A Deep Dive Into The Trade Desk

One of the biggest challenges in business is creating awareness of a product or service. That's where advertising comes in.

30 years ago, advertising was an uncertain science. There were only a handful of media outlets that offered any kind of ad distribution. Large companies advertising at a national level had to place ads with the "big 4" television networks, magazines with national distribution (like People or Better Homes and Gardens), or nationally relevant newspapers like The New York Times or USA Today. Local advertisers focused advertising on local TV affiliates, community newspapers, billboards, etc.

Two big issues for buyers in legacy advertising were targeting potential customers and measuring return on investment. Targeting could be done in a broad sense. If you were selling fitness equipment, of course you would want to place more ads in Sports Illustrated than in, say, Vogue.

Return on investment was almost impossible to measure with any reasonable accuracy. That ad your company placed in a national magazine certainly got seen by a lot of people, but did it drive any sales? And if so, how many sales? Enough to earn a return on the cost of placing the ad? Buyers really had little idea.

Enter the internet in the late 1990's and early 2000's.

Of all the businesses the internet upended, advertising has been one of the most affected. The internet began with a digital version of traditional advertising known as "banner ads". Then came the big "walled garden" services like Google (GOOG) and Facebook (META), who used more personalized information such as search terms and history, or "likes" to businesses or organizations, to closely target ads to potential buyers. Now, targeting very specific potential buyers was possible. Instead of broad "potential fitness customers", you could tailor your equipment to people searching specifically for "adjustable weight dumbbells" or "low cost treadmills".

Additionally, digital ad sellers provide super accurate ways to measure ROI on ad spend. Ad dashboards include number of impressions and number of interactions (e.g., clicks). Now, ad buyers knew EXACTLY how their ads performed, allowing them to adjust spend, creative, and targeting to get the maximum return on investment.

Today, digital advertising is evolving again. Virtually all types of media are consumed via digital means. Television consumption has moved to streaming, audio/radio programs to podcasts, newspapers and magazines to websites and mobile apps. Ads are a major part of video games, and even street billboards have turned digital! The "walled garden" approach, though still lucrative, isn't enough to contain the proliferation of digital consumption anymore.

Enter the stock we are looking at today: The Trade Desk (TTD). It has made itself into a "key player" in the next generation of digital advertising. With the stock currently in the Green Screens, is it a potential buy?

What The Trade Desk Does

When you think about it, there is no possible way most advertisers can efficiently manage their online ad spend.

There are literally tens of thousands of channels offering ad inventory. Every news website, blog, podcast, and ad-supported streaming video presents an opportunity to advertise.

So how can an advertiser know WHERE to spend their money to get the best bang for the buck?

That's where the digital ad value chain comes in. Here's a simplified version:

The Trade Desk's position in this chain is as a Demand Side Platform (DSP). Ad agencies or large advertisers send their ad creatives to TTD and set a budget. They then rely on Trade Desk's programmatic artificial intelligence (AI) algorithms to distribute those ads to the most relevant and least expensive available ad slots. For this service, Trade Desk takes a cut of around 19% of the total ad cost.

What value does Trade Desk provide it clients for this cut? 3 things:

1. Omni-channel ad opportunities. Trade Desk can place video, audio, or display ads across 350 partners and ad exchanges. It offers its clients visibility everywhere there are digital ads. Connected (streaming) TV ads are about 45% of sales, mobile apps are 35%, website display ads 15%, and audio 5%.
2. Audience targeting. Trade Desk has AI that can match the products or services you are advertising to the most relevant audiences at the lowest ad rates. Over time, it gets better and better at targeting its client's ads, improving their ROI without them having to do anything.
3. Performance tracking. Trade Desk's advertiser dashboard allows its clients to track the effectiveness of their ad creatives. This helps them develop the highest converting ads possible.

Since Trade Desk's bidding is programmatic, it does all of this with minimal need for a customer to self-manage. With nearly 800 billion ad impressions per day, Trade Desk is providing a lot of value for a lot of clients!

The Revenue Story

Trade Desk is a very rapidly growing company. Its 3 year compound annual revenue growth rate stands at 36%, and 2022 is looking to come in close to that figure - pretty impressive considering depressed conditions for ad spend.

Going forward, there is every reason to believe Trade Desk can continue 20%+ growth for the foreseeable future. Digital advertising is already an unfathomably large market, over $650 billion worldwide and growing at 12% annually. At an average 19% take rate, that would represent a $125 billion revenue opportunity for Trade Desk. Considering the firm does only about $1.6 billion in sales at present, there is massive revenue upside in market share alone!

