AppLovin: Why This Mobile Ad Tech Is Taking Market Share (NASDAQ:APP)

Investment Thesis

AppLovin Corporation (NASDAQ:APP) is on a path towards reporting $1.2 billion of free cash flow in 2023. This is a very conservative estimate. I believe that AppLovin could make close to $1.6 billion next year, but to be conservative, let’s stick with $1.4 billion. This means that AppLovin is priced at approximately 10x next year’s free cash flow.

What’s more, the business is delivering attractive top line growth, too. So, unlike other ad-tech companies, the business is not ”just” surviving. It’s actually taking market share for its peers, namely Unity Software (U).

Altogether, I believe this is a great business, that has the potential to be a rewarding investment into 2024. Let’s get to it.

AppLovin’s Near-Term Prospects

AppLovin is a company specializing in enhancing the performance of businesses, particularly those involved in mobile games and app development, within the app ecosystem. They provide unique tools and software designed to simplify the process for app creators, enabling them to increase user engagement and boost revenue generation.

The company’s core focus revolves around determining the most effective advertisements and content to display to app users. They also offer comprehensive performance analytics to app developers, allowing them to assess their apps’ success and optimize revenue streams, making it a pivotal aspect of their operations.

In addition to their core services, AppLovin offers a diverse portfolio of over 350 free apps, primarily mobile games. These apps leverage their proprietary tools and methodologies to achieve significant popularity and monetization through data analytics.

One integral component of AppLovin’s business strategy involves an aggressive M&A strategy. Typically, I would look to avoid businesses that support their growth via M&A, as those businesses embrace high-risk acquisitions while oftentimes not being price-sensitive on those acquisitions.

However, given the significant amount of stock ownership that founder and CEO Adam Foroughi has in the company, I’m assured that Foroughi is determined to play the long game. And that’s my mindset. too.

With this context in mind, let’s discuss AppLovin’s financials.

AppLovin’s Revenues Are Growing

Unlike many ad-tech peers, AppLovin is still delivering some top line growth. To a substantial extent, its recent growth has come about through the debut of AXON 2.0, the latest iteration of AppLovin’s AI decision-making engine.

Indeed, let’s get some further context on the drivers of AppLovin.

What you see above, is that AppLovin’s Software segment makes up more than 50% of the underlying. But what’s particularly noteworthy is that this segment, which places ads on mobile applications owned by 3rd party publishers, is actually growing at a very reasonable rate.

AppLovin’s Software segment is this business’ crown jewel. This segment was up 28% y/y. Furthermore, AppLovin’s Software segment competes with Unity Software’s Grow Solutions segment.

And even though Unity’s growth rates include a large acquisition it made last year, the organic growth of this business was 7% y/y in Q2. In other words, AppLovin’s segment is taking substantial market share away from Unity.

That’s why, even as the market has been particularly weak in the past month, AppLovin’s stock has held its ground. I contend that investors realize that this business is meaningfully undervalued.

Focus on the Free Cash Flow

What makes AppLovin particularly compelling is that this founder-led business is focused on free cash flows.

AppLovin’s Software business consistently makes higher than 60% EBITDA margins. Think about it like this, not only is AppLovin’s Software business growing in the 20s% CAGR, but it’s also incredibly profitable.

I maintain that within the next 12 months, AppLovin’s Software business will make up close to 65% to 70% of AppLovin’s business.

Moreover, including AppLovin’s Q3 guidance, AppLovin is going to make $980 million in EBITDA. Therefore, we can safely estimate that AppLovin will make $1.3 billion adjusted EBITDA in 2023.

And if we take analysts’ current estimates of 11% revenue growth for 2024, and keep in mind that the business will be significantly more profitable in 2024 given its Software Segment, this means that AppLovin should easily make $1.5 billion of EBITDA. Indeed, AppLovin stated during the earnings call that the business’ EBITDA profile was abnormally strong in Q2 2023. On a more normalized basis, its EBITDA margins will moderate at mid-40%, which is still impressively high.

However, to add on a margin of safety, let’s assume that in 2024 AppLovin ”only” makes $1.4 billion. Again, this leaves this stock in the bargain basement at under 10x EBITDA.

The one downside here is that AppLovin has around $2.4 billion of net debt. Even though the business makes very strong free cash flows, this high debt level will in the very near term restrict its ability to make any further needle-moving acquisitions.

The Bottom Line

I estimate that AppLovin is on a path to generate around $1.4 billion in free cash flow in 2024. This estimate is somewhat conservative, and it’s plausible that the figure could approach slightly higher.

This valuation implies that AppLovin Corporation is trading at approximately 10x next year’s free cash flow, making it a compelling option for investors.

Despite the challenging landscape of the ad-tech industry, AppLovin is not merely surviving; it is thriving and gaining market share compared to its competitors, notably Unity Software.

The heart of AppLovin’s success lies in its Software segment, responsible for over 50% of its operations and boasting a commendable 28% y/y growth rate. With its CEO’s strong ownership in the company and a commitment to a long-term vision, AppLovin’s strategic growth through acquisitions seems well-calculated, and its focus on free cash flows makes it a promising prospect for investors.

The core Software business, with consistently high EBITDA margins exceeding 60%, is expected to dominate AppLovin’s portfolio, driving substantial profitability.

In conclusion, I believe this medium-cap stock could deliver some attractive returns in 2024.