A complex and chaotic industry obscures value at YUME, a digital video ad network

June 16, 2014

This investment idea submission was posted to SumZero, a site for portfolio managers, on June 14, 2014.  YUME shares were at $5.42.

"Misunderstood and overlooked in a complex and chaotic industry, YUME is -30% YTD. But recent insider buying, 30% top line growth and a huge market opportunity suggests the bottom is in"

YUME is a provider of digital video advertising solutions, essentially an ad network that uses a sophisticated data-driven platform to match brand advertisers with providers of professional digital content across any screen. YUME had customer relationships with 73 of the top 100 U.S. advertisers at 12/31/13 and aims to convert a portion of television ad budgets to its network of third-party digital content sites and apps. Though the digital video industry is undeveloped, crowded and chaotic (the company calls it "dynamic and competitive" in its 10-K) , YUME's competitive advantage lies in its proprietary Software Development Kit (SDK) that publishers embed in their content. YUME's SDK facilitates the precise delivery of video ads to any participating device in any operating system or application and collects relevant data, including audience targeting, delivery, execution and reporting. And in what is an important differentiator, YUME's platform is not dependent on browser-based cookies that have limited utility on smartphones, tablets and connected TVs.

YUME's ad inventory is sourced from lesser-known sites that publish professional video content but may not have the resources to monetize video inventory itself. YUME has non-exclusive, revenue-sharing arrangements with hundreds of such publishers, from digital newspapers, enthusiast content and trade publications to popular blogs. Aggregating audience scale is important to brand advertisers accustomed to the reach of television.

Industry Backdrop:

The opportunity for YUME is substantial: U.S. broadcast and cable television advertising is a $70B market that is ripe for disruption as audiences - especially younger ones - fragment away from conventional television. Television advertising continues on a mid-single digit upward annual revenue trajectory boosted by incremental CPM (price) hikes despite persistent audience erosion. But there is plenty of historical precedent for migration of ad spend from entrenched incumbents to scrappy upstarts. Advertisers and agencies ultimately wake up to structural changes in the media landscape and belatedly shift dollars to follow consumer content consumption; it takes hold later than it should, starts with a trickle and often becomes a flood. At $6B in gross billings in 2014, we are in the trickle stage for digital video as an ad medium; billings are projected to double over the next 3-4 years. The following chart from eMarketer provides forecasts for television and digital video advertising:


 
In fact, YUME itself uses a television analogy to describe its position in the digital video market. If YouTube and Hulu are the broadcast networks, YUME - with its more obscure, less visited content partners known as sub-premium content - represents the cable networks of the digital video space. For historical reference, cable networks U.S. ad revenue has gone from zero to $36B over the past 35 years.
The largest player in the digital video advertising space, of course, is Google with its YouTube service. A decent estimate has YouTube at about $3.5B of revenue in 2014 or 65% of the entire global video advertising market. Video ad dollars captured by Facebook and Hulu brings the total market share for the top 5 or 6 premium publishers to about 85%, which means YUME's current addressable market is about $850m (of the $5.5B pie), growing at ~40%. Several premium publishers sell their own video ad inventory, especially those whose core business is offline video advertising (e.g., broadcasters and cable networks). There are other ad networks and automated exchanges operating in the space, though few, if any, are as video-centric, optimized for mobile and brand-friendly as YUME. The shift away from the desktop to consuming digital video content on mobile devices is shown in this chart from eMarketer:


 
The presence of Google as a primary competitor in a marketplace tends to negatively impact the value of its smaller competitors and that is certainly a factor with YUME and its stock price performance. But we believe that there is more advertiser demand for quality digital content than existing inventory, suggesting there is room for more than a single dominant player here. Further, non-Google publishers likely prefer handing inventory to an ad network that is not competing with them for audience and advertisers as YouTube does. Finally, it’s important to remember that plenty of YouTube’s content remains user generated and unprofessionally produced despite a recent emphasis on higher quality submissions.
Another factor complicating the YUME investment analysis (and, indeed, comprehension of the entire digital video industry) is the growing prominence of programmatic ad buying and, especially, Real Time Bidding (RTB), a dynamic auction-based ad buying format that brings pure efficiency to the ad buying marketplace. While automated exchanges and RTB platforms are threats over time as the technology and execution improves, many brand advertisers remain wary of open exchanges and RTB due to poor campaign execution. There have been several recent media reports of brand advertisers finding their programmatic, exchange-served video ads running in objectionable content and, further, plagued by fraudulent (bot-driven) traffic and gaps in audience measurement across multiple screens. Brand advertisers are beginning to insist on more precision and accountability from ad tech vendors and that plays to YUME’s strength. With what it calls its Placement Quality Index (PQI), YUME’s proprietary algorithms optimize audience targeting and ad performance across digital properties and consumer screens, YUME can deliver a more secure ad environment for brands. In March, joined the shift to programmatic by launching Video Reach, its automated platform capable of delivering ads across multiple screens.

Valuation:

YUME sits squarely in the maligned, misunderstood and complex ad tech space. That unfortunate factor, along with a modest Q4 2013 revenue miss (attributed to timing and overaggressive forecasting) and what appears to be recent indiscriminate dumping of stock related to VC distributions to limited partners, has weighed heavily on YUME shares. The stock is down ~30% YTD and down 43% from its August 2013 IPO and now trades at a meaningful discount to its closest peers TRMR, MM, RUBI using the most relevant metrics of EV/EBITDA and EV/Revenue. YUME shares also trade below the ~$6 price paid by pre-IPO investors in the Series D round in 2012. There was insider buying from a YUME board member in late May around $5.25 per share.

YUME reported 2013 revenue of $151m (+29%) and adjusted EBITDA of $9m (-25%) and has provided 2014 guidance of $190m to $200m (+29%) and $2m to $8m. With the digital video category forecasted to grow by 42% in 2014 and 30% in 2015 according to the above eMarketer chart, it seems YUME's guidance may be a bit conservative. As for 2015, $250m of revenue (+23% over $195m mid-point of 2014 guidance) seems readily achievable. That should be sufficient to generate some scale economics and sustainable positive EBITDA, perhaps in the $15m range (6% margin), which would put YUME's current trading multiple at just 7x adjusted 2015 EBITDA and 0.44x revenue, very undemanding multiples given the growth profile and industry momentum. Note that my current EV uses a $5.25 YUME share price and $59m of balance sheet cash ($1.84 per share) but ignores a hefty net receivables balance of $30m at 3/31/14. Our target price of $9 per share - the August 2013 IPO price - implies a $230m EV and a EV/2014 revenue multiple of just 1.18x, well below that of technology companies with comparable or lesser growth rates.

Summary Investment Thesis:

YUME operates in the fastest-growing segments of digital advertising - video and mobile. As consumers view more digital video content, prefer it on a tablet or smartphone and brand advertisers shift dollars from television ad budgets, YUME is well positioned to continue its impressive recent revenue growth. The stock has been punished in recent months and now trades at the most attractive relative value among its closest ad tech peers. A return to YUME’s $9 IPO price could be driven by the company exceeding guidance in coming quarters and as investor comprehension and sentiment improves in the sector. With nearly $2 per share in balance sheet cash and EBITDA moving sustainably into positive territory, the risk/reward profile is favorable at current price levels. Recent insider buying in the $5.25 range suggests that we're not alone in that view.