Perhaps the biggest opportunity is in connected television (e.g. streaming services). Trade Desk already gets nearly half of revenue from this channel, partnering with heavy hitters like Disney (DIS), Peacock (owned by Comcast), and FuboTV (FUBO). Ad-supported streaming is becoming a major trend, with both Disney and Netflix (NFLX) adding ad-supported tiers in the past few months.

The connected TV (CTV) opportunity is clear when you consider traditional TV ad spend. Currently, about $170 billion is spend on traditional TV ads, vs. only about $20 billion on CTV. However, Nielsen recently reported that streaming TV viewership surpassed cable for the first time ever in 2022. It is clear more of this money is going to move to CTV in the future.

Another factor that will help Trade Desk's growth is the emerging weakness in the "walled garden" approach. For over a decade, two firms - Google and Facebook - have controlled 50% of the worldwide digital ad market. Many factors - including privacy restrictions, data ownership, and new sources of digital media - are conspiring to weaken these two firms' grasp on online ad dollars. While I expect both to remain strong, I also expect "open internet" ad spend to grow faster over the next decade. Trade Desk will benefit from that.

On the recurring side, Trade Desk acts like a "toll collector" on ads run through its platform. Its clients pay the firm many times daily - thousands for large ad buyers! While the volume and cost of ads certainly ebb and flow based on economic conditions, the revenue model can be considered a recurring one.

Leadership and Financials

Without question, one of The Trade Desk's major assets is founder and CEO Jeff Green. He founded the firm in 2009. Through his ownership of 98% of the Class B "super-voting" shares, he controls close to 50% of voting power in the firm.

It's hard to complain about Green's leadership. Not only has he expertly navigated some very competitive waters to establish Trade Desk as one of the leading DSPs, he has done it quite efficiently. Trade Desk is entirely debt-free and generates free cash flow margins exceeding 32%. Cash returns on invested capital exceed 40%. This is one impressive business, financially.

At just 45 years old, Green looks poised to continue leading Trade Desk for the foreseeable future. He received a massive stock option package worth over $800 million in 2021, but only if the stock price appreciates considerably over the next 10 years.

The Competitive Picture

Being such a large and emerging market, digital advertising is fiercely competitive. As mentioned, Google and Facebook still own about 50% of the market, and other players with natural ad or search inventory like Amazon (AMZN) and Roku (ROKU) have entered the fray.

Even in the "open internet", the DSP portion of the value chain is pretty crowded. Competitors include MediaMath, Acuity, Criteo, SmartyAds, Adelphic, Adform... and many more. There are dozens, as you can see here.

There are no substantial structural moats in this business. Switching costs are low, and many advertisers already use multiple DSPs. Network effects don't really apply, and I don't see any unique assets or intangible advantages like brands to keep competitors at bay.

Trade Desk's competitive advantage so far has been its success delivering ROI on ad dollars for its customers, as witnessed by its 95% customer retention rate. It has simply been a better run company than a lot of its competitors.

Is TTD A Stock To Watch?

All of this adds up to a really tough call on whether or not to add Trade Desk to our Watch List.

On one hand, this is a winning player in a very, VERY large potential market. An addressable market in the hundreds of billions alleviates the concern of having lots of competition - there is plenty of room for many winners. It also creates an opportunity down the line to consolidate weaker competitors, a decent strategy once the market matures and growth slows. Trade Desk is a natural consolidator with its strong financial performance and industry leadership.

The risks are pretty clear. There are few structural competitive advantages. New DSPs pop up all the time, and large integrated platforms like Google, Facebook, Amazon, and Roku manage their own ad inventory. It's not inconceivable that the largest CTV providers may also decide to self-manage their ad businesses over time.

Then there's the binary event risk of Jeff Green leaving the firm. His acumen is clearly a major competitive advantage. His leaving would instantly make Trade Desk a far less attractive stock. The big pay package in 2021 was obviously meant to address that concern. Added with his 50% voting control, there don't seem to be many reasons for him to consider leaving. But it remains a big risk.

After much consideration, I've decided to PASS on adding Trade Desk to the Watch List. It was a very tough decision. I do believe the company could perform very well for investors - if it interests you, add it to your personal watch list! But the lack of real structural competitive advantages, a lot of competition, and the traditionally weak performance of stocks in the ad tech space give me pause. There are too many other good Green Screen stocks to consider.