Outbrain: Enhancement Of Algorithms And Stock Buyback Could Bring The Price Up (NASDAQ:OB)

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Outbrain Inc. (NASDAQ:OB) is said to be the largest online advertising platform, and appears to be trading significantly undervalued. In my view, with sufficient development of new products and enhancement of algorithms, OB’s stock price could trend north soon. Keep in mind that with the recent buyback program announced in 2022, the liquidity in the market could increase. Despite risks from the company’s contracts with media partners and new products not being successful, the current stock price appears too low.

Outbrain

Outbrain offers a recommendation technology for readers to discover new things on the open web. The company offers engaging and tailored content for each of us on many well known platforms. I am pretty sure that you have seen one of its advertisements in the past because Outbrain works with large and established business partners.

Source: Company’s Website

Source: Company’s Website

Source: Company’s Website

Source: Company’s Website

As of today, the company claims to be the largest online advertising platform on the open web with close to 1 billion monthly unique users in 2021 and 10 billion recommendations to content. With these figures, in my view, as soon as the company successfully monetizes its reach, the free cash flow could be quite impressive.

In line with my previous commentary, I decided to run a financial model about Outbrain because management decided to launch a buyback program. I assumed that Outbrain is buying its own shares because their price became too cheap in the market:

On February 28, 2022, the Company’s Board of Directors approved a stock repurchase program under which the Company is authorized to purchase up to $30 million of the Company’s common stock. Source: 10-Q

Impressive Expectations From Investment Analysts

Financial analysts expect Outbrain to deliver a median sales growth of close to 8% between 2022 and 2024. The median EBITDA margin is also expected to be close to 4%, and the net income would be positive in 2024. Finally, there is not a lot of information about the free cash flow expectations, but the company reported positive FCF in 2021. In my view, expecting FCF/Sales around 4.6% like in 2021 would make sense.

Marketscreener.com

Marketscreener.com

Balance Sheet

The balance sheet statement includes a significant amount of cash in hand, which I don’t think most investors did notice. As of June 30, 2022, cash and cash equivalents is equal to $391 million, and the asset/liability ratio stands at 1.45x.

10-Q

10-Q

With long-term debt worth $236 million, the net debt is negative because the company has plenty of cash in hand. Perhaps, reducing the total long-term debt to reduce interest expenses would make more sense. With that, acquiring more targets would make a bit more sense.

10-Q

10-Q

More Products, Better Algorithms, And The API Could Bring Significant Revenue Growth And Push The Fair Price To $9.7 per share

Under normal conditions, Outbrain will most likely improve its algorithms, effectively manage its supply and demand, and design new products for media partners. As a result, management would expand the use of the platform, and revenue growth would stay close to market estimates.

Besides, I would be expecting that Outbrain will be able to enhance user engagement. In my view, if management successfully facilitates the discovery of content and offers exactly what visitors are looking for, long-term monetization would occur:

We believe that the user experience has a profound impact on long-term user behavior patterns and thus “compounds” over time improving our long-term monetization prospects. Source: 10-Q

I also believe that Outbrain will most likely develop new technological capabilities that will enhance its relationships with advertisers. It is another critical feature that Outbrain needs to deliver sales growth. Without developing new relationships with advertisers or acquiring advertising companies, revenue growth will simply not remain elevated:

Our growth is partially driven by retaining and expanding the amount of spend by advertisers on our platform, as well as acquiring new advertisers. Improving our platform with functionality and features that increase engagement and ROAS increases the attractiveness of our platform to existing and new advertisers while also growing our share of their advertising budgets. Source: 10-Q

Let’s mention that Outbrain also offers an API-based platform, which will likely multiply the productivity of clients and advertisers. With a sufficient number of programmers, I believe that the API could bring a significant amount of scalability, and enhance sales growth.

