Doug O'Laughlin from Fabricated Knowledge on management incentives at $APP (podcast #166)

Doug O'Laughlin, Founder and Editor of the Fabricated Knowledge and Mule’s Musings Newsletters, joins the Yet Another Value Podcast for the 3rd time to discuss his thesis on AppLovin Corporation (NASDAQ: APP). Doug became excited about the idea and wanted to come on to chat about it because a very aggressive PSU that recently happened at AppLovin, and what these management incentives could mean for the business.

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Transcript begins below

Andrew Walker: Hi, hello, and welcome to Yet Another Value Podcast. I'm your host, Andrew Walker. If you like this podcast, it would mean a lot, if you could follow, subscribe, rate, review it wherever you're watching or listening to it. With me today, I'm happy to have, Doug O'Laughlin. Doug is the founder of two different mule podcasts. Mule [inaudible] includes a link to both of them in the show notes, but, Doug, how's it going?

Doug O'Laughlin: I'm doing really good. I'm really excited to talk about an awesome hoked idea right now. I just got really obsessed with that idea and I really wanted to talk about it. I think it's super asymmetric and yeah, but other than that, I'm doing my best grinding out in these choppy markets. It's been a tough tape, but one that I'm trying to continue to work out. But yeah, I really... Yeah.

Andrew: How quickly did you pull all of your money from Silicon Valley Bank, since we last spoke, and were you the number one cause of them going under?

Doug: No, unfortunately, I was not. I think some people on Twitter were. However, that's an aside.

Andrew: Let me start this podcast with a quick disclaimer. Just to remind everyone, nothing on this podcast is investing[?] advice, always true. But it may be a little more true today because we're going to talk about one idea and I'll go to that idea in a second. But every time we've talked, we kind of go off on tangents so we could run the gamut of a hundred different things, a thousand different situations. So everyone should just remember, please do your own work, this isn't financial advice. Consult a financial advisor, if that makes sense and that is out of the way, I guess I'll turn it over. So, the company we're gonna talk about, you emailed me a couple of weeks ago and were like, "Hey, I'm working on this company and it's really juicy. It's not a semiconductor company, but it's the most exciting thing I'm working on. Can I come on the podcast and talk about it?" And I was like, "Hell yeah man, come on over." So the company you're here to talk about is AppLovin and I'll just flip it over to you. What is AppLovin? What got you so excited about it?

Doug: So, AppLovin is a mobile gaming ad company that consists of two segments in the business, essentially a giant portfolio of hyper, casual mobile games. And then the software for mobile game developers, that is primarily an ad tech stack. What makes me so excited about it is a very aggressive PSU that recently happened, that looks... One, I thought was curiously timed, but, two, the price photos are very impressive. So, it's a $16 stock today. The first vesting is $36. That's like a 3x from when they originally granted the stock, the PSU, and up to I think a 4/5x. This is... [crosstalk]

Andrew: 79 is the very top end of the package, yup.

Doug: Yeah. 79 is the top end of the package and this is supposed to be the comp for the next four years. And hell, a 3x over four years is pretty good. So all this comes together., and you're like, wow, this is either the most delusional grant I've ever seen or something is happening here, and when the board is deciding to... I mean, the board is trying to incentivize them, but
there has to be some basis in reality. Now, maybe we're totally off base here and the board is completely out of touch with reality, but the shares of this company have traded a lot higher in the past and that's... But at that time, it was kind of in the software bubble phase and truly it traded at a pretty insane multiple and it was like a 2021 IPO. So, that cohort of stock is down meaningfully and the shares are down. I want to say like, 85/90% from all-time highs, but if you look at the company, it's a super busted company, kind of recent IPO. It's led by a founder and they do these super aggressive PSUs, and so I was like, hmm, let's take a look. When I took a look, I was like, oh there are definitely things going on here that I think are really interesting and create a lot of options for the company to do well. I think the first part of it that I think is really interesting is, we're kind of really close to the IDFA lap. April 2023 is the first full year that we had the lapping of IDFA.

Andrew: Doug, let's just pause there because I think most listeners want to know what IDFA is, but obviously that's an acronym and if you're not plugged into AdTech, you might not 100% know. So why don't you just describe IDFA and what they're lapping?

Doug: Okay man, honestly, I didn't even remember what the acronym stands for, but essentially, the...

Andrew: I think it's identification... Yeah, I can't remember. Something out...

Doug: It's also sometimes referred to as ATT. So essentially what happens is, I'm sure you see this if you are an Apple user, which I'm going to assume most of the podcast over index is to that. Whenever you go into an app, you can press, "ask app to not track," right? And that's one of the big things, that's like the huge thing. So I think 60-70% of users say, "Don't track me," and this really killed a lot of the insight and targetability that AdTech had for users and so it created this huge data wasteland where all of a sudden, you used to have all these metrics that you could target your potential customers with, but all of those got taken away from you. That really ruined AdTech in a lot of ways. The more niche-targeted solutions, essentially, why would you spend in a completely unproven way? So, in a lot of different ways, the IDFA thing, kind of just ruined the AdTech market for a lot of profit goals.
Now, this actually creates a really interesting knock-on that I'll talk about, but at the high level, this is the beginning of the IDFA lap so that in theory, if it's going to stabilize, the comp should get better. That's one way to look at it. If you look at their actual software business, they grew last year meaningfully. So I don't think that that's the only thing that they have going, but I think the thing that got me most excited is that I started to do a lot of work on this and I was like, what...? Because you're just like, what could you possibly be seeing? The thing I think that they're seeing is that there has actually been a really subtle thing that has happened to them that has kind of put them in the driver's seat, compared to historically. One, there's consolidation, it's pretty much become ironSource, Unity versus AppLovin. Those are the two big dogs in a market called mediation.
Mediation essentially is, and this is really important to this whole thesis, so we have to talk a lot about this. Mediation is real-time bidding on a per unit of advertisement within an app. So historically, it was called a waterfall method and that means, let's say... and we're going to use mobile games because most of their business is mobile games. They would serve an ad on a mobile game and then the ad would come up and they would sell the ad slot, right? Because the publisher is selling the slot and they would sell it to the exchange that would on average offer the highest price, but that actually doesn't really create the best per-unit economics. Every ad slot should be bid on. So that's what real-time bidding is and the thing is, the problem is, if you're a publisher, you have to plug your inventory slot into all these different bidders and try to be able to real-time sort all the bids at the same time. That is impossible for one company to do, and so, that's where mediation came in. Mediation, essentially, is a service sold to publishers that helps improve... It does all of that for them. So, every single time, now, you go on a mobile game and an advertisement slot pops up, the advertisement's slot, if it's done by mediation, is being done in real-time bidding. Every slot is being bid on and that creates much higher yields and much better revenue for the publishers and it's just a more efficient auction dynamic.

