Criteo (CRTO) remains at the forefront of the programmatic buying space, with strong technology and scale advantages, but the key issue here is that its core retargeting business looks to be in decline. In response, Criteo has implemented a new business transformation plan, with a new CEO at the helm. With numbers set to come under pressure in the interim and little sign of a successful turnaround anytime soon, the stock is now available at fire-sale prices.

With Criteo now firmly in the “ick” category, I think there could be something here for patient investors – at current levels, I believe the bar has been lowered too far, leaving the risk/reward skewed firmly to the upside, in my view. Criteo is still a highly cash-generative asset and assuming a base case FCF trajectory (continued core declines; new products to maintain current growth rates) could see its cash balance exceed its market cap within 4-5 years.

4Q Highlights

Criteo reported above-consensus 4Q revenue ex-TAC and EBITDA of $266 million and $109 million, respectively for the quarter, while guiding FY20 revenue ex-TAC to -10% y/y (ex-FX), on stricter GDPR implementation and ad-targeting restrictions by browsers (e.g., Firefox & Microsoft), which are set to come into effect this year.

Source: Earnings Presentation

Client count rose 276 on a sequential basis, aided by strong holiday performance, though spend per client declines accelerated (-6% y/y vs. -5% in 3Q).

Source: Company Filings

Geographical & product penetration: Criteo saw a decline in revenue ex-TAC in APAC (-2% ex-FX vs. -2% in 3Q), while core EMEA grew (+1% ex-FX vs. +1% in 3Q) and Americas growth was -3% ex-FX vs. flat in 3Q.

Source: Earnings Presentation

While the mobile ID-based solutions and Retail Media products, which utilize multiple first-party or cookie-less mechanisms, still constitute ~50% of the overall business, management aims to cover the other 50% from its first-party coverage, ID graph, products at the higher end of the marketing funnel, and through partnerships with other players. New solutions constituted 16% of total Revenue ex-TAC and grew +44% y/y, while the re-targeting product declined modestly in the upper-mid single-digit range, especially with large customers.

Source: Company Filings

Business transformation. As part of the ongoing initiative, the company’s four-pronged strategy includes building out a full-stack differentiated DSP, expanding its product portfolio, exploring partnerships/M&A opportunities, and investing in tech innovations. Per new CEO Clarksen (excerpted from the 4Q19 transcript):

The plan is being built on four strategic pillars that will provide focus, organize our teams, and drive momentum. These are number one, to strengthen our retargeting business; number two, to expand our product portfolio; number three, to explore strategic game changers; and number four, to drive technology and operations excellence. So one by one.

Source: Earnings Presentation

Share Repurchase. Alongside the continued share price performance, management has been executing on its $80mn share repurchase program (announced in August 2019) – at end-2019, the company had purchased ~3.2mn shares, bringing the total to ~$59mn at an average price of $18.07 per share. Per management, the base case remains for the buyback program to run until completion, leaving an additional $20 million to go (likely implying $10 million for 1Q20 and 2Q20).

Source: Company Filings, Guidance, Author Est

Reviewing the Guidance

In addition to the 1Q20 revenue ex-TAC of $209-212mn and adjusted EBITDA of $55-58mn, the full-year 2020 guidance for revenue ex-TAC reflects a decline of approximately -10% YoY on a constant currency basis, implying a revenue ex-TAC of ~$848mn. Applying adjusted EBITDA margin guidance of 30%, this implies adjusted EBITDA of $254mn for the full-year.

Source: Press Release

Though the guide was below consensus, there was likely some cautiousness embedded, especially with regard to anticipated and announced privacy and platform initiatives coming into effect this year. Specifically, management guided to 7 percentage points of headwinds from stricter GDPR implementations and ad-targeting restrictions effective this year in browsers/platforms such as Microsoft and Firefox. On the GDPR front, management also highlighted their expectation for the stricter implementation of explicit consent, which should result in the increased prominence of consumer opt-out functionality.

Maybe just regarding the 7 points of headwinds that we’ve baked into our guidance. I mean, the reason why we took a realistic view is primarily to address two topics; the first one is the ad targeting restriction. And the second one is relating to regulation. So without getting into the full breakdown, with respect to ad targeting restriction, it is primarily through the implementation of further restrictions that have been announced effective this year in the browser, so namely Firefox or Microsoft. And with respect to the regulation, we took the view that there would be a stricter GDPR implementation that could have a material impact on the business as up to 7%.

While revenues are guided to decline, management did point toward significant leverage benefits within the R&D and G&A expense line items – for instance, the closure of an R&D center in Palo Alto, California.

Because product on R&D is going to be benefiting from the rightsizing of the location now that we’ve closed the Palo Alto center, and we are going to deliver efficiency on the G&A side. So that will be primarily in sales and operations that you will not see — you will see a small deleverage as a percentage of revenue ex-TAC Privacy Initiatives & Financial impact.

Management Reshuffle Introduces Fresh Perspectives

Criteo’s 4Q19 call was also notable as it was the first we heard from the company’s new CEO, Megan Clarken (15 years at Nielsen before taking the helm at Criteo). The prevailing takeaway was Clarken’s ability to inject a fresh perspective, given her traditional media background. New initiatives thus far include a move toward mobile apps and connected TV (part of a full-stack demand-side strategy to combine the company’s upper funnel and lower-funnel capabilities). In addition, Clarken also plans to explore partnerships to add complementary capabilities (e.g., cross-platform targeting and measurement).

Source: Earnings Presentation

Asset Value Emerging Amid Turnaround

Criteo’s turnaround plan is built around active steps to move up the funnel, shifting from retargeting to broader services that help advertisers target up the funnel. The new CEO is also pushing for further retail media ad solutions (e.g., sponsored products on Best Buy sites), along with more cross-platform ad delivery and measurement services. In sum, the turnaround is complex, and execution will be key given the ongoing shifts in the ad tech landscape, which will likely lead to headwinds ahead.

Yet, the market has de-rated the stock excessively, in my view, and I now see asset value emerging in Criteo – the stock has traded down to ~2-3x EV/EBITDA. In addition to M&A potential (Criteo’s broad shopper graph and deep client and publisher relationships could be better realized within a broader product suite), the cash on its balance sheet alone accounts for ~47% of Criteo’s market cap (see cap structure outlined below).

Current Price

$13.70

Diluted Shares Outstanding

64.7

Current Market Cap

885.8

Less: Cash and Cash Equivalents

418.8

Plus: Debt

4.4

Plus: Minority Interest

(30.7)

Adjusted Enterprise Value

$440.7

Source: Company Filings, Market Data as of 19th Feb

With the company set to add >$100m in FCF over the next year in my base case scenario (lower earnings/operating cash flow offset by lower capex), the cash balance could exceed Criteo’s current market cap within 4-5 years. The excess cash leaves plenty of room for further capital return – an additional $80m buyback program, for instance, would imply an ~10% buyback yield. Thus, Criteo offers investors many ways to win at current levels – a further buildup in the net cash balance and the massive capital return optionality should eventually shift investor focus toward Criteo’s overwhelming asset value, in my view. Key risks include an intensifying competitive and regulatory environment, as well as execution risks around the turnaround plan.

Source: Company Filings, Author’s Projections

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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2020-02-24