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Jul 6, 2021
[12 min Read]
PUBM has been a name that has been floating around for a few weeks now, usually in the context of its high short interest. As we dug into the name further, we were pleasantly surprised to find out that this company is not dog-shit, is not failing, nor is it in a dying industry (as most of the other short interest plays that will remain unnamed), but a thriving company in an accelerating industry. This post will guide you through how we stumbled on the name, the company and its financials, the industry, the short-interest, and the plan. There are several angles of attack here, enough for everyone to get their grubby little hands dirty: traders, investors and gamblers. A summary:
Plan: Shares for the conservative players. Options - the chain is limited because options were just introduced - pound any and all strikes - with focus on the longer-dated.
Disclaimer: Multiple people have contributed to this report, and most have shares in the $30 range when the idea of this play was first conceived.
The Origins and Chart Analysis
What caught our interest originally, was a volume scan. After market close on 6/7, $PUBM showed up on a scanner looking for relative volume increases. This is a scan I use a lot, as it's a good way to follow the whales as they tip their hand when scaling into a position. When you see big volume moves (over the relative average), but little price movement, it's usually a sign of institutional accumulation. The big players piece into positions slowly as not to price themselves out with a massive market order. In the case of $PUBM, despite a 3x volume spike, price only increased a modest 5%. These moves are often signs of trend reversals when an institution slams its wizard staff into the ground and says, “You shall not pass!”. The last three weeks have seen the most shares traded in $PUBM's history - even more than when $PUBM IPO'd in December of 2020.
In addition to accumulation volume, the PUBM chart is a perfect example of both types of head and shoulder patterns (topping H & S, and bottoming inverse H & S) - see Chart 1. The original H & S called out the top, and now we see an inverse head and shoulders formed, which is typically a signal of a bottoming, reversal pattern. The breakout was rejected at the original “neckline” of the topping pattern, and retested the breakout point on 7/2/21 - and has held. This is the beginning of a text-book trend-reversal breakout. The chart setup is a buy. But what is it we're buying?
So What Exactly is Pubmatic?
In short, Pubmatic is an advertising technology company. For most of human history, business owners have been using ads to sell their products, inform their customers of a value proposition, or build brands. With the advent of the internet, “adtech” companies like Google have grown rich and powerful by allowing advertisers to communicate with any type of customer they want, virtually instantaneously, as much as they want. No other form of advertising offers these features and as such, the digital advertising market has become extremely complex with hundreds of billions of dollars on the line every year. This trend toward digital advertising is expected to continue (figure 1):
Figure 1 - Digital ad spending worldwide
Pubmatic operates and competes in this space, specifically programmatic advertising. Before programmatic, digital ads were bought and sold by teams of people on either side of the equation, which was slow and cumbersome. Now there are scores of companies that have built software and infrastructure that allows digital ad space to be traded programmatically. The market share of programmatic advertising as part of all digital advertising has been on the rise (figure 2):
Figure 2 - market share of programmatic advertising
Since Pubmatic is a programmatic ad company - it is benefiting from these two tailwinds: more ads are becoming digital and more digital ads are becoming programmatic.
Programmatic channels primarily have two sides to them: the buy side and the sell side. At a basic level, publishers generate revenue by selling digital ad space on their content, and advertisers/marketing agencies will purchase this ad space to place an ad in front of a potential customer.
Pubmatic is an SSP or supply side platform. Publishers will integrate and configure Pubmatic's software to allow for the transactions to take place. Publishers want the best outcomes possible for their ad slots, so more often than not, they'll integrate with multiple SSPs in an effort to increase their overall yield. I can't stress this enough: the programmatic ad market is so complex, I would be willing to bet that a single person couldn't wrap their head around the whole thing. It is mountainous in size. Trillions and trillions of programmatic ads are served up across advertising verticals, across global markets, and across billions of devices every month. Any sizable publisher that wants to efficiently sell their inventory at scale must work with an SSP and compete in the broader programmatic ad market.
Needless to say, most digital channels continued to grow as people spent more time inside and on their devices. Pubmatic's revenue continued to grow YoY as overall advertising spend took a big hit (due to COVID). The most exciting part about this is that global ad spend is projected to return to its normal growth pattern - you can see this already taking place in figure 3.
