EUR 850.00 For Business Accounts Only

Morningstar | Criteo Reports In Line 3Q Results and Announces the Acquisition of Manage; Maintaining $35 FVE

Criteo’s third-quarter results met our internal expectations and consensus. The no-moat firm is making some headway in diversifying its services, widening the types of clients it targets, and lessening the impact of Apple’s ITP, as it may possibly return to top-line growth by the end of 2019. While we are confident that demand for online advertising will remain strong during the next five years, we remain a bit cautious regarding Criteo’s ability to broaden its portfolio of products and effectively cross-sell the various offerings to current or new clients. We note that today’s announcement of the acquisition of Manage, a programmatic in-app ad buyer, was the right move as Manage will help Criteo grow its top line next year while slightly expanding margin due to less dependency on ad inventory purchased in browsers. Although we included Manage’s potential contribution to Criteo’s numbers in 2019 and beyond, our fair value estimate of $35 per share remains unchanged. At current levels, Criteo's shares may be attractive for investors willing to bear a variety of risks associated with this very high uncertainty name. We note the firm also announced an $80 million share buyback program, possibly benefiting shareholders.

We think Criteo appears to be well on its way to adding technological capabilities that will accompany its clients nearly through the entire marketing funnel, from initial brand awareness to the expertise it has had historically in retargeting and further increasing chances of a purchase or transaction. All of this is brought forth by the combination of the firm’s Criteo Customer Acquisition, Criteo Audience Match, Criteo Sponsored Products, and Storetail, which helps e-commerce sites or apps create native ad inventory for further monetization. In addition, such a strategy could pique the interest of ad agencies into working closely with Criteo from which both sides may benefit. While we continue to think it will take time before Criteo recognizes returns on such a strategy, the firm has taken the rights steps, in our view.

Its latest step is the recently announced acquisition of Manage, an in-app programmatic ad buyer in Mountain View, California, servicing the demand side of the online advertising workflow. We expect Manage to help Criteo further entrench its offerings and services in its clients’ current and future marketing strategies. We note that while this may help improve Criteo’s client retention rate, in our view, it will not necessarily create a switching cost moat source for the firm. We think Manage will also help Criteo to slightly lower cost of ads purchased as an increase in volume likely will be accompanied by some discount. Based on management’s comments during the call, we think Manage will generate close to $18 million in revenue this year (equivalent to 2% of our estimated Criteo net revenue) and is likely to grow at a 10%-15% annual rate through 2022. Assuming Manage’s operating margin of around 33%, and Criteo management saying that it paid 5 times Manage’s 2018 EBITDA, we estimate the acquisition was for around $30 million.

Total net revenue (or ex-TAC revenue) declined 5% year over year to $223.5 million, mainly due to less spending by smaller clients. While the firm added 213 clients during the quarter, which increased the client count to 19,213 (up 11% from last year), gross revenue generated per client did dip 17%. The decline in average spending per client is also likely due to lower ROIs on overall ads purchased by Criteo, as its reach in the Safari browser is now nearly nonexistent. While we expect continuing decline in gross revenue per client, we think its impact on gross and net revenue will be partially offset by growth in the number of clients. Criteo continues to more aggressively target midsize businesses.

Operating margin (based on gross revenue) during the quarter dipped around 1 percentage point from last year to nearly 5% as the firm’s hosting cost increased, the impact of which was partially offset by the surprisingly higher take rate for the second consecutive quarter. As Criteo’s midsize clients increase as a percentage of total clients, we expect the take rate to dip back to the 41%-42% that it has been historically. Criteo’s acquisition of Manage will likely allow the firm to control some R&D and sales and operations cost, which we think will create further operating leverage this year and will continue to widen operating margin through 2022. Plus, the firm could realize the benefits of targeting smaller businesses to which its more automated and less costly platform can be applied. We continue to expect 9% average operating margin the next five years, compared with 6% in 2017.