#014 - Digital Turbine

Digital Turbine pre-installs apps on phones. It charges companies to be pre-installed on phones. It shares this revenue with carriers and OEMs. It’s a gatekeeper for valuable phone real estate.

Digital Turbine - (NASDAQ: APPS)

Digital Turbine pre-installs apps on phones. It charges app-driven companies like Amazon and Netflix to be pre-installed on phones. It shares this revenue with carriers and OEMs. It’s a gatekeeper for valuable phone real estate.

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Please note that this article does not constitute investment advice in any form. This article is not a research report and is not intended to serve as the basis for any investment decision. All investments involve risk and the past performance of a security or financial product does not guarantee future returns. Investors have to conduct their own research before conducting any transaction. There is always the risk of losing parts or all of your money when you invest in securities or other financial products.


Industry Overview

Digital Turbine competes in one of the most attractive markets. Digital Turbine competes in the phone real estate market. Digital Turbine doesn’t compete for your phone real estate but benefits from the increasing number of companies that compete for your time when looking at an Android-powered smartphone.

Depending on where you look, Android owns ~70% of the mobile operating system market share while iOS is primarily the rest. Digital Turbine doesn’t work with the iOS operating system, but there’s still a large enough market for Android products.

There are virtually no companies that compete with Digital Turbine. The most apparent risks and competition come from larger companies like carriers or OEMs.

Digital Turbine doesn’t work with iOS. Let me get that out right now.

Business Overview

Digital Turbine works as the middleman between wireless carriers and app-driven companies like Uber, Facebook, Lyft, etc. Digital Turbine preinstalls app slots on new phones and then sells these spots to companies mentioned above. Digital Turbine is then paid when consumers click on one of these apps or make a purchase through the app. Digital Turbine pays a large portion of this to wireless carriers (AT&T, Verizon, and others). This is why the gross profit margin may seem small compared to other software companies.

Digital Turbine acquired Mobile Posse in March 2020. Mobile Posse “turns telecom companies into mobile media organizations by aggregating customizable news, entertainment, sport and weather content from multiple sources and delivering it directly to smartphone users via a single pre-loaded app.”

Digital Turbine reports revenue as either “Application Media” or “Content Media.” Application Media is the revenues from selling app slots to app-driven companies and Content Media revenue is from giving telecom companies the Digital Turbine platform to show consumers news and other information relevant to them. Content Media revenue is largely from the acquisition of Mobile Posse and it’s also grown more than 45% Q/Q the last two quarters.

Total Addressable Market

Assuming 5bn people have a phone (Link), 70% Android market share, and Digital Turbine is able to continue to expand the number of phones under its control and increase the prices app-driven companies have to pay for pre-installed apps, the future outlook for Digital Turbine is rather attractive.

This will be a rough estimate, but let me take an optimistic perspective.

5bn people with phones * 70% Android market share * $5 per device (spread across monetization from 20+ app installs) = $17.5bn as the TAM or potential annual revenue. Digital Turbine likely won’t capture all $17.5 billion as revenue, but likely more than the $200 million it collects today.

Digital Turbine is likely doing $0.35 per device in 2021 with ~570 million devices doing ~$200 million in Application Media revenue.

This estimate doesn’t include any revenue from content media. I think in the estimate above, the number of people with phones is likely underestimated considering phone ownership is increasing and who knows if more people will own 2+ phones. Android market share will likely remain stable to declining (due to Apple/others?) and if Digital Turbine can be successful and be the winner in this space (with little to no competition so far), the largest guess is how much can Digital Turbine monetize each device? $5 per device seems reasonable via common sense (I could be way off who knows), but $5 spread across 10+ app-driven companies (effectively paying 50 cents) seems possible if not a bit conservative.

Competitive Advantages

  • Valuable Middleman

    Digital Turbine connects app-driven companies with carriers and OEMs. The relationship between companies and carriers/OEMs is only possible with a middleman, in this case, Digital Turbine.

    Think of the number of apps being created each day. Probably hundreds if not thousands. All these companies want to be installed on smartphones, but it’s likely difficult for these app-driven companies to connect with various carriers and OEMs.

    The carriers and OEMs are even less likely to work with the thousands of apps that want to be pre-installed on phones. Digital Turbine has relationships with more than 40 partners and works with app-driven companies to make this business model work. Digital Turbine simplifies this process as the middleman and benefits all parties involved.

Financials

I think that Digital Turbine is confusing for many investors. The potential isn’t immediately clear and some of these terms can be very confusing from an initial glance at the company. Digital Turbine has been very successful in the past few years and had a great 2020 and the stock price reflected that. Valuation is likely a concern, but getting the long-term revenue right might help ease some of the concerns.