Figure 3 - Global Advertising Forecast
So not only did Pubmatic gain a greater share of the total advertising dollars in 2020, the overall advertising pie is going to grow as well. This rebound in ad spend is yet another tailwind for Pubmatic. If you're keeping count - that makes three so far:
More ads are becoming digital
More digital ads are becoming programmatic
More overall ad spend in the future
Shut up and talk about the short interest!
Since short interest is what all the kids talk about these days, that was where we headed to next. In addition to looking at squeeze probability, it is good to know if a company is highly shorted. Most short-sellers know their stuff (except maybe Melvin), and if a company is highly shorted, it's usually for a reason. $PUBM has short interest that is estimated as high as 50% in some places. We actually believe this to be an inflation due to a quirk in the public float involving share types, which the aggregators such as Bloomberg and others haven't caught on to yet (will explain later). There is a chance we are incorrect about this, but according to our calculations, the short interest is closer to the 20% mark - which of course, is still very high. Price peaked at $77 during the first week in March, and shorts have hammered it ever since. The question is, why?
The insider lockup
Like most newly IPO'd companies, there was an insider share lockup. These insider shares were mostly of the class B variety; these were shares awarded to VC firms and investors that have been with the company since its inception in 2008. PUBM announced during the Spring that those insiders with class B shares (of which there are 40+ million of), were free to sell as of 6/1. While we don't know if this is what short-sellers had in mind, it is probably a safe bet. A similar situation happened to PLTR a few months back when they had their own insider lockup expiration. So the next question is…
Did the insiders sell?
Some did, but not many. It is estimated that roughly 4-6M class B insider shares have been sold - only one firm has liquidated, the other big players are still in. Why are they still in the game? $PUBM has an interesting quirk in their share and voting structure where class B shareholders hold a 10:1 voting advantage over the class A (public float) holders. Their one class B share gets 10 votes per share, vs our 1 vote per class A share. If you want to still retain voting power within the company, you really do not want to sell your class B shares. Furthermore, if class B shareholders sell, it consolidates the voting power of the remaining class B shareholders. Why this is important is because everytime a class B share is sold, it converts to a class A public share; this is what is missing when everyone talks about the short interest. Some of these class B holders have sold, converting their shares into class A and thus increasing the public float, and diluting the short interest. However, most insiders have held - and will most likely continue to hold if they still want a voting stake within the company. Worth noting is that two of the biggest holders, VC firms Nexus India Capital and August Capital, both have seats on the Board of Directors - so it is unlikely that they will sell a meaningful amount any time soon. So the lockup has come and gone without too much damage - share price bottomed out and has now increased. Why else would someone be short?
The privacy wave
Consumer data has been called the oil of our generation. All of the data that is generated on your devices is sold, recorded, and analyzed. Companies do this in order to serve you targeted ads based on your spending habits and characteristics. In the past, all of this has been done without the full knowledge or consent of the end user (you). Once people started to realize just how far the tracking had gone, governments and individuals started to demand better privacy from adtech companies. Apple has been leading this effort across the board since privacy has become part of their brand image. Agencies and advertisers have become drunk off of readily available third party consumer data and as the privacy wave makes its way across the world, we're going to see less third party data available to advertisers.
Last year, Google said they would start phasing out browsers from accepting the third-party cookies that help advertisers, publishers and data brokers profile you to help advertisers target ads toward you. The change would prevent an adtech company (PUBM) that recorded your visit to a trading website from later showing you ads for that stupid day trader guy with long red hair and a beard (I know you've seen those ads before). This in effect would hinder all adtech companies from doing what they do.
But this dropped two days ago (6/23)
Google delayed this cookie phasing out until 2023 so the show goes on (Leo trading gif).
But cookies ARE eventually going away, right?
The adtech industry is addressing this with the use of identifiers, typically in the form of hashed email addresses or phone numbers that are collected upfront from the end users. Pubmatic has been working vigorously on getting these identifiers put in place through the use of their identity hub product, which is identifier agnostic. There is a lot of speculation surrounding which of these identifiers will end up winning, but since Pubmatic can integrate with any of them, they don't much care which one wins out in the end. Pubmatic's management will need to keep a close eye on the privacy developments as they move forward, because the sunset of the third party cookie won't be the only problem. That said, the adtech industry is notoriously finicky, and Pubmatic has been able to keep up with the times. Management has repeatedly said that they take a long term approach toward their investments, and I expect them to continue to be able to deliver value to publishers and agencies as these investments like Identity Hub pay out. While the privacy wave is a headwind, Pubmatic has been working on addressing it for years now. In aggregate, Pubmatic has a lot more going for it than against it. Next stop… financials.
