Nexxen International Q2: Valued cheaply despite improved outlook for profitable growth

investment thesis

Nexxen (NASDAQ: NEXN) is up over 40% from my previous article where I assigned a Buy recommendation to the company. My bullish thesis centered on the company’s return to organic growth by capitalizing on its competitive product offering, which it was built gradually through multiple acquisitions. Additionally, we found the stock to be cheaply valued and therefore anticipated that the management team would use its large cash position to aggressively buy back shares. My thesis continues to perform as expected, with the company delivering 4% year-on-year growth in ex-TAC ​​contribution in Q2 with solid FCF generation. Growth is expected to remain strong for the rest of this year as it benefits from political spending and new steam from data licensing revenue. Profitability and FCF generation remain strong, with the stock attractively valued at an EV/FCF multiple of just 5.7. Therefore, I continue to maintain my Buy rating on NEXN stock.

Financial highlights and my expectations for what’s to come

In Q2, ex-TAC ​​contribution increased 4% year-over-year to $83.1 million, as shown above. Adjusted EBITDA reached $26.8 million at a margin of 32%. CTV remains a key growth driver for the company and grew 14% year over year. CTV’s growth is supported by the company’s end-to-end platform, which consists of the demand platform (DSP) and the supply platform (SSP), which are interconnected through the data platform. This allows Nexxen’s clients to track and target users with ads while measuring the outcome. The Nexxen data platform does not rely on Google (GOOGL) cookies, as it has its own identity graph for each user, created by combining multiple identifiers on its platform.

Looking ahead, I expect Nexxen’s partnership with Alphonso and LG Electronics to contribute favorably to revenue growth in its CTV segment. In addition, it has signed a deal with Vivo to run ads in its large library of music videos. Earlier this month, management successfully added a highly profitable new revenue stream to the business through a data licensing partnership with The Trade Desk (TTD). While the revenue contribution from this won’t be significant in the short term, other licensing deals like this could lead to a massive opportunity for the company to improve its overall margins.

Management’s full-year ex-TAC ​​contribution of $343 million implies that year-on-year growth in H2 is expected to be close to 14% versus the 4% growth seen in the first half of this year. This acceleration in growth is likely driven by the expected benefit from increased political spending related to the US election. As shown in the excerpt below from the company’s Q2 earnings report, management has maintained a disciplined approach to spending. As a result, the full-year adjusted EBITDA margin is expected to exceed 29%, compared to the 26% achieved last year. Investors should keep a close eye on its operating expenses, especially those related to sales and marketing, to ensure that management does not need to overspend to drive organic growth.

Given the company’s net cash position of $152 million and the expectation that the business will continue to generate FCF in the coming quarters, capital allocation becomes a crucial consideration for shareholders. On that note, I expect the company to continue to aggressively repurchase shares in line with its recent $50 share repurchase program. Regarding capital allocation, the company’s CFO stated:

Our debt-free balance sheet and cash generation capabilities allow the flexibility to invest in share repurchases, sales growth initiatives and innovation, and we are not currently planning any major acquisitions in the near term.

Thoughts on Evaluation

Management’s guidance for this year calls for ex-TAC ​​contribution and adjusted EBITDA of $343 million and $100 million, respectively. To estimate expected FCF for this year, I will deduct expected cash expenditures for capital expenditures and tax payments, which are approximately $20 million and $15 million, respectively, from the adjusted EBITDA figure. Based on this, I estimate that FCF will likely reach around $65 million. Therefore, NEXN stock is valued at a Price/FCF multiple of 8.1 at the current share price of $7.7. When factoring in its net cash position of $152 million, it has an EV/FCF multiple of just 5.7. It’s worth noting that the company’s stock-based compensation expense has gradually declined and is now at an annual run rate of nearly $12 million, as shown below.

I see NEXN as very attractively valued, especially given peers like Magnite (MGNI) and PubMatic (PUBM), which have similar high single-digit growth rates and trade at considerably higher Price/FCF multiples of nearly 10. Additionally, NEXN remains an attractive acquisition target given its size, cheap valuation and unique technology platform. This, along with its large cash position, likely mitigates the downside risk from current prices.

Risks to consider

Addiction to video ads

Nexxen generates most of its revenue from video-related advertising, including CTV. A similar company I cover, Perion Network ( PERI ), has reported declining ROI for advertisers in its video segment, which has led to a significant decline in revenue for that segment in recent quarters. While Nexxen benefits from an advanced technology platform that supports its video ads, investors should be wary of the company’s heavy reliance on video advertising.

Competition

The AdTech industry is highly competitive, and Nexxen stood out with its complete end-to-end platform and access to valuable user data. This has positioned it well against competitors who are more focused on either the supply side or the demand side independently. Investors should monitor Nexxen’s growth rates in the coming quarters to gauge whether its platform is gaining market share.

The macroeconomic impact

Advertising expenditures are sensitive to economic conditions, and economic weakness could affect the Company’s prospects for growth and profitability. I will point out that the company’s organic growth has been negative over the past two years in a challenging advertising environment. In addition, the company is expected to benefit from political spending in the next two quarters related to the US presidential election. This will lead to tougher comparisons in Q3 and Q4 next year.

Conclusion

Consistent with my initial thesis for the company, I still find the stock attractive despite the significant recent price rally. With an EV/FCF multiple of 5.7, the stock offers a favorable margin of safety, while the company’s large cash position should help mitigate significant downside risk. Therefore, I maintain my Buy rating on NEXN stock.