Stock of the Week - AppLovin (19.12.2024)

AppLovin (APP.US) has emerged as one of 2024's most remarkable tech success stories, with its stock surging over 780% year-to-date as the mobile advertising and gaming company successfully expands beyond its core market. While the company's meteoric rise has attracted significant investor attention, questions remain about valuation sustainability and competitive dynamics in the rapidly evolving adtech landscape.

Q3 FY24 Results 

For the third quarter, AppLovin reported:

• Revenue: $1.20 billion (+39% year-over-year) vs. estimate $1.13 billion
• Adjusted EPS: $1.25 vs. $0.30 year-over-year
• Adjusted EBITDA: $721.6 million (+72% year-over-year) vs. estimate $641.8 million
• Software Platform Revenue: $835 million (+66% year-over-year)
• Apps Revenue: $363 million (+1% year-over-year)
• Adjusted EBITDA Margin: 60%

Earnings vs Estimates. Source: Bloomberg

Strategic Evolution 

AppLovin's transformation from a mobile gaming-focused company to a broader advertising technology platform represents one of the most successful pivots in recent tech history. At the heart of this evolution is the company's AXON 2.0 AI engine, which has demonstrated remarkable improvements in ad targeting and monetization capabilities. This technological advancement has driven the Software Platform segment's impressive 66% year-over-year growth, with the system's self-learning capabilities continuing to enhance performance as it processes more data, creating powerful network effects.

The company's expansion into e-commerce advertising has exceeded early expectations, with some advertisers reporting performance metrics approaching those of Meta. AppLovin's ability to reach 1.4 billion daily active users across mobile apps and connected TV devices provides a compelling foundation for capturing share in the estimated $120 billion e-commerce advertising market. This expansion comes as the company has strategically streamlined its gaming portfolio from 350 titles in 2021 to 287 currently, focusing resources on higher-performing assets.

Competitive Position

AppLovin's unique position in both buying and selling advertising inventory creates valuable data feedback loops that continuously improve AXON's targeting capabilities. AppLovin's dual role in the ad ecosystem, both as an ad network and a publisher, gives it a unique data advantage, enhancing its machine learning algorithms' effectiveness. The company's comprehensive suite of tools, including AppDiscovery, MAX, Adjust, and Wurl, provides end-to-end solutions for developers and advertisers, increasing switching costs and platform stickiness. The integration of services like MAX and Adjust under one umbrella makes AppLovin a one-stop solution, significantly raising the barriers for competitors to attract their customers away. This integrated approach has helped AppLovin maintain leading positions in critical metrics such as fill rates and eCPM (earnings per thousand impressions), demonstrating superior technological capabilities relative to competitors.

Potential Risks

The investment case for AppLovin requires careful consideration of both growth potential and valuation concerns. With a market capitalization now exceeding $100 billion and shares up over 780% year-to-date, AppLovin trades at elevated multiples relative to peers and historical levels. The stock's high valuation, particularly when measured by traditional metrics like P/E ratio, suggests that much of AppLovin's future growth might already be priced in. The 22V Research recently identified APP as the most overbought stock in the Russell 3000, raising questions about near-term upside potential. 

Competitive pressures present another key risk factor, with Unity's advertising platform representing significant competition through planned features like automated bidding and AB testing. While AppLovin expands into e-commerce, it must navigate an increasingly competitive landscape where giants like Amazon and Google also play significant roles. Additionally, the plateau in mobile user engagement growth

Management Guidance 

Looking ahead, management has provided strong guidance for Q4 2024, projecting revenue of $1.24-1.26 billion (+31% year-over-year) and adjusted EBITDA of $740-760 million with a 60% margin. AppLovin's management has demonstrated confidence in their growth model by continuing to invest in AI and data science, areas critical for future technological advancements. The company's robust cash flow generation and commitment to shareholder returns, evidenced by $230 million in share repurchases during Q3 and a new $2 billion authorization, provide some downside protection despite elevated valuations. The $2 billion share repurchase program signals not just confidence in the stock's value but also a strategy to return capital to shareholders amidst high stock valuations.

Wall Street Perspective 

Analyst sentiment remains generally positive despite valuation concerns. Morgan Stanley maintains an Equal-weight rating with a $200 price target, emphasizing management's confidence in 20-30% growth despite high expectations. Morgan Stanley's call for an Equal-weight rating reflects a cautious approach to the stock's near-term performance given its current price levels. William Blair holds an Outperform rating, highlighting AI leverage potential and promising e-commerce results. Jefferies maintains a Buy rating with a $270 price target, noting strong margin performance and encouraging e-commerce pilot data. Despite some concerns about valuation, the consensus among analysts leans towards optimism, with several upgrading their forecasts post-Q3 results.

Investment Conclusion 

While AppLovin's current valuation appears stretched, the company's technological advantages and expansion opportunities provide some justification for premium multiples. The successful extension of AXON's capabilities into e-commerce could represent a significant growth catalyst, though execution risks remain high. For investors considering a position, the key factors to monitor will be the company's ability to maintain its growth trajectory while successfully expanding into new markets, as well as competitive dynamics in the evolving adtech landscape. The combination of strong organic growth, emerging opportunities in e-commerce, and robust cash flow generation suggests AppLovin could sustain its momentum, though careful position sizing may be warranted given elevated valuations.

Valuation

We based our projections on historical averages and company projections, assuming a continued delivery of growth scenario for the company. This results in a 21% revenue growth and a 60% operating margin across the 5-year forecast. Considering the substantial influence of terminal value in DCF analysis, especially for shorter forecast periods, we’ve applied a 5.5% revenue growth and 10% terminal WACC, down from 10% in forecast years.

Under these assumptions, our model suggests an intrinsic value of $282.01 per share, indicating potential downside of 9.9% to current share price. It’s important to note the high sensitivity of DCF-derived intrinsic values to input assumptions. Below, two sensitivity matrices illustrate different Operating Margin and Revenue Growth scenarios, as well as Terminal WACC and Terminal Revenue Growth variations.

Source: Bloomberg Finance LP, XTB Research

Source: Bloomberg Finance LP, XTB Research

To evaluate AppLovin’s performance relative to its peers, we analyzed a group of four comparable companies with similar business growth trajectories: Palantir, Workday, Cadence Design, and Synopsys. AppLovin outperforms the peer group average across several key metrics, as evidenced by the mean, median, and cap-weighted multiples we calculated.

Valuations based on three separate multiples indicate mixed results. While some metrics suggest AppLovin is undervalued, others point to a potential overvaluation of approximately 30%. This disparity highlights both the upside potential of the company and the inherent uncertainty in its valuation, depending on which multiple or perspective is prioritized.

Source: Bloomberg Finance LP, XTB Research

Recommendations: AppLovin has 26 recommendations, with 20 "buy" and highest price of $480, 6 “hold” and zero “sell”. The 12-month average stock price forecast is $355, implying a 13.4% upside potential from the current price.

Technical analysis (Daily interval): 

The stock price breached a strong support level at the 38.2% Fibonacci retracement yesterday, which had been defended for seven consecutive trading sessions. It has now touched the 30-day EMA. Bears will likely target the 50-day EMA at $269.22 and the 61.8% Fibonacci retracement level at $257.22. Bulls, on the other hand, will attempt to regain control and push the price above the 38.2% Fibonacci retracement level, aiming for the 23.6% Fibonacci retracement level. Currently, the 23.6% level serves as strong resistance. The RSI is showcasing bearish divergence with lower highs and lows, while the MACD also diverges lower. Additionally, the ADX is nearing a bearish crossover. Source: xStation