CRITEO SA CRTO
November 18, 2016 - 3:27pm EST by
Defy_Augury
2016 2017
Price: 40.00 EPS 1.96 2.41
Shares Out. (in M): 65,816 P/E 20.3 16.6
Market Cap (in $M): 2,632 P/FCF 14.8 12.0
Net Debt (in $M): -348 EBIT 143 211
TEV ($): 2,283 TEV/EBIT 15.9 10.8

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Description

Thesis

  • Even after last quarter’s beat and raise, Criteo is undervalued due to header bidding fears and the collapse of Criteo’s ad-tech “peers."
  • CRTO is trading at just 20x trailing earnings and 16.5x forward earnings despite forecasting annualized EPS growth of 20% (conservatively under 28% consensus) in my base case and 14% in my bear case over the next three years.
  • Criteo is the leader in retargeting and has sustainable competitive advantages due to its independence and scale.
  • Retargeting benefits from the secular growth in Ecommerce. Criteo’s revenue should grow at a similar rate as ecommerce (15% to 20% per year through 2020) before taking into account market share gains and new markets/verticals.
  • Criteo is currently addressing just a third of its TAM, even before including video and offline opportunities.

 

What Does Criteo Do?

If you have ever looked at a ticket on Expedia and then noticed advertisements on other websites for similar flights, you have been the subject of Criteo retargeting. Criteo provides display (image based as opposed to video) retargeting for more than 12,000 companies including  Walmart, Best Buy, Macy’s Dick’s, Sears, eBay, Microsoft, Samsung, Visa, Intuit, Adidas , Airbnb, BMW, Expedia, Trivago, and Travelocity. No customer accounts for more than 2% of sales. 66% of revenue is from retail verticals, 16% from travel, and 18% is from classifieds (customers like eBay), autos, and telecoms. Geographic revenue mix is 39% Americas, 38% EMEA, and 23% APAC.  In order to generate effective retargeting advertisements companies need access to their customers’ websites/apps to assess customer intent (demand side) and access to publisher inventory to display ads on platforms likely to attract customers (supply side). Criteo is well integrated on both sides of the ecosystem having observed over $500 billion in sales on their customer’s websites/apps (more than Amazon and eBay combined) and generating over 8 billion advertisement clicks on the websites of their 14,000 publisher partners over the past year.  The process of (1) analyzing customer intent across devices, (2) determining the best inventory placement and advertisement display, and (3) assessing how much to bid for inventory based off different ROI targets, all in milliseconds, is technologically complex and requires advanced machine learning algorithms to be done effectively. The Criteo Engine that drives this algorithmic process is considered the best in the world.

 

Criteo’s revenue model is unique among ad-tech companies in that they only receive revenue on a CPC, or cost per click, basis, meaning that they only get paid when their advertisement leads to a customer click. This is in contrast to the more popular CPM, or cost per impression, basis, in which customers pay if an advertisement appears on a site, even if it is not visible.

 

Criteo benefits from secular growth in Ecommerce

Criteo’s sales are highly levered to the growth of Ecommerce. According to the Census Bureau, Ecommerce has grown at a ≈15% CAGR over the past 5 years in the US, and eMarketer forecasts Ecommerce to grow ≈21% per year worldwide through 2020. Weighting eMarketer’s regional forecasts by Criteo’s current regional revenue share, Ecommerce sales should grow between 15% and 18% in Criteo’s current markets through 2020 (although CRTO is growing their revenue share in the faster growing APAC markets). It seems reasonable to assume CRTO sales grow at a similar 15%-20% CAGR over the same period, before taking into account changes in market share.

 

Criteo is addressing a small fraction of its TAM/Customers

Up to this point, CRTO has been focusing solely on traditional display advertising. They just announced their intention to enter search retargeting (display ads on Google) which they estimate to be a $6 billion revenue ex-TAC market, and have yet to enter acquisition marketing (advertising to attract new customers), which they estimate to be a $9 billion revenue ex-TAC market. These two markets increase CRTO’s TAM from $10 billion to $25 billion and leverage CRTO’s existing technology and relationships. In addition, although the technology isn’t ready for video and offline retargeting, these two markets offer large revenue opportunities for CRTO.

 

Moreover, CRTO has primarily served retailers while getting little business directly from brand manufacturers (P&G, Kellog’s etc.). The recent acquisition of Hooklogic not only gives CRTO access to new inventory on retailers’ sponsored product pages and the opportunity to improve their performance through CRTO’s data and algorithms, but it also gives CRTO the opportunity to cross sell Hooklogic’s manufacturer customer base . Finally, CRTO is just entering China, the largest Ecommerce market in the world, in a meaningful way in 2016-2017. 

 

Criteo has sustainable competitive advantages

 

Scale

Only Google sees more transaction data than CRTO. More data leads to smarter  algorithms,  better retargeting, and higher click rates. Higher click rates enables CRTO to pay more for inventory than competitors and increases the supply with which they can distribute the best ads. This improves client ROI, which attracts more clients and increases the amount of data. I believe this is a sustainable positive feedback loop.

 

As a result of their scale and focus, CRTO has the best results in retargeting. Here’s some evidence showing the superiority of their product and the quality of their economic model:

 

 Product Superiority

  • Win 90% of head to head tests they run when prospecting clients, with the losses driven by the client’s technology not being able to fully utilize CRTO’s platform
  • CTR (click through rate) is 7x the industry average
  • Amazon benchmarks their retargeting technology against Criteo (Zappos uses Criteo)
  • CRTO is often the first tester of Google and Facebook’s new advertising products

 

 

 Quality Economic Model

  • 90% client retention
  • Exclusive remarketing partner of more than 75% of its customers
  • 77% of revenue ex-TAC is from uncapped budgets. Clients see CRTO service as a COGS item rather than a separate advertising budget and let CRTO spend as much as it wants as long as the spending meets its ROI targets.
  • Spend per existing client growth (similar to SSS growth) has averaged 23% since 2014
  • Take rate (basically gross margin) has been 40% or above every quarter since 2011

 

Independence

Although Google and Facebook retargeting is not yet as good as Criteo’s it is certainly possible that their technology improves over time given their resources, scale, and talent. However, even if their technology becomes equivalent to Criteo’s, advertisers are still likely to prefer CRTO for three reasons. First, many of Criteo’s customers compete with Google and Facebook and feel uncomfortable giving them access to proprietary data.  Second, while Google and Facebook exclude each other from accessing the competitor’s inventory, Criteo has access to both Google and Facebook inventory. Third, Google and Facebook’s cross device tracking is limited to their own platforms and the data is less transparent for customers. Because of these factors and the fact that it is inefficient to have multiple retargeting providers, Criteo can continue to gain market share even if their technology is only equivalent to these competitors.