Q3 2021

  • Revenue = $88.6 million

  • Gross profit = $37.7 million

  • GAAP EBIT = $20.5 million

  • Adjusted EBITDA = $22.5 million

  • Q/Q revenue growth = 25.0%

  • Gross profit margin = 42.6%

  • GAAP EBIT margin = 23.2%

  • Adjusted EBITDA margin = 25.4%

2020:

  • Revenue = $138.7 million

  • Gross profit = $53.7 million

  • GAAP EBIT = $13.2 million

  • Adjusted EBITDA = $19.6 million

  • Y/Y revenue growth = 33.9%

  • Gross profit margin = 38.7%

  • GAAP EBIT margin = 9.5%

  • Adjusted EBITDA margin = 14.1%

2019:

  • Revenue = $103.6 million

  • Gross profit = $35.6 million

  • GAAP EBIT = $3.4 million

  • Adjusted EBITDA = $8.9 million

  • Y/Y revenue growth = 38.6%

  • Gross profit margin = 34.3%

  • GAAP EBIT margin = 3.3%

  • Adjusted EBITDA margin = 8.6%

2018:

  • Revenue = $74.8 million

  • Gross profit = $25.1 million

  • GAAP EBIT = -$5.8 million

  • Adjusted EBITDA = -$0.2 million

  • Gross profit margin = 33.5%

  • GAAP EBIT margin = -7.8%

  • Adjusted EBITDA margin = -0.2%

What’s Interesting

  • Misunderstood Business

    Touched on this slightly above, but Digital Turbine was trading at less than $6 per share less than a year ago. Although this is in hindsight, it had strong revenue with an understandable business model. This business initially got on my radar through Scott Miller at Greenhaven Road Capital.

    Scott has a great thesis on Digital Turbine which seemed like a classic asymetric bet. “Heads I win, tails I win.” Yes, you read that right. The market wasn’t understanding the full potential of the business.

    As more apps and companies are created each day, these companies are fighting for one of the most valuable pieces of real estate, your phone. Companies will likely bid up the average revenue per device to be one of the few pre-installed apps on your phone. There are a number of other products that Digital Turbine offers, but the primary business model is connecting companies and carriers to pre-install apps on phones.

    Without digging, this wouldn’t have been obvious.

  • Cell Phone Real Estate

    How much time do you spend on your phone? Your cell phone likely has most of your attention throughout the day. Why wouldn’t it? People call you, email you, text you, you get news updates on your phone.

    Digital Turbine is the gatekeeper for companies that want its apps installed on your phone from day 1. This is a good spot to be in.

Future Questions

  • How big is the market?

    I think the total addressable market section above does a decent job of trying to value this market, but if I were to invest in Digital Turbine, I’d have to be more convinced of how large this market could be and what else I’d be paying for.

    The Content Media revenue line is also interesting considering it’s growing 45%+ per quarter. The acquisition of Mobile Posse was a great decision and partially shows the skill of Digital Turbine’s management team.

  • Competition?

    This initial shallow dive didn’t uncover any serious competitors. I think the larger worry is what happens if companies try to go directly to carriers. I think Digital Turbine’s relationships with plenty of app-driven companies and more than 40 partners help to fend off any competition that isn’t readily apparent.

  • Pricing Power?

    Google? Facebook? Other large apps? Although some of these companies likely won’t even have to pay anything at all or anything meaningful to Digital Turbine, what’s stopping companies like Uber Eats, Grubhub, and Doordash from paying top dollar to be the only food delivery app on your phone? Although you might say, “well I’d just download the other two anyway,” you could easily make the argument that being the only food delivery app installed on your phone is a good position to be in.

    I’d also argue that Facebook is willing to pay 25 cents to be pre-installed on your phone because, without users, Facebook’s business model doesn’t work. Facebook wants you to be addicted to using the app and if you have to download the app, Facebook might lose users.

    Sure, Facebook, Amazon, and some of the larger companies may be able to work directly with carriers and OEMs, but considering carriers and OEMs already get a large % of the revenue generated from installing apps and these carriers would need to build out the software and platform necessary to work with Facebook and others, it doesn’t seem entirely likely.

Conclusion

Good company. If you’ve been reading for a while, you likely know that I tend to be optimistic in these shallow dives, but I think optimism helps more than pessimism.

Digital Turbine has gained popularity in 2020 and so far in 2021 due to the tremendous return if you’ve been lucky enough to own the business. I think there are still some key questions to be answered if you don’t already know the business.


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