Advertising is a cornerstone of the economy. Many of the things you buy result from an ad first planting the idea in your head. The industry is evolving with technology, migrating from print and broadcast television to digital outlets like the internet and streaming platforms.
The global digital ad space is worth $514 billion and is only getting bigger. Supply-side ad-tech platform PubMatic (PUBM 1.21%) could thrive in this massive industry. Though it's relatively unknown, it could be a potential long-term winner. Time to dive in.
What does PubMatic do?
Digital ads are bought and sold on ad exchanges, much like stocks trade on the New York Stock Exchange. Investors might be familiar with The Trade Desk, a demand-side platform that helps brands purchase ads. Both buyers and sellers are needed on ad exchanges. PubMatic is on the opposite side of The Trade Desk. As a supply-side platform, PubMatic helps publishers, content creators, and app developers sell their ad inventory to brands. Both platforms bring buyers and sellers together from opposite sides of the transaction.
PubMatic works with major companies like Verizon, Zynga, Electronic Arts, and more than 1,000 publishers, content creators, and developers. Revenue in 2021 hit $227 million, a year-over-year increase of 53%, but this represents only a 3% to 4% market share.
The company has competition from direct peers like Magnite and "walled gardens" like Meta Platforms and Alphabet, which own the entire ad transaction and don't give advertisers the kind of transparency or control that independent exchanges do.
I don't think investors should worry about the competition until growth slows down -- the global advertising pie is too big. PubMatic reported that fourth-quarter 2021 revenue from connected TV grew sixfold over 2020. In other words, there are a lot of opportunities out there.
Strong financials mean high business quality
PubMatic's business model seems simple enough, but how do you know if it's working? You need to look at the company's financials. In addition to the impressive top-line growth last year, management is guiding for $282 million to $286 million in 2022 revenue, good for 25% growth at the midpoint. The decelerating growth is due to a tough comparison following 2021's strong showing and a hangover from the Omicron variant impacting 2022's first-quarter results. However, I think the slower near-term growth is acceptable considering the long-term opportunities in the ad-tech space.
What gives me confidence in PubMatic is the company's strong net revenue retention rate (NRR), which measures the change in how much existing customers are spending with the company over time. Its NRR was 109% in 2019, then 122% in 2020, and 149% in 2021. It's clear customers are increasing their spending as they work more with the company.
PubMatic's business is profitable too. It's generating both free cash flow and net income. Management emphasizes profitable growth and benefits from outsourcing a lot of its research and development to India, where salaries aren't as high. Investors should look for both free cash flow and net income to climb along with revenue moving forward.
The stock is an eye-popping value
Interestingly, the stock's valuation is much lower than a demand-side platform like The Trade Desk, which trades at a price-to-sales (P/S) ratio of 19.4 compared to just 4.5 for PubMatic. Based on profits, The Trade Desk's price-to-earnings (P/E) ratio is also higher: 68.6 versus 19.4.
That's not to say this should be an apples-to-apples comparison -- both companies are profitable and growing revenue at similar rates. The Trade Desk grew revenue 43% in 2021 and is an exceptional company. But is it worth a valuation that's more than triple that of a company like PubMatic? I'm not sure of that.
Try to take a long-term perspective of the stock. Yes, there is competition from big-tech platforms, walled gardens, and companies like Magnite. But PubMatic is a business with a $1 billion market cap that should grow 25% this year, and it's already profitable and has a market opportunity valued at hundreds of billions of dollars. Its strong fundamentals and industry tailwinds should deliver solid returns for patient investors.