 

 

Why Does the Opportunity Exist?

 

Header Bidding

Header bidding is a new advertising technology that gained popularity in the US in 2015. Essentially the technology changes the auction dynamics for inventory. Instead of having a waterfall auction with a limited number of bidders at each level, CRTO will have to bid against more competitors. Moreover, instead of being a second price auction in which the party that puts in the highest bid ultimately pays the price of the second highest bid, header bidding moves to a first price auction where the winner actually pays the price that they bid. Ultimately, header bidding has benefited publishers and hurt buyers through higher CPMs for inventory. In response to higher inventory cost, CRTO can either (1) buy fewer impressions, which lowers CRTO’s gross revenue, (2) buy inventory at higher prices without passing on the price increase, which lowers CRTO’s take rate, or (3) pass the price increases to advertisers through lower ROIs. Prior to 3Q I thought the effects of header bidding were evident in declining take rates in the US. However, US take rates increased in Q3 so I’m less convinced of this now. It’s possible that CRTO shifted strategy from lowering its take rate to buying fewer impressions, which would explain the less impressive gross revenue growth this quarter. Nevertheless, despite the potential effects of header bidding, CRTO has been able to beat revenue and EBITDA targets every quarter since header bidding became popular in 2015. Over the same period the stock declined from $57 to under $25 as the TTM P/E multiple compressed from 43x to just 20x today.

 

CRTO argues that header bidding is a “low single-digits type of issue.” They believe that buyers will start lowering their bids over time because there hasn’t been a fundamental change in supply and demand that should change the value of inventory. They also believe that their superior technology will eventually enable them to predict the second best price in the new auction format so that they can bid the minimum amount above that to win the auction. As a result, CRTO may eventually pay a lower price than before header bidding, while those with inferior technology will subsidize the more advanced players. While I agree that header bidding doesn’t change supply and demand, it does increase the ability of buyers to express their demand through a broader auction (more liquidity). Therefore, mild price increases for inventory seem rationale to me. Furthermore, given the higher CPMs for publishers, it is likely that header bidding expands to Europe and APAC over the next year or two.  I also would not count on CRTO being able to predict other bidders’ pricing, given the difficulty of doing this in the stock market.

 

On the other hand, I think it is likely that advertisers will start accepting lower ROI targets as they become more dependent on Ecommerce for growth and shift their advertising budgets from other forms of advertising like mail and catalogues that are even lower ROI and less measurable than retargeting. Also, header bidding has a negative impact on Google, and given their power over the entire internet advertising ecosystem, they have been pushing back against header bidding and may slow its adoption or change the technology in their and CRTO’s favor over time. If these scenarios play out, header bidding would have essentially no impact on CRTO.

 

Ultimately, although I think header bidding  is a minor headwind, I don’t think the issue comes close to justifying the stock decline (down 56% from the July 2015 high to the February 2016 lows) that came as the company continued to grow revenues 33% and EPS 89% YoY over the first three quarters of 2016. I incorporate aggressive header bidding effects in my base case by lowering CRTOs gross revenue growth rates in the sell side model I am using (which has average sell side expectations) by 200 bps each year through 2020 and reducing CRTO’s take rate from 40% to 39% (more than the 70 bps decline in take rate in the US since the end of 2014). Even with these effects, EPS would grow at a 17% CAGR through 2020.

 

Google/Facebook Overhang

Many investors are reluctant to buy any company that competes with Google and Facebook. This is probably a good rule most of the time, but I believe this is an exception for a few reasons. First, as explained above, I believe many advertisers will not use Google or Facebook for retargeting because they are uncomfortable giving them access to data and they don’t offer access to each others’ platforms. Second, Google and Facebook benefit from their relationships with CRTO because CRTO is one of the largest buyers of their high CPM inventory. I don’t think it would be in their interest to close off a high CPM bidder from their platforms (for reference Google accounts for about 20% of CRTO’s inventory spend and Facebook accounts for about 10%). Third, CRTO is a trusted independent partner that helps Google and Facebook develop their advertising technology for the wider ecosystem. For example, CRTO is often the first to test Google’s new advertising products, was the first to test Facebooks mobile advertising platform, and has a custom integration with Facebook Dynamic Product Ads. Fourth, Criteo is singularly focused on retargeting and at this point has better performance than Google and Facebook’s performance isn’t even comparable. These relationships require monitoring but I believe CRTO has found a strong niche in the ecosystem. An incremental positive for CRTO, would be integration with Snapchat, which they are not on yet, as it could reduce the power of these large suppliers.

 

Ad-Tech “Peers” Overhang

Ad-tech has been crushed over the past twelve months. FUEL is down 49%, RUBI is down 53%, TUBE was down 40% before being acquired, while CRTO has managed to fall just 11% (CRTO’s decline came earlier and they are down 36% from the recent $57 high). Despite having very different business models than these public competitors and CRTO having been able to overcome some of the issues that caused their poor results, I think the sector’s performance has contributing to the downturn in CRTO’s shares.

 

FUEL ($459mm market cap) was the closest public competitor to CRTO, as they offered a retargeting service, but they have shifted from managing campaigns to offering their technology as a service to ad agency trading desks after a string of revenue misses and guide downs.  This shift was likely due to their inferior technology and CPM revenue model when compared to CRTO. In the most recent quarter they gave guidance 18% below the street and announced their new CFO was leaving the company after less than a year on the job. With no earnings, increasing leverage, and a $100mm market cap, they simply don’t have the scale to compete with CRTO. I think their losses are more likely a reflection of CRTO’s strength then the industry’s weakness and they will ultimately go bust or be acquired.

 

RUBI ($298mm market cap) is a SSP (sell side platform) so it is in a very different business, but  their disappointment has been due to (1) header bidding (which is especially bad for SSPs because inventory can be sold before it ever reaches the SSP), (2) the acquisition of Chango, a retargeting competitor to Criteo that is not meeting expectations, and (3) the shift to mobile. In the last quarter, sales guidance was 11% below consensus, EBITDA guidance was 17% below consensus, and EPS guidance was 33% lower than consensus.