We believe that our proprietary micro-services, API-based cloud infrastructure provides us with a strategic competitive advantage as we are able to deploy code an average of 300 times per day and grow in a scalable and highly cost-effective manner. Source: 10-Q

Under the previous conditions, I assumed sales growth close to 8%-7%, an EBITDA margin around 5%-4%, and FCF/Sales close to 2.5%. My results include net sales around $1.972 billion, FCF of $49 million, and 2032 EBITDA of $79 million. If we also use an exit of 8x, the net present value of the terminal value would be $118 million. Finally, the implied equity valuation would be $542 million, and the IRR would stand at 19%. With 55.7 million shares outstanding, the fair price would be $9.7 per share.

Author's DCF Model

Author’s DCF Model

Worst Case Scenario

Outbrain reported more than $39 million in research and development, so I would say that the company is working on new innovations and products. With that, let’s not be naive. Outbrain may not please clients and advertisers. New products may not be as good as expected by clients, which could lead to revenue growth deceleration and a decline in free cash flow. In the worst case scenario, management may suffer brand destruction and a deterioration of the corporate image. As a result, the stock price will likely decline:

There is no assurance that our efforts to promote new or enhanced solutions, like video solutions or new advertiser tools, will be successful. If we are unable to generate an adequate return on our investment with respect to our research and development efforts, our business, results of operations, and financial condition may be adversely affected. Source: 10-k

10-k

10-k

Outbrain may suffer a bit if management loses its relationship with several media partners that represent a significant part of Outbrain’s revenue. In 2021, one partner accounted for close to 11% of the total amount of revenue. In a very detrimental scenario, losing that client would push the revenue down by approximately 11%. The free cash flow may decline too, which may make the stock price fall.

In 2021, our largest media partner accounted for approximately 11% of our revenues, whereas in 2020 and 2019, each of our two largest media partners accounted for approximately 10% of our revenues. Source: 10-k

Under this case scenario, I also assumed that Outbrain may not be able to sign many new agreements with advertisers, and may also lose some existing clients. Let’s note that the company does not sign long-term commitments with clients, so it may be easier for them to walk away. With less clients, revenue growth would decline over the long term.

We do not have long-term commitments from our advertisers. We seek to increase the number of advertisers and to reach new advertisers. Attracting new advertisers and expanding existing relationships with our advertisers requires substantial effort and expense. Source: 10-k

With sales growth of around -7.5% to -5%, I obtained 2032 net sales around $456 million. Also, with an EBITDA margin around 2.5%, FCF/Sales of 0.5%, and a discount of 20%, the NPV of FCF would be close to $15 million. With an exit multiple at 2x EBITDA, I obtained an implied enterprise value of only $15 million and equity valuation close to $175 million. If we also assume 55.7 million shares outstanding, the implied fair price would be $3.1 per share.

Author's DCF Model

Author’s DCF Model

If Outbrain Buys Other Companies, The Fair Price Could Be Much Higher Than $10

Outbrain has a lot of expertise in the M&A markets, and has already proven that it is ready to grow inorganically. Zemanta, and AdNgin were recently acquired. Considering the cash in hand, in my view, management could acquire a lot of new targets, which would bring more revenue, and would significantly push the company’s fair price up.

We have a track record of successfully executing a number of acquisitions and partnerships, helping us efficiently expand our offerings, grow our business and grow our talent. In 2017, we acquired Zemanta, providing us with advanced programmatic capabilities. In 2018, we acquired AdNgin, an advanced user interface optimization platform. In January 2022, we acquired vi, providing us with an expanded video offering for advertisers and media owners. Source: 10-k

I also believe that the cash in hand could be used to sign new partnerships. In my view, with sufficient investment in marketing, Outbrain’s new partnerships could become a catalyst for future revenue.

Conclusion

Considering the most recent stock buyback program and the new investments in algorithm enhancement, Outbrain’s stock price may trend north soon. Let’s keep in mind that Outbrain has a significant amount of cash to sign new partnerships, and it is considered to be the largest online advertising platform. With minor risks and considering that Outbrain may not develop new successful products, the company is quite cheap at its current stock price.

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