The Trade Desk Could Be The Investment Of A Lifetime

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About: The Trade Desk, Inc. (TTD)
by: Joseph Kowaleski
Summary

The Trade Desk has changed the way digital advertisements are bought and sold.

Advertising is a critical component that drives economic activity; The Trade Desk's improvements to the digital ad-buying process present a huge opportunity.

The Trade Desk has annihilated its competition by enabling advertising agencies instead of trying to disrupt them.

The challenges are that the stock is expensive based on current multiples, and the entirety of The Trade Desk's future opportunity is difficult to quantify.

Despite the risks, The Trade Desk has mega-cap potential based on the numerous secular tailwinds; this warrants owning a small position.

Thesis

The Trade Desk (TTD) is changing the landscape for digital advertisement. 2019 marks an inflection point in advertising. Digital advertising is expected to cross the 50% threshold of total media ad spending. The Trade Desk provides valuable tools that empower ad buyers in this space. The stock may appear expensive, but The Trade Desk is a strong buy with huge potential.

Source

Market

Advertising is a key driver of economic activity. Studies have shown how crucial advertising is for driving economic activity. This study conducted by IHS in 2014 revealed the following important findings:

  • Advertising contributed $3.4 trillion to the U.S. GDP in 2014, comprising 19 percent of the nation’s total economic output.
  • Each dollar spent on advertising expenses generates nearly $19 of economic output that would not have otherwise existed.
  • In 2014, advertising accounted for $5.8 trillion in overall consumer sales and supported, totaling 16 percent of all sales activity in the U.S.
  • Advertising supported 20 million, or 14 percent, of the 142 million jobs in the U.S. in 2014.
  • Every $1 million spent on annual advertising expenses supports 67 American jobs.
  • Every direct advertising job supported another 34 jobs across all industries.

Source: ANA/TAC/IHS

Everyone is familiar with Google (NASDAQ:GOOG) (GOOGL) and Facebook (FB), the two most dominant players in advertising. These businesses are sell-side advertisers. The Trade Desk is not competing against these mega companies, The Trade Desk is empowering the buy side. The Trade Desk has no conflicts of interest; it provides a service to ad buyers. The sell-side like Google and Facebook are inclined to want to sell ads to the buy side. The Trade Desk provides a completely transparent "clear-box" platform to buyers.

The Opportunity

The Trade Desk adds tremendous value to the buyers of advertisements. It's important to understand who is buying these ads.

Top ad categories 2018

Source: Kantar Media

The common thread between the industries of the biggest ad buyers is that they are commoditized. Think of retail, while Amazon.com (AMZN) has significant advantages in distribution and its efficient use of working capital, does the consumer really care? The answer of course is no. Consumers are looking for the cheapest and easiest way to get products. Whether goods come from Amazon or Walmart (WMT) doesn't really matter. The auto industry is facing significant headwinds, brand power in the auto industry has faded since millennials just aren't that interested in cars. Most consumers also aren't performing complex analysis in determining which telecom providers have the best service, and so on.

Advertising and branding is a big part of what separates these commodity-based businesses. The essence of these commodity-based businesses presents an opportunity for those who can effectively market their offerings. Retail is a $6 trillion industry in the United States. As long as the opportunity is there, these industries will remain highly competitive and have a strong demand to differentiate from the competition.

This is where the Trade Desk steps in. The Trade Desk works directly with advertising agencies who work with clients of these industries. According to IBIS, there are 509,953 advertising agencies worldwide that will rake in $234 billion in 2019. At the end of 2018, The Trade Desk had just 742 clients or just one thousandth of the entirety of advertising agencies. The opportunity is enormous.

Just how exactly will The Trade Desk take advantage of this opportunity? The answer is in programmatic advertising and using data to target the right audiences. Google and Facebook have built empires on this very same principle. The Trade Desk describes itself as an enabler not a disrupter. The Trade Desk enables advertising agencies to not only purchase digital ads for clients, but gives better insights into the effectiveness of ad campaigns. It's crucial that businesses make the best use of advertising spend. If The Trade Desk can help maximize value to business, the company has a long runway ahead. Considering the company boasts 95%+ client retention rates, it would appear The Trade Desk is having the desired effect. Agencies would not continue to run failing ad campaigns.

Source

It's interesting that social media, search, and mobile leads programmatic advertising. I don't believe this to be an apples to apples comparison. Programmatic isn't really a media channel, it is more of a method to purchasing ads. I would expect as time goes on the perceived effectiveness of programmatic advertising to increase. As data and analytics improve, advertisers will be able to run more effective targeted ad campaigns.

Source

Programmatic advertising is taking over. The Trade Desk believes that all media will be digital and programmatic. Programmatic advertising is based on data, not best guesses. This graphic of display ad spending is just a small part. The Trade Desk also sees a big opportunity for ads in other segments such as connected TV and audio.

