Expanding Into Global Advertising Will Improve AI Capabilities And Operational Efficiency

Key Takeaways

• The strategic shift to focus on high-margin advertising and automation aims to enhance operational efficiency and improve net margins.
  
• AI-driven model enhancements and share repurchases underscore a focus on revenue growth and returning capital to shareholders.
  
• AppLovin's expansion into broader advertising and reliance on automation present strategic risks that could impact growth, margins, and financial stability amidst competitive pressures.

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 expansion beyond gaming advertising to capture the broader global advertising market, including e-commerce and other verticals, is expected to significantly increase revenue as they address a massive market opportunity with over 10 million online advertisers worldwide.
  
• The transition to a pure advertising platform, along with investments in automation and self-service capabilities, is likely to improve operational efficiency and boost net margins by reducing the need for a large workforce while scaling operations effectively.
  
• The divestiture of the Apps business to focus on the high-margin advertising segment suggests a strategic reallocation of resources, which could enhance adjusted EBITDA margins and lead to stronger earnings performance.
  
• Continuous AI-driven model enhancements, which have historically driven significant growth, could further improve revenue growth as these models optimize and personalize ad experiences across a variety of verticals.
  
• The ongoing share repurchase strategy, financed by substantial free cash flow generation, indicates a strong commitment to return capital to shareholders and could contribute to enhancing earnings per share (EPS) over time.

AppLovin Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming AppLovin's revenue will grow by 19.7% annually over the next 3 years.
• Analysts assume that profit margins will increase from 33.5% today to 51.6% in 3 years time.
• Analysts expect earnings to reach $4.2 billion (and earnings per share of $11.96) by about April 2028, up from $1.6 billion today. However, there is a considerable amount of disagreement amongst the analysts with the most bullish expecting $5.5 billion in earnings, and the most bearish expecting $3.2 billion.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 53.8x on those 2028 earnings, down from 60.9x today. This future PE is greater than the current PE for the US Software industry at 30.2x.
• Analysts expect the number of shares outstanding to grow by 3.33% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 7.47%, as per the Simply Wall St company report.

AppLovin Future Earnings Per Share Growth

Risks

• AppLovin's reliance on developing more automated tools to handle increased demand and client onboarding could be a risk if these systems face delays or inefficiencies, affecting operational scalability and potentially impacting future revenue growth.
  
• The competitive landscape might intensify as AppLovin moves beyond gaming into broader advertising categories, which could lead to pricing pressures and affect net margins if competitors respond aggressively.
  
• The transition from a gaming-focused company to a broader advertising platform involves risks, including potential disruptions or distractions that could affect the company's focus and execution, impacting earnings and growth.
  
• The divestiture of the Apps business, while strategic, might lead to a temporary disruption or misallocation of resources, affecting the company’s short-term financial performance and contributing volatility to revenue streams.
  
• Heavy reliance on the advertising business, particularly during peak seasons like holidays, introduces an element of seasonality and potential volatility to cash flows and revenues, which may affect investor perception and stock performance.

Valuation

• The analysts have a consensus price target of $482.366 for AppLovin based on their expectations of its future earnings growth, profit margins and other risk factors. 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 $105.0.
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2028, revenues will be $8.1 billion, earnings will come to $4.2 billion, and it would be trading on a PE ratio of 53.8x, assuming you use a discount rate of 7.5%.
• Given the current share price of $282.7, the analyst price target of $482.37 is 41.4% 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.