Digital Turbine: A growth company with expanding gross profit margins.
Opdateret: 14. aug.
Digital Turbine is a growth company that is facing some short-term headwinds but could potentially turn out to be a long-term winner. When examining Digital Turbine, there are several aspects to appreciate, but also some concerns that are somewhat worrisome. In this analysis, I will investigate whether the risk/reward of 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 any shares in Digital Turbine. If you would like to copy my portfolio or view the stocks in my portfolio, you can find instructions on 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. If you want want to purchase shares or fractional shares in Digital Turbine, you can do so through eToro. eToro is a highly user-friendly platform that allows you to start your investment journey with as little as $50.
Digital Turbine was founded in 1998. It describes itself as a leading, independent mobile growth platform that elevates the landscape for advertisers, publishers, carriers, and device original equipment manufacturers. Digital Turbine is primarily known for their product, Ignite, which collaborates with carriers such as Verizon and original equipment manufacturers like Samsung to pre-install advertiser apps on mobile devices. Ignite is installed on more than 600 million devices worldwide and will soon be available on all Samsung devices. Ignite is a great product, but the problem was that revenue was only generated once per device. Digital Turbine has made acquisitions to become a more comprehensive platform and has developed technologies such as their patented SingleTap technology. This technology enables users to download apps directly from the browser, bypassing the need to go to Google Play. These advancements are expected to increase Digital Turbine's recurring revenue from digital advertisements in the future. The way Digital Turbine generates revenue is by receiving a fixed amount for each device on which Ignite is installed. Additionally, Digital Turbine shares advertising revenue with their partners based on a predetermined agreement. In a previous call, their management described their future business as the Shopify of apps. While Digital Turbine has patented their SingleTap technology, I still don't believe 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 to joining Digital Turbine, Bill Stone served as Senior Vice President of Qualcomm. He has also held executive positions in companies like Verizon and Vodafone. It means that he has over 30 years of experience in telecommunications, mobile applications, content, technology, marketing, and distribution. He has a BA and an MBA from Rice University. He has been described as a leader who isn't afraid to part ways with products or ideas if they are not aligned with his plans, which is a commendable quality in a leader. It is difficult to find extensive information about Bill Stone, but reviews from Glassdoor indicate that employees are satisfied working at Digital Turbine. This suggests that the company has a positive working culture, which is often influenced by the CEO. Furthermore, I also appreciate his active efforts in expanding Digital Turbine's business through acquisitions. Hence, despite the lack of information, I will give Bill Stone the benefit of the doubt.
I believe that Digital Turbine does not currently have a moat, but it is something they can potentially develop in the future. I will give management the benefit of the doubt due to their vast experience in the sector, and because I appreciate some of the recent decisions they have made. Now, let us investigate the numbers to determine if Digital Turbine meets 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 invested capital, also known as ROIC. Ideally, you would like to see a return on invested capital (ROIC) above 10% in all years. As Digital Turbine is a growth company, it is not surprising to see volatile numbers in the past, and it shouldn't be concerning. It is nice to see that Digital Turbine has delivered a positive return on invested capital (ROIC) in the last four years. However, I would like to see a much higher ROIC than the 1,6% we saw in the last fiscal years. Nonetheless, at the current stage that Digital Turbine is in, it will be a roller coaster.
The following numbers represent the book value + dividend. In my previous format, this was referred to as the equity growth rate. It was the most important of the four growth rates I used in my analyses, which is why I will continue to use it in the future. As you are accustomed to seeing numbers in percentage form, I have decided to provide both the actual numbers and the percentage growth year over year. As with the ROIC, these numbers are highly volatile and have been fluctuating significantly. However, it is encouraging that their equity has reached the highest level in the last three years and has grown consistently since 2018.
Finally, we will investigate the free cash flow. In short, free cash flow refers to the cash that a company generates after covering its operating expenses and capital expenditures. Levered free cash flow is the amount of money a company has remaining after paying all of its financial obligations. I use the margin to provide a clearer understanding. Free cash flow yield refers to the amount of free cash flow per share that a company is projected to generate in relation to its market value per share. Like other financial metrics for Digital Turbine, free cash flow varies significantly. It is encouraging that Digital Turbine has achieved a positive free cash flow in the past four years. However, you would like to see the leveraged free cash margin reach its former heights. Nonetheless, as with the other numbers, it is important to remember that Digital Turbine is still in the growth phase.