Andrew: Let me just pause there to make sure we've got the business and make sure the listeners understand the business. Because I've Looked at AppLovin, Unity, and ironSource several times over the year and even today I'm like... So, basically what it is, is I am Candy Crush, right? I make Candy Crush and one of the many ways Candy Crush monetizes, is if you're playing for free every... I haven't played Candy Crush since it came out, but every five levels, they're going to hit you with an ad or something, right? A little ad and you have to press X or if you tap on it you can go download, whatever. Normally a game they're advertising, right? So that's one of the ways. Candy Crush can monetize. What AppLovin and Unity say, is, look, Candy Crush if you really want, you can go try and build your own ad network. But similar to what everyone found with search networks and search advertising, and everything, that's going to be really inefficient. It's probably going to... You're going to make a lot more money if you let us handle getting all these advertisers. We have to go connect with 100 different game publishers and get everything in real time[?] everything. We'll handle the ad, you just say, "Hey, here's an ad slot," and we'll instantly go run an auction and supply whoever the highest bidder is, we'll give that ad. So that's what they're doing. They're basically connecting a game with an ad slot to all these bidders, connecting the two of them, and then just taking a fee.

Doug: Yeah, perfect. That's a perfect explanation and sometimes the double explanation is really helpful to actually understand what's going on. [crosstalk]

Andrew: Well, you got all the specifics and technicals, so I was like [inaudible] [crosstalk] Candy Crush.

Doug: Yeah, giving a really good high-level example was really helpful. So there's actually this really, and this a required reading, if you are interested in this thesis. It's by Mobile Dev Memo, and it's called, "Why Mediation is the primary front in the mobile advertising wars, post ATT" and this was something that really opened my eyes and maybe understand what's really going on here. That I think that the market, maybe, underappreciates and why there is... And so remember ironSource got bought by Unity and Unity is the game engine, so they are the evil empire in terms of this and then AppLovin is just the software side of things. There are competitor dynamics between them, but it's really consolidated into two, maybe, I think there are up to four players, but it's really two big players and two trail players with consolidation moving to the bigger players. But the thing that's important, is in this world... So, the auction house dynamic is maybe the best way to describe this. You're in a big auction house and in the past, everyone was sitting in an open seating, so you could see who's bidding on what. You can understand what you're bidding on, but now, everyone is a private bidder. So no one has an understanding of the bidding auction dynamics, and the only person who actually understands what is being bid on and the prices for it is the supply side. So the auctioneer now is the only one with the full set of information, because in the past you could sit there and there were data sources you could buy that would tell you what type of user this was, how valuable they were and that was kind of market information. But since IDFA took that ability away, now, the most complete set of information is everyone's approximation. So each DSP, demand-side platform, just think of each bidder who is bidding on the value of this ad for this ad slot. When they bid, they're making an estimate of how valuable that ad slot is and how valuable that user is.
Now, there are a lot of different ways that can come at it. Contextual, whatever they're... Everyone has their own set. But, when you're on the SSP side when you're on the mediation side, you're sitting there and you're receiving all the bids. And this is from the piece, one of the things that's been completely cut out of the ecosystem, is the ability to understand the average LTD of these players. But on the other side, if you're sitting and you're getting all the bids, you can actually create an average bid because you have the most full information set. So it's created this data advantage that is primarily being accrued to the mediation players, but this is... Yeah.

Andrew: So in our Candy Crush example, what would happen is, AppLovin, they serve as the supply side for maybe not Candy Crush, but for someone AppLovin would get five bids and ones 10 cents for this customer every other one is two cents, to make the numbers really easy, right? So that's interesting on its own, but the bidder would only know, hey, my bid, won with 10 cents, the game person would only know, hey, it was 10 cents. But AppLovin has data and says, "Oh look at that, everyone else thought this customer was worth two cents. These guys thought it was worth ten cents. The average comes out to about four cents. That's really interesting and they can start develop... Obviously, I'm simplifying and using an extreme example, where one's bidder[?] is 5X everyone else, but they can start using all that information to tangential has, especially when you're probably[?] over hundreds of thousands of different ads. They can figure out all sorts of other things with that data.

