overview
The Trade Desk (TTD) reported earnings well ahead (10-15 pts higher) of my top-line expectations on both 2Q22 results and the 3Q22 guide. Revenue growth in Q2 was +35% YoY, a deceleration from +44% in Q1, but above their guidance of +30%. Sequentially, revenue grew ~20% QoQ or $61.5M vs. 2Q21 of ~27% or $60.2M. The Q3 revenue guide of "at least $385M" represents growth of 28% YoY, with political contributing LSD %. In 3Q20 political contributed ~770bps to the top-line, so management is expecting a more muted impact consistent with non-presidential election cycles and likely more competition from OOH ad-formats compared to 2H20 (as they should).
If we take the Q3 revenue guide at face value (some will interpret it as conservative after beating Q2), there are signs of a sequential moderation in growth. The $385M is only a 3% QoQ ($8.2M) increase - below the 7.5% QoQ ($21.1M) in 3Q21, but more in-line with 2019/pre-COVID seasonality where 3Q19 increased 3% QoQ. If we assume political contributes 250bps in Q3, then excluding political 3Q22 revenue will be essentially flat compared to 2Q22.
On the earnings call, management noted that all verticals that represent at least 1% of spend increased double digits in Q2. Travel and pets "more than doubled" compared with a year ago. Food and drink (13% of '21 spend), and technology (8%) were also "very strong", with food and drink "accelerating on a YoY basis every month during the quarter". Home and garden (7%) and Automotive (10%) grew "slower than average", but grew "faster than the average in July" (easier comparisons).
So how could I have been so wrong in my modeling of Q2/Q3 revenue growth? And how is The Trade Desk (TTD) putting up such good numbers while everyone else is showing signs of weakness?
First, I underappreciated the extent/magnitude of share gains. I never doubted or disagreed with TTD's strong competitive position as the leading independent DSP - with the best technology and scale. However, I did think that cyclical headwinds would more than offset secular tailwinds + share gains relative to their guidance and consensus estimates.
Solimar's rollout and recent new business wins + retail media ramp + CTV partnerships + UI2 are driving the outperformance. On the earnings call, Jeff Green (TTD CEO) admitted to not being immune to the macro but said "...through 1H22, believe we grabbed more land/market share than any period in our history."
There is one wrinkle though...
The company stopped reporting gross billings on a quarterly basis at the end of 2020. And while revenue is a function of gross billings, a significant swing factor is the take rate % - where +/- 50bps can drive $10M upside/downside or ~400bps growth in a given quarter. The take % can be influenced by mix of business (volume-based discounts for larger accounts) and campaign complexity/targeting and use of first/third-party data (more data, more complexity = higher take). Between 1Q17 - 4Q20, the take rate % averaged 20.8% with a standard deviation of 71bps. Therefore, without this disclosure, it is impossible to quantify or prove the extent of share gains (which would be measured by % change in gross billings or ad spend).
So in the absence of a reported billings number, the closest KPI we have to measure billings and billings growth is 'accounts receivable' which is defined in the 10-Q as:
"The Company generally bills clients based on Gross Billings, which is the gross amount of Supplier Features they purchase through its platform and the platform fees, net of allowances. The Company’s accounts receivable are recorded at the amount of Gross Billings for the amounts it is responsible to collect."
You can see from the below charts/tables that revenue growth has been outpacing receivables growth YTD - as well as our estimate of billings. And in 2Q22, accounts receivable increased by only $142M or 8% QoQ, compared to revenue of 19.5% QoQ. From this, we conclude that the rate of billings growth (client ad spend) is more muted than what is implied by the reported revenue figure and consistent with our top-down view of the advertising industry.