Another important aspect to consider is the level of debt, and it is crucial to determine whether a business has a manageable debt that can be repaid within a 3-year period. This can be assessed by calculating the ratio of long-term debt to earnings. After performing the calculation on Digital Turbine, it is evident that the company has a debt-to-earnings ratio of 24,62 years, significantly exceeding the recommended limit of 3 years. The high debt is a result of acquisitions, and management is committed to paying off the debt, as 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 associated with investing in Digital Turbine. One risk is macroeconomics. CEO Bill Stone has discussed how the macro environment has been the most dynamic he has witnessed in his 30-year career. He mentioned that the macro environment has resulted in a slowdown in digital ad spending. Furthermore, there has also been a slowdown in U.S. device volumes, as consumers have decided not to spend money on new devices. This means there are fewer new devices that will have Digital Turbine's products installed. Nonetheless, Bill Stone believes that these macro headwinds are temporary. Another risk is debt. Digital Turbine's significantly high debt will impact the return on invested capital in the future. And high debt is a significant concern. In his book "Rule #1 Investing," Phil Town discusses the impact of 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 their debt. Finally, we need to mention share dilution. Since 2014, when Digital Turbine made their initial public offering (IPO), the number of outstanding shares has increased from 36,383 million to 99,197 million. It is an increase of 172%! As a shareholder, you own a portion of the business, and it is disheartening to witness your ownership diminishing year after year. Thus, I don't like to see this level of dilution.
There is also a lot of potential for Digital Turbine moving forward. A growing addressable market. I mentioned that I liked how Digital Turbine has acquired different companies, even though it has resulted in high debt. The acquisitions that Digital Turbine has made since 2021 mean that the addressable market for Digital Turbine has grown from $96 billion to $369 billion. Furthermore, according to Fortune Business Insights, the global advertising market is expected to grow at a CAGR of 23,2% from 2022 to 2029. If Digital Turbine manages to develop synergies through its acquisitions, its 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 app download rates for the advertiser and a higher return on investment (ROI) for the ad campaign. Companies like Amazon, Microsoft 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 consistently increased its gross profit margin over the past 5 years, rising from 34,3 % to 48,1%. Operating margin, EBITDA margin, and EBIT margin all decreased slightly in a challenging fiscal 2023 but management has mentioned that while margins may fluctuate quarter over quarter, they anticipate long-term margin expansion as they continue to execute on their growth opportunities.
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 of 0,16, which is from fiscal year 2023. I chose an estimated future EPS growth rate of 15% (which is lower than the consensus analysts' expected growth rate from Finbox). I also selected an estimated future PE of 30 (which is double the growth rate, as the historical PE for Digital Turbine has been higher). Additionally, we have already established a minimum acceptable return rate of 15%. Doing the calculations, we come up with the sticker price (some call it fair value or intrinsic value) of $4,80. We want to have a margin of safety of 50%, so we will divide it by 2, meaning that we want to buy Digital Turbine at a price of $2,40 (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 78. The capital expenditures were 25. I tried to look through their annual report to see how much of the capital expenditures were used for maintenance. I couldn't find it, but as a rule of thumb, you can expect 70% of the capital expenditures to be used for maintenance. This means that we will use 18 in our further calculations. The tax provision was 5. We have 99,197 outstanding shares. Hence, the calculation will be as follows: (78 - 18 + 5) / 99,197 x 10 = $6,55 in Ten Cap price.
The last calculation is the Payback Time. I also described in "MY STRATEGY". With Digital Turbine's Free Cash Flow Per Share at 0,90 and a growth rate of 15%, if you want to recoup your investment in 8 years, the Payback Time price is $14,21.
You could argue that Digital Turbine is a growth company. Thus, it would be better to value the company using a discounted cash flow model. Hence, I have done the same. To do so, I will need some numbers that you can see below. The numbers are the fiscal 2023 numbers, which I found at Finbox. However, I have determined the perpetuity growth rate and the discount rate myself. The reason I chose a 3% perpetuity growth rate is that it typically falls between the historical inflation rate of 2-3% and the historical GDP growth rate of 4-5%. I decided to choose the middle option with the lower price. The chosen discount rate of 12% is because it falls within the typical range of 9-12%. I decided to go with the highest option due to the current market conditions. Remember that all the numbers used 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 a year-over-year growth rate of 20% for EBIT and Depreciation & Amortization. The EBIT growth and the Depreciation & Amortization forecasts are lower than the analysts' consensus, but I prefer to be conservative. Finally, I decided that Net Working Capital will grow by 10% a year. 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 is $19,74. The price with a 50% discount would be $9,87.
Digital Turbine is an interesting company. It has a lot of potential for growth moving forward, and if the macro conditions improve, Digital Turbine could do very well. I'm a bit concerned about the absence of a moat and the high level of debt. There are also uncertainties regarding management, as we lack sufficient information. However, if they manage to develop synergies with their recent acquisitions and if Single Tap becomes as big as management believes, Digital Turbine could experience substantial growth. Nonetheless, Digital Turbine is a speculative stock, and I wouldn't feel comfortable having a significant investment in it. However, if you want to add a speculative stock to your portfolio, I believe that Digital Turbine is a better option than many other companies due to its potential. If I were to add Digital Turbine to my portfolio, it would be at a price below $9,87, which is the value I obtained from my discounted cash flow calculations.
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