45% of Q1 spend on our platform was in mobile. Our Q1 year-over-year mobile video ad spend growth was about 60%. Mobile in-app spend growth was about 60% as well. Data spend was up 80% and cross-device spend was again up around 300%. Audio spend had an amazing quarter, growing over 270% in Q1, and connected TV spend grew well over 3x from a year ago.

CEO Jeff Green on Q1 2019 earnings call

The Trade Desk is benefiting by improving the process of buying digital advertisements across a wide variety of expanding mediums.

Competition

With programmatic advertising proving bountiful for The Trade Desk, there will inevitably be competition. Many of The Trade Desk's competitors have been acquired, names like Turn, AppNexus, and Rocket Fuel. It appears like The Trade Desk's key advantage is in its data and intelligence. The company has been improving its take-rate by leveraging its data, but not in excess. The Trade Desk's magic is not just in the purchasing of the ads, but in the tools it offers agencies.

The key for platforms like The Trade Desk is adding value to ad campaigns.

Koa, the Next Wave product, has reduced the average CPM clearance price by 20% for marketers using the tool, Green told investors. But The Trade Desk gets a cut of that 20%: So if a marketer bids at $12 CPM instead of a $15 CPM because the Koa tool predicts the publisher’s floor pricing and auction mechanics, The Trade Desk will take part of that $3 savings.

Agency buyers may not begrudge The Trade Desk’s high take rate as they have other platforms, like Rocket Fuel, the former ad tech leader that was hammered after going public and revealing a take rate over 50%.

“Smart marketers care less about working media dollars and more about returns,” Friedman said. “The dialogue we should be having is about whether marketers have the ability to decide if something enhances the campaign more than it’s costing.”

Source: Ad Exchanger

In essence, The Trade Desk has been on the cusp of innovation that provides value to ad buyers. By using technology to understand pricing strategies from sellers, The Trade Desk is able to benefit its own bottom line along with passing savings off to its clients. What I really love about The Trade Desk is the client focus. Competitors with higher take rates are doomed to fail because they don't benefit the client. The Trade Desk is different in that it provides a service to ad-buyers instead of trying to disband the industry and go directly to brands.

The Trade Desk is really the only company amongst its competitors that have employed this type of strategy. With over half a million ad agencies globally, trying to build a quality platform on top of an ad agency is a losing proposition. This fundamental principle to which the business was founded is now bearing fruit.

The Trade Desk’s method of going to agencies to support their bid to the brand, instead of trying to win in-house brand advertising budgets directly, has become “a model for many DSPs,” said Ashwini Karandikar, global president of Amnet, Dentsu’s programmatic business.

Source: Ad Exchanger

Valuation

Chart Data by YCharts

The Trade Desk is expensive by current multiples but has proven to be able to turn a profit, as it has since 2013. The company is very healthy and stable with no debt. I don't think there is any risk to the company structurally, the only risk is in valuation. As a fundamental investor, the value of the company is equal to what Buffett would say, cash flows from now until judgement day. One metric such as a forward P/E is merely analyst's expectations for cash flows over the next 12 months. A time horizon as short as one year is not enough to properly value the company.

In most cases, I like to model and invest based on a five-year time horizon. I think The Trade Desk is different. I don't think five years is enough time to grasp the full opportunity ahead.

To effectively value The Trade Desk, we must effectively forecast what a mature revenue number would be. We know digital ad spending is expected to grow from 333 million to 518 million in 2023. I often think it's naive to just assume a business can take a meaningful market share. But, I think this case is different, The Trade Desk's services are inherently useful to businesses. As we can see, advertising provides significant value creation. It's self-evident based on the fact that two of the top 5 largest public companies compete in this very industry.

It's important to consider the take rate of that market share. Considering the vastness of advertisement opportunities offered by The Trade Desk, I think the company could actually take about 10% market share. If the company can maintain the roughly 20% take rate on that 10% of total media spend, that would result in about 10 billion in revenue. The platform has scale, so if The Trade Desk can improve margins to 20% and the company is valued at a typical multiple of 15x earnings, it would be a 30 billion dollar company. This is a very rough valuation to say the least.

Conclusion

The biggest risk in owning The Trade Desk is trying to quantify the company's opportunity. The Trade Desk is truly changing the way digital advertisements are bought and sold. I added a small position in The Trade Desk for around $200 following the post-earnings meltdown. I feel comfortable owning a small position. Although the stock indeed does look expensive, I think The Trade Desk is one of the best chances investors have in owning the next Amazon, Google, or Facebook before the company becomes a mega-cap tech company. I don't believe that's exaggerating the opportunity investors have. The post-earnings pullback did not last long, the company has shot back to all-time highs at $245.

I think the lack of clarity in being able to pinpoint a confident assumption of The Trade Desk's opportunity in quantifiable terms makes it too risky to make a significant holding. When viewing the opportunity from a qualitative perspective, it appears that The Trade Desk has a slew of secular tailwinds that will drive significant growth over the long term. I believe this stock is one to own a small position when thinking with a very long time horizon.

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.