The offset in revenue for the TTD is a higher YoY take rate - which is not a bad thing assuming it is sustainable. Typically we see downward pressure on take rates over time as DSPs grow share of wallet with existing customers and volume-based discounts kick in. And during economic contractions, less use of expensive third-party. If we hold the take rate % constant relative to 2021 revenue growth is as follows:
Holding A/R % Take Rate Constant:
1Q22 Actual +43.5% YoY vs. 28.7% YoY (Delta 1,480bps)
2Q22 Actual +34.6% YoY vs. 24.5% YoY (Delta 1,010bps)
3Q22 Guidance +28% YoY vs. 17.8% YoY (Delta 1,014bps)
Holding Billings % Take Rate Constant:
1Q22 Actual +43.5% YoY vs. 31.5% YoY (Delta 1,195bps)
2Q22 Actual +34.6% YoY vs. 26.7% YoY (Delta 795bps)
3Q22 Guidance +28% YoY vs. 17.4% YoY (Delta 1,047bps)
The bottom line... if the strong revenue performance is really being driven by an increase in take rate % while total billings growth is slowing (as it appears), then the "share gain" narrative is far less impressive. It also increases the risk of an even greater deceleration NTM assuming 100-200bps YoY improvement in the take rate is not sustainable... which I don't think it is sustainable since platform fees are inherently deflationary. Either way, I underestimated the take % in my model this Q and next.
Management's Q3 guidance for 28% revenue growth or mid-20s excluding political, is a sequential deceleration of 660 - 960bps. If we assume a 50bps QoQ increase (150-175bps YoY) in the take rate Q3/Q2 (consistent with prior years), then the implied gross billings YoY growth rate is 26% YoY or down 0.55% QoQ (vs. 0-3% increase 2018/2019). If we lose a 1,000bps revenue growth tailwind as we lap a higher take as advertising spending continues to slow, then it is not unreasonable to assume revenue growth slows to 10% YoY NTM.
Now... with respect to Connected-TV (CTV) trends. The programmatic channel has long outpaced total growth in CTV since it is growing off a smaller base with less share of the overall market. But if we could have an apples-to-apples look at TTD CTV advertising spend (NOT revenue) versus ROKU, PARA, MGNI, PUBM, and CMCSA - I still think we would see a similar slowdown at TTD.
Said differently, I don't believe the correct read here is that TTD grew revenue 35% in Q2 and guided to 28% revenue growth in Q3. And management said CTV continues to grow faster, so CTV advertising spend is growing 40%, 50%, 60%, etc. I am not saying that TTD isn't taking market share, but I do have a hard time believing that TTD is posting such high levels of growth when platforms/walled gardens, publishers, and smaller DSPs are seeing anywhere from 0 - 15% growth going into Q3.
We can debate the future of TV buying long-term (programmatic vs. upfront vs. scatter), but our field work runs counter to management's claim that the "spot market is amazingly strong - the strongest it has ever been" in the short-term (our 'Field Work' could be wrong). I understand they are differentiating between the scatter market that is tied to the upfront, vs. the "spot" that management views as being completely independent. But most advertisers running campaigns on CTV don't make allocation decisions that way.
What to do with the stock?
To be clear... I got this one very wrong. In both the near-term setup, but also in my fundamental expectations/modeling. Based on the thesis, I had a choice between The Trade Desk (TTD) or Magnite (MGNI) on the short side - and I chose poorly. I knew Magnite was the weaker operator but chose the TTD because of its size - where I thought it would see a greater negative impact from the cyclical. Right church, wrong pew.
And while I can appreciate/understand the factors that are driving the stock +35% to $74/share - the stock now commands an Enterprise Value of $35B and is trading at ~46x and ~34x consensus 2023 and 2024 EBITDA estimates, respectively. The multiple is back to the mid-point of the historical 5-year range and is trading at one of the largest premiums to its forward growth rate with clear signs of deceleration in the top-line from here going into 2023.
Meanwhile, operating expenses continue to outpace revenue growth resulting in a 460bps YoY decline in Non-GAAP operating margins. While total revenue grew +35% YoY in 2Q22, Adjusted EBITDA increased by only +18% YoY (slowest rate of positive growth since 2017), and the Q3 guide calls for a further deceleration to +14%YoY.
And for those who care, stock-based compensation represented 90% of Adjusted EBITDA in 2Q22 and 103% in 1Q22. GAAP net income has been negative for the last two quarters, and YTD CFO of $238M would have been ($12.2M) if we don't add back SBC.
All this considered, absent a significant cyclical acceleration / improving macro, it is hard to justify further multiple expansion from here. And it is more probable we see multiple contraction if fundamentals continue to trend in the current direction. So while I am certainly not proud of the outcome today, we are keeping The Trade Desk (TTD) on as an active short for tomorrow.
Please call or e-mail with any questions.
Andrew Freedman, CFA
Managing Director
@HedgeyeComm
