Digital Turbine: A growth company with expanding margins.
Digital Turbine is a growth company that is facing some short-term headwind but could potentially turn out to be a long-term gainer. When looking at Digital Turbine there are plenty of things to like but also some things that are somewhat worrying. In this analysis I will investigate if the risk/reward if investing in Digital Turbine is worth it.
This is not a financial advice. I am not a financial advisor and I only do these posts in order to do my own analysis and elaborate about my decisions, especially for my copiers and followers. If you consider investing in any of the ideas I present, you should do your own research or contact a professional financial advisor, as all investing comes with a risk of losing money. You are also more than welcome to copy me.
Since I have attended the workshop with Phil Town, I have decided to change the layout of my analyses a bit. I will do some more calculations and briefly describe the company and if it has a moat. I have changed the format of the analysis a bit to try to make it shorter and with less numbers. If you want to read more about how I evaluate a company, please go to "MY STRATEGY" on my website.
For full disclosure, I should mention that at the time of writing this analysis, I do not own shares in Digital Turbine. If you would like to copy my portfolio or see the stock in my portfolio, you can read about how to do so here. I don't own shares in any of their direct competitors either. As always, I will keep this analysis unbiased.
Digital Turbine was funded in 1998. It describes itself as a leading, independent mobile growth platform that levels up the landscape for advertisers, publishers, carriers, and device original equipment manufacturers. Digital Turbine is mostly known for their product Ignite that cooperates with carriers like Verizon and original equipment manufacturers like Samsung to install advertiser apps into mobile devices. Ignite is installed in more than 600 million devices around the world and will soon be installed on all Samsung devices. Ignite is a great product but the problem was that revenue was only generated once for each device. Digital Turbine has since made acquisitions to be a more complete platform and developed technology like their patented SingleTap technology (which allows the user to download the app directly from the browser instead of going to Google Play), which should result in Digital Turbine getting more recurrent revenue moving forward from things like digital advertisement. The way Digital Turbine is making revenue is that they receive a fixed amount per device Ignite is installed in, and the partner and Digital Turbine will share the advertising revenue with their partner through a predetermined agreement. In the latest earnings call, their management described their future business to be the Shopify of apps. While Digital Turbine has their SingleTap technology patented, I still don't think that the company has a moat. However, they may develop one in the future.
Their CEO is Bill Stone. He joined Digital Turbine in September 2012 and became the CEO in 2014. Prior t joining Digital Turbine, Bill Stone served as Senior Vice President of Qualcomm. He has also held executive position in companies like Verizon and Vodafone. It means that he has more than 30 years of experience in telco, mobile applications, content, technology, marketing, and distribution. He has a BA and a MBA from Rice University. He has been described as a leader that isn't afraid of parting ways with products or ideas if they are not in line with his plans, which is a good quality of a leader. It is hard to find much information about Bill Stone but reviews from Glassdoor indicates that people are happy working at Digital Turbine, which indicate that it has a good working culture, which is usually something that starts with the CEO. Furthermore, I also like that he is actively expanding the business of Digital Turbine through acquisitions. Hence, despite not having much information, I will give Bill Stone the benefit of the doubt.
I believe that Digital Turbine does not have a moat, but it is something they can develop in the future. I will give management the benefit of the doubt due to his vast experience in the sector, and because I like some of the moves, he has done lately. Now let us investigate the numbers to see if Digital Turbine lives up to our requirements for a strong moat. In case you want an explanation about what the numbers are, you can have a look at "MY STRATEGY" on the website.
The first number I will investigate is the return on investment capital, also known as ROIC. Ideally, you would like to see a ROIC above 10 % in all years. As Digital Turbine is a growth company it is not surprising to see horrific numbers in the past, and it shouldn't be concerning. It is nice to see that Digital Turbine has delivered a positive ROIC in the last 3 years. However, I would like to see a ROIC much higher than the 3,4 % we saw in the last fiscal years. Nonetheless, at the current stage that Digital Turbine is in, it will be a rollercoaster.
