Is It Too Late to Buy Magnite Stock?

Magnite's (MGNI 4.43%) stock sank 35% to a nine-month low on Aug. 10 in response to its second-quarter earnings report. The ad tech company's revenue rose 11% year over year to $152.5 million, which exceeded analysts' expectations by $18 million. Its adjusted EPS fell 36% to $0.09 but also cleared the consensus forecast by six cents.

Unfortunately, concerns about the slowing growth of Magnite's connected TV (CTV) business, its shrinking margins, high leverage, and long-term competitive threats all overshadowed its earnings beat. Let's review those red flags and if they indicate it's too late to buy Magnite as a long-term play on the digital advertising market.

Image source: Getty Images.

Understanding Magnite's growth strategies

Magnite was created via the merger of two smaller ad tech companies, The Rubicon Project and Telaria, in 2020. It subsequently acquired the video advertising companies SpotX and SpringServe, as well as the analytics company Nth Party Team and the ad publishing platform Carbon, to expand its ecosystem.

All of those mergers and acquisitions turned Magnite into the world's largest independent sell-side platform (SSP) for digital ads. SSPs help publishers manage and sell their own ad inventories, while demand-side platforms (DSPs) like The Trade Desk (TTD 1.67%) sell ad space across a wide range of platforms.

Digital advertising giants like Alphabet's (GOOG 9.96%) (GOOGL 10.22%) Google and Meta Platforms (META 0.43%) bundle together SSPs, DSPs, and other tools on their diversified advertising platforms. However, Google and Meta's services lock their advertisers into walled gardens -- so independent SSPs and DSPs are usually more appealing options for companies that want to launch more ads across the "open" internet.

To avoid going head-to-head against Google and Meta in the saturated desktop and mobile ad markets, Magnite, The Trade Desk, and other smaller ad tech players are aggressively expanding into the CTV market, where ad-supported streaming video platforms are flourishing independently of Google and Meta's ecosystems as linear TV platforms fade away.

Its core growth engine is losing its steam

During its investor day presentation in September 2021, Magnite claimed it would grow its annual revenue by at least 25% organically over the next few years while maintaining an adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) margin of 25%-40%. It expected the expansion of the CTV market to drive that growth.

Unfortunately, Magnite's year-over-year growth in CTV revenue (in ex-TAC, or excluding traffic acquisition costs, terms) has decelerated for three consecutive quarters. It also still generates nearly 60% of its revenue from desktop and mobile ads.

Source: Magnite. Ex-TAC basis.

Magnite expects that slowdown to deepen as its CTV revenue declined 7%-10% year over year (on an ex-TAC basis) in the third quarter, then stay roughly flat year over year in the fourth quarter.

It attributes that slowdown to two major challenges. First, the macro headwinds have been throttling ad purchases in the automotive, media, and entertainment markets. Second, some of Magnite's larger partners -- including Roku and Disney -- are moving their ad inventories from traditional direct-sold transactions to programmatic ones. In other words, Roku and Disney are gradually building their own walled gardens and cutting smaller ad-tech companies like Magnite out of the loop.

Other existential threats loom on the horizon. The Trade Desk's OpenPath bypasses SSPs completely by directly connecting advertisers to publishers. Netflix also partnered with Microsoft instead of smaller independent players to launch its ad-supported tier, and it reportedly plans to build or buy an in-house advertising platform after that deal expires in 2024.

All of those problems challenge the notion that Magnite can keep expanding its CTV business. Magnite's CTV segment still grew faster than its desktop segment in the second quarter, which suffered a 7% year-over-year decline in its ex-TAC revenue. But it actually grew slower than its mobile segment, which grew its ex-TAC revenue by 21%.

Its flaws are becoming more apparent

Meanwhile, Magnite's adjusted EBITDA margin shrank six percentage points year over year to 28% in the second quarter as one of its buyers went bankrupt, and it expects its adjusted EBITDA margin to stay flat sequentially in the third quarter -- which would still represent a seven percentage point drop from a year ago.

Magnite is also still deeply unprofitable on a generally accepted accounting principles (GAAP) basis, and it ended its second quarter with a high debt-to-equity ratio of 2.7. It generated enough cash to retire 23% of its convertible notes during the quarter and it still expects to generate $100 million in free cash flow (FCF) for the full year, but all of that red ink and high leverage could make it an unappealing investment as long as interest rates stay elevated.

Magnite's stock might seem cheap at 2 times this year's sales and 8 times its adjusted EBITDA, but it deserves that discount because its core growth engine is sputtering out and its balance sheet is a mess. Simply put, investors should avoid Magnite and stick with more promising tech stocks in this volatile market.