Ad-Tech Round-Up: Why We Think Google, Amazon Will Rise On Top

A common theme in the latest earnings season is that forward sentiment on ad spending remains cautiously optimistic, with seasonality-driven demand ahead of the holidays likely to be stifled by mounting macroeconomic uncertainties. The growing risk of economic recession within the next 12 months also points to a further slowdown in ad spending, which is inherently cyclical and sensitive to changes in the macroeconomic environment.

Yet, some digital verticals – which are currently the fastest growing ad formats – will be more resilient than others ahead of the looming downturn, especially as some deal with compounding pains from industry-specific challenges like ad signal loss and a secular downtrend. In the following analysis, we provide an overview of both near- and longer-term considerations within the “ad-tech” environment, and discuss their implications on some of the names within our coverage – including Amazon (AMZN), Disney (DIS), Google (NASDAQ:GOOG / NASDAQ:GOOGL), Meta Platforms (META), Netflix (NFLX), and Warner Bros. Discovery (WBD) – which spans retail media, connected TV, traditional linear TV, social media, short-form video, and search.

We view Google as currently the most resilient name in digital advertising given Search’s extensive reach and market share, as well as competitive performance metrics such as return on ad spending (“ROAS”), which is critical in today’s market climate as advertisers look to maximize conversion of every ad dollar spent ahead of mounting macroeconomic uncertainties. Meanwhile, Amazon is rapidly catching up on the digital advertising race with its competitive advantage in first-party (“1P”) data on global consumer behavior and purchase habits through Amazon.com. And over the longer-term, advertising-based video on demand (“AVOD”) will likely see the fastest growth in digital advertising, which makes strong tailwinds for Disney and WBD given their respective efforts in winding down reliance on traditional linear TV, and Netflix which is looking to resuscitate growth with a new ad-supported revenue stream.

Advertising is Inherently Macro-Sensitive

The advertising industry is inherently sensitive to macroeconomic weakness, as it follows closely behind consumer behavior and trends. Advertisers are becoming increasingly cautious on ad spending as consumer spending wanes ahead of surging inflation and rising interest rates that have weakened purchasing power, especially on discretionary goods and services.

In the latest update by Magna Global, a leading research and intelligence source in media and entertainment, global ad spending is expected to advance 9.2% y/y to $816 billion in the current year, with an anticipated slowdown in 2H22 (+8% y/y in 2H22E vs. +14% y/y in 1H22A) as financial conditions continue to deteriorate in the face of surging inflation, rapidly rising interest rates, and looming recession risks. Specifically, in the U.S., where inflation remains “stubbornly stuck” at 40-year record highs alongside aggressive monetary policy tightening that will likely push the economy into recession, Magna has downward-adjusted its forecast for total ad spending in 2022 from $325.6 billion earlier in the year to now $323 billion (+9.8% y/y).

The upcoming holiday season, which has typically been a peak quarter for ad spending to align with consumer shopping trends, is expected to be relatively muted this year as advertisers brace for more macro weakness ahead. The industry has already seen this year’s holiday shopping season being pulled forward as consumers become increasingly sensitive to prices, looking to spread out spending and capitalize on sales and discounts to alleviate stress on dwindling household budgets – holiday ad spending has also been adjusted accordingly, with an “uptick in pre-holiday ad demand in October”. Meanwhile, online holiday sales in the U.S. this year are expected to grow at a mere 2.5% y/y compared to 8.6% in 2021, underscoring weaker-than-expected ad spending ahead of this year’s peak advertising season.

Yet, a non-recurring boost from the upcoming midterm elections as well as the World Cup is expected to offset some of the near-term declines in ad spending due to deteriorating macroeconomic conditions. Specifically, political spending ahead of the upcoming midterm elections has been comparatively more robust than previous cycles, matching volumes observed in an election year:

…political forecasts remain strong and, unlike other verticals, appear to be fully funded and not price-sensitive. In an analysis of the data from the Federal Election Commission, spending was up 47% in the third quarter compared to the 2018 mid-terms while overall fundraising is 74% higher, leaving roughly 89% more funds available at the end of September than in 2018…Given the current political environment, qualitative commentary has pointed to midterm election spending that could approach an election year. specifically, Kantar estimates the budget could approach $7.8 billion; for perspective, Magna Global’s 2021 estimate for U.S. ad revenue from Long Form AVOD, OTT and CTV was $5.8 billion.

