Great Q1 Earnings powered by Axon AI
AppLovin (NASDAQ:APP) delivered a very impressive Q1 earnings report. The company reported revenue of $1.06 billion, a 48% YoY increase, beating consensus by $85 million. The strong growth was driven by AppLovin’s advanced AI technology, Axon 2.0, which continues to drive record revenue growth and margins.
For the quarter, the company achieved an adjusted EBITDA of $549 million, with a 52% margin. This strong profitability is the result of its AI monetization strategy.
Key Highlights
- Revenue of $1.06 billion, up 48% year-over-year.
- Adjusted EBITDA of $549 million (+101% yr/yr) with a margin of 52%.
- Net income of $236 million, with a 22% net margin.
- Continued success driven by Axon 2.0 technology for app monetization.
The main idea of this article is that AppLovin’s AI-powered Axon engine is truly a game-changer. It’s a great sample of how a company should integrate and monetize its AI capabilities. We will look into the impressive Q1 performance, the company’s record margins and cash flow numbers, and make a compelling case for AppLovin’s bullish outlook.
Axon 2.0: An AI Game-Changer
AppLovin’s AI-powered Axon 2.0 technology is revolutionizing the advertising industry, and we believe it is a game-changer. The technology is still in its early stages but delivering hard to believe results. Even AppLovin management acknowledges that Axon’s performance has surpassed their expectations. From the earnings call:
Adam Foroughi (CEO)
First, a key driver of our growth will be the ongoing improvements to AXON. Our models are still in an early stage and will continue to improve themselves, but more importantly, our teams are still finding ways to materially improve these algorithms. While these gains may not be predictable, they may sometimes lead to quarters like Q1 where we far exceed expectations.
It’s really eye-opening to hear when the CEO admits that Axon’s performance is unpredictable. This gives us an idea about the transformative nature of AI.
Another key aspect of Axon’s AI technology is its ability to grow massive margins at no cost. The AI models and algorithms enable exponential operating leverage when looking at the margin improvements of the company. By continuously refining and optimizing its algorithms, the technology is able to deliver unprecedented levels of advertising effectiveness. This level of productivity is truly remarkable and highlights the scalability and efficiency of AI-driven solutions. From the call:
Adam Foroughi (CEO)
So, every time our research science team creates some sort of innovation or breakthrough on those models, that ends up a step-function gain in the business because if you think about these models, it’s all math. And if the math gets more accurate, then we’re going to see a gain in the business, and these are very high margin gains because there’s no costs associated with that gain.
Our understanding is that the near-term opportunity for Axon is in the rapidly growing CTV market. As the shift from linear TV to streaming is accelerating, the demand for personalized and efficient ad’s is increasing. Axon’s ability to optimize and deliver targeted ad campaigns enables AppLovin to capitalize on the massive CTV opportunity. The CTV ad market today is around $30 billion and will grow to $42 billion by 2027.
However, we think that the true potential of Axon sits beyond these initial verticals. As Axon continues to evolve its AI models, company management is exploring new applications and industries. This is where the financial impact of Axon becomes increasingly difficult to predict. We believe that the broad applicability of Axon could lead to unprecedented growth and profitability for the company in the long run.
Revenue Momentum Looks Very Strong
We want to take a step back and look at the long-term trajectory of the company’s revenue performance. The company generated revenue of $1.06 billion in Q1, with a growth of 48% YoY. AppLovin’s 3-year revenue trajectory shows strong momentum, starting from Q3 2023 (which is when Axon 2 was launched). The trajectory implies the strong momentum will continue as there is increasing demand for its Axon solutions.
AppLovin’s Software Platform revenue growth trajectory is also very impressive. The segment revenue grew for the fifth consecutive quarter to $678 million in Q1, representing 91% YoY growth and 18% QoQ growth. The Software platform segment now accounts for 64% of the company’s total revenue. We anticipate the upward trend to continue and stay at these elevated levels. Our reasoning is that Axon AI is continuously learning and improving itself, so it can only get better.