 

The above list excludes CRTO’s most direct competitors, which have been acquired. Twitter acquired TellApart for $535 million at an estimated  5x EV/S in April 2015. Tesco acquired Sociomantintic in April 2014 for around $200 million, an estimated 2x EV/S. Struq was acquired by Quantcast (private) in October 2014, Triggit was acquired by Gravity4 (private) in March 2015, and Dotomi was acquired by Conversant for $295 million in November 2013. This was a very crowded field and CRTO appears to be the winner in a winner-take-all market.

 

In contrast to their public competitors, in their most recent quarter CRTO ($2.6b market cap) beat sales estimates by 2%, EBITDA estimates by 19% and EPS estimates  by 30%. Guidance for the fourth quarter  year was also above expectations. Simply put, CRTO’s business model and performance has been completely different from its public competitors, yet I believe their performance has been dragging down CRTO.

 

Valuation

Despite having grown revenue 33% and EPS 74% over the past year, and consensus expecting 18% annualized revenue growth and 22% annualized EPS growth over the next 3 years, CRTO is trading at just 20.3x trailing earnings and 16.5x forward earnings. Furthermore, consensus is expecting just 15% “core” net revenue growth over the next two years (core excludes revenue from search and the Hooklogic acquisitions), which is at the low end of the 15% to 20% Ecommerce growth expected through 2020. Given that CRTO has consistently taken share, this level of core revenue growth seems highly conservative. The market is also likely underestimating non-core revenue growth through search, Hooklogic, China expansion, and video opportunities.

 

To value CRTO I created three scenarios. The primary differences between the scenarios are core gross revenue growth rates and take rates. My base case assumes core revenue grows 16% per year through 2019, just 100 bps more than Ecommerce. I also lower the take rate from historical levels of between 40% and 41% to 39%. I put an 18x multiple on 2019 EPS of $3.15 (mainly because it gets me a similar value to what I get through a DCF), discount it back at 10%, and subtract cash to get a value of $48 (+20%). My bear case assumes core revenue grows at 13%, slower than Ecommerce, and take rates fall 200 bps. This results in 2019 EPS of $2.48. Putting a 15x multiple, subtracting the cash and discounting this back at 10% results in a value of $33 (-17%). Finally, my bull case assumes core revenue growth of 20% per year, at the high end of Ecommerce growth, as CRTO takes share and expands to new markets and verticals. This results in 2019 EPS of $4.06. Using a 20x multiple I get a value of $66 (+66%).

 

It’s also worth noting that TUBE, an unprofitable $540mm market cap ad-tech company which focuses on a cross platform, video-based SAAS product was recently acquired by Adobe at 2x EV/Sales, 3x EV/Gross Profit, and 41x EBITDA (all multiples based off of 2017 estimates). IF CRTO were to trade at these multiples, it would be valued at $71, $46, and $164 respectively.  I am not arguing that CRTO is worth $164, but these multiples give me more confidence that the downside is limited.

 

Overall, while the risk reward is less favorable than before 3Q earnings, I still think this is a rare opportunity to buy an industry leader riding secular growth with 65% upside and a favorable risk/reward.

 

Risks

  • Amazon-ing/Alibaba-ing of the internet. The more you believe Amazon and Alibaba types will increasingly dominate ecommerce at the expense of Google, Facebook, and other popular websites, the less confident you should be in CRTO’s growth. I believe this is the greatest risk to the thesis.
  • Insourcing of retargeting. Large companies like Walmart may choose to insource retargeting efforts in the same way Tesco did. No customer accounts for more than 2% of CRTO’s revenue, and it would be unlikely customers could create a better solution than CRTO given their data advantage. If Walmart really wanted to insource retargeting they could easily acquire CRTO.
  • Ad blocking. Increased adoption of ad blockers would reduce the amount of inventory available to advertisers and increase prices. This issue came to the forefront in September 2015 when Apple announced that they would allow ad blocking on iOS 9, but CRTO has been able to exceed all of its guidance since that announcement. Important things to note regarding ad blocking are (1) publishers already adjust their impressions based on the percentage of users using ad blockers (27% in France, 26% in the US, 21% in UK, 20% in Germany) so buyers don’t pay for impressions that have been blocked. (2) Many publishers have adapted to ad blocking technology and force users to turn off ad blocking in order to access their sites content (Forbes, Washington Post, Wired). (3) Ad blockers are more popular on desktops than mobile and don’t work in apps, which is where users are spending more time. (4) Technologist developing the ads create methods to get around ad blockers. There is a constant arms race between ad blocking and advertisers. (5) Criteo gets paid on a CPC basis so there is no risk of their customers getting angry at CRTO for charging them for purchasing inventory that is never seen by customers.     
  • Google and Facebook adopt the nuclear option and exclude Criteo from accessing their inventory. This is not in their interest and is highly unlikely.
  • Recession. Advertising budgets decrease during recessions but companies might be more likely to slow other advertising expenditures that have less quantifiable impact before lowering their CRTO budgets.

 

·  

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

  • Hooklogic
  • Search
  • China growth
  • Earnings beats
    sort by    

    Description

    Thesis

     

    What Does Criteo Do?

    If you have ever looked at a ticket on Expedia and then noticed advertisements on other websites for similar flights, you have been the subject of Criteo retargeting. Criteo provides display (image based as opposed to video) retargeting for more than 12,000 companies including  Walmart, Best Buy, Macy’s Dick’s, Sears, eBay, Microsoft, Samsung, Visa, Intuit, Adidas , Airbnb, BMW, Expedia, Trivago, and Travelocity. No customer accounts for more than 2% of sales. 66% of revenue is from retail verticals, 16% from travel, and 18% is from classifieds (customers like eBay), autos, and telecoms. Geographic revenue mix is 39% Americas, 38% EMEA, and 23% APAC.  In order to generate effective retargeting advertisements companies need access to their customers’ websites/apps to assess customer intent (demand side) and access to publisher inventory to display ads on platforms likely to attract customers (supply side). Criteo is well integrated on both sides of the ecosystem having observed over $500 billion in sales on their customer’s websites/apps (more than Amazon and eBay combined) and generating over 8 billion advertisement clicks on the websites of their 14,000 publisher partners over the past year.  The process of (1) analyzing customer intent across devices, (2) determining the best inventory placement and advertisement display, and (3) assessing how much to bid for inventory based off different ROI targets, all in milliseconds, is technologically complex and requires advanced machine learning algorithms to be done effectively. The Criteo Engine that drives this algorithmic process is considered the best in the world.