The next numbers are the book value + dividend. In my old format this was known as the equity growth rate. It was the most important of the four growth rates I used to use in my analyses, which is why I will continue to use it moving forward. As you are used to see the numbers in percentage, I have decided to share both the numbers and the percentage growth year over year. As with the ROIC, these numbers are all over the place and it has been another rollercoaster. However, it is encouraging that their equity has reached the highest number in the last two years and has grown year over year for the last four years.
Finally, we investigate the free cash flow. In short, free cash flow is the cash a company generates after it has paid for operating expenses and capital expenditures. Levered free cash flow is the amount of money a company has left remaining after paying all of its financial obligations, I use the margin for it to make more sense. Free cash flow yield is the free cash flow per share a company is expected to earn against its market value per share. Like with the other numbers, free cash flow is all over the place. It is encouraging that Digital Turbine has delivered a positive free cash flow in the last three years. However, you would like to see leveraged free cash margin increase and not decrease. Nonetheless, as with the other numbers, it is important to remember that Digital Turbine is still in the growth phase.
Another important thing to investigate is debt, and we want to see if a business has a reasonable debt that can be paid off within 3 years by calculation long-term debt to earnings. Doing the calculation on Digital Turbine, I can see that Digital Turbine has 14,65 years earnings in debt, which is way above the limit of 3 %. The high debt is due to acquisitions, and management is determined to pay off debt, which is something they mentioned in their latest earnings call. Nonetheless, it is something that needs to be monitored if you are investing in Digital Turbine.
Like every other investment there are risks when investing in Digital Turbine. One risk is macroeconomics. In the latest earnings call, CEO Bill Stone talked about how the macro environment has been the most dynamic he has seen in his 30-year career. He mentioned that the macro environment means that digital ad spending has slowed. Furthermore, there has also been a slowdown in U.S. device volumes, as consumers has decided not to spend money on new devices, which means there are less new devices that will get Digital Turbine's products installed. Nonetheless, Bill Stone believes that these macro headwinds are temporary. Another risk is the debt. Digital Turbine's way higher than desired debt will affect the return on invested capital moving forward. And high debt is a big deal, in his book Rule # 1 investing, Phil Town mentions the following on debt: "A business that is carrying a lot of debt relative to its income has an unpredictable financial future. If there are any problems with the economy, a business with a lot of loans might be in big trouble". I want to see management continue to pay off debt. Finally, we need to mention share dilution. Since 2014, where Digital Turbine made their IPO, outstanding shares have grown from 36,383 million to 98,985 million. It is an increase of 172 %! As a shareholder you own part of the business, and you don't like to see your ownership getting smaller year over year. Thus, I don't like to see this amount of dilution.
There are also a lot of potential for Digital Turbine moving forward. A growing addressable market. I mentioned how I liked that Digital Turbine has acquired different companies, despite it resulting in high debt. The acquisitions that Digital Turbine has made since 2021 means that the addressable market for Digital Turbine has grown from $96B to $369B. Furthermore, according to Fortune Business Insights the global advertising market is expected to grow by a 23,2 % CAGR from 2022 to 2029. If Digital Turbine manage to develop synergies through their acquisitions, their business could grow significantly in the coming years. Another potential growth booster is SingleTap. According to management SingleTap has the potential to reach more than $1 billion in revenue. Using SingleTap results in higher ratios of app downloads by the advertiser and a higher ROI on the ad campaign. Companies like Amazon and Epic Games are rumored to be companies that will use SingleTap, while Meta should also be working with Digital Turbine to integrate SingleTap into their platform. If companies like these use SingleTap, it will result in a wide distribution and result in a revenue stream for Digital Turbine moving forward. Growing margins. Digital Turbine has grown their gross profit margin each year for the last 5 years, where it has gone from 33,5 % to 46,4 %. In the latest earnings call, management mentioned that they have grown their EBITDA margin for six consecutive quarters and expects to make it seven quarters. Expanding margins is something that management is focusing on and growing margins in the current inflationary environment is encouraging and should lead to higher profitability moving forward.
