Outbrain (OB -0.72%), one of the world's largest providers of "chumbox" ads, went public in July at $20 per share. Its stock stayed flat on the first day and subsequently tumbled to the mid-teens.
That dismal debut wasn't terribly surprising. Its top competitor Taboola (TBLA -0.24%), which went public by merging with a SPAC (special purpose acquisition company) in June, has also lost over a fifth of its value since its opening trade, after all. Outbrain had been in talks to merge with Taboola for several years, but the merger was called off in 2020 amid COVID-19-related challenges.
Outbrain hasn't impressed the market yet, but could investors be overlooking its strengths? Let's take a fresh look at Outbrain's business, its growth rates, and its valuations to find out.
Image source: Getty Images.
What is a "chumbox" advertising platform?
"Chumbox" ads are sprinkled across web pages as grids of thumbnail images that promote sponsored links. These ads, which are usually associated with tabloid-style and clickbait content, use sensational headlines like "You Won't Believe What (Celebrity) Looks Like Now", "You Will Be Shocked By This Article", or "1 Weird Trick to Lose Weight" to drive clicks to other websites.
Critics claim these ads are annoying and misleading, but they still generate plenty of clicks and revenue.
How fast is Outbrain growing?
Outbrain's revenue rose 12% to $767.1 million in 2020, even as ad purchases slowed down during the pandemic, and grew 42% year-over-year to $475.2 million in the first half of 2021 as those headwinds waned.
Traffic acquisition costs (TAC) increased 11% in 2020 and 36% year-over-year in the first half of 2021, growing at a slower rate than its total revenue and indicating Outbrain isn't spending too much money to drive more traffic through its ads. As a result, its gross margin rose from 20.6% in 2019 to 21.5% in 2020, then expanded 440 basis points year-over-year to 23.7% in the first half of 2021.
The company also generated a net profit of $4.4 million in 2020, compared to a loss of $20.5 million in 2019, and stayed profitable in the first half of 2021 with a net profit of $25.9 million. Its adjusted EBITDA skyrocketed more than six times year-over-year to $45.2 million in the first half of 2021.
Outbrain ended the second quarter with a net revenue retention rate of 150%, which means that its customers are renewing their advertising deals at significantly higher dollar values. This growth indicates it won't need to aggressively boost its TAC to retain its clients or increase its top-line sales.
For the full year, Outbrain expects its ex-TAC (excluding traffic acquisition costs) gross profit to rise by 37%-39%, and for its adjusted EBITDA to grow 96%-101%. Analysts expect its full-year revenue to increase 30% and for its bottom line to stay in the black with a more than a 13-fold jump in its diluted earnings per share.
Why aren't investors interested in Outbrain?
The stock trades at just 19 times forward earnings and less than one times this year's sales. Taboola, which expects its ex-TAC gross profit and adjusted EBITDA to rise at slower rates than Outbrain's this year, trades at 148 times forward earnings and four times this year's sales.
That difference indicates that Outbrain's traditional IPO was conservatively valued, even though it was priced far below its original range of $24 to $26, while Taboola's SPAC-backed debut looks overvalued.
Investors seem reluctant to buy Outbrain for three reasons. First, chumbox ads are top targets for ad-blocking extensions. Second, Apple's recent privacy changes to iOS and Alphabet's upcoming ban on third-party cookies in Google Chrome could throttle its ads sales.
In its S-1 filing, Outbrain warns that evolving beyond data tracking cookies "could be more disruptive, slower, or more expensive than we currently anticipate" and could "materially affect the accuracy" of its ads and recommendations. Many other digital advertising companies face the same challenges.
Lastly, Outbrain has customer concentration issues. Over the past two years, its two largest media partners each generated about 10% of its revenue. If ad blockers, cookie bans, and other platform changes alter how internet users view and click ads, it could potentially lose those big customers.
Outbrain looks like an undervalued growth stock
Outbrain's tactics might be controversial, but companies are still buying its ads and people are clicking on its sensational headlines. Apple and Google's platform changes might affect its business, but the company plans to tackle those challenges with the development of new algorithms.
Outbrain's low enterprise value of about $900 million and its cheap valuations also make it an attractive takeover target for larger tech or advertising companies.
Therefore, Outbrain looks like an undervalued growth stock right now, and investors who believe Apple and Google won't wipe out its niche advertising market should consider buying a few shares.
