Back in October 2018, we wrote an article on Seeking Alpha in which we said to buy the dip in programmatic advertising leader The Trade Desk (TTD). The thesis was simple. The Trade Desk is in the early innings of a robust long term growth narrative that overlaps data, automation, and advertising. Ultimately, that growth narrative will propel TTD stock meaningfully higher in the long run. Against that favorable long term growth backdrop, near term weakness is just a buying opportunity.
From the time we wrote that article to early May 2019, TTD stock rallied more than 70%, while the S&P 500 was barely positive over that same stretch. Clearly, buying the dip was the right move.
Over the first few weeks of May, however, TTD stock has dropped in a big way due to a not-that-strong forward guide issued in its Q1 earnings report. TTD stock is now in the middle of its worse sell-off since October 2018. Yet again, we think this is an opportunity to buy the dip. The long term growth narrative remains healthy, while near term weakness is overstated. TTD stock will recover from this sell-off soon, and proceed to head meaningfully higher in the long run.
The big idea behind TTD stock is that programmatic advertising is the future of the advertising world, and in that world, The Trade Desk is the hyper-growth company to own.
Programmatic advertising is simply data-driven advertising. Before, ad allocation and ad transactions were done by humans, in a largely guess-and-check format. Programmatic advertising takes those processes, makes them smarter by using data, and makes them more time/cost efficient by using machines and algorithms. As such, programmatic advertising is simply the secular automation and data trends applied to the advertising world. Because programmatic advertising is powered by secular growth trends, and because the process yields improved outcomes for brands and advertisers, it is inevitable that programmatic advertising eventually becomes the norm across the entire ad world.
The global ad market measured around $617 billion in 2018. Global programmatic ad spend measured around $70 billion. Thus, only 11% of ads are being transacted programmatically today. Next year, global programmatic ad spend is expected to hit $84 billion, on a global ad market of $665 billion, implying nearly 13% penetration. By 2020, programmatic ad spend is expected to hit $98 billion, while the global ad market is expected to expand to $718 billion, implying nearly 14% penetration.
These trends will persist. Programmatic ad spend's penetration rate will keep growing over the next several years, as will the the size of the global ad market. At scale, within the next decade, the global ad market could very well measure $1 trillion. At current expansion rates, 25% programmatic ad spend penetration seems reasonable within the decade, too. That implies a $250 billion programmatic ad spend market within the next decade, up nearly four-fold from today's $70 billion market.
Meanwhile, The Trade Desk is the most interesting player in this space, mostly because of its track record of robust market share gains. Over the past three years, gross spend growth through TTD has significantly outpaced programmatic ad spend growth globally. This has resulted in consistent and significant market share expansion. Based on Zenith market data and TTD's SEC filings, gross spend through TTD represented roughly 2.4% of global programmatic ad spend in 2016. That number rose to 2.8% in 2017, and 3.4% in 2018. If 1Q19 growth rates persist, TTD's market share will close in on 4% in 2019.
In the big picture, then, The Trade Desk is one of the fastest-growing companies in one of the fastest growing markets. Ultimately, that means this company has a ton of growth potential left. As stated before, the programmatic ad market could run towards $250 billion within the next decade. Given current trends, The Trade Desk could easily nab 10% of that market at scale. That implies somewhere around $25 billion in gross ad spend within the next decade. Revenues usually run around 20% of gross spend, so that further implies $5 billion in revenue is doable within the next decade, a more than ten-fold increase from last year's sub-$500 million revenue base.
(Source: Trade Desk 1Q19 Earnings Deck)
Meanwhile, margins are healthy and stable, with GAAP operating margins hovering around 20% for the past several quarters. Conservatively assuming that scale does spark some operating leverage in the long run, then operating margins should run towards 25% when revenues are around $5 billion. Taking out an additional 20% for taxes, you're left with $1 billion in potential net profits in the long run for TTD. A growth stock average 21 P/E multiple on that implies a potential future market cap for TTD stock in excess of $20 billion. The current market cap is well under $10 billion. Thus, the numbers imply that TTD stock still has tremendous upside in a long-term window.
Against that favorable growth backdrop, dips in TTD stock are normally buying opportunities. This recent one is no exception. There are some concerns today surrounding the stock's valuation, slowing revenue growth trends, and compressing margins. But the valuation adds up if you appropriately extend the growth outlook. Revenue growth is slowing today simply due to the law of large numbers, and should broadly remain above 30% for the next several years. Meanwhile, margins are compressing due to growth-related investments which will peel back over time and be replaced with operating leverage at scale.
In other words, the reasons for the May meltdown in TTD stock don't hold much water in the big picture. As such, this dip is nothing more than a buying opportunity for medium- to long-term-oriented investors. A recovery should ensue over the next several weeks, so long as macro market conditions remain favorable. Even if they don't, and the stock struggles for gains amid escalating trade tensions, that isn't a big concern for long term investors. In the big picture, the stock will ultimately head way higher from here as The Trade Desk helps programmatic advertising become the global norm across the entire ad industry.
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.