Source: RBC Capital Markets Ad-Tech Recap

Non-recurring ad spend related to the World Cup and midterm elections in the U.S. in the fourth quarter is forecast to contribute 1.7 percentage points towards y/y ad spending growth this year. This makes anticipated organic ad spending growth for full-year 2022 in the U.S. to be around 8%, a much more moderated level compared to 2021’s 18% backed by a recovering “[post-pandemic] environment with elevated consumer spending”.

Digital Advertising is the Long-Term Winner

The ongoing transition from traditional ad formats to digital advertising is already well underway, with the latter now accounting for more than two-thirds of total annual global ad spending. Looking ahead, search and short-form video is expected to see the fastest growth for digital ad placements, followed closely by retail media and AVOD over the longer-term:

• Search: Online search engines are currently the most popular digital advertising platforms, boasting 19% y/y growth in the first half of the year. And the trends are expected to extend into the foreseeable future, as search ads approach the end of 2022 with at least 17% y/y growth. Political ad spending tailwinds in the fourth quarter are expected to benefit search ads the most, forecast at as much as $1.3 billion. And looking forward to 2023, demand for search ads is expected to grow by about 13% y/y, with deceleration consistent with the IMF’s forecast for further economic contraction in the following year.
• Short-form video: Short-form video is another popular digital advertising platform, as the format continues to take a greater share of user screentime. Short-form video advertising demand grew 14% y/y in the first half of the year, and is expected to close off at 15% growth for full-year 2022. Consistent with broad-based deceleration in ad spending in 2023 (forecast at +5% y/y in the U.S.) ahead of further economic contraction, alongside expectations for greater demand in long-form video / AVOD advertising, short-form video ad demand is expected to grow at a decelerated rate of 13% in the following year.
• Retail media: Retail media advertising refers to display ads / brand ads shown through search on e-retailer apps and websites. Growing retail media advertising demand builds on the back of search ads, as it follows closely with the transition in consumer shopping patterns from offline venues to online platforms, which has been fast-tracked during the pandemic. Retail media ad spending is expected to see rapid growth next year at more than 35% from $31 billion forecast in the current year to $42 billion forecast for 2023. Retail media ad formats are viewed by advertisers as a potential compensatory channel for app-based advertising performance that has been hampered by user data privacy restrictions enforced by Apple (AAPL) last year. Specifically, the emerging ad format benefits from a competitive advantage in 1P data that can be used to effectively deploy targeted ads and enable performance measurability demanded by advertisers.
• AVOD: AVOD is another emerging high-demand ad format that follows the secular transition in consumer preference from linear TV to on-demand video streaming. Demand in the ad format is expected to accelerate over the longer-term as the increasingly saturated video streaming sector consolidates and improves monetization of their respective subscriber bases with advertising. This is further corroborated by the upcoming roll-out of ad-supported options across Netflix and Disney+, which follows the footsteps of Hulu and HBO Max where more than half of their respective subscriber bases are signed up on an ad-lite tier.
• Social media: Social media ad formats are expected to experience the slowest growth as it struggles with both weakness in ad spending ahead of macro deterioration, as well as industry-specific challenges pertaining to ad signal loss following Apple’s implementation of App Tracking Transparency (“ATT”) last year. The format has already demonstrated relatively muted growth compared to the rest of digital advertising channels in the first half of the year with a mere 3% y/y growth – a far cry from the 38% y/y growth in social media targeted advertising demand observed in 2021. Another headwind facing social media ads is that “usage has reached maturity”, which further strips app-based social media advertising platforms’ appeal to advertisers, especially ahead of a cautious spending environment. Ad spend on social media channels this year is expected to slow to 4%, and improve in 2023 with forecast 6% growth.

