There’s no denying that The Trade Desk (NASDAQ:TTD) is a very interesting and fast-growing digital ad company. But its growth is already reflected in the TTD stock price. Shares are up 20.1% this year, and it has skyrocketed almost 200% from its 52-week low near $136.
In fact, the company now has an astounding $14.4 billion market value. This is despite the fact that its revenue in the first quarter was just $160 million.
I estimate The Trade Desk will make about $723 million in revenue this year. That means TTD stock trades for 19.5 times its expected sales — and this reflects a pretty full valuation.
Demand-Side Platforms and Connected TV Ads
The Trade Desk is a demand-side platform, or DSP. DSP software companies help merchants and businesses buy digital advertisements across a number of platforms, not just the internet.
DSP ad agencies are sort of like Alphabet’s (NASDAQ:GOOG, NASDAQ:GOOGL) ad business, except that they also include other media outlets to reach consumers. The opposite of this is called an SSP, or supply-side platform, that is used by magazines and publishers to fill their space with ads.
For example, The Trade Desk is now big into what is now called Connected TV, or CTV, in the ad industry. This includes over-the-top TV shows — essentially on-demand channels or subscription-based channels that offer advertisements.
This type of TV experience, as opposed to the traditional linear TV where shows run in succession on cable TV channels, is popular with millennials.
The Trade Desk’s Revenue and Profits Have Risen Nicely
One of The Trade Desk’s key financial traits is explosive revenue growth since it went public in mid-2016. You can see this in the chart below.
It shows that revenue has grown from $45 million to almost $950 million by 2021. This is based on my estimates for 2020 and that of analysts polled by Seeking Alpha for 2021. The growth rate has consistently been between 30%-50% annually, except for recent events.
Moreover, the company has had a very profitable history. For example, the company’s adjusted earnings before interest, taxes, depreciation and amortization (EBITDA) has consistently averaged in the low-30% range up until recently.
But I expect that to continue in the next several years. You can also see this in the chart above.
In addition, and most importantly, The Trade Desk has generated significant free cash flow (FCF), even after deducting its capitalized software expenses. That is called adjusted FCF.
This chart below shows that its FCF margins have been growing over the past several years. I estimate that in 2020 the FCF margin will be as high as 18%.
This will provide over $134 million in cash to the company’s balance sheet before debt repayments, but after all software and capital expenditure costs.
As a result, the company has been piling up cash. That’s what happens with profitability. As of March 31, 2020, The Trade Desk had accumulated $446 million in cash and investments, with just $143 million in long-term debt.
Recent Earnings Portray Its Profitability
Recently, The Trade Desk saw a 33% year-over-year increase in revenue. Moreover, its adjusted EBITDA margins rose from 20% last year to 24% this past quarter.
Even more importantly, its FCF for Q1 rose to $33.4 million, up from just $2.2 million last year.
The Trade Desk benefited from the stay-at-home orders in the past quarter. More people were watching CTV and consuming on-demand digital ads.
CEO Jeff Green made a significant point about this in his presentation and the earnings release, according to AdExchanger, an industry site.
The Trade Desk’s Main Disadvantage
AdExchanger also points out that The Trade Desk has a major disadvantage compared to Alphabet, Microsoft (NASDAQ:MSFT), Twitter (NYSE:TWTR), Facebook (NASDAQ:FB), Snap (NYSE:SNAP) and other social media advertisers.
They operate under the cost-per-click or CPC revenue model, which also includes conversion through downloads. The ads are sold on the basis of how many direct consumer clicks on the ad are achieved.
By contrast, The Trade Desk operates under a CPM model or cost-per-mille. Ads are sold on the basis of every 1,000 (mille) impressions provided by the platform, not the number of clicks or downloads from an ad. A formula, using the click-through rate, or CTR, can be used to compare the two.
But, in general, it is harder to sell adds using a CPM rate rather than a CPC rate. In other words, the CPC ad rates tend to be higher, along with more consistent revenue to the platform.
The Trade Desk’s Main Advantage Is CTV
However, advertisers are following consumers in their cord-cutting, CTV streaming habits, according to AdExchanger. The article points out that the Green had a very strong April as its CTV ads, which in general are not as high at Google and Facebook, took off.
Restaurants and merchants need to find their clients. They cannot do that with traditional linear TV. CTV ads help promote specific activities in specific states.
In the long run, this will prove to be quite an advantage for The Trade Desk.
The TTD Stock Valuation Probably Reflects This Growth
At 20 times revenue and 105 times free cash flow, the Trade Desk is at full value right now. It seems to reflect the tremendous growth rate that the company both has and likely will continue to experience.
It might be worthwhile to wait for TTD stock to move down before taking a position. Traditionally, for example, super-fast growth stocks will have a stock market value of no more than 10 to 12 times revenue.
So, watch this stock carefully. The company will continue to pile up cash and generate large amounts of free cash flow. I would wait to catch it at a more reasonable price.
One Reason Why TTD Stock is Too High
Here is one reason why I feel this way. One of The Trade Desk’s main competitors is a company called AppNexus, which has a platform called Xandr. For example, in January 2020, Walmart (NYSE:WMT) ran a competition between the two platforms for its DSP media account, according to AdExchanger.
In August 2018, AT&T (NYSE:T) bought AppNexus for a reported $1.5 billion to $2 billion. Variety magazine says the deal talks were for $1.6 billion, according to the Wall Street Journal. But in 2019, the division, under the Xandr name, generated just $607 million in revenue.
So that means that AT&T paid no more than 3.3 times revenue ($2 billion divided by $607 million) for AppNexus. Compare that to TTD stock’s present value of 19.5 times revenue.
Moreover, AT&T says Xandr’s EBITDA margins in 2019 were over 70%. I showed above that the adjusted EBITDA margins for TTD were half that. The TTD margins were “adjusted” and the Xandr margins were not adjusted. But there is still a wide gulf between the two companies’ margins.
In other words, the private market value of TTD stock is much lower than the public value of the company. Take that into consideration when thinking of buying into this growth story.