Digital Turbine: Don't Give Up, Here's Why

Summary

• 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.
• I do much more than just articles at Deep Value Returns: Members get access to model portfolios, regular updates, a chat room, and more. Learn More »

andresr/E+ via Getty Images

Article first published on Deep Value Returns.

Investment Thesis

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

(Source)

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.

(Source)

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.

(Source)

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:

(Source)

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.

(Source)

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%.

(Source)

Also, as you can see below, the business' free cash flow is rapidly increasing y/y.

(Source)

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:

(Source)

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.

(Source)

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

(Source)

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.

(Source)

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.

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.

Comments

[Manzanita Research]

@Michael Wiggins De Oliveira I've enjoyed your article here and Youtube discussion about $APPS. I decided to buy some AH at 43. However one thing that concerns me which you can possibly help me understand is -- why did APPS drop significantly in spite of beating earnings the past 2 quarters? Q22021 -6.82% , Q32021 -19.01%. Why was the market disappointed in spite of $APPS beating both EPS and Revenue targets? Most importantly has whatever was disappointing analysts been resolved? It seems odd if guidance was the problem since the stock dropped for both of the past 2 quarters even with beats?

[usedcarguy]

@Manzanita Research IMO, the company doesn't do the greatest job of explaining to investors exactly what it is that they do. It's also a relatively small player that only 2 years ago pre-COVID was a $7.00 stock which later in the year went parabolic. It's been volatile ever since. I think there's been some concern that they wouldn't be able to integrate the acquisitions and was priced for perfection, but mostly it's an issue of flying under the radar along with the need for some price consolidation. Another poster a while back said the situation reminds them of how TTD was 3-4 years ago.

[randominvestor]

@Manzanita Research
The big problem is the reduction in gross margin in the last 2 quarters that is why it dropped like a rock… the market sees the revenue increase but the loss in the margin was the big problem…they can make all the revenues they want but those revenues have to be profitable! I am not saying they are not however considering that there is not enough cushion for any other gross margin reductions as this will turn this investment into a complete flop…
Management did discuss about future gross margins north of 30 % but market so far in these two quarters sees reduction in gross margin and talk…need to get it up…as the market fears knows this is a bad and volatile period for advertisers in general and really dont know how long it will last so apps is like a binary bet… if it keeps or increase its gross margins then it will fly to the moon.. if it keeps growing of course.
Anymore reduction and really is gonna be a really bad investment…
That said risk reward is a good bet and probably this advertising thing will blow over once the situation with the supply chains… also this is not accounting for any positive developments from synergies… also if apps just kees margin stable is also a good investment…

[usedcarguy]

@randominvestor I believe this was due to some of the products offered by the acquired companies being lower margin and thus distorting the overall direction of the company.

Can't remember, but it seems like there may have also been some issues in regards to how margins are calculated that would have understated them. Need to go do some digging on that one.

[Stock09]

Entry Point here? Reasonable PT end 2022?

[High Sharpe]

I am buying a bit here.

[Miwicz]

@High Sharpe if youre a long term investor i think under 50 seems like good entry

[clrodrick]

@Miwicz Under $50 has been my nibbling point as well.

[Miwicz]

@clrodrick there are 3 somewhat recent insider buys around $50

[john boy]

could be making another move soon

[GARPdude]

@john boy To the downside? It's currently in a bear flag pattern. If $50 doesn't hold, we could see $45 or $42 in the next few trading days.

[danirak]

@GARPdude It is all depends on NASDAQ direction, APPS just follows NASDQ.

[Miwicz]

@danirak generally yes. Could see huge break from the index around earnings

[Duuuuh]

It would seem better to play both AAPS & IS until the market chooses which is
best. Good luck!!

[compoundreturns]

This company has 10+ bagger potential over the next 3-5 years. Loading up here and riding it out, longs will be rewarded on this one.

[John W in IT]

Since the author mentioned IronSource, I'd like to compare IS with APPS.
They have similar organic revenue growth, around 60%.

IS gross margin 83%, APPS 34%.
IS EV/Sales (TTM) 13.6, APPS 8.5
IS Opration cashflow(TTM) 141M, APPS 41M
IS Operation cashflow margin 28%, APPS 6%
IS Balance sheet, net cash 753M, APPS minus180M
APPS has greater execution and integration risk, due to the aggressive M&A strategy.
IS is more than 60% more expensive, but with better margin, cash flow, and balance sheet.

I am long IS, not saying APPS is not good, just prefer quality over value.

[Out_on_a_limb]

@John W in IT, you are not comparing the same margins or sales (cf. the article), etc. If you compare the 2 graphs over 6 months, IS is weaker.

IS is not the same kind of business, it is less diversified in terms of software as it is essentially a games platform. The virus is still around, but I am not sure people will play as much as now in the future. How many games can one play?

