Outbrain: Improved algorithms and stock buyback could push the price up (NASDAQ: OB)
Outbrain Inc. (NASDAQ:OB) is said to be the largest online advertising platform and appears to be trading significantly undervalued. In my opinion, with enough new product development and improved algorithms, OB’s stock price could go up. north soon. Keep in mind that with the recent buyback program announced in 2022, market liquidity may increase. Despite the risks associated with the company’s contracts with media partners and the failure of new products, the current share price seems too low.
Outbrain offers recommendation technology for readers to discover new things on the open web. The company offers engaging and personalized content for all of us on many well-known platforms. I’m pretty sure you’ve seen one of its advertisements in the past, as Outbrain works with large and established business partners.
To date, the company claims to be largest online advertising platform on the open web with nearly 1 billion monthly unique users in 2021 and 10 billion content recommendations. With these numbers, in my opinion, as soon as the company manages to monetize its reach, the free cash flow could be quite impressive.
Consistent with my previous comment, I decided to launch a financial model on Outbrain because management decided to launch a buyback program. I assumed that Outbrain was buying its own shares because their price had become too cheap in the market:
On February 28, 2022, the Company’s Board of Directors approved a share buyback program under which the Company is authorized to purchase up to $30 million of common stock of the Company. Source: 10-Q
Impressive expectations from investment analysts
Financial analysts expect Outbrain to achieve median sales growth of nearly 8% between 2022 and 2024. The median EBITDA margin is also expected to be close to 4%, and net income would be positive in 2024. Lastly, there isn’t much information on free cash flow expectations, but the company has reported a positive FCF in 2021. In my opinion, expecting FCF/sales of around 4, 6% as in 2021 would make sense.
The balance sheet includes a significant amount of cash on hand, which I don’t think most investors have noticed. As of June 30, 2022, cash and cash equivalents were $391 million and the asset/liability ratio was 1.45x.
With long-term debt of $236 million, net debt is negative because the company has plenty of cash. It might make more sense to reduce total long-term debt to reduce interest costs. With that, acquiring more targets would make a bit more sense.
More products, better algorithms and the API could bring significant revenue growth and push the fair price to $9.7 per share
Under normal conditions, Outbrain will most likely improve its algorithms, effectively manage its supply and demand, and design new products for media partners. As a result, management would expand the use of the platform and revenue growth would remain close to market estimates.
Also, I would expect Outbrain to be able to improve user engagement. In my opinion, if management successfully facilitates content discovery and offers exactly what visitors are looking for, long-term monetization would occur:
We believe that user experience has a profound impact on users’ long-term behavior patterns and “gets worse” over time, improving our long-term monetization prospects. Source: 10-Q
I also think Outbrain will most likely develop new technology capabilities that will improve its relationship with advertisers. This is another essential feature that Outbrain needs to drive sales growth. Without developing new relationships with advertisers or acquiring ad companies, revenue growth simply won’t stay high:
Our growth is fueled in part by retaining and increasing the amount advertisers spend on our platform, as well as acquiring new advertisers. Improving our platform with features and functionality that increase engagement and ROAS increases our platform’s attractiveness to existing and new advertisers while increasing our share of their advertising budgets. Source: 10-Q
Let’s mention that Outbrain also offers an API-based platform, which will likely multiply the productivity of clients and advertisers. With enough programmers, I think the API could bring significant scalability and improve sales growth.
We believe that our proprietary microservices and API-based cloud infrastructure gives us a strategic competitive advantage, as we are able to deploy code an average of 300 times per day and grow in a scalable and highly cost-effective way. Source: 10-Q
Under the previous conditions, I assumed sales growth close to 8%-7%, an EBITDA margin around 5%-4% and FCF/Sales close to 2.5%. My results include net sales of approximately $1.972 billion, FCF of $49 million, and 2032 EBITDA of $79 million. If we also use an 8x output, the net present value of the terminal value would be $118 million. Finally, the implied equity valuation would be $542 million and the IRR would be 19%. With 55.7 million shares outstanding, the fair price would be $9.7 per share.
worst case scenario
Outbrain has made over $39 million in research and development, so I would say the company is working on new innovations and new products. On this, let’s not be naive. Outbrain may not appeal to customers and advertisers. New products may not be as good as customers expected, which could lead to slower revenue growth and lower free cash flow. In the worst case, management can suffer brand destruction and deterioration of corporate image. As a result, the stock price will likely fall:
There can be no assurance that our efforts to promote new or improved solutions, such as video solutions or new advertising tools, will be successful. If we are unable to generate an adequate return on our investment in our research and development efforts, our business, results of operations and financial condition could be adversely affected. Source: 10-k
Outbrain could suffer a bit if management loses its relationship with several media partners who represent a significant portion of Outbrain’s revenue. In 2021, a partner accounted for nearly 11% of total revenue. In a highly detrimental scenario, the loss of this customer would result in a decline in revenue of approximately 11%. Free cash flow may also decline, which may cause the stock price to fall.
In 2021, our largest media partner represented approximately 11% of our revenue, while in 2020 and 2019 each of our two largest media partners represented approximately 10% of our revenue. Source: 10-k
In this scenario, I also assumed that Outbrain might not be able to sign many new deals with advertisers and might lose some existing customers as well. Note that the company does not sign long-term commitments with its customers, so it may be easier for them to walk away. With fewer customers, revenue growth would decline in the long run.
We have no long-term commitments from our advertisers. We seek to increase the number of advertisers and reach new advertisers. Attracting new advertisers and developing existing relationships with our advertisers requires considerable effort and expense. Source: 10-k
With sales growth of around -7.5% to -5%, I got net sales in 2032 of around $456 million. Moreover, with an EBITDA margin of around 2.5%, an FCF/Sales of 0.5% and a discount of 20%, the NPV of FCF would be close to $15 million. With an exit multiple at 2x EBITDA, I got an implied enterprise value of just $15 million and an equity valuation close to $175 million. If we also assume 55.7 million shares outstanding, the implied fair price would be $3.1 per share.
If Outbrain buys other companies, the fair price could be well over $10
Outbrain has deep expertise in M&A markets and has already proven that it is ready to grow inorganically. Zemanta and AdNgin were recently acquired. Given the money available, in my opinion, management could acquire many new targets, which would bring in more revenue and significantly increase the fair price of the business.
We have a reputation for successfully executing a number of acquisitions and partnerships, which help us effectively expand our offerings, grow our business and develop our talent. In 2017, we acquired Zemanta, providing us with advanced programmatic capabilities. In 2018, we acquired AdNgin, an advanced UI optimization platform. In January 2022, we acquired vi, giving us an expanded video offering for advertisers and media owners. Source: 10-k
I also believe that the money in hand could be used to sign new partnerships. In my opinion, with sufficient investment in marketing, Outbrain’s new partnerships could become a catalyst for future revenue.
Given the most recent share buyback program and new investments in improving the algorithm, Outbrain’s stock price may soon trend north. Keep in mind that Outbrain has a significant amount of money to sign new partnerships with, and is considered the biggest online advertising platform. With minor risks and given that Outbrain cannot develop successful new products, the company is quite cheap at its current price.