Considering that many of the dominant ad management platforms are laying off workers while warning of a poor holiday season, investors were pessimistic about Magnite (MGNI 0.70%) before earnings. However, when it reported earnings on Nov. 9, investors were pleasantly surprised, and the stock surged 66% higher the next day.
Here are two reasons why Magnite bounced higher after earnings.
1. Improving prospects for ad-supported connected TV
Magnite is the world's largest independent sell-side ad platform (SSP); it helps publishers sell their inventory of ad spaces to advertisers.
The one area it differentiates from many of its SSP competitors is that it primarily relies on connected TV (CTV) for generating revenue. In the third quarter of 2022, CTV was a significant chunk of Magnite's revenue at 44%, followed by mobile at 35% and desktop at 21%. As a result, when things improve in CTV advertising, Magnite thrives. And advertising trends on CTV are flourishing.
First, consumers are increasingly cutting the cord; according to audience measurement company Nielsen, streaming finally exceeded cable viewing in the U.S. for the first time in July, after four consecutive months of hitting new viewership highs.
Second, according to a recent Comscore study, American viewers are adopting ad-supported streaming services faster than subscription streaming services. This trend of consumers trading higher-priced streaming subscriptions for ad-supported tiers resulted in publishers putting more ad inventory on the market -- benefiting Magnite, as there are more ad spaces for it to sell.
These two powerful trends are a strong counter to all of the headwinds in this economy. As a result, management believes Magnite will continue to grow its business, even during a recession.
2. Great fundamentals and good news on inflation
Magnite beat analyst estimates for revenue and earnings when it reported its recent results. However, what the company said about its future was more interesting for investors.
First, the company continues to reduce its net leverage ratio. When it closed the SpotX acquisition at the end of April 2021, it had net leverage of 6.2 times. Most people consider a net leverage ratio, which is net debt to earnings before interest, taxes, depreciation, and amortization (EBITDA), of above 4 or 5 as in the danger zone.
Image source: Magnite.
The good news is that its net leverage had dropped to 2.6 times at the end of the third quarter. The company's ultimate target is 2 times or less. As a result, the company has moved out of danger of near-term financial disaster -- a good thing in this economic environment.
Second, the company raised its full-year 2022 revenue excluding traffic acquisition costs (ex-TAC) projections from over $500 million to over $510 million. The best part is that management forecasts are conservative -- there is room for additional upside if the economy improves. Management uses ex-TAC numbers, as it provides the most valuable measurement of the company following its acquisition of SpotX.
Third, it raised its full-year 2022 free cash flow (FCF) projections from $100 million to $105 million. Many investors use FCF to judge the company's ability to repay debts, issue dividends, grow the company, and buy back shares.
MGNI Free Cash Flow data by YCharts
Companies with a positive and increasing FCF often outperform those without it during a poor economic environment. And if the company continues to increase its cash flow, investors will reward Magnite by bidding up its stock price.
Finally, the U.S. Bureau of Labor Statistics released a favorable Consumer Price Index (CPI) number, which showed a decline in inflation. The market interpreted the CPI decline as a sign that the Federal Reserve could slow its interest rate hikes and that the U.S. might avoid a recession. This news significantly boosted investors' positive reactions to Magnite earnings.
Should you buy after the bounce?
During early 2021, you could easily make the case that Magnite was significantly overvalued, selling at a price-to-sales (P/S) ratio of over 26.
MGNI PS Ratio data by YCharts
However, its current P/S ratio of 2.6 is undervalued, considering that the ad market will eventually rebound, with ex-TAC revenue bouncing higher than the current quarter's 12% growth. Before this bout of rising interest rates brought the U.S. to the brink of recession, management expected the company to produce ex-TAC revenue growth of over 25% with an adjusted EBITDA margin of 35% to 40% over five years.
CEO Michael Barrett sees the company growing market share and eventually processing $15 billion to $20 billion in ad spend annually, up from several billion today, in an industry that market research company Evolve Business Intelligence projects to grow to $65 billion by 2030.
If you are a risk-tolerant investor and can withstand short-term gyrations in stock prices, now might be a great time to pick up a few shares.
