Taboola: Earnings Beat Despite Advertising Market Headwinds

Taboola (NASDAQ:TBLA) is a leading ad-tech platform that has an elite list of publisher customers including Business Insider, CBS, Bloomberg, ABC, USA Today, and many more. Basically, when you visit the aforementioned websites, you are likely to see display advertising. However, unlike traditional "banner ads", which are often irrelevant to the website, Taboola's adverts aim to seamlessly merge with content, as you can see in the image below.

Given the global programmatic advertising, the market was valued at $451.3 million in 2021 and is forecast to grow at a 35.8% compounded annual growth rate [CAGR]. Taboola is poised to benefit from this trend. In fact, Taboola recently beat both top and bottom-line financial estimates for Q4,22, which was positive given the tough advertising climate. In this post, I'm going to break down its financials and valuation. Let's dive in.

Mixed Financials

Taboola reported mixed financial results for the fourth quarter of 2022. Its revenue was $371.27 million, which beat analyst expectations by $3.87 million despite declining by 8.93% year over year. This was impacted by a cyclical decline in the advertising industry, which resulted in a budget loss of ~$71 million, which was extensive. A positive is this was offset slightly by a $35 million increase in budgets, driven by newly signed partners. Notable wins included the Huffington Post, Fox Sports, Time Out, BuzzFeed Brazil, and Japan in addition to a lucrative 30-year deal with Yahoo. This basically means if an advertiser wishes to run adverts on Yahoo News, search, or its related media properties such as Yahoo Finance, they must go through Taboola. This effectively gives Taboola access to close to 900 million monthly active users.

The Yahoo partnership is also interesting because Yahoo has been a rival of Google since the early days, and even though the two companies have taken very different paths, it is clear there is still some rivalry. Taboola aims to effectively disrupt Google's lucrative advertising model (paid display ads) through its "walled garden" approach of publisher partnerships. This is poised to be especially useful given the web "cookie" is crumbling. The Apple iOS 14 update, launched in 2021 meant apps must now ask users if they wish to be tracked. Google also announced plans to phase out cookies for its chrome browser by 2023. In a "cookieless" world, the way advertising track users will generally focus on "contextual" based advertising. For example, if a user is reading the income statement of a technology stock on Yahoo Finance, one may assume they were interested in stock investing and adverts can be tailored to that user. Given Taboola has partnerships with over 9,000 publishers, the company is poised to benefit from this trend.

Taboola also has bold plans to expand its reach with a "Taboola anywhere" strategy. This will include the ability to run adverts on OEM devices such as Samsung and China-based Xiaomi in addition to bringing the content to automobiles, home audio devices, and much more.

Taboola has also continued to roll out its Taboola News platform for android, which was only launched in 2022 but has since grown at a blistering pace to ~$50 million in annual revenue.

Improving Network Effects

A competitive advantage Taboola is growing is its improving network effects. For example, as more publishers sign up to the platform, this will attract more advertising partners who want to connect with those audiences. Then, as more data is captured, greater targeting can be achieved, which further increases advertisers on the platform. Then, of course, a large network of advertisers attracts more publishers and the cycle repeats.

Margins and Balance Sheet

Taboola reported earnings per share [EPS] of $0.06, which beat analyst expectations by $0.01, which increased from the break-even level reported in Q4,21. This was driven by a $17 million decline in operating expenses, which was the result of a cost restructuring program. Breaking down expenses by line item, the company reported a 16.17% decline in general and administrative expenses to $23.7 million in Q4,22. This is a positive sign as it means the company is generating improved operating leverage. Sales and Marketing expenses also declined by 5.4% year over year, which makes sense given the macroeconomic climate. Research and Development [R&D] expenses were reduced by 16% year over year, which looks to be a conservative reduction. Technology companies must continually innovate to stay ahead and thus R&D investment is usually necessary, thus, I don't deem this expense to be "bad" overall.

The company has a strong balance sheet with cash, cash equivalents, and short-term investments of $263 million. Taboola has a total debt of $298.7 million, of which the vast majority, $223 million is long-term debt and thus manageable. Management has made it a strategic priority to pay down its debt and aims to "retire" $30 million to $40 million of debt in 2024. This is a positive sign, especially given the rising interest rate environment.

Valuation and Forecasts

In order to value Taboola, I have plugged its latest financial data into my discounted cash flow valuation model. I have forecast just 5% revenue growth for next year, which is based upon an expected slowdown in the advertising market due to the macroeconomic climate as per the current trend. This is slightly offset by the new publishers signed in Q4,22. In years 2 to 5, I have forecast a faster 15% revenue growth per year. I expect this to be driven by a recovery in the advertising market, which is cyclical by nature. In addition, the company should start to experience revenue gains from Yahoo, which would have been partially integrated as a partner by 2024. In 2025 onwards, Yahoo is expected to be fully integrated with advertising optimized and thus this should help enhance growth.

In order to increase the accuracy of the valuation model, I have capitalized R&D expenses, which has boosted net income. I have forecast a pretax operating margin of 10% over the next 10 years, which is in line with the average margin for the advertising industry. I do expect margin pressure in 2023, as Taboola aims to invest a staggering $30 million into the Yahoo integration, which will involve new people, ad servers, and related infrastructure.

Given these factors, I get a fair value of $8 per share. TBLA stock is trading at ~$3.40 per share at the time of writing and thus it is ~57.67% undervalued.

As an extra data point, Taboola trades at a price-to-sales (P/S) ratio = 0.61, which is cheaper than its P/S ratio of over 1.2 in early 2022. However, it should be noted that the stock trades at a more expensive level than competitor Outbrain (OB), but cheaper than The Trade Desk (TTD) and Alphabet (GOOGL). See the chart below for details.

Risks

Recession/Cyclical Advertising market

Many analysts have forecast a recession for 2023. Therefore, I would expect the advertising industry to continue to face headwinds, as advertisers reduce spending due to macro uncertainty and lower consumer demand. A positive is the advertising market has been cyclical by nature and thus a rebound is expected long term.

Final Thoughts

Taboola is an innovative advertising technology that has continued to sign an elite list of publishers despite a tough economic backdrop. The company continues to surpass analyst expectations and is poised to benefit from the "cookie-less" world, which is fast approaching. Given my valuation model and forecasts indicate the stock is undervalued intrinsically, I will deem it to have potential as a great long-term investment once we get past the rough seas of the current advertising climate.