Doug: Yes, and one of the reasons why this is really important, is because this auctioneer is also buying and selling ads. In the auctioneer example, we're assuming the auctioneer isn't buying and selling ads, but AppLovin is buying and selling ads. So they have a demand-side platform, they have a user acquisition platform and they also have this full supply and demand side platform. It's very opaque, welcome to AdTech, but they play on both sides of the spectrum and they also have a closed-loop ad exchange, as well. So, all of a sudden, they have a meaningful data advantage and they have a closed-loop ad exchange. This creates a big data information advantage that I think that they're going to be able to exploit, going forward, and they're one of the few players with this data available to them.
IronSource, obviously is the other one. I think the thing that maybe is lost on public markets, is that their business has slightly ever so slightly improved in competitive positioning. Now, to be fair, the business itself, I understand, AdTech. this is hard. The multiples are may be justifiably where they should be, but you look at it and you're like, okay there's like... Take the complexity away, you look at it and you're like, this business seems to have consolidated meaningfully into ironSource and Unity and AppLovin. AppLovin is meaningfully ahead of ironSource in the mediation game and you can go do extra calls on this. Essentially, AppLovin has just has seemingly an execution advantage and they continue to ship faster and kind of take share and they have always been the leader in mediation. The heuristic is they're about a 60% market share mediation. So, all of a sudden, consolidation, relative advantage, all these things are happening, they're software business this entire time, by the way, did not shrink. IDFA, as bad as it was for the open ecosystem of advertising, their business grew meaningfully in 2022.
Now, going forward, I understand the problems with some of the comps and how do we know what it can grow? But I think that there is a real chance that the forward-looking numbers are going to be much better than the expectations the market has put there. I think that... And what's also important to note in this, is that there's also another side of their business, that really doesn't matter quite as much as it used to and they're trying to sell, so they have... So, in the process of making this AdTech stack, they were making all these products and they're like, hey look, you should try our software because it's so good, but they couldn't convince anyone to share with them because they're like, why would we share with you? Why would we do that? What they did, is they actually bought hundreds and hundreds of games. They scaled[?] their whole supply AdTech network themselves and then they started to use, they dogfooded their own product and all of a sudden...

Andrew: Yeah, I was going to say they dogfooded their own product? I use that [inaudible]

Doug: Yeah, they dogfooded their own product and I mean, it's frankly, pretty impressive. They did it kind of backwards, which is really rare to see that they were like, "Okay, we have this product, we think it's good. We're gonna acquire hundreds of companies. Become one of the largest software, become one of the largest mobile games developers," just to be able to bootstrap these software products and let's say, 2021 to now, the software business was much... 2020, it was about one third, two thirds, in [inaudible] terms software to mobile games. Now, today, it's more like three-fourths, one-fourth. When they were going public, the whole bull[?] case was predicated on this software business becoming a lot bigger than becoming more mature, and what happened was, the bull[?] the case happened. The software business has taken on its life of its own and now they're actually trying to sell the mobile games [inaudible]. Now, that is TBD, I don't... They've been talking about strategic review and trying to sell the games for a long time. I don't know if they are going to now, because they've really moved the [inaudible] margins on these things. So they've really made them more cash flow businesses, even though the revenue has shrunk meaningfully. Revenue has in absolute terms decreased year over year, but EBITDA has increased or essentially stayed flat in the mobile game side of the business which I think is really impressive, but that's an aside.

Andrew: I just wanted to... I'm just laughing, you mentioned the games and I knew they had the game, but I hadn't thought to look at some of the games. So some of the games, you might have seen ads for Game of War or Mobile Strike. I think Mobile Strike's the one where they had Arnold Schwarzenegger pitching it for a while, but one of the things is Machine Zone is one of their games and just the front of it is, "We're the destination to kick ass." That's like on a publicly traded company. That's the front of their website or they have another one is Lion Studios which has a knockoff wordle and all these really silly games that you would definitely get click-baited into advertising. But, I was looking at those then I had to laugh because I saw those. Please continue, I didn't mean to cut you off, but you just have to share kick ass when you can, right?

Doug: Yeah, they actually have, I think some of the largest match. So, essentially, other than Candy Crush. Like matching 10 Mansion, there's like a lot of other weird and word games they're really strong in. So these hyper-casual ga-... [crosstalk]

Andrew: Wordscape, yeah.

Doug: Yeah, Wordscape. So, these hyper-casual games, were probably the poster child of pandemics assess, right? Because all of a sudden we have a lot of time to burn and we're at home. Our screen time quadruples year over year. One of the biggest incremental in flows during 2020 and 2021, was hyper-casual games. It created this giant boom market that obviously was unsustainable and AppLovin was valued on boom market valuation with a boom market revenue. So, I understand why it was, I want to say, 20/30 times, [inaudible] something that was clearly unsustainable and it was like a one time. But, in this process, this gave them all the financial wherewithal and ability to create what they always wanted in the end, which was this software business. And I think the software business is inherently valuable to take breaks[?] there, seem to be much higher than a traditional SSP. It's something like 20% to 25%. So they're.. And that isn't the only metric of quality in AdTech, but it is directional to the value that they're giving. They meaningfully have executed and done a really impressive job. And I actually want to maybe take a second to talk about the ironSource versus AppLovin dynamics, because I think [inaudible] [crosstalk]

Andrew: That's great, because if I can just jump in, I'll prime you because you're about to take that one of the next questions on my mouth. Look, one of the ways I knew AppLovin, is from last year. Unity, their big competitor, offers to buy ironSource. A very big premium deal and AppLovin steps in with what I think was a really ill thought of acquisition offer from what I can remember and I can go through the basics, but they offered... Unity was barely a premium deal and they offered them part in stock and part and non-voting stock and they were valuing the non-voting stock, which was a new share of stock at the same as the vote. It was a very strange deal and I think a lot of people at the time saw this and said, what's happening is AppLovin thinks that the Unity - ironSource merger is a killer for them, and will take a lot of share and they're just lobbying in a Hail Mary bid to try to break this up, which failed. I've rambled a little bit, I'll let you [inaudible] because it is important story, right? A, it consolidated the market a lot, which could be good, but B, the way they responded to the merger, kind of indicated maybe they thought there was some strategic issues with it. So, please go ahead.

Doug: Oh yeah, so this is actually a huge part of the story. So, whenever the Unity - ironSource deal went through, I think AppLovin has taken essentially a straight line down since. [inaudible] to a certain extent as well, because the valuation has really come in, but...

Andrew: AppLovin, from memory, was 45 when this deal happened. They made their offer, the stock went down on the offer because it was going to be pretty dilutive. And since then, as you said, it's gone straight down to 16. Now, the whole market's gone down and all that type of stuff too, but they're down a lot more on a kind of Alpha Beta adjusted Metro.

