Share prices of supply-side advertising-technology (adtech) specialist Magnite (MGNI -9.12%) have plummeted 86% from their all-time high over one year ago. And it's something that institutional investors, so-called "smart money," didn't think would happen. In fact, they made a bet Magnite could reach $91.26 per share by 2026, more than 10 times where the stock trades today.
In this article, we'll look at why smart money believed Magnite could hit this price. We'll also discuss what happens to the company if the price target isn't reached.
Why $91.26 per share?
In March 2021, Magnite took on $400 million in convertible-note debt. At just a 0.25% interest rate, grabbing cheap money made sense. However, lenders were poised to make little in interest. Instead, they made the transaction in hopes the debt would convert into stock, allowing them to participate in Magnite's upside.
Magnite's $400 million notes convert at intervals between $63.88 and $91.26 per share, and they mature in March 2026. As of this writing, Magnite stock trades at $8.71 per share, suggesting 625% to 948% upside to reach conversion prices.
This was a modest bet by smart money at the time, not a bold one. When Magnite issued these convertible notes, its stock was trading in a range of around $40 to $50 per share -- a reasonable starting point to hit $91.26 per share over five years.
However, from where it trades today, it would be a herculean task to get Magnite stock up to the conversion prices with the 3.5 years remaining.
Why smart money was bullish on Magnite stock
Various independent companies combined to form Magnite. They united via mergers and acquisitions to create the largest supply-side player in the adtech space, hoping to dominate the connected-TV (CTV) opportunity. And the strategy has paid off by attracting top-tier streaming services as customers. Disney, fuboTV, Roku, Fox, and more all use Magnite to sell their ad slots.
Magnite has also been rewarded in revenue growth. In 2021, the company generated revenue of $468 million, which was up 111% year over year. And excluding traffic-acquisition costs (ex-TAC -- a pass-through item often excluded by adtech players), CTV revenue in 2021 accounted for 34% of total revenue and was up more than 300% from 2020.
Granted, these impressive growth rates for Magnite are due to acquiring other companies. However organic growth is still solid as well. For example, in the first quarter of 2022, Magnite's CTV revenue ex-TAC was up 27% from the year-ago period after adjusting for acquisitions.
The CTV market is an attractive market. According to eMarketer, nearly $19 billion is expected to be spent on CTV ads in the U.S. this year. And advertisers are getting more comfortable with committing to the format. Up-front ad sales (slots sold ahead of time) are surging, with $6.4 billion expected in 2022, up 34.6% from last year. And up-front ad spend is forecast to surpass $8 billion next year, placing Magnite on the right side of powerful tailwinds.
No wonder the smart money bet Magnite stock would go up.
Is Magnite in trouble?
As a shareholder, I'm sorry to say that I don't believe Magnite can go up 10 times in value by 2026. Stocks go up over long periods of time due to positive business fundamentals and vice versa. And as we've seen, Magnite's business has done well and is positioned to keep growing with the growth of CTV.
However, there's another component to stock market returns: valuation. When Magnite sold its convertible notes, shares were trading at roughly 20 times trailing sales. Now it trades closer to two times sales. And for the record, two times sales is more normal for a company like Magnite, so I wouldn't hold my breath expecting its valuation to shoot up again.
If Magnite stock doesn't reach the conversion prices for its debt, it will be on the hook for paying it back. Fortunately for Magnite, it has a profitable business model and expects to generate $100 million in free cash flow in 2022 alone. And it has over $200 million in cash and equivalents on the balance sheet. In short, I expect it to take care of its obligations with ease.
That said, it's probable that Magnite will need to pay back its convertible notes. And this will limit shareholder returns. Companies with debt need to satisfy obligations before rewarding shareholders with meaningful share repurchases, among other things.
In summary, Magnite is a strong company and well positioned to repay its debts. But its debt load could put a ceiling on its potential returns, which is something to be aware of.