In the Saga Partners Investor Letter sent out this week, we provided an update to our investment in The Trade Desk (NASDAQ:TTD). We first wrote about TTD in August 2018. Below is the excerpt from the recent letter.
Source: FactSet Research Systems, Inc.
Sales and operating income both grew 55% in 2018 and are expected to grow a respective 36% and 0% in 2019. Flat operating income this year reflects continued investment in infrastructure such as connected TV, data processing and global expansion. Somewhat counterintuitively, the lower the operating income, the better the results. The Trade Desk has historically been able to reinvest in areas that have driven its market dominance and propel growth. The more areas it is able to reinvest cash flow at high rates of return, the better future results will likely be, i.e. the lower the earnings today, the higher the future cash flows will likely be.
The Trade Desk is truly an exceptional company. Its platform helps advertisers comb through a huge universe of possible ad inventory to target and value the token few that make sense for that specific advertiser. It is very rare to come across a company that has high and growing barriers to entry, economies of scale, network effects, and compounding demand. The cherry on top is that it is founder-led with management owning a significant number of shares that make up nearly its entire net worth.
When we analyze the competitive dynamics of a company, we look at both the demand and supply of the industry. Many investors tend to focus much of their time on the demand side, such as what revenues will be over the next few years. Fewer analysts consider the supply side, which is often what provides insight to any barriers to entry and therefore potentially favorable or unfavorable long-term economics. With The Trade Desk, there are very favorable dynamics on both the demand and supply side of the equation.
On the demand side, a company’s total addressable market, or TAM, is a phrase that gets thrown around a lot, particularly in the technology space. It should typically be taken with a grain of salt when analyzing a company’s future prospects. However, The Trade Desk operates in a huge and growing potential market. Essentially all global advertising spend could be a potential customer. Companies are increasingly realizing that buying advertising space in a programmatic, data-driven way improves their return on ad spend and grows their business more effectively. The programmatic advertising space is currently growing at about 20% a year and The Trade Desk is growing at roughly twice that rate.
On the supply side, the industry is consolidating. Increasing economies of scale are forcing smaller demand side platforms (DSPs) to either get acquired or go out of business. A new start up DSP will not have the cost structure or ability to compete with the already established players.
Google (NASDAQ:GOOG) (NASDAQ:GOOGL), Facebook (NASDAQ:FB), Verizon (NYSE:VZ), AT&T (NYSE:T), and Adobe are some of the companies that offer similar competing demand side platforms. One disadvantage of these DSPs is their core businesses are largely monetizing their media content. They are less focused on trying to buy inventory for advertisers and more concerned with selling its own inventory to advertisers for the highest possible price. There is an inherent conflict of interest when advertisers use Google’s DSP that Google prefers an advertiser to spend more money on google.com or youtube.com instead of at a competing website. This is one reason it is likely there will be at least one independent DSP as the industry matures.
Additionally, there are transparency benefits in having a single demand side platform. Companies advertising want to come to a single place to have the ability to value inventory relative to all available options throughout the world. This makes it possible to purchase inventory at the fairest price for a specific advertiser trying to reach a specific end-market. The more inventory sold over a platform, the more value an advertiser receives, attracting more advertisers to the platform, and therefore attracting more inventory to sell to those advertisers. This increasingly looks like a winner-take-all dynamic and The Trade Desk has established itself as the dominant independent demand side platform.
Of course, when our investors see their shares trading at 5x their original cost basis, a fair question to ask is “how can this company still be undervalued”? It’s also not uncommon for “value investors” to look at The Trade Desk’s current multiples and quickly look the other way.
We discussed platform companies in our 4Q18 letter when we stated:
The highly scalable unit economics, when combined with the self-reinforcing network effects, make it theoretically possible for a platform company to expand to the total size of the market. This creates a winner take all dynamic and makes it possible for a single business to gain a majority market share as an industry matures. A platform monetizes by capturing a portion of the value it creates. As value grows, so does earnings power. Profit margins improve drastically as a platform grows to dominate a market. This does not occur because a platform is raising prices or gouging suppliers the way a traditional linear monopoly might, but because the overall value the platform creates grows exponentially.”
While many might lump The Trade Desk with the other high flying and seemingly overvalued SaaS technology companies, when we look 10 years down the road, The Trade Desk will be valued at a significantly higher valuation than the ~$10-billion market cap it had at the end of the second quarter.
The Trade Desk’s flywheel is starting to spin faster and it’s becoming more apparent that it will be the winning platform in this very large space. It has the ability to grow at scale while requiring relatively nominal incremental invested capital. When you find an opportunity such as this, the best thing to do is back up the truck. Any single year’s performance of the stock can be quite erratic, but we continue to believe the probabilities are highly favorable for superior future performance over a multi-year period. Really good things tend to happen for a company that has huge/growing demand and limited/declining competition.
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.