Integral Ad Science – Flexible Price Action, Resilient Operating Performance (NASDAQ: IAS)

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Shares of Integral Ad Science Holding Corp. (NASDAQ: IAS) struggled after the company went public in the summer of last year. At the time, I had concluded that Integral relied on impressions, because it was trading at attractive relative valuations. With stocks under pressure since the summer, amid falling tech valuations, appeal has increased significantly as the company is doing very well operationally and gearing up for another strong 2022.

Number of impressions

Integral Ad Science is on a mission to make impressions count. The company hopes to become a benchmark for trust and transparency in digital media for major brands, publishers and platforms.

Customer impressions are measured across many channels and parameters, and with the increase in the number of channels and parameters, it is the reliability and quality of impressions that become more important, as they are currently lacking. Hard-to-measure impressions include screens, social platforms, video, browsers, CTV, and other channels.

With the amount of advertising spending on the rise, there is a real role to play for those who can provide reliable data on these hard to measure channels. The company aims to do this with its Media Rating Council, which is the metric to verify that an impression is seen by a human and not a bot. The company has relationships with all the major players, including users of platforms like Amazon, Facebook, Google, Instagram, and Pinterest, among others.

With hundreds of billions spent on online advertising, this requires quality metrics, because there certainly was and still is real potential. The company went public at $18 per share last summer, which has reduced to a business valuation of $2.7 billion.

The company generated $213 million in sales in 2019, on which it recorded a loss of $34 million. The company grew sales 13% to $240 million in 2020, in what was a very strong year to be sure, as operating losses narrowed to $14 million. Encouragingly, the company ended 2020 with >20% revenue growth, with Q1 2021 sales growing 24% to $67M, at a run rate of $268M , implying a valuation of about 10 times sales. The fact that operating profit was posted at $3 million in the first quarter of 2021 was encouraging, at least no losses were showing, which was the case with many tech IPOs at the time.

The 10x sales multiple translates to relative appeal, but the 20% revenue growth was decent, but nothing spectacular. Also, the fact that profitability was achieved was heartening, but, of course, earnings multiples were not indicative here. Besides the valuation risks, I think the advertising market was cyclical, as the effectiveness of the solution (and that of its peers) was arguably the biggest risk.

And now?

After the stock went public at $18 and traded around the $20 mark in the early days of trading, the stock saw relatively low volatility following its offering as relative attractiveness made stocks to climb to the $30 mark later in 2021. Since then, stocks have sold off, alongside the rest of the sector, now trading just below the $12 mark, down 60% from the higher and down a third from the offer price.

Since the public offering, we’ve seen a lot of news flow. In August last year, Integral announced the $220 million purchase of Publica, a connected TV advertising platform, with few financial details announced other than the purchase price. The company further reported strong sales in the second quarter, with revenue up 55% to $75 million and shifting amid a rapid increase in programmatic revenue. The company posted EBITDA of more than $25 million, albeit heavily misrepresented, with $41 million in adjusted stock-based compensation related to the IPO.

The company guided flat sales on a sequential basis, although EBITDA was expected to pull back a little to $17 million, but operating momentum was still very strong. Other operational dynamics were observed in the rest of the year, notably a partnership with TikTok.

Third-quarter sales slowed 32% as revenue of $79 million was higher than expected, as adjusted EBITDA of $25 million was also significantly higher than expected, but stable on a sequential basis. Stock-based compensation fell back to $8 million in the third quarter, though the company is reporting quite a bit of D&A charges. Additionally, the company reported a strong year-end, with fourth-quarter sales at a midpoint of $95 million and adjusted EBITDA of approximately $29 million.

The company quickly built a reputation for exceeding its own forecasts. In March, it became apparent that fourth quarter revenue rose 31% to $102 million and changed, with EBITDA improving further to $33 million. This resulted in real profits with stable stock-based compensation around $9 million and while D&A expenses were $17 million, the majority is likely amortization expenses, revealing profitability real.

With a resulting stock count of 143 million shares, the valuation fell to $1.7 billion, or nearly $1.9 billion when taking into account net debt of $170 million. . Guidance for 2022 calls for revenue at a midpoint of $420 million and EBITDA at a midpoint of $131 million. This translates to 30% revenue growth and similar EBITDA growth after this metric hit $103 million in 2021.

This all comes down to 4-5x sales and an adjusted EBITDA multiple of 15x, as realistic earnings multiples are likely still very high, at least double the EBITDA multiple.

Conclusion

With signs on the horizon that the advertising market is weakening a bit, in part due to a reversal of the pandemic game with less spending and therefore likely advertising on digital channels, there are room for a downside surprise. Despite this concern, I am pleased with continued 30% revenue growth this year, albeit in slightly mild form. Additionally, EBITDA margins are showing at a similar pace as the business is truly profitable, and discipline seems to be needed in equity compensation, not always applicable for recent IPOs.

Given all of this, I see the allure growing rapidly here and while there are still some concerns, the risk-reward ratio has improved significantly as the allure quickly becomes apparent to opportunistic investors with a tolerance to certain risks.

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