AppLovin: Capitalizing On The Surging Growth Of Mobile Game Apps
Summary
- AppLovin announced its IPO price range of $75 to $85 per share. The company is selling 25 million shares.
- At the high end of the IPO price range, the company is aiming to raise $2.1 billion, and it would be valued at $30.4 billion.
- Our base case valuation of AppLovin is an EV of $35.1 billion, implied market cap of $35.7 billion, and target price per share of $99.8.
- The company has been a key beneficiary of the surging growth of popular game apps.
- Despite strong sales growth, its operating margins worsened in 2020 due to higher operating expenses.
Investment Thesis
AppLovin (NASDAQ:APP) is one of the key beneficiaries of the exploding demand for mobile apps, especially for mobile games. The company's sales growth has been surging in recent years as the company has benefited from both organic growth and has been aggressive in making numerous acquisitions in the past three years.
Most developers lack access to the marketing, monetization, and data analytics tools required to stand out among the more than 4.8 million mobile apps available on the Apple App Store (AAPL) and Google Play Store (GOOG) (GOOGL). The company's products and services help many app developers to scale up their business and create a successful app that can be sustained long term. This is where the company's capabilities in app development, marketing, and analytics really stand out.
There are more than 1.3 million mobile gaming apps on the Apple App Store and Google Play Store. Mobile gaming accounts for 39% of worldwide app downloads and for 72% of all app store consumer spend by value, according to Sensor Tower.
Although the company's operating margins declined in the past two years mainly due to higher operating expenses, we believe that the company's profit margins will turn around this year due to a combination of higher economies of scale and lower operating expenses as a percentage of revenues.
Comparable Companies Valuation Analysis
In the comparable companies valuation analysis, we used the following companies as comps to AppLovin:
Our base case valuation of AppLovin is an EV of $35.1 billion, implied market cap of $35.7 billion, and implied target price per share of $99.8. This represents 17% upside from the high end of the IPO price range of $85. We have a POSITIVE view of the AppLovin IPO.
Our base case valuation of AppLovin is based on a 16x EV/S multiple (using 2021 sales estimate), which represents a 10% higher than the average EV/S multiple of the comps. It is also below the EV/S multiple of Unity Software and Roblox which trade at EV/S multiple of 26.8x and 19.2x, respectively.
The comps' average sales growth in 2020 and 2021 are similar to the sales growth rates of AppLovin in this period. Among the comps, Roblox has the highest sales growth and Activision has the lowest sales growth in 2020 and 2021. Overall, we have assumed higher sales growth for AppLovin versus its peers in 2021 and 2022 and this is one of main reasons why we have applied a 10% higher valuation multiple than the comps.
However, Roblox is trading at 19.2x EV/S in 2021 and we have applied a 16x EV/S multiple for AppLovin (17% lower valuation multiple than Roblox). We believe the market will attach a slightly higher valuation multiple for Roblox than AppLovin, mainly due to the former company's higher sales growth and operating margins in 2021, and its brand is more recognized worldwide.
