Criteo Takes a Step Back in the Name of Long-Term Growth

Criteo SA (ADR) (CRTO -0.90%) released stronger-than-expected second-quarter 2018 results early Wednesday, including continued client growth, high retention rates, and the sustained outperformance of its latest product offerings. But the advertising retargeting leader also reduced its full-year revenue guidance, causing shares to plunge nearly 20% when all was said and done yesterday.

Still, I had the chance to catch up with Criteo management yesterday evening. So now that the dust has settled, let's adjust our sights to get a better view of what Criteo accomplished over the past few months, as well as the reasons underlying the company's modified outlook.

Image source: Getty Images.

Criteo results: The raw numbers

Data source: Criteo. Ex-TAC = excluding traffic acquisition costs.

What happened with Criteo this quarter?

• Revenue ex-TAC increased 2% at constant currency, driven by new client additions and despite "significant headwinds from external factors [...] with existing clients."
• Adjusted EBITDA grew 27% (20% at constant currency) to $69 million. 
• By comparison, Criteo's guidance provided in May called for lower revenue ex-TAC of between $226 million and $230 million, and lower adjusted EBTIDA of between $53 million and $57 million.
• On an adjusted (non-GAAP) basis -- which excludes items like stock-based compensation, acquisition costs, and restructuring expenses -- net income rose 35% to $35 million, or $0.53 per share, also above consensus estimates for $0.39 per share.
• Criteo's client count grew 16% year over year, including more than 400 net new clients this quarter, to roughly 19,000. Client retention remained near 90% for all products.
• Revenue ex-TAC from non-retargeting products -- such as Criteo Customer Acquisition, Criteo Audience Match, and Criteo Sponsored Products -- grew 72% at constant currency, to roughly 6% of total sales.
• Criteo Direct Bidder is now connected to more than 2,300 large publishers, up from 2,000 last quarter.
• Criteo agreed to acquire retail media technology platform Storetail, which allows retailers to monetize native placements on their e-commerce sites. Storetail has no material revenue, but should prove "highly complementary" to Criteo's previous acquisition of HookLogic and its Criteo Sponsored Products offering.

What management had to say

"From the conversations I have had with clients since returning as CEO, I've heard many positive comments on the value we bring," CEO JB Rudelle offered in a prepared statement. "We are building on this trust to expand our client relationships with more products and solutions."

CFO Benoit Fouilland added, "Our model once again proves to be strong and resilient, as the combination of growth, increasing profitability and strong cash flow demonstrated in Q2."

Looking forward

For the third quarter of 2018, however, Criteo expects revenue ex-TAC of between $218 million and $223 million -- below Wall Street's average models for $244 million -- or a constant-currency decline of 5% to 3% year over year.

In addition, Criteo now expects full-year revenue ex-TAC to be flat, plus or minus 1%, down from its previous outlook for growth of 3% to 8%. It simultaneously raised its 2018 adjusted EBITDA margin guidance to between 30% and 32% of revenue ex-TAC, compared to between 28% and 30% before.

During the subsequent conference call, Rudelle explained that Criteo is effectively taking "one step backwards before taking several steps forward," and needs to "deeply transform" itself in order to restore accelerated growth.

He elaborated:

In particular, our move from a single-product to a multiproduct platform has been so far way too slow. Furthermore, in the past two years, our decision-making processes regarding product road-map priorities have not always been fast enough. Overall, for our business to function at optimized speed, we need some engineering that will take some time to produce its effects.

During a follow-up call with Fouilland yesterday evening, he reiterated to me that a "significant transformation needs to happen [...] in order to restore growth for the long run."

Fouilland also noted that the need for this transformation stems from a combination of revising Criteo's go-to-market strategy for newer products, as well as delays in hiring that will negatively affect sales growth in the second half. Keeping in mind the acquisition of Storetail, he also voiced optimism for Criteo's opportunity to capture incremental business from retailers, which represent a large portion of the company's base and have expressed concerns for their dependency on the ad-industry's virtual duopoly in Facebook and Google.

As Rudelle put it during the company's call with analysts, "Outside of Google and Facebook, [...] we have the opportunity to be the third pillar of any advertiser playbook -- that is, the ad platform of choice for open internet."

Still, while I think patient investors should have no problem with Criteo's long-term view and impending transformation, it's hardly surprising to see the stock pulling back hard as our fickle market absorbs the near-term repercussions of this strategy.