In this week's episode of Industry Focus: Tech, host Dylan Lewis and Motley Fool contributor Daniel Sparks dive into the smaller side of the online ad market. These three companies -- Roku (ROKU -1.90%), The Trade Desk (TTD 1.41%), and Telaria (TLRA) -- have all of that sweet exposure to a massive, high-margin market, with none of the FAANG size or crushing privacy concerns looming over them. Roku's made such huge progress in its first year on the market, wisely moving away from hardware and nailing its role as an agnostic streaming provider. The Trade Desk has grown like gangbusters by helping its clients advertise anywhere they want. And Telaria, a small-cap video management platform, is carving out a very lucrative niche for itself on the supply side of the ad equation. Tune in to learn more.

To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. A full transcript follows the video.

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This video was recorded on May 10, 2019.

Dylan Lewis: Welcome to Industry Focus, the podcast that dives into a different sector of the stock market every day. It is Friday, May 10th. This is going to be an ad-focused show. I'm your host, Dylan Lewis, and I've got's Dan Sparks with me on Skype. Dan, what's going on? 

Daniel Sparks: Nothing much. Good to do this!

Lewis: Yeah, it's been a little bit since we've had you on the show. You pinged me earlier in the week and said, a lot of companies I follow in the digital advertising space reporting earnings. When we talk about digital advertising, it's easy to focus on Google and Facebook. Those two have that duopoly, everybody talks about it. The reality, though, is there are a lot of small players there that don't get enough press. We're going to try to cover some of them on today's show. 

Sparks: Yep, sounds good! Of course, they all conveniently reported at the same time, pretty much. 

Lewis: It's nice when that works out. You get fresh results from a whole bunch of people in the same space. The first company we're going to talk about needs very little introduction. I think a lot of Fools know it. I believe it's a Rule Breakers recommendation. That's Roku. This is the digital streaming platform. It's kind of an everything streaming company. They have the hardware, they have the software, they basically make it easy for you to stream the stuff that you want to watch. 

Sparks: They definitely made headlines this week, their stock just soaring, I think over 20% yesterday. This morning, it was up again a little bit. Not sure if that's still the case with all the talk of trade going on, which really moves things around. But yeah, really made some big headlines. We saw revenue growth accelerate during the quarter. Came in rising 51% year over year. Of course, that's driven by the platform revenue, primarily. Platform revenue increased 79% year over year. Also a slight acceleration. What's interesting here, too, is management specifically said, there's seasonality in Q1. So we can't expect this huge fourth quarter that we just had again in the first quarter. And here they are, reporting more massive growth, of course which flows down to big increase in gross profit dollars, because there's high margins on that platform revenue. To see that again, it just really validates what they're doing. Up against these big companies -- like Amazon in particular is a great example, up against these companies -- we were wondering, how is Roku going to live up to these platforms from much more well capitalized, large tech stocks? And here we are, seeing them do a great job. 

Lewis: Yeah, I remember doing a prospectus show on Roku, right before they went public, with one of your good friends, Evan Niu. We were talking about the business and looking at the revenue composition, where we thought this company was going. And at the time, I think hardware made up more than half of their sales. We were looking at saying, well, that's not going to stick, that's not going to be the business that really makes them money long-term, they're going to have to figure out how to make platform revenue. They've found a pretty compelling offering. I think it's about two-thirds of the pie now. That part of the business has totally overtaken hardware in terms of contribution to sales. It's a really exciting business, because it's high margin, like you were talking about. Really, what drives all of that is, they can get targeted and pretty dynamic when it comes to advertising.

Sparks: Yeah. The platform revenue really is the story here. Like you said, advertising is a big part of it. Which, of course, that'll tie into The Trade Desk and Telaria when we talk about these companies in a bit, because one of the reasons advertising on their platform works so well is because Roku is not a publisher. You have Amazon investing billions of dollars into their content. You have Hulu investing billions of dollars in their content. But then these advertisers, there's a conflict of interest. When they come to compete to put advertisements on platforms like that, there's Hulu and there's Amazon taking care of their mother ship, their content. They really want to make sure that that's the big story on their platforms. But then you have Roku, who's not a content producer, just an open platform. That's one of the reasons that platform businesses work so well. 

Of course, in this platform business is also subscription and transactional revenue. Having that open platform, and really just an open mind to taking revenue from transactions on video, which is kind of like purchasing or renting a movie, having 48 hours of access to it. Or subscriptions, or ads, by just really being open to it, unlike Netflix, which is closed off to transactions and ads, and only focused on subscription. That makes Roku the platform of choice. That's what we've seen. At first, we weren't sure how much that objectivity and that openness was going to work. But now we're seeing accelerating growth in the amount that users are streaming content on the platform. And it's just really playing out and looking like Roku could dominate for the foreseeable future as the platform of choice. 

