Over the past few months, as ironSource (NYSE: IS) — a company that thrives in the ad “app economy” — has been in decline, and I’ve been buying as much as I can.I believe Since November, the stock has only followed the general downward trend in growth companies, even as business continues to be hot. In other words, just as the 2020 tide lifts all boats, the 2021/2022 tide floods all boats, although not all boats are the same.
With the stock currently trading in the low double digits and the low single digits, I don’t see how a company with such a growth rate could fall further, and once the stock falls, the stock is expected to be a bull. Macroeconomics improved and investors reduced their “risk” aversion.
In particular, I’ll attest that IronSource’s quality is similar (if not better) to The Trade Desk (TTD) and Cloudflare (NET), albeit a staggering 5x cheaper.
I have previously described IronSource as my top stock for 2022: ironSource: My Top Belief Top Tech Stock for 2022. Investors can also view some articles by other contributors.
first quarter results
In May, ironSource reported its fourth earnings report since its IPO. Last year’s revenue grew from $120 million to $190 million, a 58 percent increase. Note that the sequential growth from Q4 to Q1 was 20%. In fact, growth accelerated again from 46% in the first quarter. (Although management apparently expected this result more or less, since the first-quarter guidance was as high as $185 million, the “beat” wasn’t as big as the fourth quarter.)
From these numbers alone, there are already several things to observe. First, any business that grows at 58% is a healthy business. Sure, some companies have only grown at this rate for a few quarters, but IronSource’s multi-year track record is impeccable. Second, the re-acceleration of growth rates (month-over-month comparison) is particularly encouraging as it shows the latest demand trends for the company’s products.
One thing that further draws my attention to the stock is IronSource’s incredible world-class net retention rate, which hit 153% in the first quarter, which is indicative of the stickiness of the company’s product suite and its ability to cross-sell new products to its customers. Customers with revenue over $100,000 grew 36% to 397.
Note that net retention is a backward-looking metric. For example, DocuSign’s (DOCU) net retention rate has seen a pretty severe decline over the past few quarters.
Investors’ problems with IronSource led to further losses following the release of the first-quarter report, which was downwardly revised guidance.
Guidance for the second quarter fell slightly sequentially, halving the growth rate in just one quarter. Full-year guidance is also down significantly (~5%).
The guidance is based on reports from its clients (casual gaming) regarding uncertainty about the macro environment in the second half of the year and some post-COVID digestion. Still, management has repeatedly said that it hasn’t seen anything in its own KPIs. As such, the new guidance appears to be a case of management being very cautious.
Also note that ironSource is still a very profitable company (despite prioritizing growth as a growth company) with a historical EBITDA margin of around or above 30%. IronSource’s long-term goal is to exceed 40%. While that’s not yet Microsoft’s (MSFT) 50% profit margin, Microsoft’s growth is much lower, but it also trades at a 3x higher P/E ratio of about 9x.
IronSource’s business is currently dominated by gaming applications. IronSource sees an opportunity to expand its platform into many other verticals beyond gaming. Second, Aura currently only accounts for 10% of revenue, and ironSource is targeting 20-25% of long-term revenue. Third, ironSource continues to introduce new products (both organic and acquired), such as recently launched marketing products. In the end, ironSource sees substantial opportunity to continue expanding revenue from existing clients.
IronSource saw $50B in TAM, a large portion of which came from the Luna marketing platform.
According to Seeking Alpha data, ironSource trades at around 13 times earnings and 3 times earnings (both forward value). That’s a very cheap valuation for a software company. Suffice to say, businesses with these numbers are likely to be priced at 10 to 20 times P/S in 2020. In fact, some other companies like Cloudflare and The Trade Desk still trade at such multiples. This means IronSource’s price is 5 times lower.
This means that multiple expansions alone provide a very large advantage. Obviously, these multiples are unrealistic in the current environment (as the SaaS multiple has now fallen below the multi-year average), but the stock is currently priced as if it’s not growing at all. Just imagine you’re doing groceries and you have the option to buy one Cloudflare or five (5!!) shares of ironSource at the same valuation. One could argue that Cloudflare offers more promise for long-term growth, but IronSource actually has a stronger track record, see below.
So, in one scenario, with a 30-40% growth rate (well below its historical growth rate and net retention rate, but in line with current guidance), revenue would double in 2-3 years. If there are additional multiple expansions, then there is more upside. In this case, the stock could easily go 4x or more.
For example, given IronSource’s growth and profitability, a 10x P/S target for the stock doesn’t seem unreasonable. In this case, in order to become a 10-bagger, ironSource would need to grow its revenue to its current $2.6B market cap. While maintaining high growth rates on a billion-dollar scale has become more difficult, the Seeking Alpha page shows an example of an analyst’s estimate.
IronSource and Cloudflare and The Trade Desk
To provide more context for the comparison with TTD and NET, I have compiled the following table. It’s a bit busy, but it should make sense.
Shown below are the historical and projected growth rates for the three companies. But then I adjusted them so that they start with roughly the same revenue scale. For example, TTD had $114 million in revenue in 2015, Cloudflare had $135 million in 2017, and ironSource had $105 million in 2018. All three are aligned horizontally in the spreadsheet.
Fast forward, in five years, ironSource’s revenue will grow 10.7x (2018-2023), Cloudflare will grow 7.1x (2017-2022), and The Trade Desk will grow 7.3x (2015-2020). This means that in five years, ironSource has grown as much as about six years in the other two years.
All in all, ironSource’s multi-year growth has been faster than when the other two companies were of similar size. If these trends continue, ironSource may even surpass Cloudflare in revenue within a few years. While Cloudflare has not given guidance for 2022, ironSource has been closing in on Cloudflare’s revenue over time. Meanwhile, comparisons with The Trade Desk suggest that ironSource could also reach multi-billion dollar scale within a few years if current trends continue. Of course, TTD and IS have very different businesses (one is a software company, the other is an advertising company), so the comparison is only illustrative.
Anyway, the point here is that if the choice is between buying one piece of NET or TTD or five pieces of IS, IronSource wins by a landslide as the business has proven to be of similar quality over time, But it was trading at a staggering five times lower than its valuation.
Regardless of the macro environment, the overall long-term trend for ironSource’s business is fairly clear up and to the right. To that end, ironSource just reported quarterly growth of 58% year over year (up 20% sequentially) as a proof point. While the revised guidance may be a little disappointing to some, management is clearly taking a cautious approach to anticipating a more challenging second half of the year by lowering expectations, which some call the kitchen sink quarter.
When it comes to stocks, I like to buy stocks when they’re cheap, and in that regard, I haven’t come across many companies growing at such a high rate yet trading below many value stocks, as if IronSource is not going at all. Obviously, it’s impossible to predict exactly how much IronSource will grow over the next 10 years (the company’s revenue has grown more than 10x over the past 5 years), but current valuations leave a very large margin of safety. Specifically, ironSource seems to be 5 times cheaper than comparable TTD and NET. Investors should take advantage of this opportunity.