Quick heads up: feel free to skip to the “Wrapping Up” section at the bottom which may give you a better idea about whether or not you want to read this entire post.

These days, anytime I evaluate a company and conclude that it doesn’t have Upstart like potential, I always get a little disappointed. This is what happened here with ironSource! Although we must be realistic – I can’t create a portfolio with sufficient diversification if I only own Upstart.

What ironSource does in a few sentences:
There are two main business segments. Segment 1 (named “Sonic”) helps companies monetize/commercialize their apps. Segment 2 (named “Aura”) enables telecoms (such as Samsung and Boost Mobile) to give personalized promotions to customers at various critical points throughout the device life cycle, such as when users are first setting up their phone.

Aura is 12-13% of total revenues, growing around 90% YoY and Sonic was 87-88% of revenues, growing 81% YoY.

Highlights:
–The ironSource platform is used by 90% of the top 20 most downloaded games.

–Insiders own approximately 16.3% of shares outstanding (more than a $1.5b valuation), spread between co-founder/CEO Tomer Bar Zeev, president/co-founder Arnon Harish, co-founder/COO Tamir Carmi, and chief strategy officer Eyal Milrad. Clearly this is enough to qualify as “skin in the game”.

—Revenues have grown 82% YoY and 13% QoQ. Not all is as rosy as it sounds here, as it appears they may be in a pretty noticeable deceleration. Last year, their QoQ growth numbers looked like this, starting with Q1 2020: 17%, 21%, 19%, and 23%. Then Q1 2021 was their worst quarter of sequential growth ever, coming in at 11% QoQ. The 13% we saw in Q2 of 2021 is a modest acceleration from their low point in Q1, but it is still down a lot from 2020. However, if we step back and look at the big picture, they just grew 82% YoY. Even if they decelerate considerably further, they could still be doing better than several top performing stocks in my portfolio.

–The next earnings report will be their second ever as a public company. The company’s guidance is for revenues to contract by 4% sequentially, which translates to 48% YoY growth. Management implies later in the call that they intend to beat these numbers (as they should). Guiding for contraction, even if sandbagging, to me comes off as a display of weakness and an obvious lack of confidence in the business. That said, I don’t take this sort of guidance that seriously, since the company has never grown revenues sequentially less than 11% (based on data from the F-1 going back to Q4 2019). There is also an element of conservatism added in due to the IDFA changes. Furthermore, they explain that IDFA changes have been in effect for a couple quarters now, and they haven’t seen much impact.

—DBNER is an astounding 181%. Their historic average is closer to 150%, and management on the latest earnings call noted that DBNER will drop down closer to historical averages later this year. Of stocks that I own, only Snowflake (at 169% DBNER) comes anywhere near ironSource regarding DBNER.

–Smallish market cap relative to other stocks in my portfolio: $11b as of writing on 9/29/2021. Trailing P/S of 25 and forward P/S of 16 (based on a 53% YoY growth rate, which they are very likely to beat).

–Enterprise customers (>100k spending in the last 12 months) grew 26% YoY. Although this is not bad, it is certainly not as strong as DDOG, NET, ZI, etc. Effectively it is the worst enterprise customer growth of any company that I review. But this is not a totally fair comparison because DDOG, NET, ZI, don’t have a DBNER anywhere near 181%. What’s also worse about ironSource’s enterprise customer numbers is that they are noticeably decelerating from 2020, where enterprise customer growth was as high as 59% YoY in Q2 2020. So this means there is a possible correlation between decelerating enterprise customer growth and decelerating revenues, which of course would make perfect sense.

Key quotes from Conference call (and a few from their F-1):

“we began this new chapter after successfully completing our business combination with Thoma Bravo Advantage on June 28 of this year, a partnership which we believe will be important to our growth as a public company moving forward. As part of the merger, we raised a total of $2.15 billion in cash profit, including an oversubscribed PIPE of $1.3 billion”

“If you think about your day-to-day life, chances are you spent a good amount of time on your phone. The average is over 4 hours per day. On average, 83% of that time is spent on app that provides entertainment, productivity and connectivity. In 2020, there were 6.7 billion mobile devices, and we downloaded 140 billion apps in those devices. Yes, what is open for grabbing is that every single app on your phone is someone’s business. ironSource is a software company.”
ExponentialDave: We always say that advertisers will go wherever the eye balls are. Well, 4 hours per day is a pretty good chunk of time. Advertisers will of course be looking to access those hours as best they can, and prudent app developers want to monetize their apps. And so ironSource bridges the two parties together.