Lewis: Yes. Some other big numbers to paint a picture of how successful this business has been being platform agnostic, and just basically saying, "We'll help you put anything you want on your TV," active accounts up 40%, to just under 30 million. Streaming hours up 74% to just under 9 billion. People seem to love the platform. I actually bought one for my mom back Christmas last year, partially so I could get my hands on it and see what things look like, but also because she needed some streaming device to be able to watch my Netflix account. She seems pretty happy with it. While the hardware sales are not the focus, while the licensing that comes in from them doing smart-TV collaborations, and being the operating system, not the focus, all of that feeds the ecosystem. So it's nice that they are able to make some money, seeing just under 20% year over year player growth is great. But big picture, it's just building out the audience for everything they're doing on the platform side. 

Sparks: Yeah, and just calling out that growth in streaming hours, it's just incredible. 74% year over year. And then you just look back, the first quarter of 2018, that was 5.1 billion hours streamed. Now we're at 8.9 billion hours. It's just enormous and really testament to the way this is catching on. 

But yeah, so back to the theme of this podcast, advertising. That's one of the reasons that I really like Roku. When you listen between the lines in the earnings calls and the press releases, there's a lot of excitement from the CEO on the advertising-supported model there and really the potential. I think it's easy for us to get caught up in subscriptions because we have Apple TV+ coming out soon, which is purely subscription model. We have Netflix. So when you see things like that, it's easy to get excited about that. But the CEO is just super bullish on how advertising can grow. Just one metric to throw at you. The ad impressions available on Roku's platform more than doubled year over year during the quarter. That's enormous growth there. And then just looking at connected TV, video ads in particular, if you think about it, I mean, that's an advertiser's dream, for you just to be sitting there watching TV on the big screen in your living room, and then this advertisement comes on. That's really the cream of the crop for advertising. That's one thing that I think investors should keep an eye on. And then, the Roku CEO, he did call out that is a big growth opportunity in 2019. He said he expects that momentum to continue.

Lewis: It's clear that the company sees more success down the road. They reiterated their guidance that they were going to clear $1 billion in revenue in 2019. A lot of people very excited about that. You keyed up the fact that shares are up 28% since the report. New highs the stock is hitting. Daniel, you go back over the past 12 months for this stock, there are two different periods where you could have bought and been up over 100%. It seems like once this company gets near that $9 billion to $10 billion valuation, it comes back down to earth a little bit. I think there's probably some people looking at the stock after this report and saying, "Is this one of those times, where we're going to see it slide back down? Or can it sustain this valuation? Can it sustain this enthusiasm?" What do you think?

Sparks: That's one of the things I like about investing, you don't always have to have an opinion. I'll put that one in my "too hard" pile. But I really love the company. If I did own it, I probably wouldn't be selling, because the execution here is just phenomenal. It looks like the ecosystem effect is only improving. And their competitive advantage, in my opinion, is only improving because, obviously, Apple is going to want to be on Roku. Amazon needs their platform on Roku. Netflix needs it on Roku. And here's Roku, collecting a share of the subscriptions on the platform. I don't see that changing anytime.

Lewis: Yeah, you hear that figure, 29 million people on the platform. That is a big enough mass for them to really throw some weight around in the market and be a major player. I look at them over the past 12 months, and you have to remind yourself, they've only been publicly traded for so long. More than a year, but still, only so long. We're still really getting some of our first looks at what this business could become. I think that's probably why we're seeing a lot of volatility that we have with the stock. Maybe just the case in point for, when you like a stock and it hasn't been publicly traded that long, buy in bits. You don't need to take a huge bite, you can nibble over time.

All right, we're talking connected TV and video advertising. Why don't we talk about another company that plays on that trend, Daniel, The Trade Desk?

Sparks: All right, yeah, The Trade Desk. It's been a huge performer for The Motley Fool. That's been really exciting for all the people who followed the Fool's recommendations. That's been nice. Of course, the stock did take a hit after earnings. But let's put that into perspective. Even after that hit, the stock is up 270% in the past 12 months, 60% year to date. Huge performance here.

The underlying growth really supports that. Revenue was up 41% year over year during the quarter. Earnings per share came in at $0.21. Just up $0.01. They're really investing in this massive growth opportunity that doesn't seem to be coming down at all. Just to get a little better look at how continuing operations are performing, if you look at the non-GAAP earnings per share, $0.49 compared to $0.34 in the year-ago quarter. Adjusted EBITDA $25 million, up from $19 million. Some big numbers here.

