AppLovin: Share Price Still Looks Undervalued (NASDAQ:APP)

Thesis

Fundamentally, I think AppLovin Corp. (NASDAQ:APP) has managed to show that it has stabilized the business, outperforming what was expected to be a big decline in 1Q (via guidance), and the market seems to love this (stock was up >30% yesterday). This earnings report also reinforces my view that APP is worth a long position at this share price. More specifically, I appreciate that APP has not lost sight of its primary goal – namely, making a profit – while simultaneously pushing forward incremental investment narratives throughout its platform. Additionally, management is also committed to buying back shares to drive shareholder returns and maintaining emphasis on disciplined returns in its Apps portfolio. While I expect that near-term investor debates will continue to center on the unpredictability of the advertising and gaming end markets, I remain bullish on the APP umbrella of companies due to their potential for growth and a strong margin profile in a resurgent mobile advertising and gaming industry.

Key highlights

Both revenue and EBITDA for APP’s 4Q22 were above expectations. Quarterly segment revenue & EBITDA were led by the Apps segment, which performed better than anticipated. The quarterly guide was a surprise to me (and I believe the market), in my opinion, as management now expects to deliver $685-$705 million in sales and $250-$270 million in EBITDA. Even though the revenue forecast indicates a slight sequential decline, I consider this to be a significant outperformance, especially when compared to the street’s expectations of a larger sequential decline in 1Q22.

Software

Despite a sequential decline to $306 million, management is anticipating a slight sequential uptick in software platform revenue in 1Q23. Importantly, APP disclosed a 46% increase in revenue per installation for its app install products and a 24% increase in total installations in 4Q22 – which I think sets a certain trend moving into 1Q23. Importantly, AXON 2.0 will be released in 2023 with improved targeting and conversion rates as primary goals. In theory, I can see why investors would be excited about this development for APP. However, before jumping on the bandwagon, I think it’s best to take a “wait and see” approach and let APP demonstrate the scope of the change and its potential.

Apps

Apps revenue was $396 million, down 3% sequentially but higher than the consensus estimate of $383 million. With $128 million in write-offs over the past two quarters and a reduction in user acquisition spending over the course of last year, the portfolio has been rationalized down to 11 game studios. In this regard, I am not surprised to hear that the 1Q23 will be lower, but I am pleased to see that margins have increased significantly; at least this will give management some breathing room to reinvest. To get back to growth, management has stated that they are working on new content using a combination of IAP and ad business models and that they are willing to spend against any potential hits, even if margins were to drop to the low to mid-teens. That makes sense, since this is not a segment where they can milk for cash. Still, I think it’s best to adopt a “wait and see” stance in this case. I won’t get my hopes up about APP until I see some results.

Industry

After IDFA, developers had less success locating high-spending players, as a result, game development pipelines have shifted, with many studios now utilizing a combination of in-app purchases and in-app advertising to monetize the large segment of players who do not pay. For APP, I see this change as a positive because it opens the door for the company to service more inventory in the software realm. Management has also acknowledged the challenges faced by game developers and publishers when releasing new games, recognizing the need for truly original content rather than simple iterations of proven formulas. Finally, APP pointed out that China’s zero-COVID policies had stifled many game studios, so any loosening of those restrictions would be good news for studio productivity.

In general, I maintain a near-term pessimistic outlook on the in-app advertising market because I anticipate that game developers will be unable to afford to spend on promoting their titles in light of the ongoing declines in consumer spending on mobile games. As a result, I believe investors to be overly-focused on sentiments and narratives with regards to the mobile game industry. However, I maintain a long-term bullish bias toward the industry and think the companies in APP’s portfolio will do well as a result of this secular trend.

Conclusion

APP has demonstrated stability in the business and a commitment to profitability while making investments to drive growth and returns for shareholders. In the short-term, I believe the in-app advertising market faces near-term challenges due to declining consumer spending on mobile games, but I expect the industry to thrive in the long term, and APP is well positioned to take advantage of this trend. As such, I reiterated my long bias for APP.