Outbrain (OB, Financial) is a leading native advertising and content recommendation platform.
The problem with traditional “banner ads” on websites is that they are often irrelevant and look like an ad. Thus, these tend to result in low engagement and clicks by the user, which means higher cost for the advertiser. However, native ads are those which seamlessly embed into relevant content. Imagine you are reading a blog post on summer outfits, and the Outbrain platform embeds an ad disguised as a blog post which will show “Best Summer Sneakers."
The result for the over 20,000 advertisers that use Outbrain’s platform is high engagement, low cost per click and a high return on investment digital advertising strategy. Premium publishers include CNN, Washington Post, BBC, Sky News, etc., while their advertisers include leading brands such as Samsung (XKRX:005930, Financial), Nestle (XSWX:NESN, Financial), Honda (HMC, Financial) and many more.
Source: Outbrain investor presentation
Outbrain uses artificial intelligence and algorithms in order to optimize the advertiser's budget. In addition, the firm benefits from strong network effects, where more advertisers = more publishers = more data = better results.
Seth Klarman (Trades, Portfolio) has been buying
Seth Klarman (Trades, Portfolio) is a legendary value investor who has been dubbed by some as “the next Wrren Buffett." It was interesting to see that in the third quarter of 2021, Klarman was loading up on shares of Outbrain (OB, Financial). The average share price of the stock during the quarter was $17 according to GuruFocus data, and since then, the stock is down 37%.
In my opinion, this decline is likely thanks to rising inflation and the suspected rise in interest rates which has impacted the valuation of all growth stocks. I see no particular reason to be concerned about the company itself.
Founder-led
The firm is founder-led by Yaron Galai, who is originally from Israel but now lives in New York. He owns 6% of the company’s shares and thus has "skin in the game." Investing into firms where the founder has a large number of shares is a strategy I and many legendary investors such as former hedge fund manager Nick Sleep use.
I also noticed Yaron has a series of patents related to online advertising; I am assuming these are part of the Outbrain platform, but either way, they offer a competitive advantage.
Is the stock undervalued?
In order to value Outbrain's stock, I have plugged the latest financials into my discounted cash flow model. I have predicted revenue to increased 20% per year for the next five years, which I think isn’t unreasonable given their revenue increased of 30% in 2021.
I have predicted margins to grow steadily to 7.5% in eight years, as the company's “traffic acquisition costs” and R&D bets start to pay off.
Given these factors, I get a fair value estimate of $12 per share. The stock is currently trading at $11 per share and thus is undervalued by 11%. The firm could easily continue to grow revenues at a 30% clip in my view, and thus would be even more undervalued. However, to be conservative given the rising rate environment and its negative impact on growth stocks, I have used these estimates.
The firm is also trading at a low price-sales ratio of 0.59. The market cap is $600 million, and the last year brought in $1 billion in revenue.
Competition risk
There is a vast amount of competition in the online advertising industry. We have the dominant player Alphabet (GOOG, Financial)(GOOGL, Financial) with a 40% market share and also Meta Platforms (FB, Financial), which has another 40% market share.
Even in the programmatic advertising space, there are a few competitors such as Taboola, Adobe, Media Math and ezoic. The Trade Desk could also be seen as a competitor, although they do have a partnership with Outbrain which is a positive.
Final thoughts
Outbrain is a fantastic company and truly does offer a superior native advertising platform with premium content publishers. The premium content publishers are becoming even more vital as the Google algorithm is causing the internet to consolidate around the most high authority websites to combat spam, fraud and misinformation. Thus, I think Outbrain is a great opportunity for the long term. The major risk right now is the rising interest rate environment, which is squeezing the valuations of all growth stocks.