     

    Criteo’s revenue model is unique among ad-tech companies in that they only receive revenue on a CPC, or cost per click, basis, meaning that they only get paid when their advertisement leads to a customer click. This is in contrast to the more popular CPM, or cost per impression, basis, in which customers pay if an advertisement appears on a site, even if it is not visible.

     

    Criteo benefits from secular growth in Ecommerce

    Criteo’s sales are highly levered to the growth of Ecommerce. According to the Census Bureau, Ecommerce has grown at a ≈15% CAGR over the past 5 years in the US, and eMarketer forecasts Ecommerce to grow ≈21% per year worldwide through 2020. Weighting eMarketer’s regional forecasts by Criteo’s current regional revenue share, Ecommerce sales should grow between 15% and 18% in Criteo’s current markets through 2020 (although CRTO is growing their revenue share in the faster growing APAC markets). It seems reasonable to assume CRTO sales grow at a similar 15%-20% CAGR over the same period, before taking into account changes in market share.

     

    Criteo is addressing a small fraction of its TAM/Customers

    Up to this point, CRTO has been focusing solely on traditional display advertising. They just announced their intention to enter search retargeting (display ads on Google) which they estimate to be a $6 billion revenue ex-TAC market, and have yet to enter acquisition marketing (advertising to attract new customers), which they estimate to be a $9 billion revenue ex-TAC market. These two markets increase CRTO’s TAM from $10 billion to $25 billion and leverage CRTO’s existing technology and relationships. In addition, although the technology isn’t ready for video and offline retargeting, these two markets offer large revenue opportunities for CRTO.

     

    Moreover, CRTO has primarily served retailers while getting little business directly from brand manufacturers (P&G, Kellog’s etc.). The recent acquisition of Hooklogic not only gives CRTO access to new inventory on retailers’ sponsored product pages and the opportunity to improve their performance through CRTO’s data and algorithms, but it also gives CRTO the opportunity to cross sell Hooklogic’s manufacturer customer base . Finally, CRTO is just entering China, the largest Ecommerce market in the world, in a meaningful way in 2016-2017. 

     

    Criteo has sustainable competitive advantages

     

    Scale

    Only Google sees more transaction data than CRTO. More data leads to smarter  algorithms,  better retargeting, and higher click rates. Higher click rates enables CRTO to pay more for inventory than competitors and increases the supply with which they can distribute the best ads. This improves client ROI, which attracts more clients and increases the amount of data. I believe this is a sustainable positive feedback loop.

     

    As a result of their scale and focus, CRTO has the best results in retargeting. Here’s some evidence showing the superiority of their product and the quality of their economic model:

     

     Product Superiority

     

     

     Quality Economic Model

     

    Independence

    Although Google and Facebook retargeting is not yet as good as Criteo’s it is certainly possible that their technology improves over time given their resources, scale, and talent. However, even if their technology becomes equivalent to Criteo’s, advertisers are still likely to prefer CRTO for three reasons. First, many of Criteo’s customers compete with Google and Facebook and feel uncomfortable giving them access to proprietary data.  Second, while Google and Facebook exclude each other from accessing the competitor’s inventory, Criteo has access to both Google and Facebook inventory. Third, Google and Facebook’s cross device tracking is limited to their own platforms and the data is less transparent for customers. Because of these factors and the fact that it is inefficient to have multiple retargeting providers, Criteo can continue to gain market share even if their technology is only equivalent to these competitors.

     

     

    Why Does the Opportunity Exist?

     

    Header Bidding

    Header bidding is a new advertising technology that gained popularity in the US in 2015. Essentially the technology changes the auction dynamics for inventory. Instead of having a waterfall auction with a limited number of bidders at each level, CRTO will have to bid against more competitors. Moreover, instead of being a second price auction in which the party that puts in the highest bid ultimately pays the price of the second highest bid, header bidding moves to a first price auction where the winner actually pays the price that they bid. Ultimately, header bidding has benefited publishers and hurt buyers through higher CPMs for inventory. In response to higher inventory cost, CRTO can either (1) buy fewer impressions, which lowers CRTO’s gross revenue, (2) buy inventory at higher prices without passing on the price increase, which lowers CRTO’s take rate, or (3) pass the price increases to advertisers through lower ROIs. Prior to 3Q I thought the effects of header bidding were evident in declining take rates in the US. However, US take rates increased in Q3 so I’m less convinced of this now. It’s possible that CRTO shifted strategy from lowering its take rate to buying fewer impressions, which would explain the less impressive gross revenue growth this quarter. Nevertheless, despite the potential effects of header bidding, CRTO has been able to beat revenue and EBITDA targets every quarter since header bidding became popular in 2015. Over the same period the stock declined from $57 to under $25 as the TTM P/E multiple compressed from 43x to just 20x today.

     

    CRTO argues that header bidding is a “low single-digits type of issue.” They believe that buyers will start lowering their bids over time because there hasn’t been a fundamental change in supply and demand that should change the value of inventory. They also believe that their superior technology will eventually enable them to predict the second best price in the new auction format so that they can bid the minimum amount above that to win the auction. As a result, CRTO may eventually pay a lower price than before header bidding, while those with inferior technology will subsidize the more advanced players. While I agree that header bidding doesn’t change supply and demand, it does increase the ability of buyers to express their demand through a broader auction (more liquidity). Therefore, mild price increases for inventory seem rationale to me. Furthermore, given the higher CPMs for publishers, it is likely that header bidding expands to Europe and APAC over the next year or two.  I also would not count on CRTO being able to predict other bidders’ pricing, given the difficulty of doing this in the stock market.

     

    On the other hand, I think it is likely that advertisers will start accepting lower ROI targets as they become more dependent on Ecommerce for growth and shift their advertising budgets from other forms of advertising like mail and catalogues that are even lower ROI and less measurable than retargeting. Also, header bidding has a negative impact on Google, and given their power over the entire internet advertising ecosystem, they have been pushing back against header bidding and may slow its adoption or change the technology in their and CRTO’s favor over time. If these scenarios play out, header bidding would have essentially no impact on CRTO.

