CRTO Q2 2015 Notes

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1

Hi all,

Below are my notes on CRTO’s Q2 2015 earnings.

Thanks,

Anirban
(Long CRTO)

Links

Prepared remarks: http://files.shareholder.com/downloads/AMDA-2220FT/141323757…

Press release: http://files.shareholder.com/downloads/AMDA-2220FT/141323757…

Transcript: http://seekingalpha.com/article/3395725-criteos-crto-ceo-jb-…

Some comments

  1. Let’s start by looking at Ex-TAC revenue:

-------------------------------
Quarter   Ex-TAC      YoY Growth
-------------------------------
Q2 15    €110,455    64.80%
Q1 15    €105,160    67.63%
Q4 14    €96,303    75.56%
Q3 14    €77,596    65.75%
Q2 14    €67,022    67.42%
Q1 14    €62,733    69.38%
Q4 13    €54,855    
Q3 13    €46,815    
Q2 13    €40,032    
Q1 13    €37,036  
-------------------------------

Ex-TAC revenue increased 65% QoQ, partly aided by favourable currency movements. The strength of the US dollar helps them because Americas is their fastest growing geography. The growth was about 52% in constant currency, again nothing to sneeze upon.

The Americas growth rate was 114% and contributed about €40M to the total Ex-TAC revenue. EMEA grew 38% to €49M, while Asia-Pacific grew 66% to €22M. Asia-Pacific is still a small pie of the overall business, but I like the growth there. I like how the Americas market is growing. This market is highly competitive but also highly lucrative.

  1. Adjusted EBITDA grew 64%, or 60% at constant currency, to 22M€. This is pretty good as well.

  2. Let’s next look at the client adds. Recall that ‘client’ refers to those interested in placing adverts. Also note that there’s some client churn as well, so the numbers can’t be figured out by simply subtracting client count in Q1 15 with those in Q2 15.


------------------------------
Quarter  total     adds
------------------------------
Q1 14     5,567     ---
Q2 14     6,131     ---
Q3 14     6,581     ~450
Q4 14     7,190     ~600
Q1 15     7,832     ~640
Q2 15     8,500     ~730
------------------------------

Their client retention rates are around 90%. That’s pretty solid, and Criteo is seemingly taking big strides in adding both large and mid-market clients. This was another quarter of record client adds. Solid retention rates coupled with record client adds seem to suggest that these guys are delivering value to their clients.

I like to track the average revenue ex-TAC (per client) to get a sense of the leverage obtained by adding more clients. I ‘m trying to see if the average ex-TAC/client is showing signs of flatlining, which would suggest that more clients are added but they might not be ‘high’ value clients. E.g., what is the impact of adding large versus mid-market clients? Let’s look at the numbers:


---------------
Q2 15     12.9
Q1 15     13.4
Q4 14     13.4
Q3 14     11.8
Q2 14     10.9
Q1 14     11.3
Q4 13     10.8
Q3 13     10.1
Q2 13     9.4
Q1 13     9.7
---------------

The above don’t really point to anything that I would say is worrisome. The Ex-TAC/client slowed down in Q2 versus Q1, which is sort of similar to what happened in 2014. I would watch what happens here in the next two quarters. At some point, there wouldn’t be much more leverage to obtain from adding more clients (i.e., the average would flatline, but it’s not clear if we are already there.). Usually Q4 is a big quarter for advertising, so we will have to wait to get a sense of the ongoings.

  1. I also look at the growth in Publisher count. Recall that ‘publishers’ are those with the ad spots or inventory. It seems their publisher market place is growing nicely. Their direct relationships went up to 11,000 publishers. They had reported more than 10,000 publishers at Q1 2015. There’s a bit of network effect going on here. Clients are receiving high value from advertising with Criteo, which possibly helps them bring more ad inventory to them, and high-quality ad inventory in turn attracts more clients. I like what’s going on here.

  2. Ad Blocking in iOS8 has been a cause of concern. However, ad blocks have been around for ages, and it is my opinion that they are difficult to use. One key issue with any form of ad blocking tech is the ability to distinguish between functional components of a web page/app versus the non-critical components of the web page/app. This might appear to be a simple thing but is not so easy a problem to solve. Many don’t use ad blockers because solutions don’t address this problem. Additionally, we should note that this is an Apple specific concern. The question to ask here is — what percentage of Criteo’s target base are Apple iOS users? And what percentage of these users are going to use any form of ad block?

  3. Guidance
    Q3 2015 Guidance
    Ex-TAC Revenue = €117M (at mid-point)
    Adjusted EBITDA = €22M (at mid-point)

FY 2015 guidance
Ex-TAC Revenue = €472.5M (at mid-point)
Adjusted EBITDA = €123.5M

The above implies Q4 2015 guidance of:
Ex-TAC = €139.9M
Adjusted EBITDA = €51.4M

Some of the questions in the conference call focussed on margin compression, i.e., if we look at the EBITDA as a percentage of Ex-TAC revenue, it looks like there is a trend of declining margins. My calculations have the numbers at Q1 Q2 15 - 19.7%

Q1 15 - 26.7%
Q4 14 - 33.1%
Q3 14 - 25.6%
Q2 14 - 19.8%
Q1 14 - 23.1%

The guidance implies Q3 15 margin at 18.8% and then a jump in Q4 15 to 41.6%. This trend seems consistent with what we had seen in 2014, but the expected margin expansion for Q4 15 does seem large. This could be just the way they are investing in the business. The call pointed to ongoing investments in data centres (Paris, Shanghai) and new offices (Middle East, Canada, Eastern Europe etc).

