PubMatic: Still Has Room For Upside Despite Weak Macro (NASDAQ:PUBM)

Description

I recommend buying PubMatic, Inc. (NASDAQ:PUBM). The buy case for PUBM is based on the growth and potential of the digital advertising industry. Digital advertising is expected to see significant growth in the coming years, with global spending on digital advertising projected to increase from $455 billion in 2021 to $834 billion by 2030. PUBM’s platform, which provides a specialized cloud infrastructure for real-time programmatic advertising transactions, is well-positioned to take advantage of this growth. Additionally, PUBM has been successful in maintaining low operating expenses thanks to its largely offshore R&D team, and the company’s technology and development expenses are expected to stabilize at a lower percentage of revenue than its peer Magnite (MGNI).

Company Overview

The PubMatic, Inc. platform leverages a custom cloud architecture to enable programmatic advertising transactions in real time. This entails a wide range of tactics, such as auctions for advertising space on a per-impression basis, internationalization of demand, analytics for target audiences, and management of brand.

Digital Advertising Will Outpace The Overall Advertising Market Growth

Free Internet is made possible, at least in part, by advertising revenue. Advertisements on the Internet, when delivered on a large scale and with a personal touch, can have a much greater ROI for purchasers. By pooling and analyzing data about their digital audiences, publishers can increase the value of their ad inventory and better serve their advertisers.

The ecosystem supporting digital advertising has grown more complicated in recent years for a number of reasons. While programmatic bidding has simplified the bid/ask process of large quantities of digital advertising space, it has also introduced serious complications as a result of the proliferation of media types, slow speeds, rising costs, and tighter rules. In my opinion, a specialized solution is needed to optimally power these tech-driven transactions on a massive scale for both buyers and sellers.

Moreover, as advertisers shift more of their ad spending to digital, they are calling for increased visibility and management of the entire supply chain. By knowing what kind of ad inventory they are buying and what kind of content is surrounding their ads, advertisers can avoid accidentally paying for fake inventory or having their ads displayed next to content that could damage their reputation. The need for openness and command is prompting more and more marketers to work directly with suppliers that have the capacity to achieve their needs. Therefore, more advertising dollars are being directed toward less obfuscated digital mediums.

My expectation is that developments in the digital advertising industry will provide a substantial boost to the potential of the PUBM market. By 2030, global advertising spending is expected to have increased from its 2021 level of $590 billion to $1.25 trillion in 2030. Digital advertising, I believe, will outpace the overall advertising market growth as advertisers follow audiences online. Statistics show that by 2030, global spending on digital advertising will have increased to $834 billion from its 2021 level of roughly $455 billion billion.

PubMatic’s Platform

PUBM infrastructure enables real-time programmatic bid/ask process. This infrastructure is being rolled out internationally to equip businesses with the swift financial dealings needed to offer consumers a faultless digital advertising encounter. Also, PUBM’s offering is omnichannel, meaning that it caters to a wide variety of publishers and digital devices.

PUBM’s system was designed to process real-time, programmatic advertising deals efficiently. In addition, it can compile and analyze the crucial information that comes with every exchange. To put it plainly, the PUBM technology platform optimizes the ad experience for the consumer by quickly processing each possible ad.

PubMatic’s Gross Margins Have Room To Grow

PUBM’s rapid expansion and increased profitability can be attributed in large part to the fact that the company owns all of its own infrastructure, unlike its rivals. The company, for instance, has been able to increase the number of impressions served while simultaneously decreasing the cost per impression. Moreover, the cost to process impressions remains relatively consistent, so PUBM’s expansion into new areas like mobile and CTV will not result in higher unit costs. As such, I believe PUBM’s gross margins have room to grow.

PUBM has been successful in maintaining low operating expenses thanks in large part to its largely offshore R&D staff, which has allowed the company to keep costs low. As of 3Q22, 46% of PUBM’s technical staff is based in India, where salaries are significantly lower. Since PUBM has a competitive advantage in engineering costs, I anticipate that its R&D spending will eventually level off at a lower percentage of sales than that of its closest competitor, Magnite, where R&D costs account for about 20% of sales.

Global Presence With Omnichannel Reach

To mirror the borderless nature of digital ads, PUBM has presence in all of the major international markets for advertising. PUBM does this so that it can meet the needs of publishers who have interests in and access to a wide variety of audiences through their media. Similarly, many PUMB advertiser and agency clients oversee international brand portfolios with varying advertising requirements. Each of these groups is actively seeking out platform that can serve their needs on a global scale and accommodate a wide variety of ad types and devices. In my opinion, PUBM is in a prime position to help publishers and ad buyers improve the efficacy and efficiency of their advertising businesses through the provision of global, omnichannel reach.

Revenue Down, Profitability Up

PUBM’s 3Q22 revenue growth of 11% fell short of analysts’ expectations of 15% growth. In addition, the 1% revenue growth forecast for the fourth quarter is indicative of a rapidly deteriorating environment for ad demand. Put another way, no one saw the magnitude of the slowdown coming, as PUBM had projected fourth-quarter revenue growth in the mid-twenties. While I agree with management that they are being cautious, I must say that the unpredictable nature of the advertising market makes accurate predictions nearly impossible.

Though I’m disappointed by the decline in revenue, I’m heartened by the improvement in profitability. In its earnings report, PUMB showed an EBITDA margin of 39%, which was significantly higher than analysts’ forecasts. I have faith in the company’s resilience in the face of a prolonged downturn because of its dedication to profitability. Another factor that I believe will help PUBM’s bottom line in FY23 is a planned reduction in capital expenditures.

Market share is increasing for PUBM in a competitive environment. I was impressed to learn that SPO (supply chain optimization) now makes up more than 30% of platform activity, up from 24% in the previous year. I wouldn’t be surprised if smaller, loss-making players accelerated their share gains given the advertising market’s rapid decline.

Valuation

I believe PUBM is worth USD15.04 in FY23, which translates to 16% upside.

As mentioned above, I think the advertising industry is going through a winter phase now due to a bac macro backdrop. However, that does not mean that it cannot grow. I believe PUBM is likely to capture share from smaller players, albeit growth is still going to decelerate.

That said, I think there is an ongoing negative narrative that affects all players in the digital advertising ecosystem. Until such time where things turn for the better, I believe valuation will continue to stay depress in the near term. For these reasons, I believe valuation is going to maintain at the current level.

Key risk

Fragmented supply side

There is still a great deal of fragmentation in the supply side landscape, and demand is putting constant pressure on take rates. My guess is that the vast majority of publishers are utilizing multiple SSO to generate income from their digital properties. Due to market fragmentation and intense competition, PUBM will likely be unsuccessful in its attempts to increase its take rates from publisher clients. That said, I believe that PUBM will be successful in increasing spending from existing customers by means of SPO deals; however, I worry that this success may be achieved at the expense of lower economics.

Summary

PubMatic, Inc. is a provider of a specialized cloud infrastructure platform that enables real-time programmatic advertising transactions. This platform has allowed PUBM to scale profitably and increase the number of impressions served while reducing the cost per impression. The digital advertising industry is expected to see significant growth in the coming years, and PubMatic, Inc. is well-positioned to take advantage of this growth with its strong platform and cost advantages.