     

    Ultimately, although I think header bidding  is a minor headwind, I don’t think the issue comes close to justifying the stock decline (down 56% from the July 2015 high to the February 2016 lows) that came as the company continued to grow revenues 33% and EPS 89% YoY over the first three quarters of 2016. I incorporate aggressive header bidding effects in my base case by lowering CRTOs gross revenue growth rates in the sell side model I am using (which has average sell side expectations) by 200 bps each year through 2020 and reducing CRTO’s take rate from 40% to 39% (more than the 70 bps decline in take rate in the US since the end of 2014). Even with these effects, EPS would grow at a 17% CAGR through 2020.

     

    Google/Facebook Overhang

    Many investors are reluctant to buy any company that competes with Google and Facebook. This is probably a good rule most of the time, but I believe this is an exception for a few reasons. First, as explained above, I believe many advertisers will not use Google or Facebook for retargeting because they are uncomfortable giving them access to data and they don’t offer access to each others’ platforms. Second, Google and Facebook benefit from their relationships with CRTO because CRTO is one of the largest buyers of their high CPM inventory. I don’t think it would be in their interest to close off a high CPM bidder from their platforms (for reference Google accounts for about 20% of CRTO’s inventory spend and Facebook accounts for about 10%). Third, CRTO is a trusted independent partner that helps Google and Facebook develop their advertising technology for the wider ecosystem. For example, CRTO is often the first to test Google’s new advertising products, was the first to test Facebooks mobile advertising platform, and has a custom integration with Facebook Dynamic Product Ads. Fourth, Criteo is singularly focused on retargeting and at this point has better performance than Google and Facebook’s performance isn’t even comparable. These relationships require monitoring but I believe CRTO has found a strong niche in the ecosystem. An incremental positive for CRTO, would be integration with Snapchat, which they are not on yet, as it could reduce the power of these large suppliers.

     

    Ad-Tech “Peers” Overhang

    Ad-tech has been crushed over the past twelve months. FUEL is down 49%, RUBI is down 53%, TUBE was down 40% before being acquired, while CRTO has managed to fall just 11% (CRTO’s decline came earlier and they are down 36% from the recent $57 high). Despite having very different business models than these public competitors and CRTO having been able to overcome some of the issues that caused their poor results, I think the sector’s performance has contributing to the downturn in CRTO’s shares.

     

    FUEL ($459mm market cap) was the closest public competitor to CRTO, as they offered a retargeting service, but they have shifted from managing campaigns to offering their technology as a service to ad agency trading desks after a string of revenue misses and guide downs.  This shift was likely due to their inferior technology and CPM revenue model when compared to CRTO. In the most recent quarter they gave guidance 18% below the street and announced their new CFO was leaving the company after less than a year on the job. With no earnings, increasing leverage, and a $100mm market cap, they simply don’t have the scale to compete with CRTO. I think their losses are more likely a reflection of CRTO’s strength then the industry’s weakness and they will ultimately go bust or be acquired.

     

    RUBI ($298mm market cap) is a SSP (sell side platform) so it is in a very different business, but  their disappointment has been due to (1) header bidding (which is especially bad for SSPs because inventory can be sold before it ever reaches the SSP), (2) the acquisition of Chango, a retargeting competitor to Criteo that is not meeting expectations, and (3) the shift to mobile. In the last quarter, sales guidance was 11% below consensus, EBITDA guidance was 17% below consensus, and EPS guidance was 33% lower than consensus.

     

    The above list excludes CRTO’s most direct competitors, which have been acquired. Twitter acquired TellApart for $535 million at an estimated  5x EV/S in April 2015. Tesco acquired Sociomantintic in April 2014 for around $200 million, an estimated 2x EV/S. Struq was acquired by Quantcast (private) in October 2014, Triggit was acquired by Gravity4 (private) in March 2015, and Dotomi was acquired by Conversant for $295 million in November 2013. This was a very crowded field and CRTO appears to be the winner in a winner-take-all market.

     

    In contrast to their public competitors, in their most recent quarter CRTO ($2.6b market cap) beat sales estimates by 2%, EBITDA estimates by 19% and EPS estimates  by 30%. Guidance for the fourth quarter  year was also above expectations. Simply put, CRTO’s business model and performance has been completely different from its public competitors, yet I believe their performance has been dragging down CRTO.

     

    Valuation

    Despite having grown revenue 33% and EPS 74% over the past year, and consensus expecting 18% annualized revenue growth and 22% annualized EPS growth over the next 3 years, CRTO is trading at just 20.3x trailing earnings and 16.5x forward earnings. Furthermore, consensus is expecting just 15% “core” net revenue growth over the next two years (core excludes revenue from search and the Hooklogic acquisitions), which is at the low end of the 15% to 20% Ecommerce growth expected through 2020. Given that CRTO has consistently taken share, this level of core revenue growth seems highly conservative. The market is also likely underestimating non-core revenue growth through search, Hooklogic, China expansion, and video opportunities.

     

    To value CRTO I created three scenarios. The primary differences between the scenarios are core gross revenue growth rates and take rates. My base case assumes core revenue grows 16% per year through 2019, just 100 bps more than Ecommerce. I also lower the take rate from historical levels of between 40% and 41% to 39%. I put an 18x multiple on 2019 EPS of $3.15 (mainly because it gets me a similar value to what I get through a DCF), discount it back at 10%, and subtract cash to get a value of $48 (+20%). My bear case assumes core revenue grows at 13%, slower than Ecommerce, and take rates fall 200 bps. This results in 2019 EPS of $2.48. Putting a 15x multiple, subtracting the cash and discounting this back at 10% results in a value of $33 (-17%). Finally, my bull case assumes core revenue growth of 20% per year, at the high end of Ecommerce growth, as CRTO takes share and expands to new markets and verticals. This results in 2019 EPS of $4.06. Using a 20x multiple I get a value of $66 (+66%).

     

    It’s also worth noting that TUBE, an unprofitable $540mm market cap ad-tech company which focuses on a cross platform, video-based SAAS product was recently acquired by Adobe at 2x EV/Sales, 3x EV/Gross Profit, and 41x EBITDA (all multiples based off of 2017 estimates). IF CRTO were to trade at these multiples, it would be valued at $71, $46, and $164 respectively.  I am not arguing that CRTO is worth $164, but these multiples give me more confidence that the downside is limited.