Doug: Yeah, they were essentially, my understanding is, their enterprise values were very similar and the CEO for better for worse is a deal CEO, he really is.

Andrew: Yes [inaudible]

Doug: I'm sure... So, essentially, I think what he saw at the time was like, hey, there is Unity, it's kind of the same size as us. Let's be the fish that ate the whale, kind of vibe, because Unity is one of the most valuable things in the entire gaming ecosystem and you can talk, for better for worse, they're pretty bad at ads and really good at the gaming side of things and so they thought, hey, ironSource will shore us up. What actually happened, is kind of a little interesting because ironSource was always the number two player and they continued to be the number two player. It's really one of the big things that expert networks will talk to you about this, but essentially, ironSource just doesn't have the plug-in to the Google Network at all, actually. So, if you're bidding on the Google side, demand side, for mobile games, your bids will just not go through to ironSource. Right now, they're mostly done with AppLovin. For whatever reason, they still haven't got this together. So, every quarter this goes along, you're like, what is happening? This is one of these really slight things where I think market share is made, if that makes sense.
The historical overweight of Google will probably be good for them, going forward. Also, Google's ecosystem had a huge inflow of money because of how bad the Apple ecosystem got hit. So, there's this kind of interesting dynamic where you're like, wait, can you explain to me why ironSource hasn't been given a bidding to the Google Network? It's still, the last time I checked at least, it's still not that way. And Google actually did a press release today, essentially talking about how Google bidding is now available to all max developers. And essentially, it talks about improving... It's an open beta available to all of the mediation platforms. We know that historically Google bidding is strongest and the beta was probably first done to AppLovin. There's this interesting dynamic here of ironSource is actually law[?] shared this entire time on a relative basis and one of the things that I highlight in the write-up is, they actually launched something called, Axon. Axon is their machine learning model or whatever and in the in the course of two or three quarters, their revenue went from like 90% year-over-year to like three 300% year-over-year. There was this...

Andrew: They launched Axon several years ago and I think you're driving Axon 2.0 is coming out, but just so people know, it's not like a recent thing. They actually launched it several years ago and then Axon 2.0, I think is actually the [inaudible].

Doug: Yeah, Axon, and the thing that's interesting is, now they're launching Axon two and so, the competitor dynamic seems to be that even after the Unity - ironSource deal, AppLovin is still beat the crap out of ironSource. Also, I thought it was really interesting and maybe missed by the investor community, there' was like a giant scandal during the ironSource acquisition because Unity announced the layoff then bought ironSource the next week and there was also an interview with the CEO. The CEO is the former EA Games CEO, when everyone [inaudible] [crosstalk]

Andrew: I love this [naudible]

Doug: It's so freaking funny because he goes on this... The actual interview has been deleted since, by the way, but everyone has the quotes to it, but he essentially calls all game developers who don't want to monetize their product, fucking idiots. That is a direct quote. So, after time, everyone's really pissed off, they fire all the game developers who are like, "You guys aren't really even working on the game engine. You're just calling us fucking idiots and you're firing people and then you're buying ironSource." This created this level of, and this was in June, this level of distraction that I think that is maybe underappreciated because right now, I would guess Unity is mostly trying to put out fires, and obviously in a great ironSource. Meanwhile, I...

Andrew: I was going to say, they're doing a big integration and guess what? Integrations mergers are distracting. I mean, AppLovin digits by MoPub and they are a deal roll up in themselves, but you've got that big integration. That's risk, but that's also opportunity for your competitors.

Doug: Yeah, and for context, and I want to put like the differences here because I think this is soft stuff, right? So they did the MoPub acquisition, they shut it down and five months. They bought it and five months were like, okay, good to go. We moved everyone over to the AppLovin network. We're good to go, five months, all done, tidied up and it's truly impressive levels of execution and time. So, I think AppLovin actually has, at least historically and with all the things that were available to look at, has really good execution. This is all to say, I think AppLovin is not quite as busted as people think and if you look at the software business, I think that it can easily grow, let's say a 15 to 20% revenue CAGR, right? That is usually pretty val-... And it seems to be the leader in its space. That's usually pretty valuable in AdTech, but if you look at the company, it trades for like, seven and a half times EBITDA. Now, free cash flow is a little bit messier, but it looks really easy to pencil in a lot of upside if you believe that this thing can continue to grow and that as software continues to become a larger part of the business, which is pretty easy to underwrite. Their EBITDA margin will start to approach the software margin. The software business made 70% EBITDA last year, they expect it to be something like 65% going forward. I expect 65, eventually, maybe 70. And so, I think that there's this really interesting dynamic here where the AppLovin software business, I don't think is worth six to seven times EBITDA. And...

Andrew: Let me ask... Oh, go ahead.

Doug: Yeah, I mean, it's not a Trade Desk because comping anything to the trade desk will make any company really expensive, but for context, I think trade desk is like $1.5 billion dollars in revenue, and the AppLovin business is something like the software business in 2023 is going to be like one billion in 2022 versus Trade Desk, 1.4 billion in 2022. The difference here is, Trade Desk is $40 billion and AppLovin is like $6 billion dollars in market cap. Should have traded Trade Desk? I don't know, but it clearly isn't a total dog of a property, but it trades like a total dog. In fact, it's like one of the cheapest companies in a comp set. Even companies like Magnite [inaudible], which is a pure-play games developer, trades at a higher EBITDA multiple than they do. There seem to be levers to be pulled, mostly the Axon launch that is coming up soon that I think is really exciting because the last time they launched Axon, they took a lot of share. Logic has, maybe, the next time they launch Axon, the improvement, they will take more share and this time they have more data from the mediation side that I think will give them a better data advantage than they had last time. Anyway, sorry.

Andrew: Let me ask a few questions here. First, number one, I just realized I grabbed the wrong cat off the rack when I was putting my hat on for the podcast. Did you get the Yet Another Value Podcast hat?

