- Digital Turbine is a free cash flow story.
- This business requires hardly any capex. Practically all of its EBITDA gets converted to free cash flows.
- Please note management's guide for its EBITDA to grow by 10x over the next 3 to 5 years.
- The stock is priced at 33x this year's free cash flows.
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Article first published on Deep Value Returns.
Digital Turbine (NASDAQ:APPS) has made meaningful acquisitions that have obfuscated its results. The key takeaway here has a lot less to do with its topline growth, and everything to do with free cash flow generation today, and looking ahead.
By any conservative measure, without any heroics this stock is cheap. Even if the share price right now is causing investors a lot of pain. The underlying business of preinstalls is now in more than 750 million devices.
I've said it before and I'll say it again, follow the user/customer growth. That tells you the story much better than the share price.
Here's why I seriously believe that this stock is incredibly cheap, at 33x this year's free cash flows.
Please note, Digital Turbine's fiscal year and calendar year are misaligned. I'll only refer to its fiscal year.
Revenue Growth Rates are Bumpy
As you can see above, on the back of a highly acquisitive period, Digital Turbine's growth rates have exploded to the upside. But the problem is that everyone knows these growth rates are not sustainable.
- Firstly, management itself noted on the back of its Q2 2022 results (last quarter), that its organic growth rates were only up 63% y/y.
- Secondly, management is also very upfront that they don't believe that even 60% y/y growth is sustainable, and Digital Turbine itself guides investors that the business is expected to grow at about 25% to 30% CAGR over the next 3 years.
So that's the revenue growth rate range that I wish to keep at the forefront of our discussion here, Digital Turbine is a business that's set to grow at close to 30% CAGR over the next 3 years.
But that's not why I'm bullish here, I'm bullish on this company because of its rapidly growing free cash flows. But I'll get to that in a moment.
The biggest insight here to think about is that Digital Turbine's ''preinstall'' is already on 750 million devices around the globe and growing by 60 million every 90 days. Think about that! That's a huge reach. That side of the business is very strong and there's little competition. But Digital Turbine is growing beyond this.
What Digital Turbine is attempting to do, is move beyond the ''preinstall'' side of the business and grow its in-app monetization and recurring revenue streams.
That side of the business competes against others, such as ironSource (IS). Particularly, ironSource's Aura, which helps telcos participate in the app economy, by delivering relevant content to the phone's owner. What I would remark is that ironSource is more singly focused on games, rather than Digital Turbine.
Moving on, consider the following, from the perspective of telecoms and OEMs, what they want is a way to get some of the marketing dollars that they have been left out of by the likes of Alphabet (GOOGL)(GOOG) and Meta Platforms (FB).
How to reach consumers and get some of that high-margin business? And this is where Digital Turbine is a great partner for these companies. Because Digital Turbine has scale, as you can see it's spread on 750 million devices already and growing. And Digital Turbine is fully independent.
Why Digital Turbine? What About the Apple Changes?
Digital Turbine's core business is ''preinstalls'' on Android devices. Digital Turbine calls this side of the business, On Device Media. Any time a phone user opens up their brand new phone, you'll get a select number of new apps installed on your device.
Companies pay Digital Turbine to be installed on users' devices. For brands or app developers, this allows them to reach consumers on their devices. By being already installed on a consumer's phone the likelihood of the user embracing those app services dramatically increases. So, it's a huge ROI for those brands.
As I remarked previously, a consumer is much more likely to order a Lyft (LYFT) rather than an Uber (UBER) if the Lyft app is already installed on the consumer's phone. That's just one example. That's simplicity and ease of customer adoption, is something that brands will pay dearly to participate in.
Meanwhile, for Digital Turbine, they get paid to put those apps on the user's phone. So, this makes a lot of sense. Now, remember, a portion of that revenue has to be split with telecom companies, such as Verizon (VZ) and OEMs, such as Samsung (OTC:SSNLF). And that's why its gross margins are lower than so-called ''high margin'' businesses.
But I'll address this point soon. The point to remember is that Digital Turbine gets its revenues, but those revenues have to be split to telecoms too.
However, before discussing that element, allow to me clarify a certain dynamic:
A lot of people note that because of iOS changes, that Digital Turbine would struggle for growth.
The first thing to note is that the majority of Digital Turbine's prospects are tied to the Android system.
Secondly, many advertising companies have simply lowered their ad spend on iOS and migrated towards Android. Indeed, as an example, you can see above Meta moved a meaningful portion of its ad spend to Android.