     

    Overall, while the risk reward is less favorable than before 3Q earnings, I still think this is a rare opportunity to buy an industry leader riding secular growth with 65% upside and a favorable risk/reward.

     

    Risks

     

    ·  

    I do not hold a position with the issuer such as employment, directorship, or consultancy.
    I and/or others I advise hold a material investment in the issuer's securities.

    Catalyst

    Messages


    SubjectMobile
    Entry11/18/2016 08:03 PM
    MemberBJG

    Thank you for the write up.  How does the shift to mobile affect their business model?  In other words, as users shift transactions to specific apps, does that box them out altogether.  I know retargeting does exist in mobile, I just think the game is different when I go to my Amazon app to buy X and my Expedia app to buy Y.  Once I'm in a given app, I'm much more captive and commited and it seems a business like Crit is much less effective.


    SubjectRe: SteelHouse Lawsuit
    Entry11/21/2016 12:29 PM
    MemberDefy_Augury

    Regarding the Steelhouse lawsuit

    -Both sides dropped their claims on November 1

    -It’s important to note that SteelHouse was countersuing the claim that they were stealing click attribution from Criteo, and five former SteelHouse clients (now with Criteo) backed Criteo’s allegations. If I were Steelhouse, which is already losing the retargeting battle to Criteo due to lack of scale, I would also respond aggressively to Criteo's claims because they represent an existential threat to their business.

    -Criteo's does not have long-term contracts with clients. If clients don't see an increase in sales (which they measure internally) they can leave Criteo at any time. If such a large proportion of the clicks Criteo says it generates were from bots, which don't generate sales, clients would reduce spending and leave Criteo. Instead, same client sales increased 15% last quarter. To me this part of the countersuit makes no sense:

    Criteo, however, allows its clients to set a price at which it is willing to pay-per-click. For example, a Criteo client may set the CPC at 50 cents. But Criteo alone determines what it will bid in exchanges, and bids $2.00 per thousand impressions. If the client is unhappy with the number of clicks and decides to increase the CPC from 50 cents to $1.00, Criteo could continue to bid on the exchange at $2.00 per thousand impressions, but now gets 50 cents more per click, increasing its profits while not actually increasing customer performance. This model deceives customers. Criteo’s customers believe that an increased CPC bid will yield better performance. But in reality, the increased CPC bid does not result in any additional traffic to the advertiser, because the exchanges occur on a CPM basis.

    Based on how I understand Criteo’s business this is just false. Clients authorize CPC levels based off of internal ROI targets. If a client authorizes Criteo to increase its CPC, all else being equal, it is effectively agreeing to lower its ROI target in order to increase volume. If the lower ROI target does not yield additional volume, the client will see Criteo as a terrible investment and stop spending on the service. They are certainly not going to increase their spending without any benefit to themselves, which they can measure internally through A/B tests.

    -Perhaps 55% of clicks could not be attributed by SteelHouse simply because they don't have the scale/technology to attribute clicks on mobile and across devices, which is technologically difficult but an increasingly large proportion of eccomerce sales. Criteo is pushing hard to develop its cross device graph precisely so that (1) clients attribute more sales to CRTO and (2) competitors can't take credit for sales that should go to Criteo, which was Criteo's accusation against Steelhouse in the original lawsuit. Here’s what the CEO said about the cross-device graph in the last investor day:

    In 2017, we plan to offer the user graph as-a-service. What this means is, as an advertiser, as you pass to us your ID, we will pass you back, at a granular user level, the consolidated Criteo user ID that were built from all the interactions of our network. We will pass this back to you so you can use it in your own tools for attribution, for measurement, perhaps for other purposes too like site personalization and given that key, if you like, to the user ID identity, that stretches across all their users, not just the ones working with Criteo. We will pass them the full Criteo-device graph. We will offer this as a free service to advertisers, but there are three main benefits for Criteo from doing this and we will go through each of these three quickly. We are doing this in order to increase sales that are attributed to Criteo. We are doing this in order to improve the scale of our cross-device graph and we are doing it to deepen our relationship with advertisers. What this means is that they cannot see what we can see. They cannot see transactions happening across devices. We think they are probably in the order of 30% to 40% more sales they are not seeing because they have not got this cross-device view. By giving them the user graph as-a-service, we can feed into their own tools, this ID, so they can see what is going on, and ultimately, by building that trust and transparency, they can give us credit for those sales. The third and final benefit, in some ways, is even more profound. If I think about advertisers, as Eric said, they are now competing with giants. In the most part, that is Amazon. It is the companies that have strong internal networks, massive scale effects inside their own businesses. For our clients, what they need is a third party platform, a technology platform, who can provide them with the benefits of a broader network. That unleveraged scale affects across everything that we are doing across all our client base. For us, that means building products and services that share and expose that network to our clients. For user graph as-a-service, in many ways, the first step for us on that journey is the first example of a product we are going build that allows our clients the benefit and the strength of our network and deepen, over time, those relationships.

    Insider Selling

     

    Obviously I would prefer insider buying over insider selling. Most of the selling has been pretty consistent through 10b5, although it did accelerate after last quarter’s beat. I’m not sure if this is due to a depressed outlook or the insiders are simply taking some money off of the table in a volatile stock. 


    SubjectRe: Mobile
    Entry11/21/2016 12:37 PM
    MemberDefy_Augury

    I agree that if users increasingly go to apps with a specific product purchase in mind CRTO won’t be as useful. This is also true on desktop. To have value, Criteo must be able to drive incremental sales that wouldn’t have been generated without the advertisements. This means CRTO is reliant on the “research” phase when potential customers are comparing products, which gives them the chance to close a sale or drive an accessory or alternative to what the customer was originally researching. I still think most people do this kind of research before completing purchases in app, which gives Criteo a chance to generate incremental sales for clients. At their investor day, Criteo gave the stat that 40% of eccomerce transaction happen across devices. Comscore says 53%-57% of ecommerce sales occur across devices.  This suggests to me that people still do the kind of research necessary for Criteo to have value for clients. It’s also important to note that mobile has grown from less than 35% of Criteo's revenue ex-TAC in Q315 to 57% in Q316 and in app advertising revenue ex-TAC grew over 300% last quarter, making it between 5% and 7% of total revenue ex-Tac, so I don't think the company is being left behind by mobile. I think the concern is less about technology and more about consumer behavior. Will consumers start becoming more assasin like and immediatly buy things that come to mind, or will they continue to research potential purchases beforehand? If it's the former we should be worried about every tech company that generates revenue through ad sales. 


