Internet valuations have become a focal point after a series of high profile deals and the rapid appreciation in equity values that have left some to justify higher price targets on dubious metrics and bubble inducing logic (i.e. expensive stocks are compared to other arguably overpriced stocks). There is a fixed ad opportunity given finite ad budgets, which we use to find that the market value ascribed to twelve major Internet ad names exceeds the fair value of the global Internet ad spend by about 33% in aggregate. We do not see an imminent sell-off in the names or advocate making near term trading decisions based solely on valuation. However, our work suggests we may eventually hit a pocket of volatility and/or a time frame were investors are no longer willing to pay for commensurate earnings growth (i.e. the names grow into their lofty multiples). We believe investors should be keenly focused on the catalysts that could trigger this volatility: declines in engagement, slower user growth, and systematic factors.
Finite Opportunity - By 2015 we should see $560 billion being spent on advertising around the globe and the Internet should continue to gradually gain market share as $12 to $16 billion rotate into internet ad budgets each year. Internet advertising growth has been relatively stable over the past few years and gives us confidence that we can predict the size of budgets in 2015. Zenith estimates global internet ad spend will grow 14% to $132 billion while an acceleration of growth (not seen in years) to 16% would amount to $134 billion. The twelve internet ad names we examine capture about 80% of this spend.
Industry Value - Looking at a broad number of valuation metrics, it is clear to us that the internet ad names tend to trade on price to sales growth, which averages 0.29x (0.30x median) off of 2015 numbers. A company capturing 100% of internet ad sales would be worth $542 billion using this multiple. Using the more optimistic industry growth assumption (16%) implies the market opportunity is valued at $622 billion. Using GOOG premium multiple of 0.31x and the optimistic growth scenario would value the industry at $665 billion.
The Disconnect - The aggregate adjusted market cap of the twelve ad names amounts to $724 billion, which exceeds the industry fair value by 33%. To put things in perspective, the aggregate market cap of GOOG, FB, and TWTR combined exceeds that of the industry by 12%. This is not entirely a fair comparison as the aggregate market cap does include value for things other than just online ad sales (e.g. FB payments). However, this fault is offset by the fact that the twelve names only represent about 80% of the online ad market, we deduct YHOO's Alibaba stake, and we reduced Tencent's cap by the proportion of revenue not tied to advertising.
Expectations - GOOG, FB, and TWTR would need to capture 74%, 32%, and 6% of the global ad market at current levels vs. their 51%,11%, and 1% estimated share of 2015 ad spend, respectively. It is not possible for all these companies to capture this much incremental share and suggests there are high expectations that go well beyond 2015.
Tony Wible joined Janney Montgomery Scott in 2008 and is a Managing Director covering the Media and Entertainment sector after spending the previous 10 years at Citigroup Investment Research—most recently covering the Broadcasting and Entertainment Services industries.
Tony can be reached at firstname.lastname@example.org.
Janney Montgomery Scott LLC, is a U.S. broker-dealer registered with the U.S. Securities and Exchange Commission and a member of the New York Stock Exchange, the Financial Industry Regulatory Authority and the Securities Investor Protection Corp. Disclosures may be reviewed at Wible's Weekly.
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