| AppLovin Comparable Companies Valuation Analysis | |||||
| (US$ billion) | Mkt Cap | Sales (2019) | Sales (2020) | Sales (2021E) | Sales (2022E) |
| Unity Software | 27.6 | 0.5 | 0.8 | 1.0 | 1.2 |
| Roblox | 38.9 | 0.5 | 0.9 | 2.0 | 2.5 |
| Activision Blizzard | 74.9 | 6.4 | 8.4 | 8.5 | 9.7 |
| Zynga | 11.3 | 1.3 | 2.0 | 2.7 | 3.1 |
| Source: Author, from Company data, Yahoo Finance, Marketscreener | |||||
| AppLovin Comparable Companies Valuation Analysis | |||
| Sales % Change YoY | 2020 | 2021E | 2022E |
| Unity Software | 42.4% | 25.3% | 27.8% |
| Roblox | 81.7% | 114.5% | 26.2% |
| Activision Blizzard | 31.8% | 1.4% | 13.0% |
| Zynga | 49.4% | 36.7% | 13.0% |
| Average | 54.3% | 50.9% | 17.4% |
| Median | 49.4% | 36.7% | 13.0% |
| AppLovin | 46.0% | 51.0% | 32.1% |
| Source: Author, from Company data, Yahoo Finance, Marketscreener | |||
| AppLovin Comparable Companies Valuation Analysis | |||
| EV/S (2020) | EV/S (2021E) | EV/S (2022E) | |
| Unity Software | 33.5 | 26.8 | 20.9 |
| Roblox | 41.2 | 19.2 | 15.2 |
| Activision Blizzard | 8.3 | 8.2 | 7.2 |
| Zynga | 5.6 | 4.1 | 3.6 |
| Average | 22.2 | 14.6 | 11.8 |
| Median | 20.9 | 13.7 | 11.2 |
| Source: Author, from Company data, Yahoo Finance, Marketscreener | |||
| AppLovin Comparable Companies Valuation Analysis | ||||
| Operating margins (2019) | Operating margins (2020) | Operating margins (2021E) | Operating margins (2022E) | |
| Unity Software | -27.9% | -6.6% | -9.3% | -2.3% |
| Roblox | -15.0% | -28.8% | 12.3% | 14.3% |
| Activision Blizzard | 32.6% | 40.4% | 42.6% | 44.1% |
| Zynga | 18.9% | 21.3% | 22.6% | 23.9% |
| Average | 2.2% | 6.6% | 17.0% | 20.0% |
| Median | 2.0% | 7.3% | 17.4% | 19.1% |
| AppLovin | 19.5% | -4.3% | 3.0% | 6.8% |
| Source: Author, from Company data, Yahoo Finance, Marketscreener | ||||
AppLovin Comparable Companies Valuation Sensitivity Analysis (EV) | |||||
| (US$ billion) | EV/S (X); 2021E | ||||
| Low | Base | High | |||
| 12.8 | 16.0 | 19.2 | |||
| Low | 2.0 | 25.3 | 31.6 | 37.9 | |
| Estimated sales (2021E) | Base | 2.2 | 28.1 | 35.1 | 42.1 |
| High | 2.4 | 30.9 | 38.6 | 46.3 | |
| Source: Our Estimates | |||||
AppLovin Comparable Companies Valuation Sensitivity Analysis (Implied Market Cap) | |||||
| (US$ billion) | EV/S (X); 2021E | ||||
| Low | Base | High | |||
| 12.8 | 16.0 | 19.2 | |||
| Low | 2.0 | 25.9 | 32.2 | 38.5 | |
| Estimated sales (2021E) | Base | 2.2 | 28.7 | 35.7 | 42.8 |
| High | 2.4 | 31.5 | 39.2 | 47.0 | |
| Source: Our Estimates | |||||
AppLovin Comparable Companies Valuation Sensitivity Analysis (Implied Market Cap) | |||||
| (US$ per share) | EV/S (X); 2021E | ||||
| Low | Base | High | |||
| 12.8 | 16.0 | 19.2 | |||
| Low | 2.0 | 72.4 | 90.0 | 107.7 | |
| Estimated sales (2021E) | Base | 2.2 | 80.2 | 99.8 | 119.4 |
| High | 2.4 | 88.1 | 109.6 | 131.2 | |
| Source: Our Estimates | |||||
Income Statement Forecast
AppLovin generated sales of $1,451.1 million and an operating loss of $62.1 million in 2020. The company's sales have nearly tripled from 2018 to 2020. The company's operating margins declined from 50.1% in 2018 to 19.5% in 2019 and -4.3% in 2020. The major reasons for the lower operating margins are due to higher cost of sales, sales & marketing, R&D, and other operating expenses as a percentage of sales.
We estimate AppLovin to generate sales of $2.2 billion (up 51% YoY) and an operating profit of $65.2 million in 2021. From 2020 to 2025, we have assumed the company's sales to grow at a CAGR of 28.6%. We have also assumed the company's operating margin to turn positive to 3% in 2021 from -4.3% in 2020. We estimate its operating margins to improve further to 6.8% in 2022, 10.6% in 2023, and 17.8% in 2025. We estimate AppLovin to have sales of $5.1 billion and an operating profit of $0.9 billion in 2025.
