AppLovin's IPO Filing: A Closer Look

Yesterday marked a significant milestone for AppLovin, as the company submitted its S-1 filing. This action propels the Palo Alto-based software firm, specializing in mobile applications, closer to a public offering.

The financial performance outlined within the filing is notably strong. Unlike some recent IPOs that rely on pandemic-driven surges or sector hype, AppLovin’s documentation demonstrates consistent growth alongside increasing adjusted profitability.

Having surpassed $1 billion in annual revenue, AppLovin has established itself as a substantial player in the market. Consequently, its initial public offering is anticipated to garner considerable attention.

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We have thoroughly examined AppLovin’s IPO filing to identify key details. This analysis adds another name to our ongoing list of companies preparing for public offerings.

The Exchange has a backlog of topics beyond IPOs that we are eager to explore. A temporary pause in IPO activity would allow us to diversify our coverage!

Let's delve into the specifics of AppLovin’s filing.

Generally Positive Initial Assessment

To begin, the company focuses on providing tools for developers to acquire users and generate revenue from their applications. AppLovin possesses an extensive portfolio of mobile applications, comprising over 200 free-to-play mobile games managed by 12 distinct studios, as detailed in its S-1 filing. These applications collectively boast 32 million daily active users globally.

This company presents a compelling subject for analysis, particularly for those interested in the mobile application landscape. However, our primary focus today lies on its financial performance. We will examine its growth trajectory, revenue quality, profitability, cash flow dynamics, and capital structure. The majority of the findings are encouraging, although certain aspects of AppLovin’s capital structure warrant consideration.

It is worth recalling that KKR acquired a stake in AppLovin in mid-2018, valuing the company at approximately $2 billion. Considering the company reported revenue of $483.4 million that same year, and subsequently nearly doubled it to $994.1 million in 2019, this valuation now appears remarkably conservative.

While growth decelerated in percentage terms in 2020, reaching total revenues of $1.45 billion, the company maintained comparable growth in absolute dollar terms. AppLovin experienced growth of 106% from 2018 to 2019, and 46% from 2019 to 2020.

The circumstances surrounding KKR’s investment at a 4x revenue multiple, given the 100% growth rate, remain unclear. The company demonstrates robust growth, but is the revenue being generated of a consistently high standard?

The answer is largely affirmative, though some adjustments to the reported figures are necessary for a comprehensive understanding. Examining the company’s annual results reveals a steady increase in the cost of revenue as a percentage of total revenue from 2018 to 2020. Specifically, this figure rose from 11% in 2018 to 24% in 2019 and 38% in 2020.

This trend is concerning, and without further information, one might conclude that the overall revenue quality is deteriorating. However, this is not entirely the case. The 2020 cost of revenue includes approximately $1 million in share-based compensation and $228.3 million in “amortization expense related to acquired intangibles.”

Removing these items from the cost-of-revenue line increases AppLovin’s gross margin for 2020 from 62% to 77.5%, a significant improvement. AppLovin frequently engages in acquisitions, such as the $1 billion deal to acquire a German software firm in February, resulting in ongoing amortization expenses from prior transactions.

Overall, AppLovin has maintained margins consistent with a software-based business as it has expanded. This was a key aspect of our investigation. Now, has this growth translated into profitability? The answer is initially yes, but later no.

AppLovin transitioned from a $260 million net loss in 2018 to a $119 million net profit in 2019. However, the company returned to a net loss of $125.9 million in 2020. While a profitable year in 2019 is positive, what factors contributed to the 2020 loss?

Two primary factors were at play. Firstly, share-based compensation expenses increased substantially, from $10.2 million in 2019 to $62.4 million in 2020. Secondly, the aforementioned “amortization expense related to acquired intangibles” rose dramatically from $82.4 million in 2019 to $239.9 million in 2020.

To assess the company’s profitability on a cash basis, and to mitigate the impact of these non-cash expenses, let’s consider adjusted EBITDA. AppLovin’s adjusted EBITDA grew from $255.6 million in 2018 to $301.4 million in 2019 and $407.5 million in 2020. However, the adjusted EBITDA margin, expressed as a percentage of revenue, experienced a decline.

Despite this, I anticipate that investors focused on AppLovin’s growth will likely overlook this detail. To summarize, AppLovin is growing rapidly, maintains gross margins in line with expectations, and exhibits a mixed profit picture under GAAP accounting, alongside solid performance on a non-GAAP basis.

Regarding cash flow, AppLovin’s operations generate substantial cash, which is then allocated to acquisitions. While the company’s free cash flow results are affected by its acquisition activity, the underlying business generates significant cash. In 2018, AppLovin’s operations produced $139 million in cash, increasing to $198.5 million in 2019 and $222.9 million in 2020.

The company’s investing cash flow was negative $411.6 million in 2019 and negative $679.9 million in 2020, reflecting its acquisitive strategy. However, the strong cash generation from its core operations, coupled with anticipated proceeds from an IPO, suggests the company is not at risk of depleting its resources.

Two additional points deserve attention:

Firstly, the company’s capital structure is unfavorable to common shareholders. Investors participating in the IPO will have limited influence. Consider the following excerpt from the S-1 filing, bearing in mind that only Class A shares are available to the public:

Shareholders have minimal control and voting rights.

AppLovin is among a growing number of companies prioritizing a minimal level of shareholder democracy, accepting that a monarchical control structure is sufficient to attract investment in the current market. It remains to be seen whether such structures will eventually lead to a valuation discount compared to peers with more equitable governance.

Looking ahead, it’s important to note that the company’s revenue is split between consumer and business sources, and these segments are not growing at the same rate. The following image illustrates this:

While the two revenue streams are currently comparable in size, their growth rates diverge significantly. Consequently, an investment in AppLovin could be interpreted as a bet on the continued strength of consumer app demand rather than its business income growth. Further analysis will be conducted upon the announcement of initial pricing.

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