With all eyes on the advertising space the past six months due to Alphabet's (NASDAQ:GOOG) (NASDAQ:GOOGL) and Apple's (NASDAQ:AAPL) discussions about banning third-party cookies, many investors have been scared to buy shares of companies with skin in the game -- even though investing in the adtech space could be a very lucrative idea.
Advertising technology (or adtech) companies help advertisers effectively deliver ads to their target market by using tech and software systems to make the process more efficient and targeted. Instead of an advertiser putting an ad in the paper or randomly selecting a website to advertise on, adtech companies use data to find the best matches for advertisers and publishers so that publishers make the most money while advertisers are placing their ads in front of the people they want to target.
There are plenty of big-time players in the space, however, including businesses like The Trade Desk (NASDAQ:TTD) and Magnite (NASDAQ:MGNI). PubMatic (NASDAQ:PUBM) entered the public sphere after its initial public offering (IPO) almost one year ago, and after its peak in March -- where it jumped 150% from the start of the year -- it has fallen back down to negative returns year to date. With so many competitors in this space, is there really an opportunity left for Pubmatic to succeed?
Image source: Getty Images.
The space at large
It might be wise to start with the adtech space at large. There are two sides of the adtech space: The demand side, where advertisers go to buy ad space, and the sell side, where publishers and companies who are selling ad space go. Companies like The Trade Desk work on the demand side. Its customers are advertisers and The Trade Desk looks to place its customers' ads on websites. PubMatic does not operate on the demand side, but rather the sell-side, so PubMatic and The Trade Desk actually work together at times: The Trade Desk brings an advertiser to the table while PubMatic brings a website owner looking to sell ad space.
PubMatic's main competition comes from Magnite, the biggest player on the sell side of the adtech industry. Even though PubMatic is much smaller than Magnite -- its quarterly revenue is roughly half of Magnite's -- PubMatic has a major edge. It has its own technology stack that deals with the copious amounts of data it brings in. Instead of using third-party cloud providers, PubMatic has spent years developing its own software to handle the 2.3 petabytes -- or 2,300 terabytes -- of data it collects daily.
PubMatic's place in it
PubMatic operates in all parts of the digital advertising world, including connected TV (CTV) and programmatic advertising, as well as mobile advertising -- creating stable partnerships with publishers (PubMatic's customers) as well as demand-side platforms like The Trade Desk. These partnerships have allowed the company to see rapid growth recently. In the second quarter of 2021 the company grew its revenue 88% to $50 million from the year-ago quarter, which included 100% growth from connected TV revenue. It also grew its net retention drastically: In Q2 2020 it was just 107%, but in Q2 2021 it reached a staggering 150%.
The company's decision to create its own technology infrastructure has resulted in a very high gross margin of 74% -- much higher than Magnite's gross margin of 56%. These high-margin operations have led to impressive profitability for a company in this stage of its growth. PubMatic's Q2 net income was $10 million, which represented 20% of revenue during Q2 2021. The company also reported a free cash flow generation of $17 million so far this year.
What might be most impressive about this growth and profitability is that PubMatic is doing all of this organically, which cannot be said about Magnite. In April 2020, Telaria and the Rubicon Project merged together to become Magnite. After other acquisitions, including SpotX for over $1 billion, Magnite has grown inorganically to become the largest sell-side advertising platform. PubMatic, on the other hand, has been growing organically, without acquisitions or mergers.
The potential downfall
At just 7.9 times sales, PubMatic is a cheaper stock than The Trade Desk and Magnite today, and at a market cap of $1.43 billion, it is also the smallest with the most potential to grow. This cheap price does not come without risk, however. Both Apple and Google have talked about getting rid of third-party cookies, which provide insights into consumers' actions online. While PubMatic has been shifting away from the usage of cookies, this could potentially hurt the company. On the other hand, this risk doesn't just affect PubMatic, but would also have similar effects on its competitors.
With the global digital ad spend expected to increase 10% each year until 2024 to $526 billion, this market will not be winner-take-all, and there will be plenty of room for both Magnite and PubMatic to enjoy success. With its strategic partnerships and diverse customer base across various advertising strategies, along with its personal tech stack, PubMatic has unique traits that could propel the company forward. This could result in strong adoption in the fast-growing market, which is why I believe that PubMatic could see huge success over the long term.
This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.
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