The following segment is taken from this fund letter.
The trading post (NASDAQ: TTD)
The portfolio first purchased The Trade Desk in the fourth quarter of 2017. The Trade Desk is a software platform that helps advertisers filter, evaluate and purchase digital product offerings. advertising inventory (display, mobile, social, connected TV, connected audio) available worldwide. There is a long-term, secular trend of more media moving online, providing advertisers with the ability to use data to reach targeted consumers. The Trade Desk allows advertisers to discover prices by using data (programmatically) to price inventory based on an advertiser’s specific goals.
In the digital advertising value chain, there is a market where advertising inventory is bought and sold. Ad inventory sellers called sell-side platforms (SSPs) conduct auctions for publisher inventory through ad exchanges, selling it to the highest bidder. Buyers of ad inventory, known as demand-side platforms (DSPs) like the Trade Desk, must “watch” ongoing auctions in order to potentially bid on inventory for their ad customers. Programmatic advertising offers the ability for individual targeting using granular data to determine the return on investment of ad spend.
Trade Desk’s competitive advantage comes from its high operating leverage and economies of scale. To be effective, DSPs must examine all available auctions currently running. Watching every auction costs money even if no auction is made. The only way for the DSP to monetize the “look” is to win the auction. However, the more an advertiser pays for inventory, the lower the ROI on ad spend, but bidding too low would risk losing the auction. Therefore, The Trade Desk helps advertisers determine the value of specific inventory for their specific purposes.
The Trade Desk selects inventory for its advertising clients from more than 500 billion digital ad opportunities every day, which is expected to cost more than $300 million in operating expenses for the platform this year. If another DSP had half the ad spend of the Trade Desk, to be as effective it would still have to look at the 500 billion ad opportunities, but the platform costs per ad dollar would be twice as high. It is therefore very difficult for a subscale DSP to be profitable.
Alternatively, the smaller DSP could only look at half of the ad opportunities, thereby halving their bidding spend. However, they would have less premium inventory to choose from, so advertisers would get a lower return on their ad spend. This naturally attracts advertisers to the DSP with the greatest scale. Essentially, there is a minimum level of cost that a DSP must incur looking at all the inventory available globally in order to provide a similar value proposition. This momentum is only increasing as programmatic ad inventory proliferates in the future.
There is also a bilateral network effect. It costs SSPs money to send an impression to bid on each DSP. SSPs are only paid if the print is sold. Therefore, SSPs only want to send impressions to the DSPs most likely to win the auction. They focus bid requests on scale DSP buyers like The Trade Desk. Then The Trade Desk can select all available inventory, bid on the most profitable impressions, and refine its bids based on historical prices, improving return on ad spend and attracting more advertising dollars from its clients.
Advertisers want to use the DSP that has access to the most ad inventory because it increases the chances that they will have access to the best inventory for their campaign objective. Having the most ad customers attracts more inventory, which attracts more ad customers.
While The Trade Desk has established itself as the dominant independent platform on the demand side, increasing its relative advantage every year, it is trading for a high multiple based on recent fundamentals. When evaluating The Trade Desk, the question is how many advertising dollars should be spent on The Trade Desks platform to justify a market cap of $20 billion?
Over the long term, global ad spend will continue to grow alongside the global economy, digital ad spend will grow as a proportion of total ad spend, and all digital ad spend will be allocated programmatically. From a market perspective, global ad spend was $780 billion in 2021, digital advertising accounted for nearly $400 billion, and programmatic advertising accounted for nearly $45 billion of digital. The Trade Desk is expected to have approximately $8 billion in ad spend in 2022.
Over the next five years, programmatic ad spend is expected to grow at a CAGR of 15%, reaching ~$120 billion by 2028. The Trade Desk is expected to continue to take part in programmatic ad spend going forward, growing from an expected share of approximately 16% in 2022 to 25% share in 2028. This would provide gross ad spend on The Trade Desk of $30 billion and assuming a 20% participation rate generates $6 billion dollars in revenue, with a CAGR of 30%.
Operating margins approaching the end state are expected to be around 40%, which seems possible given their relative competitive advantage against smaller competitors and the cost structure of their business model of platform, generating an operating profit of $2-3 billion.
Increasing revenue by 25-30% from a base of $1.6 billion is not the norm for most companies. Few have accomplished such feats. However, few companies have had a globally scalable platform like the Trade Desk which enjoys the greatest momentum. Unlike most linear businesses, it’s not weighed down by size. The more The Trade Desk grows, the stronger its activity becomes. It has high operating leverage which requires nominal costs to sustain the increase in advertising dollars to spend on its platform.
While the above scenario would result in a very favorable outcome for shareholders, the big returns will not come from owning The Trade Desk over the next five years, but over the next 5-20 years. $25-30 billion in ad spend in 2028 is still a drop in the global ad spend basket. There is a potential future where all digital advertising is allocated programmatically on one platform and that platform could very well be The Trade Desk, in which case it would be one of the most valuable companies in the world.
But let’s not rush to make it happen, the great walled gardens of digital media company Alphabet (GOOG, GOOGL), Meta (META) and Amazon (AMZN), which control about 2/3rd of digital advertising, should come down and be part of the open internet, but that’s a topic for a different letter. For now, we are happy to hold onto our shares for what is bound to be a volatile but likely very lucrative journey.
Source: Company filings, Factset, Saga Partners
Note: 2022E values are Factset consensus expectations, market cap and stock price as of 6/30/22.
Editor’s note: The summary bullet points for this article were chosen by the Seeking Alpha editors.