The Trade Desk: A Long-Term Winner Vs. Google But Currently Overpriced (NASDAQ:TTD)

Investment Thesis

The Trade Desk (NASDAQ:TTD) has outpaced the digital advertising industry as a whole thanks to its innovations in programmatic advertising and market positioning as an exclusively demand side platform (‘DSP’). The company’s tailwinds remain plentiful within the Connected-TV (‘CTV’) and Retail Media verticals. Additionally, a shifting identity landscape as Google’s ‘Cookies’ are phased out presents an opportunity for the company’s identity solution, UID2, to take major share. Despite its outperformance and competitive durability, TTD trades at 40x EV/EBITDA vs a peer average of about 10x. Cooling growth and overall competitive uncertainty are additional headwinds. TTD shares look unattractive at current levels, with my fair value estimate in the mid-$30’s.

The Shifting Digital Advertising Landscape

Digital advertising has been one of the fastest growing markets the past decade, climbing at an annual rate near 20% between 2011 and 2021 and overtaking traditional advertising. Despite normalizing growth post-pandemic, global digital advertising spend crossed $600 billion in 2023 and is expected to close in on $1 trillion by the 2030.

Innovations in the mid-2000’s led to the advent of programmatic advertising. Programmatic leverages consumer data and machine learning to help advertisers locate and purchase optimal media spots with the goal of improving return-on-ad-spend (‘ROAS’) and improving campaign effectiveness. Programmatic advertising exploded onto the scene as the number of internet users grew and digital media consumption skyrocketed. This led to 80% of ad-dollars going to programmatic, most likely for good.

As adoption of the technology expanded, so has the number of competitors providing it. Yet, large firms like Google (GOOGL), Facebook (META), and Amazon (AMZN) control much of the market. Google has locked down the overall advertising industry for decades given its tight grip on video and search ads. Google’s legacy internet identity solution, Cookies, has long been the gold-standard for advertisers seeking targeted ads but its depreciation was announced in 2020. After a few years of delays, Google looks ready to make big progress on its Cookies phase-out in 2024. Even with a few years to adjust, this will create a massive upheaval in digital advertising as 75% of marketers are still reliant on the technology – but it also presents an opportunity for alternatives to take its place.

Though the digital advertising industry is maturing, plenty of demand remains for the taking – and The Trade Desk looks well-positioned to do just that.

The Trade Desk Strategy & Outlook

Let’s pick back up with identity. The Trade Desk was one of the first companies to begin developing an alternative identity solution to Cookies, far before its depreciation was announced. The company introduced Unified ID (‘UID’) in 2018 and upgraded to UID 2.0 not long after. UID2 allows users to opt-in for data sharing and uses basic info such as emails and phone numbers as identifiers. Consumers opting in eliminates unwanted data sharing and creates a more durable target audience for advertisers. The technology is interoperable, meaning it captures these identifiers wherever users login across the open internet, and each consumers data is encrypted for protection. This omnichannel nature of UID2 enables marketers to target users with greater precision across almost all mediums, not just search. With the phase out of Cookies in the foreground, UID2 has potential to take a sizable chunk of the market in addition to what it already has.

UID2 has seen widespread adoption from publishers to platforms; NBC, Warner Bros., The Washington Post, and Snowflake are just a few. The Trade Desk also partnered with another pioneer of alternative identity solutions, LiveRamp (RampID), to help capture more share of the market. UID2 already has a strong foothold on the future of identity, specifically among publishers:

Though UID2 is not currently monetized by The Trade Desk, becoming the preferred identity solution would drive more advertisers and publishers to its platform and streamline data aggregation.

Connected-TV (‘CTV’) and Retail Media continue to be additional growth opportunities for The Trade Desk. Traditional TV (Cable and Broadcast) has fell below 50% of total TV viewership in 2023 with streaming climbing to nearly 40% of total viewership, most of which is through CTV. As more views flock to CTV, so do advertisers with CTV taking a growing portion of TV and overall digital ad dollars.

A driver of this trend is the increasingly common ad-supported tier of major streaming services. As these streaming platforms reach a higher level of saturation, an ad-tier is needed to further drive monetization. The Trade Desk was a first-mover in this growing vertical as the company was quick to parlay its programmatic capabilities into the space. It has paid off with nearly 40% of its revenues now coming from Video (mostly made up of CTV) in addition to Video being the company’s fastest growing revenue category according to management.

Retail Media networks, which allow marketers to advertise in partnership with retailers, have grown rapidly alongside the e-commerce industry. These networks enable advertisers to tap into retailers’ first-party data for more effective ad targeting while retailers make money selling ad-inventory. Retail media has been a key avenue for The Trade Desk’s topline growth and will be an area of focus going forward as indicated by management in Q3. The company already has a wide footprint thanks to partnerships with retailers like Walmart, Target, and a handful of large international retailers.

The Trade Desk has several opportunities in its evolving market and looks poised to be a long-term winner. But can the firm continue to take ground against competitive stalwarts like Google, Adobe, and Amazon?

Economic Moat

It’s hard to ignore TTD’s outperformance with revenues growing at an annual clip of 36% the past 5 years, vastly outpacing the industry, and the stock up 390%. Both data points tend to allude to some sort of existing (or potential) competitive advantages.

Programmatic Advertising First-mover & Data Advantages

A few early public adopters of programmatic advertising techniques were Google in 2013 (Google AdSense) and Facebook around the same time. But The Trade Desk was even earlier to the market, founded in 2009 by David Pickles and Jeff Green who is still CEO. They founded the company a couple years after Green’s first advertising company AdCEN was acquired by Microsoft (MSFT). The Trade Desk’s success since then is largely attributable to the quality of its offering and the difficulty of competitors to replicate. Programmatic methods rely on ML techniques and data. As more data is ingested into the models, they improve. Being a first-mover in a highly technical field tends to create natural advantages in the form of better models and data as the business scales. The Trade Desk has the highest rating vs peers on Gartner which underscores the platform’s quality.

