Given fragmentation in the advertising industry, it can be a challenge to gauge the overall trends. The fact that big tech walled gardens compete for the same advertising dollars as independent adtech players creates more challenges. Furthermore, some prominent companies providing adtech services are buried under segments in much larger companies; so it can be difficult to track performance.
That said, we outline a few metrics from public companies across the advertising industry to try to provide a snapshot of where the industry stands. With the uncertain macro outlook, as well as a potential shifting of advertising to the open web from walled gardens, we hope to have this note as the first in a series of regular publications to follow ongoing trends in advertising.
We note that we do not cover any of the companies in this note, excluding AcuityAds. As such, we show only reported figures and we provide brief company summaries in Exhibit 6. We note that for walled gardens, we focus on just the advertising segments, where disclosed. For those that are newer to the digital advertising and adtech ecosystem, we provide an adtech 101 in a concurrently published note (link) to help navigate some of the points discussed.
Overview
We note that profitability metrics are typically not disclosed for the advertising segment within consolidated results of walled gardens. As such, we focus just on the advertising-related revenues. We believe that advertising revenue from both walled gardens and adtech intermediaries can help gauge: 1) broad growth trends for digital advertising revenues and 2) whether there is a shift in the advertising industry towards the open internet from walled gardens, to corroborate what adtech players have messaged in recent quarters, as outlined in Exhibit 3.
With respect to the independent adtech players, we show both revenue and profitability/cash flow metrics. Furthermore, we use net revenue or revenue ex-TAC (traffic acquisition costs) to show the intermediaries' ability to retain ad dollars.
Walled Garden versus Adtech
We acknowledge that direct comparisons between walled gardens and intermediary adtech are not perfect. There is a large variance in size and scale between the two cohorts. Furthermore, business models are not directly comparable, given that adtech players are largely a facilitator of advertising, while some walled gardens play both a facilitator role as well as a provider/supplier of ad inventory. That being said, we believe that comparing revenue growth across the two cohorts offers some insight into the directional sense of ad dollars in the ecosystem.
As shown in Exhibit 1, advertising segments within Alphabet/Meta generate annual revenues of double-digit billions, while Trade Desk, the largest independent adtech player, saw gross revenue of $6.1 billion in 2021. Many of the smaller adtech players have gross revenues of ~$1 billion or less, and much less in net revenue terms. Note here that we use gross revenues as our metric since walled gardens typically report gross revenue, and since gross revenue represents the ad dollars that enter the advertising supply chain prior to intermediary fees.
Despite the wide variance for each company, if we simply look at y/y growth for the subtotals for adtech versus walled gardens, we see that walled garden growth outpaced adtech in both 2020 and 2021.
Given the big difference in scale, we expect larger y/y swings within independent adtech, but also that any marginal weakness within the walled gardens can offer independent adtech material upside, particularly to the smaller players if they are able to take market share. Unfortunately, not all independent adtech players, particularly industry leader, Trade Desk, disclose gross revenue on a quarterly basis. As such, in Exhibit 2, we show y/y growth rates, using net revenue for adtech intermediaries as a proxy in Q1/22 and Q2/22.
In 2022, revenue growth rates have slowed across the board, but we note that independent adtech firms as a group have been more resilient than the walled gardens, with adtech growing 17% y/y in Q2/22, while walled gardens grew 8%. Although two data points are not indicative of a trend, we believe that the adtech industry has room to grow if independent adtech players are successful in taking even marginal market share from walled gardens.
Adtech Commentary
In this section, we zoom in and focus in on just the independent adtech players. In Exhibit 4, we show a three-year annual history of a handful of metrics. Our focus here is on net revenue/revenue ex-TAC as it represents the portion of total advertising dollars that the adtech firm is able to retain for itself. Furthermore, we focus on EBITDA as a margin on this net revenue figure, and we define FCF here as cash from operations less capex and capitalized spend on software development costs.
We have provided the metrics for each company every year, but the key takeaways we outline are below:
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Aside from AcuityAds and Criteo, the adtech players in most cases have grown net revenues double digits annually. Albeit off a low base, we believe that continued growth in the adtech industry can persist if ad dollars shift away from walled gardens.
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All adtech players are EBITDA profitable, and in most cases, have been expanding EBITDA margins, on net revenue, annually. The general upward trend is encouraging, and we believe adtech companies can enjoy some operating leverage as scale increases and ad buyers and sellers consolidate transactions to top intermediaries’ platforms. These scale benefits will partially be offset by certain variable platform costs as well as R&D investments to maintain competitive features on the platform.
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We prefer to look at FCF over a multi-year period, especially given the pandemic impacts in recent years, as well as to smooth out working capital impacts. Looking at the aggregate three-year FCF generated by these companies, we can see that adtech firms are able to convert EBITDA into FCF in the low-teens percent.
We also provide recent quarterly results in Exhibit 5. We see that net revenue growth has slowed down, but we note that H2 is typically seasonally stronger, particularly Q4, given the holiday season. Coupled with the near-term macro uncertainty, we believe H2 results will provide an opportunity to assess whether adtech intermediaries can continue to generate healthy EBITDA margins despite potential revenue declines and/or return to low-teens revenue growth through taking share from walled gardens.