Revenue acceleration (% are YoY growth rates - from right to left) :
I've seen this sort of thing in the past (Etsy, Livongo, The Trade Desk for example) where a company finds its stride. This revenue growth is twice that of the larger industry, so we can assume that Pubmatic has indeed found its stride and is gaining market share. Management has echoed this sentiment.
One important risk to note is that Verizon Media accounts for 20% of their total revenue (taken from their first quarter prepared remarks):
It's good that this percentage has been coming down as they gain market share, but we'll want to keep an eye on that over time to make sure it continues to trend in the right direction. Also the partnership is growing over time - this is an example of SSP consolidation.
Pubmatic operates with a high gross margin, as you would expect from a cloud-based software company. Their gross profit has also been trending upwards, so they are gaining more efficiency as they develop. Their long term gross margin target is 70%, which has already been achieved.
What's more, their 2020 net profit fell in line with a highly efficient cloud computing company.
Wall Street analysts aren't predicting their profitability properly. If we assume a 20% net margin on $200 million in revenue for 2021, earnings per share is going to be 81 cents based on 49 million outstanding. Current estimates are only showing a high estimate of 38 cents per share, much lower than what should be achievable for Pubmatic. They've already handily beat earnings for Q1 so they are well on their way toward the ~80 cents figure. If they can hit these numbers, their PEG stands at .63 at the time of writing.
Pubmatic is a highly profitable company, in a growth industry, that is stealing market share, and has no debt. Wall Street is underestimating them, while trading at a lower valuation than competitors (https://twitter.com/HsSajwani/status/1403342066445283330/photo/1).
We don't know why anyone would be short this company. Maybe there is something under the hood that we are not privy to, but we only know what's publicly available, and everything looks really clean. I suspect shorts are closing - there's no reason not to. But the beauty of this potential play is you can attack this from multiple angles. Want to play the short squeeze? Go ahead - it's a possibility. Want to play the value investor? That works too - Pubmatic is undervalued compared to its peers. How about growth? The digital advertising industry is accelerating, and PUBM is still trading at levels below its valuation. How about a market mechanics liquidity play (see the bonus section)? Want to play the chart? Easy reversal pattern and ride that trend with the accompanying volume.
Bottom line is, most trading opportunities offer one or two avenues for profitability - PUBM has lots of different pathways for success - pick a path that suits your risk tolerance and hope the market doesn't shit itself.
A wise trader once told me,
“You can either trade for justice, or for profit, but not both”.
Pubmatic may just offer the rare opportunity to trade for both.
Shares and the limited calls are what's recommended for now. As some of you may have noticed, PUBM did not have an options chain up until 6/25. Some limited strike prices have been added, but still not enough. Pound ‘em and make our friendly brokerages add more. PUBM managed to get to $77 without the aid of options leverage so I see no reason why a revisit of that price is unattainable by summer's end with the company and industry tailwinds. Considering that any case for shorting PUBM has been removed, it appears a new trend is starting. Where things may get a little spicy is in the bonus section - and it is in regards to the restricted liquidity.
Bonus section - “if it ain't tight, it ain't right”
The liquidity for PUBM is very, very tight. If you've been watching the intraday movements at all, you'll notice a barren orderbook, with share bid/ask spreads routinely above $.50, and sometimes even in the dollar range. Exacerbating the already restricted float is the high institutional ownership - which currently sits at 74%. With most of the shares sitting in the coffers of big players, there aren't many shares exchanging hands on a day-to-day basis - which makes for wild price swings. What makes this interesting is that as mentioned in the paragraph above - options were just introduced as of 2 weeks ago. This is very unusual for a $1.5B market cap company that has been traded for over 6 months. Only minimal strike prices and dates have been added thus far, with more additions anticipated. The more strikes that get added, and the more OTM call bombs that people lob PUBM's way, the more interesting and volatile things can get. I say again, PUBM accelerated into the 70's after IPO, without the aid of options dynamite. With the company and industry headwinds dulled for now, sprinkle in the FD leverage and anyone short should probably pack up their bag, cash in their tickets, and GTFO.
Trade responsibly and good luck!