Looking at the above market trends, AVOD makes the most enticing emerging digital advertising platform. The ongoing transition in consumer preference from linear TV to on-demand streaming is poised to drive growth in AVOD ad space availability (e.g., Netflix and Disney+ ad-supported tier roll-out later in the year), expanding the total addressable market within the said digital ad distribution venue. The format is expected to benefit from further demand acceleration as performance measurability and ROAS metrics improve for advertisers, and ad format operators offer improved cost and pricing structures enabled by greater adoption and scale over the longer-term.

Ad Implications for Big Tech

Google

• Sentiment: Positive
• Implications: Although the company expects ad softness across both Search and YouTube due to the looming economic downturn, we view Search as a cornerstone in digital advertising that will remain favorable among advertisers given best-in-class measurability and “focus on delivery ROI (return on investment)”. Search is also viewed as the more resilient digital advertising format ahead of macroeconomic uncertainties given its economic appeal to advertisers and merchants of all sizes, as well as its market leading reach – the Google Search engine now facilitates close to 10 billion search requests per day. And over the longer-term, YouTube is expected to benefit from robust demand for short-form video ad formats. Specifically, YouTube Shorts has been implementing improved monetization efforts such as revenue sharing with content creators in recent months, which is expected to place a more evident impact on the segment’s ad revenues as demand ramps up over the longer-term. It is also well-positioned to capitalize on robust demand for short-form video ad formats as discussed in the earlier section, especially with continued momentum that has driven an increased share of user screen time – YouTube was the “leader in streaming TV viewership in the U.S. in September for the first time”, ousting Netflix with an 8% share.

Amazon

• Sentiment: Positive
• Implications: As discussed in our latest coverage, Amazon’s cloud-computing unit, AWS, has been the backbone of the stock’s valuation in the 2022 bear market, as consumer weakness weighs on sentiment over prospects of the company’s e-commerce arm. But AWS is bound to decelerate given the size of the business as observed during the third quarter, as well as broad-based macro weakness in the near-term that has enterprise budgets getting slimmed down wherever possible. This is accordingly pushing investors to look for possibilities of a new revenue and profit stream that could justify Amazon’s lofty valuation – and advertising seems to be the newfound focus. The already-profitable segment saw impressive momentum in the third quarter, with 30% y/y growth (9% sequential growth) despite a cautious ad spending environment. Paired with Amazon’s competitive advantage in owning one of the largest troves of 1P consumer data acquired from its sprawling global e-commerce operations, the company is likely the best-positioned to capitalize on retail media advertising tailwinds discussed in the earlier section.

Meta Platforms

• Sentiment: Negative
• Implications: The company has made positive progress on mitigating downside risks from ad signal loss, which is corroborated by y/y ad revenue growth after rolling off of tough post-ATT lapping comps despite significant FX headwinds. However, the company is far from immune against looming ad spending softness, especially as advertisers shun platforms that lack measurability and engagement / conversion. And increasing competition for user screen time facing Facebook and Instagram is not making the situation any easier. The near-term challenges are further corroborated by the company’s forward sales guidance of $30 billion in the fourth quarter, which falls short of consensus estimate at $32.5 billion. As discussed in a previous coverage on the stock, we view Meta’s recent introduction of new AI-enabled ad format Advantage+ a positive development. Advertiser feedback on the new format has been largely positive, with many pointing out to Advantage+’s competitive ROAS and cost metrics as causes for “some [ad] dollars to reconsider Meta incrementally for the first time in a while”. However, the company still needs to ensure engagement is kept up to sustain the ad dollars that have been rolling in as a result of Advantage+’s cost appeal. Although the company has demonstrated growth in daily and monthly active users across its family of apps, competition remains fierce in the social media landscape. And overall maturity of usage across app-based social media as discussed in the earlier section makes another looming challenge. The company has continued to invest heavily into improving usage and monetization of Reels, its take against YouTube Shorts and TikTok – these include improvements made to AI-enabled ad formats like Advantage+ aimed at simplifying the creation and deployment of video ads to attract advertisers, and incentives for content creators to expand usage of Reels. However, ramping up usage and monetization of Reels, and replicating previous success demonstrated through Instagram Stories in stamping out competition will take some time. Apple is also striking again at Meta’s comeback plan on improving ad sales and profit growth with its latest App Store policy update, requiring a commission fee of as much as 30% on in-app purchases of “boosts” used to promote posts on Facebook / Instagram. This may lead to Meta’s reversal of its recent strategy in attracting ad dollars via lowered advertising prices, as profit margins face greater challenges ahead.