Doug: Yes, I do. I have it [inaudible]

Andrew: Neither of us is wearing our hats, this is insanity. But [crosstalk] [inaudible]

Doug: If you want, we can pause it and both come back with the hats on.

Andrew: No, we're professionals. We're just going to have to power through with the wrong hats, but let me ask you, so I really like the way you framed it in your write-up, you know. I think people could get if they've just been listening here, and let's say they've been listening while they're cooking dinner or something, so this is on in the background. People could probably grab a few things here. We started out while we were talking founder lad[?] who just took a crazy aggressive PSU grant, right? The stock literally needs to more than double in the next four to five years in order for him to hit the lowest end of this and guess what? If [inaudible] doubles up for four to five years, you're going to be pretty happy, right? And that's again, the lowest end. So, a founder took a very aggressive stock[?], we've talked about multiple different levers to pull in a consolidating industry that should be at post IDFA . I don't think anybody thinks that people are going to spend less times on their smartphones. I don't think anybody thinks people are going to spend less time in the game. You've got consolidation, week on [inaudible] and a growing industry in a duopoly and we've got a reasonable [inaudible]. I think that should have shined through for everyone. I've got a bunch of other questions I want... But I just want to start with one question. What is the market missing? Every single person I know... Two years ago Unity was literally the hottest stock on earth. This is a comp, everybody's looked it up, loving it, it is big enough that anyone can cover it, it's a sexy growth industry. Anyone can look at this. What is the market missing that is kind of smacking, that you've got this thing that is trading at a value multiple, despite all these different growth levels[?]?

Doug: I do think that this is a left-for-dead stock and as time went on, people started to realize there were cracks in the castle. One of the big ones is that the games business was unsustainable. The games business started to go down, 30/40% a year, still continue to shrink, I think by some sensor tower data you think it looks like it might have troughed in Q4. I think that that there... It looks like that market is starting to stabilize out hyper-casual, which is where most of the games business is the most left-for-dead, most screwed-up business in the entire mobile games industry or actually, the entire gaming industry. It really is probably the worst property and so, high level, hyper-casual stocks[?], AppLovin is dead, right? That's the one way to put it and let's say in 2021, that would be a fair assumption to make, right? That was the majority of revenue. In fact, that was, I would say, not just the majority of revenue, that was like 75% of the revenue. But you fast forward a few years, and all of a sudden, it's 50/50 revenue software and games, and the software business has a lot more EBITDA. I think the thought process here is that people haven't really updated what the business shift is, because the entire time, when people were... Revenue was going down or, actually, revenue was flat in 2022, which is mind-boggling to me. That's just crazy because their big segment goes down 18%, their small segment goes up 50%, revenue is flat, essentially.

Andrew: Is that adjust the MoPub acquisition?

Doug: Actually, I don't know if that has those numbers in there. I think that is not adjusted for [inaudible] so...

Andrew: Because there was also some complication where they had to give payments to get people to transfer from mobile to the... Yeah.

Doug: That hurt in your term profitability as well. There is a lot of hair on this, to be clear, but I think the price is finally at a place where I think there's a lot of safety in it if that makes sense. Prices you're marching to safety. The company makes free cash flow. The company is buying back shares right now, as well, and...

Andrew: Let me jump on the share by that. Because that actually was my next question. So, anyone can go through the 10K, right? They buy back just shy of $340 million of stock throughout 2022 and their average prices are in the high 30s and in Q4, they don't buy a single share back, despite having plenty of cash and an analyst even ask them on the call, "Hey, you guys didn't buy any shares back in Q4, you guys are casually generative, you've got a billion dollars of cash on the balance sheet." I believe management even said, "Hey, our bar of MNA right now is really high because we see value in the stock," and I think analysts perhaps probably rightly, we're looking and saying, "Okay, the bar is high. Your stock is down and you're not buying back shares, you were buying it 120% higher, a couple of months ago, what gets?"

Doug: Yeah, I think that's really interesting because the comment that they push back is that they want to increase their cash balance. That is a typical deal response. I don't know why, maybe part of it is that they have a... Because at the same time that this is also happening, the games business is in strategic review. So if that happens, if they sell the games business, then they would have a huge chunk of cash. Maybe the thought process then is like a hyper led[?], like a tender or something, I don't know. That's actually something that I've been thinking quite a bit about, because I'm like, if it is so cheap, which I think it is, why don't we do purchases in Q4? Because they did repurchase $300 million throughout the year, but not in Q4. I don't know, this might be where we are price, frankly, my dictate sentiment, if that makes sense, unfortunately, maybe they continue to see the share price in free fall and they're like, "Screw it, we just need more cash." I don't know, because if you think they're going to sell their games business, then all of a sudden they're sitting on... I think the games business is worth a billion or something. That's another incremental billion in cash, but they do have some debt maturities. They are a little different in most companies, in terms of the fact that they have a lot of debt, relative to most companies their size or their growth profile or their historic... Let's say, a traditional Silicon Valley company that the hyper-growth cohort, usually has cash, not very much debt and the shares have gone down a ton because the multiples come in. They had debt the entire time and not only did they have debt, they like to do these acquisitions, so, maybe the thought process there is there's some kind of more chest[?] for the debt maturity is coming up, but I don't think it is quite... You're right, because I was kind of frustrated by that as well, because you're like, "Why are you doing this while also giving just insane PSU grants?" It's like a million shares per Tron. So it's like just the two of them, I think, get some insane... It's 12 million shares total, that would dilute the entire cap structure by like... I need to see how many shares are outstanding, but there's only... Just with what they have, that is like 3% dilution in just PSUs, right?

Andrew: Yep.

Doug: Just this PSU package.

Andrew: That's not too bad though, because they did say, "Hey, this is your PSU grant. This is like five years... [crosstalk]

Doug: Four years, yeah.

