AppLovin (NASDAQ:APP) a mobile game developer that also helps other companies manage and monetize their apps, went public on April 15. It raised $2.0 billion selling 25 million shares at $80 apiece.
The company was founded in 2011, and its revenue grew at a compound annual rate (CAGR) of 76% between 2016 and 2020. Applovin claims its total addressable market will expand from $189 billion in 2020 to $283 billion in 2024, according to IDC estimates.
Those growth rates sound impressive, but the stock still tumbled to $65.20 on the first day of trading, giving it a valuation of about $23 billion. I'll explain why AppLovin failed to impress investors, and why it still isn't a compelling buy after its post-IPO decline.
1. It's an underdog in two saturated markets
AppLovin operates two main businesses. The business segment, which generated 49% of its revenue in 2020, helps companies manage and monetize their apps.
Its consumer segment, which generated the remaining 51% of its revenue, owns a portfolio of more than 200 free-to-play games. A dozen internal and partner studios develop these titles.
AppLovin doesn't lead either market. The business segment competes against companies like Unity Software, which bundles monetization tools with its popular game development engine, while its consumer segment competes against mobile gaming behemoths like Tencent.
In its IPO prospectus, AppLovin acknowledges that many of its own studios build their games with Unity's engine, and its "clients who are also competitors" might develop their own in-app monetization services. It claims to control just 1% of the global mobile apps market.
2. Its revenue growth is slowing
AppLovin's revenue surged 106% to $994 million in 2019 before increasing another 46% to $1.45 billion in 2020.
Business revenue rose 39% in 2019 but grew just 19% in 2020 as ad spending decelerated throughout the pandemic. Consumer revenue soared 636% in 2019, mainly thanks to acquisitions of smaller game studios, but that figure fell to 86% in 2020 as it acquired fewer companies.
3. There's lots of red ink on its income statement
AppLovin generated a net profit of $119 million in 2019, compared to a net loss of $260 million in 2018. Yet it turned unprofitable again in 2020 with a net loss of $126 million.
High fees from Apple and Alphabet's Google, which usually retain a 30% cut of each app's revenue, remain a major weight on its margins. AppLovin plans to expand by buying up even more businesses, but that inorganic strategy could increase its exposure to the two tech giants' high app store fees, resulting in steeper losses.
4. New privacy measures for in-app advertising present a risk
Both of AppLovin's businesses rely heavily on ads. The business segment integrates ads into its clients' apps, while the consumer segment's free-to-play games generate some of their revenue from ads.
Apple's recent iOS 14 update, which lets users opt out of data tracking features for apps, and Google's elimination of third-party cookies could throttle the growth of its advertising business this year.
5. It carries high debt
AppLovin plans to spend about $400 million of its IPO proceeds to reduce its post-deal debt balance to about $1.77 billion, or more than five times the adjusted EBITDA it generated last year. It will likely spend the rest on new investments and acquisitions.
The company already spent over $1 billion on 15 strategic partnerships and acquisitions over the past three years, so investors shouldn't expect it to fully extinguish its debt anytime soon.
6. Its voting structure is autocratic
AppLovin will sell its Class A shares, which each represent one vote, in its IPO. Its executives and early investors, however, will still hold Class B shares, which carry 20 votes each.
It also plans to establish a third class of non-voting shares in the future. In other words, it will be nearly impossible for investors to override management's decisions or force executives to make any major changes.
AppLovin's top shareholder is KKR, which will hold 72.4% of its Class B shares after the IPO. KKR invested $400 million in AppLovin back in 2018, and that stake could soon be worth over $8 billion.
7. It's too expensive
Back in 2016, AppLovin agreed to sell itself to the Chinese private-equity firm Orient Hontai Capital for just $1.4 billion. The Committee on Foreign Investment in the United States (CFIUS) eventually blocked the deal due to concerns about personal data.
AppLovin's willingness to sell itself at such a low price casts some doubts on its ability to grow into its total addressable market. After its latest funding round in 2018, AppLovin was valued at just $2 billion.
With a market cap of $22 billion as of this writing, it trades at over 15 times 2020 sales. That price-to-sales ratio might seem reasonable relative to some other high-growth tech stocks, but it won't be so easy to stomach if the company's revenue growth continues to decelerate.
AppLovin is still growing, but it faces lots of unpredictable headwinds that will test its rich valuation. Investors should wait to see how it fares over the next few quarters instead of chasing the IPO.