Expanding EBITDA Margins and Strong Free Cash Flow
AppLovin’s margin performance in Q1 was also extraordinary. Adjusted EBITDA reached $549 million, an increase of 101% YoY, with an impressive 52% margin. This very strong profitability demonstrates the company’s scalability and operational leverage of its AI driven business model. Furthermore, the company generated record free cash flow of $388 million in Q1, an increase of 37% YoY. This is a very impressive cash flow generation capability, thanks to Axon AI.
The combination of healthy EBITDA margins and strong free cash flow generation positions AppLovin very favorably in the market. The company plans to expand its business and capitalize on growth opportunities outside mobile gaming, which is the right strategy to follow. From the earnings call:
Adam Foroughi (CEO)
Second, there is nothing that limits our models to just gaming. By expanding into web based marketing and e-commerce, we expect our AI models to improve with added demand diversity. As we continue to execute on the previously discussed themes, we expect to see further growth in our business.
We believe that the current financial strength will support AppLovin’s future expansion plans, including its CTV, OEM and Carrier initiatives, and further diversify its revenue streams to drive long-term growth.
Valuation
AppLovin’s strong financial performance and proven AI technology makes it a very compelling stock. While the stock has appreciated over 200% since last year, we believe there is still room for further upside potential.
In terms of valuation, we want to do a basic comps analysis and compare with its industry peers The Trade Desk (NASDAQ:TTD) and Unity Software (NYSE:U). The table shows that both on sales and profitability multiples, the company is still the cheapest one (see below):
A forward EV/S multiple of 6.7x is a bargain for a software company that is growing its sales by 48%. Trade Desk, which has a 28% growth rate, is more than twice expensive than AppLovin. Unity, which is struggling with its ad business, has the same sales multiple as AppLovin and twice its P/E ratio. This comparison suggests that AppLovin is heavily undervalued.
If we apply Trade Desk’s current forward EV/Sales multiple of 19 to AppLovin, we get a fair value of ~$220 per share. This indicates a 175% upside potential from the current price levels.
Risk – Can Axon AI be replicated?
AppLovin’s competitive advantage lies in its proprietary AI models and algorithms that power its successful Axon ad engine. However, a key question arises: How difficult is it for competitors to develop similar models and go after AppLovin’s business?
The company argues that its IP is the result of many years of work and is not easily replicable. The company claims to own proprietary data and algorithms that have been optimized for its business. This specialized IP and tailored approach creates a significant barrier to entry for competitors. From the earnings call:
Adam Foroughi (CEO)
We built cutting-edge AI technologies. It’s a multi-year effort for anyone to be able to look at that and go be able to replicate that. And I don’t even think it’s conceivable that it’s something that can be replicated. So, by the time there’s anyone that’s actually going to be able to compete against our technology, we will be years advanced from where we are today because we’re continuing to evolve the technology.
Second piece is, we can open-source our code tomorrow. We can hand-out the code to competition. It still won’t matter because these technologies need data that they’re achieving in the marketplace to be able to drive themselves. So, if you think about like AI models, like what makes an AI model impactful? Well, they’re utilized and that data feedback that they get from human behavior retrains the model and allows the model to continue to improve itself.
However, we want to take a more cautious approach. Rapid technological advancements and commoditization of AI could potentially enable competitors to develop comparable models over time. While the company’s AI models currently provide a strong competitive moat, it must continue investing in R&D to maintain its market leadership.
Conclusion
We think that AppLovin is a great example of a company that is able to successfully monetize AI. A company which can effectively monetize AI is something investors are actively looking for but struggling to find beyond a few companies.
They should look no further than AppLovin. The company is setting the bar for success in AI integration and monetization and is significantly undervalued. Furthermore, as Axon continues to evolve, the company will expand its business into new markets and industries. If successful, this scenario can lead AppLovin to unprecedented growth and profitability in the long run.
We rate AppLovin as a strong buy with 175% upside potential.
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