Independence & Cost Effectiveness

Superior technology only takes you so far when competing against the biggest companies in the world, so what else differentiates The Trade Desk? Independence. The Trade Desk is exclusively a demand-side platform unlike Google and Facebook which often leverage their existing platforms to act as both supply and demand of ad-inventory. Google and Facebook may be incentivized to push their own ad-inventory to advertisers even if the inventory is not optimal – in addition to controlling the price of the inventory. Both Google and Facebook make a majority of their revenues off advertising, highlighting the lack of independence as demand-side platforms. This dominance of both supply and demand by walled gardens, Google and Facebook, has been widely scrutinized, even leading to several antitrust suits. One by the US Justice Department had this to say:

“The complaint filed today alleges a pervasive and systemic pattern of misconduct through which Google sought to consolidate market power and stave off free-market competition,” said Deputy Attorney General Lisa O. Monaco. “In pursuit of outsized profits, Google has caused great harm to online publishers and advertisers and American consumers.

The companies were even alleged to be colluding to gain further control of the ad-market – further underscoring potential conflicts of interest.

The Trade Desk, on the other hand, has built trust with customers as a purely demand-side platform with advertisers best interest in mind, namely reduced cost and increased ROAS. The company even recently introduced a new sub-floor bidding tactic allowing advertisers to bid lower than what SSPs are asking, which gives more clarity on demand for inventory and helps advertisers get lower prices. This tactic is also in effort to remove the middle man (SSPs) in favor of solutions like TTD’s OpenPath which connects advertisers directly to publishers to skip the added costs. This trust with advertisers has helped the company succeed in the past and I suspect will continue to give The Trade Desk competitive durability.

Fundamental Drivers & Valuation

TTD shares took a dive 24% after its Q3 release back in November, primarily driven by lower Q4 revenue guidance than expected by analysts ($580M vs $611M estimated). Revenues tend to be seasonal with most growth in Q4 but YoY growth rates have cooled since Q1 of 2022:

Yet, full year 2023 growth is expected to be in the low 20’s. Management attributed slower growth to tougher YoY comparables and macro challenges but is optimistic for 2024 and 2025:

First, obviously, the macro environment plays a role in our business and things like higher cost of capital and increased money supply have downstream effects on most businesses. Some of those effects are opportunities which we’re seeing mostly across our client base but we’re seeing some of those effects as pressures on their businesses. But regardless of the macro environment’s effects on individual companies, we continue to see the tidal wave of opportunity over the next 2 years.

In addition, Wall Street analysts are predicting topline growth to average about 20% annually the next 5 years according to Seeking Alpha. My base case revenue forecast holds growth of 16% annually through 2032 as the firm captures CTV and Retail Media demand, alongside benefits from a growing share of the identity market. The forecast assumes TTD maintains and slightly grows its historical take rate of around 20% and slowly expands its market share of overall digital advertising spend:

The Trade Desk boasts strong gross margins in the low 80’s that have expanded overtime thanks to its capital light model and economies of scale. The company has demonstrated robust profitability in the past but has seen depressed operating margins and returns on capital as a result of increased operating expenses.

Specifically, general & admin margins have nearly doubled the last 5 years from 18% of revenues to 33%. Management also plans to increase headcount 15-17% in 2024 which will inevitably expand operating spend. It looks as if leadership is spending more to keep its historically strong revenue growth, which has hurt profitability and points to a lack of operating leverage. This is an area I will be looking for improvement in 2024. My base case has gross margin averaging 83% and operating margin climbing to 29% in 2032. Additionally, my base case holds that fixed and working capital investment will remain close to historical averages:

• Capex at 3% of revenues
• Depreciation & Amortization at 50% of Capex
• Change in Net Working Capital averaging about 3% of revenues.

Lastly, I introduced an upside and downside case and assigned probabilities to each. This allows us to test a range of assumptions and estimate the likelihood of potential outcomes. As you can see from the below results, each case has wide variability in implied share price, with currently more downside than upside based on the case assumptions. Additionally, I assigned a probability to each case, with the heaviest weight given to my base case. Even with a higher probability of the upside case, the result is an expected value of $36.20 or 82% downside.

Risks & Uncertainty

In addition to competitive threats from large firms like Google, Facebook, and Amazon, The Trade Desk faces a few external and internal risks to be aware of. The digital advertising industry is a dynamic one. Regulation and structural shifts can create an uncertain operating environment, as we’ve seen with the depreciation of Cookies, Apple’s data privacy changes, and a myriad of antitrust suits. The Trade Desk is one of the few DSPs to reach such scale and has navigated the advertising waters for over a decade, which gives them durability in my view. Digital advertising is also closely tied to the consumer. A contracting macroeconomic environment creates tighter advertiser budgets and can harm TTD’s performance. The company has shown resilience through 2022 and 2023 though with still strong growth and stock price performance.

Internally, excessive stock-based compensation (‘SBC’) has been a criticism and presents a real cost to shareholders. Share buybacks have helped curb the dilutive effect of SBC, but it still is a substantial 27% of TTM revenues. Founder and CEO Jeff Green also holds 48% of voting power, which adds key person risk. Nonetheless, Green has led the company well and looks to continue this trend.

Conclusion

The Trade Desk has outperformed the broader digital advertising industry and has built trust as an exclusively DSP. Numerous tailwinds within CTV, Retail Media, and Identity look to make the company a long-term winner. But sometimes a great company is not a great investment. TTD looks far too overpriced and has seen cooling growth and increased operating spend. Should prices come down and profitability improve, I will look to add shares.