“We believe that the total market opportunity for ironSource was $17 billion as of 2020. Furthermore, we believe that our total market opportunity will grow to $41 billion by 2025”

“In the second quarter, we achieved record results with total revenues of $135 million, up 83% year-over-year. This was primarily driven by enhancements made to our platform and an increase in the use of our platform by both existing and new customers.“

“309 customers generated over $100,000 in revenue over the trailing 12-month period and accounted for 94% of our revenue”
ExponentialDave: ironSource has More than 4,000 customers.

“Our platform is designed to serve the 2 core constituents of the App Economy, app developers and telecom operators”

“While it has become easier than ever to create an app, it has also become harder than ever to commercialize an app. That’s where our Sonic solution suite comes in. It is built to help developers launch, grow and sell their apps into successful businesses.”

“Put simply, our platform allows developers to focus on creating great apps and content where we provide the infrastructure for the business expansion.”
ExponentialDave: They frame themselves as a pick and shovels play, in this way similar to Shopify and many other successful companies in my portfolio.

“Today, we power the business growth of thousands of apps, including that of many of the Tier 1 game developer.”

“Our strategy has resulted, and that today, we powered the lion’s share of the top 100 mobile games.”
I gave this some thought to determine if this may actually be a good thing AND a bad thing. In other words, as growth investors, if they already power the lion share of the top 100 mobile games, where do they go from here? Similar situations (outside of the gaming industry) have cropped up in companies I own, such as Snowflake and Zscaler, where they’ve both already claimed so much of the Fortune 500. Where do they go next? The answer is quite simple actually – they go for the global 2000. So the analogy here, and I am really just making a guess at it, is that the next easiest / most profitable move is to go after the top 2000 mobile games. But they do also mention expansion coming from non-gaming apps, which is already approximately 10% of Sonic revenues.

“As a result, our business model is primarily revenue share, which means that our growth is highly aligned with that of our customers. And the more our platform empowers them to grow their businesses, the more we grow ours.”

“This quarter saw the launch of several products designed to drive more efficient business growth for our customers across different solutions on our platform. In our Sonic monetization solution, we completed the shift to in-app bidding technology…This technology enables our customers to maximize the revenue by creating a realtime option, allowing different demand sources to be each available ad impression. This technology is designed to increase competition for ad space, raise efficiency and decrease customer opening, delivering real value for our customers.”

“And finally, we’re excited that Bridge Race, a game that was published using our Sonic publishing solution, was the most downloaded game worldwide in Q2 with over 100 million installs…This success follows Join Clash, another game that we published using our Sonic publishing solution, which was the most downloaded mobile game worldwide in Q1.“

“A majority of our revenue is currently generated under the revenue share model where we retain a share of the revenue our customers generate using our platform. The remainder consist of usage base fee and in-app monetization revenue”

“We generated $135 million in revenue compared to $74 million in Q2 2020, representing year-over-year growth of 83%. This growth was fueled primarily by the expansion of Sonic and our solution to it within our platform.”

“Our dollar-based net expansion rate for Q2 remains exceptionally high at 181% after achieving 176% in the first quarter at an average of 154% in the last 10 quarters. This increase was driven by new products and solutions launched over the course of 2020 that drove significant growth. Although we expect our dollar-based net expansion rate to remain very healthy, we anticipate that it will rise from quarter-to-quarter and ultimately normalize at our historical levels over the course of 2021″

“Our non-GAAP diluted EPS for the quarter was $0.04 and our net cash position was $710 million”

“While we have not yet seen any material impact for Apple’s changes, it is still too early to accurately determine the full impact. Our guidance takes into account some potential short-term uncertainties related to the change while still reflecting the ongoing success and momentum of the platform.”

“Our guidance takes into consideration the following factors: the strength of our H1 results, the momentum across our platform and the near-term potential impact of IDFA. For the third quarter of 2021, total revenue is expected to be in the range of $125 million to $130 million, representing 45% growth on a yearly basis at the midpoint.”

“in the Sonic solutions suite, around 10% or so of our revenues come from non-game developers”
ExponentialDave: This is important, especially as a potential driver of future growth.