Netflix

• Sentiment: Neutral
• Overview: Management offered largely positive commentary during Netflix’s third quarter earnings call, citing the worst is likely behind. However, we remain cautious as subscriber growth in its more profitable regions (namely, UCAN and EMEA) continues to show deceleration / declines. We await the rollout of Netflix’s first ad-supported service this month (November) across 12 countries (U.S., Canada, France, UK, Germany, Italy, Spain, Mexico, Brazil, Australia, Japan and South Korea). Competitively priced at $6.99 per month, the ad-supported tier would contrast from Netflix’s standard tier’s reputation as the most expensive streaming service, beating equivalents offered at HBO Max for $9.99 per month and Disney+ (beginning December) at $8 per month. The service is expected to help Netflix attract more consumer sign-ups by penetrating a more price-conscious cohort that it previously had a weaker grip on, and drive profitability over time through scaling up subscription volume. Paired with higher-margin advertising revenues from the newly introduced ad-supported tier, the company expects the average revenue per user (“ARPU”) for “Basic with Ads” will ultimately top its standard subscription equivalents’ over the longer-term. But as discussed in our previous coverage on the stock, Netflix currently charges advertisers double for ad placements compared to rival AVOD services, which in our view could either leave a positive impact on profit margins if successfully executed, or sour demand especially under the current macroeconomic environment where advertisers are already cautious about ad spending in anticipation of the looming economic downturn. The newly introduced service’s value proposition to advertisers is that Netflix boasts one of the most extensive viewers’ reach in streaming with more than 223 million active subscribers (recently topped by Disney’s 236 million inclusive of Disney+, Hulu and ESPN+). Although not every subscriber is signed onto Basic with Ads, Netflix’s extensive reach represents valuable first party data that can be used to effectively deliver data-driven targeted ads, thus potentially enhancing engagement, conversion and ROAS for advertisers. But given the soft demand environment in advertising within the near-term, as well as uncertainties regarding the early-stage roll-out of Netflix’s Basic with Ads service, execution will remain the key focus ahead. It is too soon to tell if Netflix can mimic the success of linear ads ahead of a secular demand environment for streaming ads, especially as it deals with eroding market share at the same time.