All right, we have gone through the numbers, potential and risk regarding Digital Turbine, and now it is time for us to calculate a price for Digital Turbine. To calculate price, we will need numbers that I have explained in the "MY STRATEGY" section of the website. I do not want to go through the whole calculation here. I chose to use an EPS at 0,35, which is the one from fiscal 2022. I chose an Estimated future EPS growth rate of 15 % (which is lower than the consensus the analysists expected growth rate from Finbox), Estimated future PE 30 (which the double of the growth rate, as the historically PE for Digital Turbine has been higher) and we already have the minimum acceptable return rate on 15 %. Doing the calculations by using the formula I described in "MY STRATEGY", we come up with the sticker price (some call it fair value or intrinsic value) of $10,50, and we want to have a margin of safety on 50 % , so we will divide it by 2 meaning that we want to buy Digital Turbine at price of $5,25 (or lower obviously), if we use the Margin of Safety price.
Our second way to calculate a buy price is the TEN CAP price, which is also explained at "MY STRATEGY". To do so, we need some numbers from their financial statements, keep in mind that all numbers are in millions. The Operating Cash Flow last year was 141. The Capital Expenditures was 26. I tried to look through their annual report to see, how much of the capital expenditures were used on maintenance. I couldn't find it though, so as a rule of thumb, you expect 70 % of the capital expenditures to be used on maintenance, meaning we will use 18,2 in our further calculations. The Tax Provision was 17. We have 98,985 outstanding shares. Hence, the calculation will be like this: (141 - 18,2 + 17) / 98,985 x 10 = $14,12 in TEN CAP price.
The last calculation is the PAYBACK TIME. I also described in "MY STRATEGY". With the Free Cash Flow Per Share at 0,63 and a growth rate of 15 %, if you want your purchase back in 8 years, the PAYBACK TIME price is $9,95.
You could argue that Digital Turbine is a growth company. Thus, it would be better valuing the company using a discounted cash flow analysis. Hence, I have done so too. To do so I will need some numbers that you can see below. The numbers are the 2022 numbers, which I could find at Finbox. However, the perpetuity growth rate and the discount rate are numbers I have come up with myself. The reason I chose 3 % as perpetuity growth rate is that it is usually a between the historical inflation rate of 2-3% and historical GDP growth of 4-5%. I decided to go with the lower option in the middle. The chosen discount rate of 12% is because it is usually between 9-12%. I decided to go with the highest one because of the current market conditions. Remember that all the numbers made in these calculations are in millions.
I also need to determine how much EBIT, Depreciation & Amortization and Net Working Capital will evolve over the next couple of years. I decided to use an EBIT and Depreciation & Amortization growth of 20 % year over year. The EBIT growth and the Depreciation & Amortization forecasts are lower than the analysists consensus, but I prefer to be conservative. Finally, I decided to that Net Working Capital will stay steady at -28. I haven't found a smart way to share all my spreadsheet here but once I did my calculations, I found that the intrinsic value of Digital Turbine to be $27. Meaning, the price with a 50 % discount would be $13,50.
Digital Turbine is an interesting company. It has a lot of potential growth moving forward and of the macro conditions improve, Digital Turbine could do very well. I'm a bit concerned by the lack of moat and the high debt. There are also some uncertainties regarding management, as we don't have much information. Hence, I wouldn't make Digital Turbine a large investment. Nonetheless, if you want to add a speculative stock to the portfolio, I believe that Digital Turbine is a better option than many other companies, because of its potential. If I should add Digital Turbine to my portfolio, it would be below the $13,50 price that I got in my discounted cash flow calculations.
My personal goal with investing is financial freedom. It also means that to obtain that, I do different things to build my wealth. If you have some extra hours to spare each month, you can turn a few hours a week into a substantial amount of money in a few years. If you are interested to know how to do it, you can read this post.
I hope that you enjoyed my analysis. Unfortunately, I cannot do a post of all the companies I analyze. I am available to copy but if you do your own trades, you can follow me on Twitter instead, as I tweet when I buy or sell anything.
Some of the greatest investors in the world believe in karma, and to receive, you will have to give. If you appreciated my analysis and want to get some good karma and show your appreciation, I would kindly ask you to donate a bit to Rolda. It is an organization that helps the animals in Ukraine. Animals are the forgotten souls in a war, and they need all the help they can get. If you have a few bucks to spare, it doesn't matter how little, I will kindly ask you to donate a bit here. Thank you.