Transition From Gaming To Advertising Will Open E-Commerce Doors

Key Takeaways

• Transition to a broader advertising platform beyond gaming could drive significant revenue and margin improvements through diversification and high-margin e-commerce clients.
  
• Divesting from the Apps business and focusing on AI-enhanced ad personalization aims to boost financial performance and advertiser satisfaction.
  
• Shifting focus from gaming to broader advertising poses execution risks, impacting revenue if scaling and onboarding are inadequately managed.

Catalysts

Engages in building a software-based platform for advertisers to enhance the marketing and monetization of their content in the United States and internationally.

• AppLovin's transition from a gaming-focused platform to a comprehensive advertising platform is expected to drive future revenue growth by tapping into a broader set of advertisers across various industries beyond gaming, potentially increasing their revenue significantly.
  
• The successful diversification from gaming into e-commerce and other advertising verticals suggests a potential improvement in net margins, as the company leverages its platform to attract high-margin e-commerce businesses beyond its traditional gaming advertisers.
  
• The development of self-service and automation tools is likely to ease the onboarding of numerous advertisers, which can lead to substantial revenue expansion going forward with increased efficiency and reduced operational costs.
  
• AppLovin's strategy to divest its Apps business will allow the company to focus solely on becoming a high-growth advertising platform, potentially boosting their financial performance by reallocating resources to higher-margin opportunities in the advertising sector.
  
• The increasing focus on using AI and machine learning to enhance advertisement personalization is expected to improve the efficacy of their advertising platform, potentially leading to better advertiser satisfaction, higher ad spending, and ultimately robust earnings growth.

AppLovin Future Earnings and Revenue Growth

Assumptions

• This narrative explores a more optimistic perspective on AppLovin compared to the consensus, based on a Fair Value that aligns with the bullish cohort of analysts.
• The bullish analysts are assuming AppLovin's revenue will grow by 28.1% annually over the next 3 years.
• The bullish analysts assume that profit margins will increase from 37.4% today to 67.3% in 3 years time.
• The bullish analysts expect earnings to reach $7.3 billion (and earnings per share of $20.67) by about July 2028, up from $1.9 billion today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the price target of the more bullish analyst cohort, the company would need to trade at a PE ratio of 39.5x on those 2028 earnings, down from 61.7x today. This future PE is lower than the current PE for the US Software industry at 42.7x.
• Analysts expect the number of shares outstanding to grow by 1.24% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 7.96%, as per the Simply Wall St company report.

AppLovin Future Earnings Per Share Growth

Risks

• The shift from gaming to a broader advertising platform brings execution risks, particularly in scaling their non-gaming business and ensuring effective onboarding of a diverse range of advertisers, which could impact revenue growth if not managed properly.
  
• The planned sale of the Apps business, with a significant portion of the consideration as a minority equity stake in a private company, introduces uncertainty around the return from this divestment, potentially affecting net margins if the performance of the new entity does not meet expectations.
  
• Limited self-service capabilities in their systems currently restrict the potential to scale the advertising business effectively, which may hinder revenue expansion in the near term if these tools are not developed and deployed swiftly.
  
• The competitive landscape for e-commerce and broader advertising, especially with large incumbents in play, may present challenges in gaining and maintaining market share, which could affect future revenues.
  
• Increased reliance on data center operations, coupled with step function increases in data center costs, could impact adjusted EBITDA margins if these costs outpace the revenue engagement efficiencies gained from these technological investments.

Valuation

• The assumed bullish price target for AppLovin is $650.0, which is the highest price target estimate amongst analysts. This valuation is based on what can be assumed as the expectations of AppLovin's future earnings growth, profit margins and other risk factors from analysts on the bullish end of the spectrum.
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $650.0, and the most bearish reporting a price target of just $250.0.
• In order for you to agree with the bullish analysts, you'd need to believe that by 2028, revenues will be $10.8 billion, earnings will come to $7.3 billion, and it would be trading on a PE ratio of 39.5x, assuming you use a discount rate of 8.0%.
• Given the current share price of $350.0, the bullish analyst price target of $650.0 is 46.2% higher.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.