Warner Bros. Discovery

• Sentiment: Neutral
• Overview: WBD’s experience as an industry leader in linear TV ads offers a few competitive advantages ahead of the secular transition to AVOD. For instance, the company could leverage its experience and relationships in building a successful linear TV advertising business onto building out its AVOD business. Another advantage is WBD’s industry-leading content library, which is an attractive point to lure subscribers, thus improving reach and market share gains in AVOD, and inadvertently, enhancing advertiser demand. Progress in this space is already being portrayed through WBD’s impressive direct-to-consumer (“DTC”) segment’s advertising revenue growth in the third quarter, which more than doubled y/y to $106 million. More than half of HBO Max’s subscribers are currently signed onto its $9.99 per month ad-supported tier. And the upcoming combination of HBO Max with Discovery+ is expected to drive further reach by enabling more bundles and subscription options to better penetrate different corners of varying consumer preference on media and entertainment, making WBD well-positioned for AVOD ad demand trends over coming years. Yet, we believe “balance” is the key word investors continue to look for at WBD. Specifically, managing a secular downturn in linear TV and secular growth in streaming continues to require prudent balance ahead for companies like WBD. WBD’s DTC segment remains unprofitable, with much of its operations currently sustained by earnings generated from its larger Studios and Networks segments. As such, growing DTC too quickly or unwinding Networks too slowly could result in an adverse impact on the company’s consolidated profit prospects. With management currently fixed on realizing post-merger cost synergies through ongoing restructuring efforts that include aggressive cost-cutting initiatives (e.g., job cuts as expected from the elimination of overlapping roles at WarnerMedia and Discovery; cancellation of high-profile projects deemed non-value-adding), investors are also looking for balance once again to ensure future growth and creativity – a core driver in media and entertainment success – is not stifled in the process. Given WBD’s restructuring efforts are ongoing, with related impacts on financials to remain prominent through at least 1H23, its progress over coming months on not only DTC subscription growth, but also maintaining a balance on synergy-realization and linear-to-streaming transition efforts remain key focus areas.

Disney

• Sentiment: Neutral
• Overview: The recovery in travel and leisure spending remains a bright spot for Disney, which benefited from improved park visit volumes and in-park spending. But inflationary pressures remain a near-term headwind for Disney’s Parks, Experiences and Products segment, which is a cash backstop for supporting growth in its Disney Media and Entertainment Distribution segment, which includes operations in Linear Networks, DTC, and content sales. And zeroing-in on ad sales, which is our focus today, Disney continues to experience softness in its traditional TV distribution channels, similar to WBD’s results as both deal with the gradual secular downtrend in pay TV viewership. But ad-supported programming on its streaming platforms Hulu, ESPN+, and Disney+ (starting December) continues to underscore the competitive advantage of Disney’s diversified DTC offering in the transition from linear TV to streaming over the longer-term, satisfying a wide range of consumer preferences from scripted content and sports to the Disney-brand catalogue – which is also similar to WBD’s diversified content library from unscripted content on Discovery+ to iconic fictional franchises on HBO Max. With close to 236 total DTC subscribers as of the end of its fiscal fourth quarter, the company makes another attractive AVOD advertising outlet for advertisers looking to spend some TV ad dollars on streaming. We view Disney’s sprawling subscription as a critical driver for its DTC advertising business, especially as much of its subscription growth at Disney+ in recent years comes from Disney+ Hotstar – an India-based offering that is significantly cheaper with very slim margins. The introduction of an ad-supported tier at Disney+ later this year will be crucial to improving Disney’s DTC profit realization timeline – similar to WBD, Disney’s DTC business is currently operating at a loss, which is a disadvantage for both media and entertainment giants when compared to Netflix. However, we expect the upcoming rollout of Disney+’s ad-supported service to be less costly than Netflix’s given Disney’s option to leverage its existing advertising tech stack for streaming used across Hulu / ESPN+. The company can also call on its existing advertising customer base from linear TV to spend additional ad dollars in streaming, which is a similar competitive advantage shared by WBD that Netflix does not have.

Final Thoughts

Under today’s macro environment, cautious ad spending will likely benefit ad-tech avenues that currently offer the best ROAS and reach/conversion effectiveness. Specifically, we view Google Search as the clear winner given its massive presence across consumers’ daily life settings. Meanwhile, retail media like Amazon is also well-positioned to take advantage of the current operating headwinds felt across app-based advertising outlets, while also building off of high advertising demand in consumer search.

But over the longer-term, we view ad spending in streaming to see the largest and fastest growth, which makes a strong tailwind for AVOD platforms like WBD’s HBO Max/Discovery+, Disney’s Hulu/ESPN+/Disney+, and Netflix. Yet, sentiment remains neutral on the big three within the foreseeable future, as execution risks remain on their respective build-outs on subscriber reach and ad economics. The increasingly prominent consumer slowdown over coming months as financial conditions tighten also remains an immediate overhang on their respective fundamental performance in DTC.