Andrew: …rolled into one, so say, hey, top exec at this growth e-text company diluting by 3% over multiple years, it doesn't seem too crazy and if we get that dilution, the stock will have at least doubled. Again, not absolutely crazy. It may be not the best, but that absolutely... [crosstalk]

Doug: But at the same time, when they're sitting on cash, why not buy back shares if you're a cure so amped up?

Andrew: Let me morph that into my next question. So we started talking about PSUs and grants. I do think you could look at this company and make an argument, "Hey the PSU grant is great. It really incentivized them." These guys already owned hundreds of hundreds of millions of shares, but I do worry if it's heads for them, they win, tails for them, they break even or something. Because they are adjusted EBITDA positive. A billion dollars in adjusted EBITDA on 2022, and guess what? People have started including stock comp in taking out of adjusted EBITDA. Stock company[?] is 200 million-ish, in 2022. So, take it out of the billion, still $800 million in EBITDA. There are some publisher bonuses that I think you need to think about, but this is a free cash flow chart of business. But I do think people might look and say, "Hey, one way to game the kind of stock comp add-back thing, would be to grant all your options once every five years," try to time it around the stock price and then say, "Oh, once every five years we add that back, but for the next couple of years, investors won't go look at that because our stock comp will be low." So you just kind of bulk it all into one thing and I wonder if investors will look and say, "Hey, they tried to time this. This is heads they win, tails they lose, in two or three years, if the stock hasn't gone up, guess what? They'll just adjust and grant another one... [crosstalk]

Doug: They'd do it again.

Andrew: …and by the way, they won't have reported any stock comp in the meantime because they did it all once and people, they won't have x." I just wonder if there's that type of game and again, these guys, they're very incentivized. They earn hundreds of millions. KKR still owns 20%. I think this is the biggest win KKR ever had, if I remember correctly[crosstalk] they still own 20% of this...

Doug: Yes, it is the biggest win they've ever had. Yeah.

Andrew: It's not like these guys are incentivized, but I just wonder if you're playing a game where the deck is really stacked for someone else.

Doug: Yeah, I think that's actually part... So, part of the analysis here is that, actually, if you look at the grants, he gifted as much shares as he could into a few trusts, essentially and within the trust, he sold them down. I think one of the reasons why the board would be upset is because he really does not own that much shares, compared to what he used to own. And now with this PSU package, he's required to hold it. If that makes sense. So, thought process here is, maybe, the CEO doesn't really have the skin in the game that he used to, and this is a way to increase the skin in the game, essentially after cashing out. I really...

Andrew: That was another question I was going to ask, just if you look through 2022, these guys are just hammering the stock all the way down and insider sales and it goes even as far as... They start 2022 in the 80 range. Even in December, when the stock is in the 11s, you see the CEO selling $25 million worth of share. You see the CTO selling $25 million worth of shares and yeah, they still own a lot and yeah, it looks like these were just 10b5-1 sales. They are selling huge amounts, so you look at them and wonder, hey, they're just getting gifted up side where the cashing out.

Doug: Yeah. That's that's probably the biggest thing I'm concerned about with this, right up. I think in a lot of ways, this is very asymmetric. And in many ways it's tilted against you, the valuation really does feel at the low end. You can see where there are levers to pull, that you think that they're their business can get stronger. There are a lot of ways that... So, if your stock is an option, why don't you write your management team options as well? That's I guess the concern here and that's where this gets really hard, to be honest with you. I am pretty cognizant of that, but I do think that, in terms of things that are bombed out, where I think the future might not be as dim as people think it is. This is probably a pretty good place to look. I think AdTech, in general, hits that. So...

Andrew: The one other thing we haven't even mentioned, well, we haven't talked about the connected TV opportunity, which we kind of second [inaudible]. The one other thing, ad rates got crushed throughout 2022. They're way down from a couple of years ago. Obviously, 2021 was a really hot market, but if you just think about, hey, once we lap Silicon Valley Bank and everything stabilizes and maybe we're in a recession, maybe we're not, but once you get to kind of, I would guess, normalized rates are higher than they were running in Q4 and Q1 and once you get to normalize ad rates, their earning should go up on that too. So not only do you get all those tailwinds we talked about, you probably have some normalization of the ad market not being the worst it's been in six years.

Doug: Yeah, I think that's also part of the reason why this is timed and sized the way it is, as well. If you think about it this way, the board is definitely thinking, this is bottom calling and for better for worse. When you see these kind of packages, there are two worlds of these kinds of packages. For context, I do a lot of governance things with a lot of people. I talk non-GAAP, talk with a few other of my friends. This is not a completely solely sourced idea. There's [inaudible] like a little bit of a teamwork effort, really looking over the governance universe and I've looked at a lot of these, and there's there are two types of these. True Hail Marys and where you look at the business and you're like, I don't see a single way out of this. You look at it, the stock is just going down, they're super levered. You're like, what is it? A debt refi? You just look at it and you're like, the most creative thinking possible cannot find me away to the other side of this. And those guys will grant all the way into the hole and it's a zero. Or just like a totally terrible outcome. I think the reason why this is so attractive to me is because it has the extremely asymmetric price vesting. But, unlike the other... And this is like, maybe a context that I can't really give on a podcast really well, but, unlike some of the other Hail Mary grants, there are clear levers, there's clear normalization. The stock itself is arguably cheap. One that you can maybe underwrite with... I did a DCF for this one and the fair value on this thing, assuming some very honor ohmic, the price is implied, it's around a 25% discount rate. So you're like, there are a lot of things going right here. Sometimes you do all this work on looking at these Hail Mary grants and you're like, I just don't see it, this is a Hail Mary. I think that this is... There are levers to pull and clearly they want to incentivize them, so that if they pull the correct levers, they get paid. So, I think that's why... Yeah.