    SubjectRe: Re: Mobile
    Entry11/21/2016 04:57 PM
    MemberBJG

    Thanks for the reply - good points.


    SubjectThoughts on the Short Piece?
    Entry11/30/2016 05:41 PM
    MemberMSLM28

    IMO pretty compelling.... any thoughts?

    http://seekingalpha.com/article/4027176-shakedown-advertisers-swindled-porn-traffic-bots-adware-criteo-settles-click-fraud-litigation#comments_header

     


    SubjectRe: Thoughts on the Short Piece?
    Entry11/30/2016 05:45 PM
    Memberspecialk992

    I would also be interested to hear any thoughts on this. I am torn- it does seem fishy but if it was such a fraud wouldn't clients be sohpisticated enough to figure out that Criteo wasn't adding value? I have talked to numerous Criteo customers and while they generally stated they didn't agree with the way Criteo calculated ROI (using a 30 day lookback for anyone who has seen a Criteo ad even if another ad was the last click before purchase) they seemed to believe that Criteo traffic was converting enough to make it worth the cost and some went so far as to state they had done A/B testing with and without Criteo and concluded it was effective. 

    The classic industry defense is that everyone knows a certain amount of traffic is fraudulent and a certain number of ads are never viewed by humans but that it all comes out in the conversion wash and factored into ROI decisions.


    SubjectRe: Re: Thoughts on the Short Piece?
    Entry12/02/2016 11:36 AM
    Memberyellowhouse

    we also own some crto. i respect/appreciate defy writing it up. i was too much of a chicken.

     

    this might belong in the 'too hard' pile given the fb/goog competition, but i've convinced myself that 1) retargeting is a necessary and growing form of digital advertising with a growth rate that eventually tracks e-commerce growth, ex-amazon, 2) it makes sense that an advertiser would prefer to work with someone other than a massive publisher, 3) criteo has massive scale - in 2015 their customers accounted for $440B of global online sales, that's 44% share ex-china 4) their algorithm must have something to it because they retain and grow customer counts and spend, 3) their move into search further validates their technology and materially expands the TAM, 4) monetizing webspace for multi-brand retailers makes a ton of sense to me and hooklogic seems like a good acquisition and 5) at 7.5x EBITDA growing at +20% this seems both cheap and very digestible for either adobe or one of the big ad agencies.

     

    i am possibly more stubborn than most, but i was not convinced by the SA piece whatsoever. i'm genuinely surprised that it seems to have gotten such traction. the issues raised (fake traffic) are in no way unique to criteo. if anything, i would expect that the amount of A/B testing that occurs for performance-based marketing places criteo's business on the lower end of the risk spectrum. the internet is full of crappy/shady websites. pornography accounts for an astronomical amount of internet traffic. personal beliefs aside, i am not in the least bit concerned to find that criteo places ads on these websites. the fact that the author highlights thechive.com as one of these sites speaks to the idiocy of this concern. it's a top 1000 site and has a more dedicated following among young men than almost any site i know of. i would be far more concerned if criteo was not advertising on thechive.

     

    as for the concerns raised by benjamin edelman (which the author lifted directly from the steel house counterclaim), let's start by reminding ourselves that many of us already know who he is. he's the a-hole harvard professor who threatened legal action against a chinese restaurant for overcharging him by $4. (https://www.boston.com/culture/restaurants/2014/12/09/ben-edelman-harvard-business-school-professor-goes-to-war-over-4-worth-of-chinese-food) he is also a litigator and consultant who makes part of his living by convincing companies that they need to pay him to investigate the ad firms they work with. he clearly knows what he is talking about, but let's not pretend that he is some impartial observer here who doesn't walk through life with an ax to grind. now on to his issue with criteo - sometimes they place ads for an advertiser on the advertisers' site. do me a favor, go to a bunch of retailers' sites and notice how much ad space there is. there's hardly any. we are talking about extremely small amounts of inventory here. next, let's talk about the instance where a criteo ad does find its way onto the advertiser's site and someone clicks on it. that means that a customer was on the site looking at a bunch of different products and they clicked on the product advertisement that criteo placed versus the products that the advertiser had selected. while that click may be less valuable than if it had originated on a third party site, i still think there's value. not to mention the fact that the advertiser was the one who got paid for the advertisement. if this is edelman's biggest problem with criteo then i feel great about the value criteo is delivering!

     

    next, the steel house lawsuit. criteo sued steel house because they were effectively falsifying clicks by inserting code that made a 'view' register as a 'click' when the advertiser did their attribution analysis. criteo got several advertisers including TOMS, Vistaprint and Bodybuilding.com to offer declarations that supported criteo's claim that steel house was misleading their analytics. steel house's counterclaim was that criteo's click through rate was too high, many of their clicks don't have an attributable source and their rate of cluster clicks (the same user clicking an ad in a 30 min window) was abnormally high. while these are potentially concerning issues (and we are still researching them), they aren't really legal claims. steel house doesn't actually identify wrongdoing. in the end, criteo decided to drop the case because they had largely achieved what they wanted - which was to expose that steel house was misleading advertisers.

     

    there's a bunch of other crap in the SA piece that i don't feel like dispelling (like how blatantly misleading it is to use gross revenue as a denominator for calculating % R&D spend), but if there are issues that you feel need to be addressed then i would be happy to talk through them.

     

    look forward to some dialogue here. like i said at the beginning, this may belong in the too hard pile. but i was compelled enough by the merits of the biz to take a smallish position.


    SubjectRe: Re: Re: Thoughts on the Short Piece?
    Entry12/05/2016 11:31 AM
    Memberyellowhouse

    i recently had a call with a c-level exec at crto's largest private competitor. here are some summarized notes from the call. they aren't word for word, but capture the essence of the conversation.

    Q - what do you think of the seekingalpha article?

    A - The Seeking Alpha article sort of sensationalizes a real topic and so by connecting it to the low quality inventory is really not the primary issue although that's more splashy. The problem ... there are many problems with chasing clicks and so the broader topic is really attribution and the fact that we're basically for the last 15 years stuck in this world of last click attribution

    Q - does crto do things that create artificial clicks?