“Already today, we have a solution for smart TVs. And we have new developments, which we’ll be happy to present to you in the next quarters.“

“And with a few months already into the rollout of IDFA, I think we have a much better view of the current impact and also, I think, a fair estimate on how it will look going forward.“

Tomer Bar-Zeev
“And I would say that when we last talked, we said that the ironSource platform is probably best geared to cope with the IDFA changes, among other reasons, because it was originally built to provide contextual — to analyze contextual data. So by definition, the platform was built with a lot of — taking into account a lot of privacy issues. So we thought that we would potentially be one of the beneficence of the IDFA changes. That’s not to say that we still might see some short-term effect from IDFA in the very short term,but we remain very positive about our estimation that long-term IDFA is a net-net benefit for ironSource because of the way we deal with contextual data and the way the platform has built from the get-go.”

“Tomer Bar-Zeev: Aura, the breakdown is — Aura is around 12%, 13% of the total revenues. Aura has been growing at around 90% year-over-year and Sonic at around 81%.”

“Again, the growth in Aura is really only capped by how fast telcos can adopt our various solutions. As you know, telcos move a bit slower than developers…And we foresee significant growth for Aura in the coming quarters“

“But mostly on the rest of the platform, we see how that will continue growing, again, evidently as you can see from the current results and our ability to increase guidance for the next quarter and the rest of the year.“
ExponentialDave: This is our hint that management fully understands the “guidance game” that goes on, whereby investors put great importance on management to beat whatever guidance they give us.

“I would say that one element that we’re very conscious about is how to best anticipate and to be able to adjust the model for potential IDFA changes, which I think we and the rest of the industry initially thought that we would see some effects in Q1, which really didn’t happen, and then in Q2, which really didn’t happen. And still, we are conscious and we’re keeping monitoring potential, again, short-term effects. And those are budgeted already in the guidance that we’re giving for Q3 and the rest of the year.”

Martin Yang: “First one, can you maybe highlight the particular new products that really contributed to the near-term momentum in the net expansion rate?“
Tomer Bar-Zeev: “So Martin, so as I said, it’s not necessarily a one product or two products that were new that drove the increase in the net dollar-based expansion rate. It’s pretty much across the platform. And that’s the whole thing. That’s the whole point of how — why we win, why we gain market share and why we grow. All the products are really connected.“

Omer Kaplan:“Yes. So it’s one of the core capabilities of our publishing product is the ability to predict based on a prototype, which means based on a game before it’s completely ready to complete what is the business liability or what is the marketability potential of this prototype of this game to become a big business. And the way it works is that we have in — primarily in the developers, right, submitting their prototypes in a completely automated way into our platform. And our platform in an automated way evaluate what is the business potential. And then once we identify that this prototype has the potential to become a very big game, then it moves into all of the growth part and the monetization part, and we maximize the scale.“

…“we are seeing cases of really small developer companies who are managing to create this huge game or these new successes because of that identification to this content, right? When you connect to our platform, you can reach such scale level.”

Bhavin Shah: “Very impressive 181% net retention rates. Maybe can you just help us understand how much of that is driven by stronger engagement with your current customers’ properties versus some of your customers adopting more solutions such as creative management, analytics and publishing?”

CEO Tomer Bar-Zeev: “So most of the growth in ironSource are coming from existing customers that constantly add, as I said, the — a typical customer will start engaging with ironSource’s platform across one or two of our solutions and would expand to adding more solutions and eventually using the full power of the platform, which drive the very strong dollar-based retention rates. That and, of course, the very strong 99% gross retention is what’s driving the very strong results”.

WRAPPING UP
My conclusion here is that ironSource does not look like a slam dunk (few things do of course). However, it shows solid promise based on revenue hyper growth and big tail winds coming from the monetization of mobile gaming. Additionally, it gets bonus points from me for having a relatively “cheap” valuation at 25x trailing sales and 16x forward sales. My reservations stem from its revenue deceleration, particularly weak guidance, and its business model, which is ultimately dependent on the success of its customer’s apps. Should the popularity of customer apps stagnate, then the company would have to rely on bringing in sufficient new successful apps to keep revenue growth humming along at current levels, which would of course be very challenging, all while fighting the increasing challenge of the law of large numbers.

And its TAM is not nearly as wide as other companies I own. Its TAM is any company that needs to monetize an app. For comparison, CRWD’s TAM is any company that needs to secure endpoints, MNDY’s TAM is any person that wants better work management solutions, etc. It’s probably the most niche company that I’ve chosen to invest in. Although it doesn’t serve a particularly wide market, those who do find themselves needing app monetization services are possibly very willing to pay handsomely for this service.

For the above reasons, I have decided to keep a starter position in ironSource of approximately 2%, which I may add or remove from opportunistically. For those of you who like more sure bets, this is probably not a good choice for you. I think we will have a much clearer picture of where the company is heading after its next earnings report.