The Trade Desk: Volatile Trade For The Daring

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About: The Trade Desk (TTD)
by: Henry Elrod
Summary

30-Day horizon offers possible triple-digit returns.

Run-up to earnings announcement 2/21/19 underway.

Risk is considerable.

Summary

Over the last five years, The Trade Desk (NASDAQ:TTD) has grown revenue ten-fold, to an anticipated guidance for 2018 of $464 million, from 2014’s $45 million. This is a compound average annual growth rate in excess of almost about 79.8%. Return on sales has averaged 14.0%, with gross profit at an average of about 78.7% over the same period.

Growing at 80.0% for an extended period, say for another five years, is probably not possible. If for no other reason, the law of large numbers makes it difficult to sustain such a high growth rate. Nonetheless, if TTD can continue to add just $90 to $110 million in new annual revenue for the next five years, sales revenue should grow to nearly $1.0 billion for 2023, and net income could triple, to around $150 million. Such growth implies significant growth in the stock price, and continuation of their current profit margins.

Given the volatility, with P/Es in a range of 23 times earnings to 59 times in 2017 alone, the stock could trade as low as the mid-80s to a high around 175. The current multiple on the September 2018 TTM EPS of $1.45, is about 100 times earnings. If the 100 level P/E multiple were to continue into 2023, the stock could exceed 225 per share.

TTD’s 4Q18 and full year 2018 earnings release is scheduled for February 21, 2019, after the closing bell, with a web-based conference call at 5 PM EST. If they meet or exceed their guidance, the stock could spike upwards. TTD has added 17.0% or so in the last 30 days, anticipating the earnings announcement.

The Trade Desk is a tech company that wrangles client advertising spending through what they call a self-service cloud-based platform. They utilize a powerful AI engine to manage programmatic advertising: discovering web ad offers based on Internet user profiles and ad site profiles, matching them to customer requests, and then bidding in placement auctions to acquire the spots in the desired time, place and price, all in real time. They also manage more traditional advertising channels, allowing the company to grow faster than the growth of programmatic digital advertising.

Company financial data for this report are taken from Morningstar’s proprietary Financial Investment Center, Yahoo! Finance, Nasdaq, the Options Industry Council, and TTD.

Issues and risks

TTD is a rapidly growing company with a short history. Since its IPO in September of 2016 (it came out at $18), the stock has traded with high volatility in a wide range. The Options Industry Council puts the 30-day volatility at about 47.1%, and based on recent call bid prices, the implied volatility in the 30-day calls is about 77.8%. According to Yahoo Finance, the beta for the underlying stock is around 2.8. This is an indication of the volatility of the stock itself, independent of the movement caused by market swings.

If the earnings number on February 21 meets or exceeds the consensus estimates, often based on the company’s guidance, the positive surprise could encourage the stock to continue its dramatic rise. On the other hand, a miss by as little as a few cents in the EPS number, or a miss on anticipated sales revenue, or a change to pessimistic guidance, could cause the stock to drop 15%, 20%, or more, in a short time.

Additional issues are the odd numbers the company sports for its current and quick ratios, and related statistics. Simple arithmetic says the company’s current ratio has averaged 1.3 over the last four years, and the quick ratio averaged 0.3 for the same period. These are low compared to traditional teaching, but are more common today when electronic funds transfers are commonly used instead of snail mail and the use of paper invoices and the clearing of paper checks.

However, computation of the average (last four years) number of days’ sales invested in accounts receivable produces 659 days, i.e., nearly two years’ sales. Worse, the number of days’ cost of revenues in accounts payable is 2,171, i.e., nearly six years cost of sales in accounts payable. These numbers appear to be just silly, but there is a simple explanation. TTD purchases advertising on behalf of their clients, and subsequently bills the clients for TTD’s fees and the amount of the purchases.

Likewise, TTD pays the advertising vendors when TTD collects from the clients. Both the additional receivables and payables are recorded in the books, but do not constitute revenue or expense to TTD. Thus, both numbers are artificially inflated and the calculation of days’ sales in A/R and days’ costs in A/P are skewed. The necessity of waiting for the customer to pay does require an additional significant cash investment in accounts receivable, but the delay by TTD in paying the customers’ advertising bills, as indicated by the large number in accounts payable mitigates the issue. The remaining red flag would show if a customer of significant size ultimately failed to pay, leaving TTD holding the bag, or at least in litigation about the liability.

TTD has a dual stock structure with Class A Common and Class B Common stocks. The Class A stock is fairly normal or typical: its holders receive dividends if any are declared (none so far), and each share gets one vote. The Class B stock, which is owned by the founders, insiders, and related trusts and partnerships, is also eligible for dividends if such are paid, but each share of Class B stock has ten votes. According to information on Morningstar, funds and institutions own roughly 97.7% of all shares held, and insiders including officers and directors own but 1.8% of all shares held, leaving about ½ of a percent held by individual investors.

This can be slightly misleading, as more than 80% of the Class B is owned by executive officers and directors, with CEO Jeff Green owning almost 72% of the Class B stock. This gives the insiders, as a group, about 70% of the total voting power of all shares across both classes, with Jeff Green owning about 53% of the total voting power of the combined classes. If holders of Class B stock sell it, other than to controlled entities, it converts to Class A. Only Class A stock was issued in the company’s IPO.

The trade

There are many possible trades that an investor could make that could have profitable outcomes. Because of the volatility and the current expectation of continued growth and profitability, call options with relatively short duration are relatively valuable, so one suggestion is to hold the underlying stock long, but sell out of the money calls with short duration. As an example, an investor could have bought 100 shares of TTD Class A Common on February 11 for around $148.50, and sold the March $155 calls for around $10.50 or so.

On the 100 share trade, this would require $14,850, plus $3 or $4 commission, and would have netted about $1,017 after commission for the call contract. If the stock is at or above $155 on March 15, the proceeds from the assignment would be $15,500, for a short-term gain of $647. With the $1,017 from the calls and the $647 from the assignment, the total would be $1,664, a gain of 11.2% in a period of 32 days. This results in an annual rate of return on the investment of 127.8%.

Disclosure: I am/we are long TTD. 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.

Additional disclosure: I am long TTD and short the calls.