| AppLovin Income Statement Forecast | ||||||||
| (US$ million) | 2018 | 2019 | 2020 | 2021E | 2022E | 2023E | 2024E | 2025E |
| Revenue | 483.4 | 994.1 | 1,451.1 | 2,191.6 | 2,895.1 | 3,638.5 | 4,386.0 | 5,106.9 |
| Cost of Revenue | 53.8 | 241.3 | 555.6 | 865.7 | 1,108.5 | 1,348.3 | 1,570.1 | 1,762.5 |
| Gross Profit | 429.6 | 752.8 | 895.5 | 1,325.9 | 1,786.5 | 2,290.2 | 2,816.0 | 3,344.3 |
| Operating Expenses | 187.2 | 558.5 | 957.6 | 1,260.7 | 1,589.1 | 1,905.9 | 2,192.5 | 2,436.5 |
| Sales & Marketing | 166.8 | 481.8 | 627.8 | 900.7 | 1,130.4 | 1,349.6 | 1,545.6 | 1,709.6 |
| R&D | 16.3 | 45.0 | 180.7 | 264.6 | 339.1 | 413.4 | 483.4 | 546.0 |
| G&A | 14.9 | 31.7 | 66.4 | 95.3 | 119.6 | 142.8 | 163.5 | 180.9 |
| Other operating expenses* | -10.8 | 0.0 | 82.7 | 0.0 | 0.0 | 0.0 | 0.0 | 0.0 |
| Operating Income/(Expenses) | 242.4 | 194.3 | -62.1 | 65.2 | 197.4 | 384.4 | 623.5 | 907.9 |
| Non-Operating Items | -482.7 | -68.1 | -73.7 | -51.6 | -25.8 | -12.9 | -10.3 | -8.2 |
| Earnings Before Tax | -240.3 | 126.2 | -135.7 | 13.6 | 171.7 | 371.5 | 613.1 | 899.6 |
| Income Taxes | 19.7 | 7.2 | -9.8 | 0.0 | 17.2 | 92.9 | 153.3 | 224.9 |
| Net Profit/(Loss) | -260.0 | 119.0 | -125.9 | 13.6 | 154.5 | 278.6 | 459.9 | 674.7 |
| % of Total Revenue | 2018 | 2019 | 2020 | 2021E | 2022E | 2023E | 2024E | 2025E |
| Revenue | 100.0% | 100.0% | 100.0% | 100.0% | 100.0% | 100.0% | 100.0% | 100.0% |
| Cost of Revenue | 11.1% | 24.3% | 38.3% | 39.5% | 38.3% | 37.1% | 35.8% | 34.5% |
| Gross Profit | 88.9% | 75.7% | 61.7% | 60.5% | 61.7% | 62.9% | 64.2% | 65.5% |
| Operating Expenses | 38.7% | 56.2% | 66.0% | 57.5% | 54.9% | 52.4% | 50.0% | 47.7% |
| Sales & Marketing | 34.5% | 48.5% | 43.3% | 41.1% | 39.0% | 37.1% | 35.2% | 33.5% |
| R&D | 3.4% | 4.5% | 12.4% | 12.1% | 11.7% | 11.4% | 11.0% | 10.7% |
| G&A | 3.1% | 3.2% | 4.6% | 4.3% | 4.1% | 3.9% | 3.7% | 3.5% |
| Other operating expenses | -2.2% | 0.0% | 5.7% | 0.0% | 0.0% | 0.0% | 0.0% | 0.0% |
| Operating Income/(Expenses) | 50.1% | 19.5% | -4.3% | 3.0% | 6.8% | 10.6% | 14.2% | 17.8% |
| % Change YoY | 2019 | 2020 | 2021E | 2022E | 2023E | 2024E | 2025E | |
| Revenue | 105.6% | 46.0% | 51.0% | 32.1% | 25.7% | 20.5% | 16.4% | |
| Cost of Revenue | 348.5% | 130.3% | 55.8% | 28.1% | 21.6% | 16.4% | 12.3% | |
| Gross Profit | 75.2% | 19.0% | 48.1% | 34.7% | 28.2% | 23.0% | 18.8% | |
| Operating Expenses | 198.3% | 71.5% | 31.7% | 26.0% | 19.9% | 15.0% | 11.1% | |
| Sales & Marketing | 188.8% | 30.3% | 43.5% | 25.5% | 19.4% | 14.5% | 10.6% | |
| R&D | 175.9% | 301.7% | 46.5% | 28.1% | 21.9% | 16.9% | 12.9% | |
| G&A | 112.8% | 109.6% | 43.5% | 25.5% | 19.4% | 14.5% | 10.6% | |
| Operating Income/(Expenses) | -19.8% | TR | TB | 202.8% | 94.7% | 62.2% | 45.6% | |
| *Note: Other operating expenses include extinguishments of acquisition related contingent consideration & lease modifications & abandonment of leasehold improvements. | ||||||||
| Source: Author, from Company data; Our Estimates | ||||||||
Company Background
The company originally started its business helping customers to improve the smartphone customer experiences for all the users. In recent years, the company has become a much bigger player in the mobile gaming segment and it also helps developers to grow their users and improve the monetization of their apps.