You look at this company, and what's really the theme here is connected TV. Connected TV is a major driver for The Trade Desk. Connected-TV spend on The Trade Desk's platform up more than 3X compared to the year-ago quarter. I think the last earnings call, Q4, the CEO said this has become material now. It's not some small thing. It's having a major impact on The Trade Desk's business. And then of course, there's omnichannel growth across the board that's really strong. Mobile, in-app mobile video ad spend both up 60% year over year. Audio up 270% year over year. A lot of success. Huge growth. That's a breakdown of earnings there.

Lewis: A little bit of a different story with that market reaction. Like you said, I think the stock is down about 10% since reporting. I look at everything in this report -- they came in above expectations, they raised their full-year guidance. This seems like a pretty strong earnings report, Daniel.

Sparks: Yeah. What it was, you look at, I think, one of their guidance metrics, maybe it was Q2 revenue, was about in line. I think also for the full year, it was about in line. But analysts also have been getting excited, because the expectations for the full year that they had going into the second quarter were well above full-year outlook The Trade Desk provided in its fourth-quarter earnings report. Analysts are getting excited, getting used to The Trade Desk just constantly beating and raising. They're doing it every quarter like clockwork. Eventually analysts are going to get ahead of themselves. It looks like that was the case here. That's what I saw happen in the stock price there.

Lewis: Yeah, I suppose when shares are up over 250% over the past year, when there's a little bit of a hiccup, when the brakes get slightly tapped, maybe, or maybe the foot just comes off the accelerator just a little bit, some people will take that opportunity to sell some shares, lock in some gains -- some pretty considerable gains, at that.

Sparks: Exactly. There always needs to be some room for a breather. If it just goes straight up forever, the valuation is just going to really get insane. We're going to see a lot bigger dips than 10% if that happened. So, yeah, really interesting.

Back to our advertising theme, one of the things that makes The Trade Desk stand out is its value proposition as an independent -- in the ad tech world, companies like The Trade Desk refer to Facebook and Google as walled gardens. The Trade Desk is outside of that walled garden. They don't have this protected data. They're an independent solution that goes to advertisers, brands, and gives them an opportunity to advertise anywhere, not just within a platform of protected data. That's the theme here. And that works especially well in connected TV, because looking ahead, The Trade Desk thinks that it's going to be a really fragmented market, connected TV. So far, that's proven to be true. There's connected-TV services coming from all over the place. This independent approach works really well.

I think, going back to their valuation, that they do deserve a market-leader valuation, even though they're much smaller than Google and Facebook, because they're an independent player. They're the largest in that regard, offering solutions for advertisers and brands.

Lewis: OK, one last ad play to talk about. That is Telaria. Daniel, listeners probably don't know this one. I have to admit, this was not a company that I was familiar with until you put it on my radar for this show.

Sparks: Just a quick overview. In ad tech, there's companies that serve the demand side, which is The Trade Desk. That means they're helping ad agencies, helping brands. And then there's those who serve the supply side, sometimes called the sell side. They're helping publishers. Telaria used to have a demand and a supply platform. But it's like working with a broker. You want them to represent you in any transaction. Real estate is a good example. So Telaria said, "We want to only represent the sell side." Kind of like The Trade Desk. It's one of the reasons they've been so successful. They really vouch for that buy side. Anyway, so they sold off their demand side platform in 2017, refocused their business, actually rebranded in the process, changed the name of their company, also their ticker symbol, I believe. They went from being called Tremor Video to Telaria. That happened in late 2017. The company believes that by doing this, they're focusing on where they can build a moat. I think it was a great decision just by giving them a better competitive advantage. In doing so, they also doubled down on connected TV.

Telaria is basically a video management platform for publishers, which means they just offer the whole gamut of solutions for publishers to be able to put their ad up for sale programmatically, which is basically through software, and directly, and make the most money as they possibly can in this evolving technological environment.

Lewis: We talked about how we'd be talking about smaller ad tech players. Roku and The Trade Desk, we're talking about $8 billion, $9 billion companies. Telaria, we're talking about a $350 million business. Totally different scale here. I think that's probably reflective of the fact that they are hyper-focused in what they're looking at. And they're a little bit in their early days.