Andrew: Oh, and you pointed out, yes, they get paid, but if you look, the chair of the compensation committee is, I believe, the last nominee from KKR who owns 20% of this obviously private equity. And this is one thing, non-GAAP is always isolated[?]. Private equity is very familiar with using the nominating committee to reward people, reward key employees, and that sort of stuff, at the right time, grant awards. Private equity is not in the business, especially when they have the most successful exit and from history, they're not in the business of pissing those executives off. You would have to think that if they're granting these, yes they want the alignment, but you would have to think they're granting this super aggressive thing with some view that at least the low side of it's attainable. And another person on the compensation committee is the lead independent director, who is the CEO of Win[?]. And if I remember correctly, Win has also been known to play these types of granting games. I can't remember for sure, but something's tickling the back of my head that they have. Not only do you have the KKR who definitely knows the play, but you've got another member of the compensation committee, who I think has played this type of games before as well, in his own personal life. So, suggest [inaudible] probably stack in the deck a little bit.

Doug: When you stack the deck like this, you want to... It's in KKR's interest to just piss a Hail Mary grant away, where it's like, hey this this is extremely upside, we're going to massively reward insiders here while I sit on the comp chair. I think that there is at least a path to get better. Another opportunity that we really haven't talked about is Whirl[?], the CTV co-option truly, but, in the proxy, it looks like they hit their 2022 estimates of what, like $75 million. It's clear that that is another little engine that is cranking away too and I also want to, maybe, take a step back and point out that Adam is a deal CEO and he's actually pulled off a lot of really good deals. Max, I thought was internal. No, Max was acquired in 2017. So, the hit rate of these acquisitions have been surprisingly good, truly, surprisingly good. Acquiring to where all the way, with the games, even most of the software acquisitions have been money good. I think that there are levers to pull and I think that they understand compensation too, within these companies. You should maybe read on the call for the acquisition for Whirl[?]. It was really interesting because it was very dark artsy, in that same way as well, because you're on the call and they're like, "Well, if they hit $500 million in revenue in 2025, but with a certain EBITDA, we're gonna give them a $600 million payout total." And you're like, wait, what the f-... That's essentially half the economics of this business. So at the same time, I also understand because if you make a $500 million CTV business over the course of three or four years, that maybe rightfully deserves some compensation. I think that AppLovin seems...

Andrew: If you make a 500 million CTV business, you probably created what, between $5 billion to a $10 billion business. So, if you pay them 300 million, that's actually money really well spent.

Doug: Yeah, but, it's in the same kind of payout metric of what would happen... I feel like the risk reward for the Whirl[?] founders is kind of similar to what would happen if they were to do this standalone. They're getting the crazy outcome option, with the same, but within the big portfolio, with a little bit more stability and someplace to land and expand. I think that the guys here know what they're doing, at least to incentivize and create these opportunities that seem to be money-good, if it makes sense. Max was truly from nowhere and obviously a leader in its phase when it got acquired, but when it got acquired, most of the people stayed around and continued to execute and created the business that it is today. So I think that it's all part of... The secret source of AppLovin might be, honestly, a lot of thoughtfulness about compensation. That's something that I think about a lot. These guys are not unaware of how this works, that if you put a big carrot in front of them, the donkey runs a little faster, right?

Andrew: Just one more thing on the PSU grant, which I think is the thing that interested you in this. I've seen these types of PSU grants before, I've written them up. I know you've seen them and you've written them up. Something interesting, and off the top of my head I can't remember someone else doing it, you can tell me if I'm wrong here. The CEO and the other key guy [crosstalk] get about seven...

Doug: CTO.

Andrew: …and the CTO, get 6.9 million shares each. Again, $36 is the strike price at the very lowest end. But as part of it, the board also authorizes another rounded up to 3.5 million shares and says, hey CEO, you can give these 3.5 million PSUs to any of your other key execs that you want, at your own discretion. And in general with these PSU type deals, I've generally seen them go to the top one to, three people. I haven't seen them go to multiple people at the senior executive level. It seems like they're setting this up to do. And again, that would just be one more thing... Look, 3.4 million shares at $36 per share, which is the low end, that's $100 million of shares to gift, if I'm doing that math in my head right. I hope I'm doing math in my head right. [crosstalk] But...

Doug: Yeah, I think what the math is right, yeah.

Andrew: So, the 3.4 million, they have 279[?] hits, so it would actually be a lot higher. It would be 700,000 at 36, but that's still a significant chunk of change. The fact that they're giving... To stop my ramblings, the fact that they're giving them to more than just the top two, doesn't suggest to me this is Hail Mary. It suggests to me, "Hey, we think now is an attractive time to put that carrot in front of people, this is an execution business. We have to execute, we have to grow, we have to keep delivering. If we don't, we will get crushed, but we see an attractive opportunity. We see an attractive price. Let's incentivize all of our top guys to run out and get that carrot.

Doug: Yeah, I think they want to unbreak the broken IPO, right? And that's the way you do it and I think the incentivization to relevel, when things are down, is really important and I think that right now, for the first time in a while, you can look... The incentives are obviously a lot higher from here, but, the stock also traded a lot, higher, relatively, recently. Middle of last year, it's a $36 stock. So that's the lower end of the vesting and I think that some of the other interesting things, is the four-year hurdle, might actually be a little bit in their favor, if they think they can hit it sooner. And, you have a cell signal, by the way, because it says, until this comp plan is done, whenever we restrike the comp package, we're gonna... I think they can restrike before four years, but it's intended to be the payment for the next four years. The restrike to me, probably means that, hey, our work here is done, if it makes sense. We pulled all the levers that the board saw and I think that's really important and I've seen this actually happen before. The first restrike after an aggressive PSU comes in two ways, an extremely dog between the tails, RSU heavy, time-vesting, just like you can tell that they're just like, "Whatever, we screw that up." Or, it comes in the way of more vanilla, because they hit the price hurdle and it's like, "Okay, we're gonna..." So I think that's also a very interesting signal on how this works out because the compensation committee is part of the board. The board knows what's happening. They have some kind of plan, view of the outcome here, and I think that that's a really good way to read into how valuable they view their own options in the business. Not the company, not the actual stock.

