating debt to a fixed rate if the option is available or incur the additional interest expense. Another factor in debt risk is the high interest rate they pay which varies between 7.00% and 13.25% annually.

As most new growth businesses incur significant headwinds related to revenue streams, Cardlytics remains exposed to one product but also to Bank of America and other institutions which generate 50% and other large portions of their business and revenues, respectively. A significant competitor entering the market with a new and improved solution or a boost in spending by companies like American Express (AXP), Visa (V) or Mastercard (MA) in data analytics and marketing sales can adversely effect the company's future sales growth. There is also a chance that advertising giants like Google or Facebook start purchasing this same information from payment processing companies and leverage their current offerings in the ad market which will hurt Cardlytics's market share. Another aspect of being limited to a single growth avenue is the prospects of their relationship with the FIs which are not contractual (except for 17 of the 2,041) which may result in an instant loss of a significant portion of revenue if the FI's terms of service with Cardlytics or their customers change.

Additionally, as a relatively new business in a up-and-coming growth market, they face cyclical spending shifts which may adversely effect their quarterly reports and share price as a result. In recent years, the overall marketing environment has been incredibly cyclical and short-term focused, meaning the company must continue to generate a high degree of new business and maintain a cutting edge platform to sustain their advantages over competitors. Just 50 years ago the majority of advertising dollars was spent in radio, 10 years ago on TV and now the majority (54%) is online. There's no telling what the next big advertising push will be, or where, but it's clear that this more accurate form of targeted advertising is where it's trending, at least for now.

Valuation

It's hard to tell just how much of the direct $11 billion market Cardlytics can capture, even as they believe they are the current leader (Source: Page 5, Market Opportunity), according to internal company reviews, but the fact that this market is growing steadily yet the company continues to grow revenues at a faster pace means they are gaining market share as the industry heats up and their solutions become more widely adopted.

As the company is expected to report roughly $130 million in sales for 2017, a further 15% to 25% increase in sales comes to a range median of $156 million for 2018. As the company continues to exhibit a double-digit growth rate in a $11 billion market, I believe a 3-4x price to sales multiple fairly values Cardlytics which brings 2018 valuation range median to $546 million, representing around 49% potential upside throughout 2018. This valuation metric is supported with net loss narrowing which can set the company on track to profitability some time in the next 2 or 3 years based on a continued 15% to 25% revenue growth rate and a control on interest and general SG&A expenses.

Investment Conclusion

As online advertising spending continues to surge and companies worldwide spend huge amounts of money and resources to enhance their online presence, companies have so far worked with target audiences, but fail to accurately understand what happens in-store and target individual consumers.

Cardlytics uses data analyzed from tens of billions of transactions across the U.S. to provide better solutions for companies looking to get real-life spending habits for their advertising needs. This in turn has provided a $30:1 ROAS, which is significantly higher than the industry average of $2.87:1 which is attracting more and more business, increasing sales by low-mid double digits.

As the company continues to attract new business and expand its platform's reach and FIs, I believe they are well positioned for significant price appreciation through the coming years as advertising dollars continue to shift online and established advertisers continue to focus on target audiences rather than target individuals and have trouble providing in-store transactions data.

As these factors materialize, I believe the company's expected $130 million in 2017 revenues, coupled with their high growth expectations and nearby profitability, presents a valuation about 50% higher than current market prices and that an investment in the company can yield a much higher return than market averages or other rather saturated advertising giants like Alphabet's Google or Facebook.

(Additional disclosure: The research team member who is a SEO/SEM specialist was not, does not and will not work with or on behalf of any company we cover and analyze. The mention was an emphasis on the inaccuracies present with current online advertising.)

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Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in CDLX over 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.