According to IDC, the company's total market opportunity is estimated to be $189 billion in 2020, growing to $283 billion in 2024, representing a CAGR of 10.6% in this period. This total market size of $184 billion was derived by adding the worldwide total in-app advertising revenue of $101 billion (including gaming and non-gaming in-app display, video, and other advertising, but excluding in-app search advertising) and worldwide direct game spending of $88 billion for 2020.
AppLovin has invested about $1 billion in 15 acquisitions and partnerships since 2018. It owns more than 200 free-to-play mobile games from 12 studios. AppLovin launched a gaming business unit called Lion Studios in July 2018. It also acquired a company called Max in September 2018. Max provides in-app bidding service, which is a type of advertising where mobile publishers can sell their ad inventory in an auction method). AppLovin also owns and operates gaming studios Machine Zone, Belka Games, PeopleFun and Firecraft Studios.
In February 2021, AppLovin signed an agreement to purchase Adjust for $1 billion (including $598 million in cash and $352 million in convertible securities, and an assumption of up to $40 million in debt). Adjust is a leading mobile app analytics& marketing products company in Germany. Adjust provides tools to prevent mobile advertising fraud and better measure the user base. This acquisition is expected to close in 1H 2021.
In the IPO prospectus, the company mentioned that it plans to use $75 million of its Class A common shares for charitable purposes. If the company raises $1 billion in the IPO, this would represent nearly 7.5% of total amount. This is a bit unusual to have this large number of shares allocated for charitable purposes. We applaud this move by the CEO and its senior management. Adam Foroughi, the co-founder and CEO of AppLovin, previously co-founded two advertising technology companies, Lifestreet Media Inc. and Social Hour Inc.
AppLovin (Key Metrics)
The table provides the company's key metrics. There has been a strong increase in the monthly active payers which jumped from 0.3 million in 2018 to 1.0 million in 2019 and 1.5 million in 2020. However, the enterprise clients declined from 192 in 2018 to 172 in 2020. The company defines its enterprise clients as third-party business clients from which it has collected more than $125,000 of revenue in the trailing 12 months. Average revenue per monthly active payer increased from $11 in 2018 to $32 in 2019 and $41 in 2020.
The company's main businesses comprise of its platform and apps. Its platform business mainly includes AppLovin Core Technologies and AppLovin Software. Its apps consist of over 200 free-to-play mobile games in five genres, run by 12 studios including those owned by the company and also those it partners with. The five major game genres offering by the company include casual, hypercasual, match-three, midcore, and card/casino. No single game of the company contributed more than 16% of its total revenue in 2020.
Source: Company data
The company collects revenue from two sources including business clients and consumers. In 2020, business clients accounted for 49% of total revenue and consumers represented 51% of total revenue.
Business Clients:
- The company has a wide range of business clients including Facebook (FB), Google, and a number of much smaller companies. It had 1,400 business clients at the end of 2020. Nearly 99% of the company's business revenue came from its 172 enterprise clients as of December 31, 2020. The company also had a solid customer retention rate of 118% in 2020 for its enterprise clients.
- AppLovin Software is a comprehensive suite of tools for developers to get their mobile apps discovered and downloaded by the right users, optimize return on marketing spend, and maximize monetization of engagement. AppLovin Software reaches an audience of over 410 million users per day. The company's software solutions provide tools for mobile app developers to expand their businesses by optimizing and automating the marketing and monetization of their apps. Since inception, the company's platform has driven more than 6 billion mobile app installs.