Andrew: The other thing I was just going to...If you think about this, we've mentioned the Whirl[?] right now, where the Whirl[?] founders can earn, I think it's up to 600 million in equity, if they hit a bunch of performance targets between 23, 24, and 25. If I'm remembering your right up correctly. If you think about these units, they're struck with a four or five year vest. They're struck this year, so they'll vest in 27. By 27, Whirl[?] alone will have paid out and if it does 500 million in revenue and [inaudible] it's going to be worth all of the market cap today, basically. Maybe I'm rounding too aggressively, maybe I'm being a little too conservative, but I'll be worth all the market cap and then you'll get all the rest of the businesses. These guys struck this right before the options really start paying off and by the time these realize, you're going to know if the offense play off alright. Options are not guaranteed, but I think they struck them and they saw advantageous timing, advantageous price, all these things that they think are going well are about start kicking in. It just doesn't make sense. Doug, I think we have gone through a lot of stuff here. This is the tough thing with... We spent almost an hour on an AdTech business, we could probably spend, I'm a new AdTech expert, but we could probably spend the next an hour, a day, for the next month, going over the AdTech business. But, anything else you think we didn't cover, that you think we should have hit on or anything we glossed over, and you think we should hit on harder?

Doug: I just think maybe something that we might not have talked about that much is the strategic [inaudible] of selling the games business, because that's been for sale possibly. I think it's not likely at this point, because it's been...

Andrew: You know, you slapped a 5x EBITDA multiple on it, and to me, it's just like, hey, why sell something for 5x EBITDA when it's really cash flow generative, it probably has synergies with your core business. As you said, you dogfooded this business, you can dog food new products and new stuff. I get like...

Doug: Probably the bottom of it too.

Andrew: And I think the article, you released, where they said they were reviewing selling the games business, was from March 2022, if I remember correctly. [crosstalk] It's been over a year...

Doug: It's been a while.

Andrew: …and I would just guess it's not happening. It's been over a year, but I do hear you on that.

Doug: I think that's an option that I don't think we talked about, if that makes sense. And also for context, they did shut down some of the games too. Part of it is they did pull back some of the levers. I think they even have a management to buyout for some of these games. So they did the right size it to a certain extent, but I think that there might be more rabbits to pull out of their habits, if that makes sense. Something I don't think we talked much about that. I think maybe the Axon too thing, I think is... You can see in the right up, they just took like 25 bit points of share within two years, essentially, after launching. They're like, "Hey, we launched this new product called Axon, and the next quarter, they grow. They move from 90-200% revenue, year over year, and they're like, "We gained share because of our new product launch called Axon." And they did this for a few quarters and they're like, "All of our revenue growth is mostly because of our new product called Axon and on the earnings calls right now, they're like, "We plan to launch Axon too, in 2023. Maybe that's the real big lever that they're thinking, but there are clearly some levers to pull and I think that between Axon, between Whirl[?] between AdTech lapping, there's a lot of positive ways for them to pull off the PSU grants, and evaluation that is just really undemanding. Seven times for EBITDA, making cash flow, growing. I think that all these things together, and the PSU, kind of... Investing is really hard, but I would... If you give me, 20 of these, I will swing at these because there are a lot of things in your favor. We don't have perfect information, but I think that with the information given to us in the price, as some kind of margin of safety, I think that all these things together, really do create something that's really interesting, super asymmetric and seems a lot more company-driven, specific levers to pull, than, let's just say, the broader market. With the stock that is beaten up like this. I think that there are a lot of ways to win. So, that's the high level of how I think about it.

Andrew: You know, the other lover they could pull that we didn't even talk about, Axon was using machine learning to improve their bidding. They have not come out and started screaming, "We're using AI, we're using [crosstalk] AI. Give us an AI [inaudible]. There is the lever.

Doug: Yeah, they need to be like, "ChatGPT is also part of our..." I don't know. Actually, the AI stuff that they're using apparently was relatively simplistic and I crushed it. So it really shows, I guess, the value of well done, simple things really crush it. It took a lot of share and I think that they talk about this on the calls. AI, as a discipline, has improved meaningfully sense. So, I'm going to guess that those shares that were given to Adam to incentivize whoever, some of those are definitely going to be to the AI people to figure it out and create an algorithm that I think is really powerful and using their mediation thing. Once again, another lever to pull and it clearly is a place where it's a lot better than it has been. So, I just think it's interesting. But yeah, I really wanted to talk about this idea because I just think it's really creative. It's really different. It's super beating up. People have a lot of PTSD on this name and I think that it's compelling. So...

Andrew: Perfect. For people who want to learn more, I'm going to include a link to your right up, its behind paywall. It's on the new mules museums sub stack, which is different than the fabricated knowledge sub stack. But, I'll put a link to that. Doug, I appreciate you coming on for the third time for the fourth time, we're both going to remember to wear the proper hats.

Doug: Wear the hats, yeah. Also, I will probably be releasing it out of paywall after a few months. That's kind of the thought process I'm going to have going forward, I think, with some of these. Especially the long right ups and I thought about most of the most of it today, honestly. What's behind the paywall? But, I think that just for the people who support me, and to be clear, passion project, love governance, I think they're good ideas, but it's a research service.

Andrew: We're taping this, May 3. I think they report earnings next week. So, this could quickly look very smart, very solid [inaudible] [crosstalk]

Doug: Yeah, or very stupid. It's somewhere between. And I feel like the odds are, it's going one way or the other or I could say, it could stay flat, who knows? That's how stars work.

Andrew: That's the tough thing about the stock market, who knows? But Doug, I appreciate you coming on. Looking forward to the fourth time, with proper hats and we will chat soon.

Doug: Yeah, cool. Thank you.

[END]