Concluding thoughts

The growth in both clients and publishers is demonstrating that Criteo is gaining momentum. It looks like investments into the business is clouding the profitability. There are also some question marks from Apple’s move to allow developers to build content blocking extensions. I don’t think the content blocking issue is a big deal. Ad block tech has been around for ages, and we need to realise that much of the free Web/app experience is setup on giving something (personal data for harvesting, ads etc) and this model is unlikely to change in a hurry. I think legislative risk is the one we should be looking out for. So far, it looks like 2015 is going to be a year of investments. This was flagged in Q4 2014 and Q 1 2015, so its not something we weren’t told, but shareholders would like to see profits increase without investments :slight_smile: I suspect the wild swings of this stock will continue for a while. I still like their long-term prospects.

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2

The question to ask here is — what percentage of Criteo’s target base are Apple iOS users? And what percentage of these users are going to use any form of ad block?

Management on the Q2 2015 conference call said that for their business iOS user made up business in the teens. This could be 13-19% so let’s call it 16% because it’s the midpoint. Ad blocking will for iOS devices would be not installed as a default so the user would have to actively install the blocking. So what percentage would do that? I think 10% of users would be a high estimate and it would likely be less than that (IMO). Therefore, I would think that the maximum impact of iOS ad blocking would be affect 1.6% the people who are targeted by CRTO. This does not mean that CRTO would lose 1.6% of its business. To figure the business “loss” to CRTO we would need to estimate the loss of clients and client overall net reduction of client spend as a result of iOS blocking. CRTO should be able to very accurately determine the portion of their impressions that are being blocking (once iOS blocking is implemented). If these figures are indeed 1.6% of the displayed ads then CRTO will be able to convey this info to their clients. But practically speaking clients will keep spending on CRTO so long as the payback in terms of increased sales justifies the spend. My prediction is that iOS ad blocking will have no meaningful effect on CRTO’s business.

Chris

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3

Anirban, thanks for the nice summary and analysis of CRTO’s 15Q2 financial report and conference call. I would only like to expand on a couple of points, 1) ad-blocking and 2) shareholder expectations.

  1. Ad blocking: JB Rudelle, CEO and Co-Founder addressed this issue twice, once during his scripted comments and once again during the Q & A. The primary takeaway is that the vast majority of advertising presented by Criteo is displayed on an Android device. Providing a user accessible ad-blocking software switch in a future release of iOS devices is anticipated to have only a minimal impact even if chosen by a large percentage of iOS users.

  2. Shareholder expectations: So far, it looks like 2015 is going to be a year of investments. This was flagged in Q4 2014 and Q 1 2015, so its not something we weren’t told, but shareholders would like to see profits increase without investments :slight_smile: It is my considered opinion, based on my own personal experience that the overwhelming majority of investors simply ignore the SEC documentation released by the company. If the pop financial TV and print press does not report it the average investor will remain ignorant of the news.

4

If Apple’s ad blocker provides an easy setting for a blanket blocking of all ads, if a large percentage of Apple users adopt ad blocker, then this would be Apple against the entire web. The backlash would be that some free sites may not be optimized for Safari. The result is that Safari users might simply not able to access those free sites on the web, seriously diminishing user experience. Apple is too smart to do that. My guess is that Apple may provide a way for users to block certain more aggressive/intrusive type of ads such as popups.

What is ironic is that currently many of the Apple users who do deploy ad blocker use 3rd party such as Adblock Plus. With Apple’s native ad blocker, Adblock Plus is seriously worried about losing users.

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Hi Chris,

My question regarding the percentage of users affected was rhetorical :slight_smile: I totally agree with your analysis - iOS ad blocking will have little meaningful impact on the business. In any case, this is a cat & mouse game, the ad companies figure out ways to bypass blockers, the blockers figure out how to fortify their solutions, and it keeps looping.

The growth in the client and publisher base shows that CRTO’s marketshare is increasing and we might be starting to see some “network effect” here.

Anirban

6

Some of the questions in the conference call focused on margin compression, i.e., if we look at the EBITDA as a percentage of Ex-TAC revenue, it looks like there is a trend of declining margins. My calculations have the numbers at Q1 Q2 15 - 19.7%

Q1 15 - 26.7%
Q4 14 - 33.1%
Q3 14 - 25.6%
Q2 14 - 19.8%
Q1 14 - 23.1%

The guidance implies Q3 15 margin at 18.8% and then a jump in Q4 15 to 41.6%. This trend seems consistent with what we had seen in 2014, but the expected margin expansion for Q4 15 does seem large.

The jump in margin is significant definitely concerning. The way I interpret the massive margin expansion is that in addition to their current ~20% margin business they will be adding very high margin revenue say ~60% in order to bring the average margin up. Am I looking at this wrong?

This feels like a earnings disappointment waiting to happen.

Eric

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Eric

My interpretation is that their customers are generally prepared to buy more ads in Q4. So the Revenue goes up, as will the variable part of their costs, but fixed components (obviously) won’t: hence apprentice margin improvement.

Others have been following the company longer, and may know more about their cost structure - what is this focus on Rev after TAC?!? - and so may be able to validate or refute the above.

Hope this helps

Cham

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