- The company's main software includes AppDiscovery and MAX. Business clients use AppDiscovery to automate, optimize, and manage their app user acquisition investments. They set marketing and user growth goals, and AppDiscovery optimizes their ad spend in an effort to achieve their return on advertising spend targets and other marketing objectives. AppDiscovery comprises the vast majority of revenue from its software.
- Revenue is generated from the advertisers, typically on a performance-based, cost-per-install basis, and shared with the company's advertising publishers, typically on a cost per impression model. Business clients use MAX to optimize purchases of app ad inventory.
- The Compass Analytics tool within MAX provides insights to manage against key performance indicators, understand the long-term value of users, and help manage profitability. Revenue from MAX is generated based on a percentage of client spend. Business clients that purchase advertising inventory from the company's Apps are able to target highly relevant users from its diverse and global portfolio of over 200 mobile games.
Consumers:
- The company has also developed and invested in AppLovin Apps, which consist of a globally diversified portfolio of over 200 free-to-play mobile games. These Apps are accessed by nearly 32 million users every day. Consumer revenue is generated when the user of its apps makes an in-app purchase (IAP).
- The company's apps are mostly free-to-play mobile games and generate consumer revenue through in-app purchase of virtual items which are used to enhance gameplay and improve the probabilities of the mobile game progression opportunities.
- During the three months ended December 31, 2020, the company had an average of 2.1 million monthly active payers (MAPs) across its portfolio of apps. Over that period, the company had an average revenue per monthly active payer of $41.
| AppLovin (Key Metrics) | |||
| 2018 | 2019 | 2020 | |
| Enterprise Clients | 192 | 167 | 172 |
| % Change YoY | -13.0% | 3.0% | |
| Revenue per Enterprise Client (in thousand USD) | 2,184 | 3,515 | 4,081 |
| % Change YoY | 60.9% | 16.1% | |
| Monthly Active Payers (millions) | 0.3 | 1.0 | 1.5 |
| % Change YoY | 233.3% | 50.0% | |
| Average Revenue per Monthly Active Payer (USD) | 11 | 32 | 41 |
| % Change YoY | 190.9% | 28.1% | |
| Source: Author, from Company data |
Major Competitors
In the mobile games and other mobile game app related businesses, the major competitors include Unity Software, Activision Blizzard, Tencent Holdings (OTCPK:TCEHY), and Zynga. In the advertising platform business, the company's major competitors include Facebook, Alphabet, and Amazon (AMZN). Many of these companies are also AppLovin's partners and customers. In addition to these mega companies, the company faces competition from thousands of smaller competitors worldwide.
Balance Sheet and Cash Flow Analysis
The company has a leveraged balance sheet. Net debt increased from $0.8 billion at the end of 2019 to $1.3 billion at the end of 2020. Net debt to adjusted EBITDA ratio also rose from 260% at the end of 2019 to 315% at the end of 2020. After KKR invested in the company in 2018, it appears that AppLovin was advised to add more leverage and expand the business more aggressively through numerous acquisitions. Through this IPO, the company's balance sheet will become much stronger.
The company generated positive cash flow from operations and free cash flow in the past two years. Its cash flow from operations and free cash flow averaged $211 million and $207 million, respectively, in 2019 and 2020.
Conclusion
AppLovin is one of the key beneficiaries of the surging growth of game-related mobile apps. Our base case valuation of AppLovin is EV of $35.1 billion, implied market cap of $35.7 billion, and target price per share of $99.8, which is about 17% higher than the high end of the IPO price range. In recent months, some of the major game-related IPOs including Roblox and Unity Software have done really well, although their share prices have come down from their recent highs. AppLovin will likely be compared against these stocks.
Despite AppLovin's decline in operating margins in 2020 due to higher operating expenses, it is more likely that investors will focus on the company's ability to continue to scale up the business and generate higher sales growth. There remains some uncertainty in terms of how quickly the company is willing to focus on the probability at the expense of lower sales growth. In addition, there are some concerns about the recent weakening sentiment on the tech-related IPOs.
This article was written by
Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.
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