Sparks: Yes, they definitely are much smaller. But what's interesting is, even though they're smaller, they do have some huge clients. They're working with five of the seven top virtual MVPDs. MVPD stands for multichannel video programming distributor. That vouches for their success there. And then Hulu is a major client for them. With Hulu, they operate and sell their video ad inventory programmatically. They provide a private marketplace where they help Hulu control the ads that they're offering. And, of course, The Trade Desk is buying ads in that private marketplace. That vouches for how well they're doing with big clients so far. But, of course, you have a very small company, only $55 million in revenue in 2018. But growing at a faster rate. They just reported first-quarter revenue growth accelerated. They reported 41% year-over-year growth in revenue. I think that was up from about 30% or so revenue growth in the prior quarter. Definitely a promising company here.

Lewis: The thing that really got me excited looking at them after you sent me the name and I started doing my digging is, you look at their full-year results for 2018 -- $55 million in revenue, $48 million in gross profit. This is a very high-margin business that they're in. And yes, right now, they're losing money because they are spending when it comes to sales and marketing, SG&A, some of their tech and development costs. But over time, you have to imagine that that scales to a pretty profitable business.

Sparks: Yeah. Not to say that they're going to be the next Trade Desk. But, just as an interesting note, their financial statements do look similar to The Trade Desk's in its early days. Just something for investors consider, too, when they go to look up their financial statements, you're going to want to go to the 10-K. Since they sold off that demand-side platform, there's an adjusted view in retrospect of the supply side only on their 10-K. Investors can really look at how the supply-side platform has developed. Also, since they only sold off the demand side in late 2017, even those years prior, you can say that the growth could have been better, because they didn't have this good value proposition.

But yeah, the growth is staggering on those adjusted financial statements. I'll just read out the revenue for 2015, 2016, 2017, and 2018. We've got $9.6 million, $29 million, $44 million, $55 million, and now we've got accelerating growth this quarter compared to the year-ago quarter. And then just one last interesting stat. Connected TV, on the platform -- and this time it's not ad spend on the platform, it's actual revenue they're getting from the connected TV. That's a little bit different way they classify it compared to The Trade Desk. First-quarter connected-TV revenue up 169% year over year, accounting for 38% of revenue, up from 33% of revenue in Q4. Definitely something to watch here.

Lewis: Big growth there. And it seems like the type of company that can really blossom into a larger valuation at some point down the road. We talked about it being so small now. What do you see as the hurdle in their way? Anytime you're working with smaller companies, the set of things that can go wrong are a little bit different.

Sparks: In ad tech, there's a lot of middlemen. There's a lot of brokers. It's something that we're still seeing develop. How will that play out? Are people going to want to eliminate certain brokers in the middle or not? Telaria seems really confident about their niche focus on video, really offering a full solution. Their clients seem to be happy with it so far. But that's something that we should watch. Make sure that they're providing immense value, and actually helping publishers make more money.

Lewis: Yeah. Well, there you have it, listeners! Those are three ad companies, ways to play digital ad spend, that are not named Alphabet or Facebook. Daniel, thanks for hopping on and sharing those names with me! Anything fun going on this weekend for you?

Sparks: Just Mother's Day. I've really got to focus on that, make sure I get it right.

Lewis: [laughs] For your mom, your wife, or both?

Sparks: It's both! They're always a concern. I'm a procrastinator with that stuff.

Lewis: Well, it's early. We're taping at 11:00, but it's only 09:00 o'clock over there. You have an extra two hours to figure this thing out. I'm even further behind than you, as it turns out, because of the East Coast time zone. [laughs]

Sparks: Yeah, better figure it out!

Lewis: Good luck! Man behind the glass, Austin Morgan, do you have any meat-smoking plans over the weekend? I know that you have been slowly honing your skills. 

Austin Morgan: Yeah. I mean, so far, I've had some pretty good success. But the weather looks pretty terrible this weekend. It looks like it's going to rain from tomorrow at noon to Monday morning.

Lewis: You're a fair-weather smoker?

Morgan: Oh, yeah, I don't want to stand out in the rain. [laughs] 

Lewis: [laughs] Listeners, of course, if you want to see the results of some of Austin's meat smokes, you can check him out on Twitter. We try to retweet them from the @MFIndustryFocus handle, but you can go follow him as well, too. Of course, if you want to get in touch with us, you can also email us over at [email protected]. If you have any tips for Austin when it comes to smoking meats, any recipes he should try out, feel free to shoot them over to us. If you want more of our stuff, you can subscribe over on iTunes or you can catch the videos from the podcast over on YouTube. As always, people on the program may own companies discussed on the show, and The Motley Fool may have formal recommendations for or against stocks mentioned, so don't buy or sell anything based solely on what you hear. Thanks to Austin for all his work behind the glass! For Dan Sparks, I'm Dylan Lewis. Thanks for listening and Fool on!