It's no secret that digital advertising will soon overtake traditional print and television media as the platform of choice for many advertisers. This impending shift has been attributed to the massive adoption of mobile devices such as tablets and smartphones. The latest data from Comscore indicates that mobile penetration in the U.S. is at about 75%, or an estimated 182 million people, a potential client base that advertisers are keen to tap into.
Last year, a total of $144 billion was spent on digital ads, accounting for 28.3% of all advertising spending. This was in stark contrast to print, which accounted for 17.3%, although TV ad spending still took the lion's share of overall spending, capturing 39% of the market. However, going forward, print and TV advertising market share is expected to decline over the next half decade and with good reason. Estimates put print and TV figures at 12.1% and 34.6% of total spending by 2019, according to eMarketer.
According to another recent report by Business Insider, traditional ad revenue is expected to remain flat overall through 2020, with a CAGR of only 0.4% compared to digital ad spending, which will grow by 11% during the same period.
With such growth prospects in sight, it is no surprise that high-profile tech names, such as Facebook (FB, Financial) and Twitter (TWTR, Financial), are ramping their efforts to grab larger pieces of this highly lucrative market. The strong growth in the digital ad segment is evident when looking at past earnings results released by both companies, which further highlights this momentum.
(Source: Data from eMarketer)
So far, Twitter's revenue is up 61% to $502 million compared to the year-ago quarter, while Facebook's advertising revenue has grown by 43% to $3.8 billion during that same period. A closer evaluation of ad trends reveals that display, which includes banners, rich media and video, accounts for the largest portion of the cash going into digital advertising, totaling about $15.55 billion.
As eMarketer's analyst Utreras puts it, "Consumers' increasing on-demand consumption of media through mobile-coupled with improvements in targeting, attribution and ROI for mobile advertising-will continue to take away ad dollars from magazines and newspapers." This is especially true when you consider that U.S adults are now spending almost three hours a day on their mobile phones and tablets.
While competition in the digital display ad sector may be stiff and largely dominated by a handful of players, I believe there are several players equally placed to reap huge returns from this boom. This is based on the fact that video ads will quickly replace standard static ads in the next five years if this research report is anything to go by. This means companies that effectively leverage video ad formats earlier on will have the competitive advantage.
Although most of the hype surrounding digital ads has been concentrated around social media brands, such as Facebook, Twitter and Google (GOOG, Financial), I believe investors need to broaden their horizons and realize that the opportunity is not only limited to these names.
Smaller ad tech companies show plenty of promise
There are a number of reasons why I believe shifting focus from these mainstream social media companies would be lucrative in the long term. One example of why we need to think differently about the future trends of digital ads is inspired by Apple (AAPL, Financial), which recently launched its iOS 9 operating system. The iOS 9 is set to bring about significant changes to how users experience web browsing, with the addition of a content blocking feature.
This content blocking feature will enable users to opt out of ads appearing on webpages and will also prevent advertisers from tracking sites those users visited. This is disastrous -- without this data, advertisers won't know which ads to show them in the future. Obviously, Google generates nearly all of its revenue from advertising and should expect a significant revenue shakeup considering 14% of the global smartphone OS market is iOS, according to data from IDC.
Moreover, Apple's ad-blocking will not only spell doom for the search engine giant but also for other ad networks and placement companies, such as Criteo (CRTO) and The Rubicon Project (RUBI), which make use of automated platforms to sell mobile ads. Criteo offers its clients an algorithm that predicts the probability and nature of user engagement with a given ad as well as the ability to create and tailor the ads to a specific user through modifying the creative content and presentation. This business model has seen Criteo grow its revenue by double digits in the past eight consecutive quarters, clearly putting into perspective the opportunity in the space.
The Rubicon Project offers an advertising automation cloud that powers a real time trading platform of digital ads between buyers and sellers. So far, The Rubicon Project has also had a stellar year with managed revenue from the overall orders business (which comprises Guaranteed Orders + Non-Guaranteed Orders), growing more than 150% year over year in the second quarter of 2015.
(Source: Yahoo! Finance)
As you can see from the chart above, both Criteo and The Rubicon Project's wins have been instrumental in the 14% and 31% uptick in share price, respectively, over the last year. Although some pundits may argue that it's still too early to speculate on how adverse the effect of ad blocking will be to these ad companies, I believe investors will see it as a huge red flag. Some may even begin doubling down on their investment. As such, in spite of the promise shown by these two small caps, I believe there is a far better alternative that is well-insulated from this new threat.
What Criteo and The Rubicon Project lack in order to remain competitive in the digital ad space market, in my opinion, is exactly what little known Adaptive Medias Inc. (ADTM, Financial) offers its clients.
The all-in-one monetization platform
For those of you who are not familiar with Adaptive Medias (ADTM, Financial), it is a leading provider of mobile video delivery and monetization solutions for publishers, content producers and advertisers. It is also one of the first companies to offer clients a digital video player built specifically for the mobile world through its Media Graph platform. In the past, the majority of video ads have been served through Google's YouTube, which has worked well for desktop. However, Adaptive Medias has created a thriving opportunity not only for desktop but also for mobile.
To put things into better perspective, recent research from Cisco (CSCO) has shown that mobile video will account for approximately 72% of all mobile traffic by 2019, which puts Media Graph in a solid position to exploit the opportunity for serving up video ads. This is based on the fact that Media Graph integrates seamlessly into the mobile device environment, allowing videos to play without a hitch, which puts it at an advantage over YouTube.
Adaptive Medias sets itself apart from rivals such as Criteo and Rubicon because its Media Graph platform offers substantially higher margins of between 60% and 80%. As a matter of fact, Adaptive Medias expects a record third quarter with an estimated $1.3 million in revenue , which would be a 36% sequential increase from the previous quarter on the backdrop of Media Graph's launch. CEO John B. Strong has reiterated how pleased he is with the industry's reception of the new platform, of which sales combined with that of its ad marketplace would enable the company to reach breakeven status by the first quarter of 2016.
For those who may be a bit sceptical about Adaptive Medias' position in the overall industry, as well as its financial health, here is what you should know. Currently, the company generates 85% of its revenue from the low margin ad marketplace, with the remaining 15% coming from its Media Graph platform, as the chart below shows.
(Source: Adaptive Medias Inc.)
However, this won't be the case for long since it will be refocusing its efforts toward increasing its publisher base for Media Graph. The company's financials are also solid, considering it currently holds no long-term debt and has slightly over $2.2 million in cash. We should also expect to see R&D costs trending downwards since its Media Graph platform has already been completed and refined.
Summary
The robust growth in the digital ad market has shown no signs of running out of steam any time soon with the difficult part for investors being where to put their money. Widely recognized names, such as Google, Facebook and Twitter, have been the main focus of the mainstream investing community but I worry that investors will have a hard time realizing meaningful gains from these choices since most of the potential growth in digital ads has already been priced in.
I therefore believe that investors looking to benefit from growing ad spending need to focus on smaller players, such as Adaptive Medias, whose value hasn't yet been unlocked. Even though the company trades below the $1 range, its revenue growth over the past three years is a clear indication that it won't stay at this level for long.