    A - It's not artificial. It's actual clicks that are translating to conversions

     Q - what do you make of steel house's counterclaims?

    A - That's all BS...They're not inflating clicks. They're great at ... it's sour grapes on that point of view that Criteo is just better at last clicks than SteelHouse by a lot and they're better than most people by a lot. 

     

     

    Q - what about the allegation that the clicks are not 'attributable'?

    A - that just means criteo doesn't disclose where the clicks came from. that makes total sense to me. That is exactly what any analytic solution would show.

    Q - what about the claims that ben edelman makes?

    A - that's just not an issue. 

    Q - as a competitor of criteo is there anything they do that would make you call them a bad actor?

    A - no

    Q - what are some of the challenges that criteo faces?

    A - they are the best at optimizing last click attribution. as the market moves towards more 'incrementality tests' that could be disruptive.

    Q - how do you compete with fb and goog?

    A - over the last year and a half fb has certainly moved towards more of a 'frenemy' relationship. they have moved to a more direct relationship with advertisers. they definitely developed sharper elbows with their partners and certainly made it harder and harder to add value in their eco-system so yeah, the shift from FBX to custom audiences is definitely makes it harder to justify a margin. That said, I feel like the pendulum kind of hit the apex on that trend and it's going to start swinging back towards a bit more openness and a bit more ... yeah, a bit more openness to working with the eco-system because the incentives just start to outweigh the risks and the costs. you got to figure out the right ways and the safe ways to play nice with the rest of the eco-system because Procter & Gamble isn't going to be like, "Okay. I'm just going to use Facebook for everything and I'm just going to trust you with all my data and do whatever you want with it." 

    It's a situation where in ad tech, I think it's something that's underappreciated. The knock on the industry is that the barrier to entry is low, but the barrier to scale is high and when you get to scale there's all sorts of network effect that starts to kick in. A good example of this for Criteo is like Universal Match. They're able to have their own cross device deterministic ID because they've have so much scale of conversion data that they can take those converts that PII, that email address from a conversion, connect it to a cookie, connect it to an app ID and have their own deterministic cross device solution. If you're a market entrant, you can't do that. You're going to have to license it

    Another example is the more you see of a particular ad unit, the better you can know how much to bid on it the next time. If we see something 10,000 times and somebody else sees it 100, we know a lot more about how much that's worth and we're going to be able to deliver better performance and win that customer and then get more data and so on and so your typical network effect.

    Q: has the shutdown of FBX been a headwind or tailwind, given that it narrowed the number of FB partners?

    A: headwind, but the impact was felt in 2015.

    Q: what do you think of criteo moving into search?

    A: I was pessimistic on it until the HookLogic acquisition. I think that all now makes a lot sense and is really strategic and really savvy because it's basically the Criteo publisher network version for search and I think now they can deliver a really killer PLA solution that not only gives you better performance on Google PLAs, but also gives you all this proprietary inventory and that seems like it would be ... I don't know the exact margin points, what it breaks down to, but that does kind of from a 5,000 foot view strike me as a compelling offering in the market. 

    Yeah. I would say that that's the primary ... yeah, it's so Criteo. They don't like to be beholden to just like in the display side, they were never the ones to just use a cages, they wanted their own publishers and so they pioneered header bidding which ended up being really savvy and it seems like they're doing ... it's the exact same thing in search. It's like okay, we don't just want to buy Google PLAs, where else do these ad units exist? They're the ad units that exist on these other retailers. No we can unify that  not too be reliant on Google.

    When they were talking about this I was like oh, their just going to optimize PLAs on Google. I was like, "Yeah, that's cool. They can probably add some value there, but it's like an under 5% margin on PACs business." It's a big TAM, but it's a small margin.

    This company started getting into bid management a long time ago and just knowing Criteo does have fantastic R&D and I think they can do some damage in that area, but then you combine it with like proprietary inventory access that only they can give you starts to be pretty interesting I think.

    Q: do you think re-targeting spend continues to grow over the next three years?

    A: It will grow. We are starting to see some of our clients go to an "uncapped" model, which is something that Criteo has bragged about for awhile.

    Q; how critical is criteo's device graph?

    A: That's critical regardless of the model. In fact, I would say that in many ways the last click model is it's limiting. When was the last time that you clicked on an ad? There's all these studies that show the vast majority of clicks on the internet are made by a small group of people. There's this natural born clicker study that was really famous, that there's just certain people that click and certain people never will and if all you can do is get credit, keep getting credit for those same clicky people, your universe is limited, but if you can show, no. The people that had a view on mobile or whatever, people don't click as much or not intentionally and that exposure delivered incremental lift you have a bigger universe to go after.

    Q: would you own criteo's stock?

    A: i would. i have owned it in the past. I think there's some threats and I think there's some concern, but man, all they do is execute

    Q: if you could put all your net worth into one stock what would it be?

    A: Google.

     

     

     

     


    SubjectRe: Re: Re: Re: Re: Thoughts on the Short Piece?
    Entry12/05/2016 03:51 PM
    Memberyellowhouse

    he had never heard of edelman. here is what he said:

    "Yeah and another way to look at it is that Zappos and others put, intentionally put product recommendations units in their site and that's what essentially that acted as and Criteo has all sorts of data around how people generally don't buy products based on those recommendations, a big chunk of them anyway so you can still make the case that yeah, if you were on the page with a pair of shoes and then already in that shoe page and then clicked on the ad of the shoe ... I don't know. It's a pretty bizarre use case that I doubt is a meaningful portion"


    SubjectRe: Will 2017 Sales growth decelerate sharply???
    Entry12/09/2016 02:37 PM
    Memberyellowhouse

    not my thread, but i'll butt in.

    thanks for posting the components of your assumptions for 2017. breaking the growth into its constituent parts is helpful.

    how are you considering the impact of hooklogic? it's expected to add mid single digit revenues to 2017. it seems like you may be omitting.

    why are you assuming only 2,500 customer adds? it seems to me like midmarket still has quite a lot of runway. over the last three quarters customer adds have been accelerating - Q1: 760, Q2: 900, Q3: 1,000. i expect they will add close to 3,900 customers this year. are you expecting a pretty dramatic slow down?

     

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