[John W in IT]

@Out_on_a_limb Before the pandemic, game-industry reveneue was growing by about 10 to 15% annually. During the pandemic, it has been growing at a doubled rate, around 25%. So the pandemic was a tailwind, but even without it, gaming was a growing industry. IS was growing 50% before the pandemic, the last two years they were growing 80%, the latest quarter they start to slow down to 60%, but they can easily maintain 30% growth. The current market valuation is priced in the slow down and probably went too far.

[idkmybffjill]

@John W in IT iron source reports net revenue. APPS reports gross revenue. So your gross margin calculations are not comparable. I’m tired of beating this dead horse.

[brainleft]

apps will hit $150 by December, easy to add and wait.

[PatienceDiscipline]

@brainleft 150 in your dreams lol

[PatienceDiscipline]

first you pump magnite, now you pump apps

[12grayzz]

@Mad Investor like magnite at these levels

[spice runner]

Painful the last few months for any growth stock, but I'm willing to ride the storm. Thanks for this article, it makes me sleep better!

[clrodrick]

APPS quickly diving back down towards the buy level once again. This sucker is super volatile!

[Finding Your Retirement]

prior to covid it was 7 bucks. the market is going to drop them back down

[GARPdude]

@Finding Your Retirement Strong support at $45. It's not going anywhere near pre-covid levels. If it does, I will take a loan against my mortgage and pile in.

[GULP Investment Group]

@Finding Your Retirement Not even remotely the same company it was pre covid. Not going to explain why, but you should research.

[Miwicz]

@Finding Your Retirement some prices are based on real FCF and growth. This is one

[FitBitBear]

Their reputation is what is preventing me from getting long (as well as their thin margins). Also their dependence on Google/Android, seems like that too much of a risk.

[idkmybffjill]

@FitBitBear they report revenue differently than other ad tech companies. If you took their net revenue number, which is how other ad tech companies report total revenue, their gross margins would be super high.

[stanley goodspeed]

Why is 33X cash flow so cheap?

[randominvestor]

I have a good position on apps… the problem with apps is the shrinking margin… in fact decreasing the margin by 3-4 % will make this investment a bummer… lets hope margins will reverse… i was hoping the author would discuss this …

[usedcarguy]

@randominvestor I would suggest rereading the article. The author did discuss it.

Hint: 3-4% doesn't matter much when when your potential revenue stream grows exponentially.

[randominvestor]

@usedcarguy
No he is not ! Show me where he is discussing why gross margins are dropping and what are the reasons that this will stop and reverse!!!
Furthermore you are completely off that 3-4 % margin dont make a difference !!! Their gross margin almost equals expenses !!! If GM drops further Apps is in the doghouse !!!
That is why the stock is so volatile!!! Growth will not cure a not profitable business !!! It can grow all it wants they have to fix margin is dangerously low !!!

[Out_on_a_limb]

@randominvestor, you sure love exclamation marks!!! But it doesn't make your points more relevant (you've not read the article). Most of the revenue was paid out to the telecoms and this ratio is going to decrease with the recent buyouts. What matters is the margin out of the contractual fees, and it will increase.

[victortan]

Yes the author said dont give up, I said if u give up then don't give in, if u give in then don't give up.

[Steven.Sheffey]

@victortan I've read your comment 3 times and it's still saying nothing.

[stanley goodspeed]

Am I correct in understanding that their platform is only applicable
to Android devices?
If so, does that mean that IPhone users cannot be engaged by APPS?
If so, it seems we are giving up a lot of upside.

[usedcarguy]

@stanley goodspeed No. But this deal only pertains to the Android ecosphere. They'll do business with anyone who will do business with them. The extent of their participation in the iOS ecosystem is up to Apple, not them.

But there are a couple of important points here. One is that they will get access to something like a billion Android devices outside of the US. The other is that becoming more important to Google's revenue stream means they're here to stay.

Even if they don't get any more business with Apple, the Android universe is large enough for this company to grow 20x plus from where they are today.

[stanley goodspeed]

@usedcarguy thanks for the clarification

[mbharrygray]

I bought, held, and traded covered calls and after one year the option premium and protective puts were my only reward. I would've done just as well if not better buying and holding voo. This stock is an F investment unless you know how to trade it with options or you tediously buy and sell shares on a timed basis. Stay away is my advice

[onsidegoose]

@mbharrygray Or if it's a long term investment..

[JeFawk]

@mbharrygray Sounds like you missed a lot of opportunities to buy in the 40-55 range and to sell in the 70-100 range.
Do you buy your stocks and then never look at them for the next year?

[Gldgate]

APPS is a powerhouse in the making. I'm over 50% cash and waiting patiently for an additional opportunity to pounce.

[john boy]

@Gldgate
what number is your opportunity?

[Gldgate]

@john boy I think adding below $55 is wise and will back up the truck below $50

[jonescm128]

Great article. I initiated a position in early December and have been adding ever since. The pullback in tech has presented so many great buying opportunities - long APPS!