And if more ad companies spend more ad dollars on Android, this will benefit Digital Turbine, as there are more ad dollars on that ecosystem, which in turn will increase the total addressable market.
Moving on, after the recent acquisitions Digital Turbine has made they provide Digital Turbine with revenues through the cycle of the ad media.
Rather than simply getting revenues on day 1 of the device, Digital Turbine has developed other products to drive revenues.
For instance, SingleTap is one noteworthy product. SingleTap is an ad banner that surfaces on the users' phones. When the user clicks on that ad banner, the user downloads an app by avoiding the friction of going to an app store. The key here is that the user can remain immersed in their experience, either shopping or playing a game, and the app is seamlessly installed in the background.
SingleTap has been a huge success for Digital Turbine and it has grown by 600% y/y as of the latest quarter and now accounts for 8% of Digital Turbine's total revenues.
This is a Free Cash Flow Story
The thing to keep in mind here, as I noted last month, Digital Turbine has practically no capex requirements. The long-term capex requirement of the business is approximately 1%.
Also, as you can see below, the business' free cash flow is rapidly increasing y/y.
As you can see here for Q2 2022, free cash flows were up 85% y/y. This rapid increase in free cash flow is echoed in management's guidance below:
Remember what I mentioned earlier, Digital Turbine has very low gross margins of just 30%, as it has to split its revenues with other telecoms and OEMs.
That being said, consider the expected trajectory for the business over the next 3 years.
Digital Turbine is expecting its EBITDA profile to go from $0.1 billion for fiscal 2021 to close to $1 billion over the next 3-5 years. Furthermore, we are already well into Q3 2022. So, we should expect to see this expansion on its bottom line happening very soon.
In fact, you can already see this taking place here, we can see that Q2 2022 saw its EBITDA line jump more than 190% y/y.
Now, let's discuss its valuation.
Valuation -- Cheap Valuation to Free Cash Flow
As you can see above, on a proforma basis, Digital Turbine is expected to grow at approximately 30% CAGR over the next several years.
If we take the guidance for Q3 2022 we should expect Digital Turbine's revenues to reach $355 million. Now, if take the consensus for this fiscal year of $1.2 billion in revenues this puts the stock trading for 4x this year's revenues.
But if we presume that management will succeed in growing its free cash flows margins at 13% and in line with the previous quarter, this would mean that by the end of this fiscal year, Digital Turbine would see its free cash flows reach $150 million of free cash flow this year.
Altogether this puts the stock trading at 33x this year's free cash flows. For a company that's clearly a global company, that's expected to dramatically grow its operations beyond its preinstall business and has a target to expand its EBITDA margins so substantially, to be priced at 33x this year's free cash flows seems absurdly cheap.
As you can see above, Digital Turbine is expecting its EBITDA to jump by 10x over the next 3 to 5 years.
The Bottom Line
Digital Turbine today is much than just a preinstallation business. Whenever you go to your phone, you are looking to do something to do with your phone. The telecoms will have an insight into your next move before anyone else. Whether it's checking a notification or going on a social media platform. Through Digital Turbine, telecoms are attempting to influence your next view.
As you can see, Digital Turbine is looking to maximize its operating leverage by increasing the value that they get out of every device. And you are seeing this already reflected on its rapidly increasing free cash flow profitability.
The business is priced at 33x this year's free cash flows, without giving any weight to its 10x EBITDA growth that Digital Turbine has guided for over the next 3 to 5 years. Just looking to the next 6 months, this business is priced at 33x free cash flow. With the 10x EBITDA growth projection not factoring to any meaningful extent here.
This article was written by
Michael Wiggins De Oliveira is an energy specialist whose primary focus is capitalizing on “the Great Energy Transition” - the confluence of decarbonization, digitalization with AI, and deglobalization - to achieve greater investment returns. Through his 9+ years analyzing countless companies, Michael has accumulated outstanding professional experience in the energy sector and a following of over 40K on Seeking Alpha.Michael is the leader of the investing group Deep Value Returns. Features of the group include: Insights through his concentrated portfolio of value stocks, timely updates on stock picks, a weekly webinar for live advice, and "hand-holding" as-needed for new and experienced investors alike. Deep Value Returns also has an active, vibrant, and kind community easily accessible via chat. Learn more.
Analyst’s Disclosure: I/we have a beneficial long position in the shares of APPS either through stock ownership, options, or other derivatives. 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.
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