Perion Network: Risks All Priced In, Time To Buy The Cash Play (NASDAQ:PERI)

Investment Thesis

With substantial cash reserves accounting for 75% of its current market capitalization, and a strong position within the growing digital advertising sector, Perion (NASDAQ:PERI) is well positioned to rally in the next 12 to 18 months. Despite a significant near-term setback due to a renegotiated contract with Microsoft (MSFT) Bing, which has substantially impacted projected revenue and EBITDA for 2024, the company’s diversified advertising solutions across various platforms offer a strong foundation for recovery and growth. The current valuation of the company at multiples significantly below industry averages suggests a deep undervaluation, especially considering the cash on hand and ongoing share buyback program. This valuation disconnects positions Perion as an undervalued player with potential for considerable upside once market perceptions realign with its financial fundamentals and strategic positioning.

Recapping the Business Model

Perion Network is a global adtech company specializing in online advertising and search monetization services. The company’s business model incorporates digital advertising solutions, such as display advertisements, social media promotions, and video marketing, integrated with its own technology that enhances ad placement, targeting, and bidding tactics to optimize the return on investment for advertisers. In addition to Advertising Solutions, Perion Network provides tools for search monetization by collaborating with top search engines (such as Microsoft Bing) to generate revenue from web search traffic via a software platform that interacts with browsers and other applications. Moreover, the company offers SaaS solutions that improve productivity, engagement, and revenue generation for content publishers and media companies, featuring tools for data analysis, optimization, and automated campaign management. Perion Network’s comprehensive suite of products positions it well to leverage the structural growth in the global digital advertising space.

Surprising Announcement in April

Since our last article on Perion published on February 23rd 2024, a lot has changed. On April 8^th 2024, Perion surprised the market with an unfortunate announcement regarding pricing changes to its contract with Microsoft Bing, which accounts for a significant share of its search advertising revenue. As a result, full-year 2024 guidance dropped from $860-880 million revenue and $172-182 million EBITDA (presented in Q4 2023) to $590-610 million revenue and $78-82 million EBITDA. The updated guidance implies a 19% decline in revenue vs 2023, and a 53% decline in EBITDA. As a result, Perion’s share price dropped c.40% following the announcement, and it has since then been fluctuating around $12 for the past month. While we are revising our price target downwards on the basis of the change to the Bing contract, we view the currently depressed share price as an even more attractive entry point.

Actual Q1 2024 Performance

While Search Advertising was the focus of the company’s preliminary press release, the actual Q1 2024 results published on May 8^th also revealed weakness in Video Advertising Solutions, down 52%. On the earnings call, management expressed confidence that this trend should revert in Q3, after another soft Q2, “moving with the market”. We do not necessarily see management’s explanation for the decline being validated by other announcements in the market: PUBM’s (PUBM) video revenue grew 33% in Q1, video “continued to grow” for The Trade Desk (TTD) in Q1, DoubleVerify (DV) witnessed “strong growth” in digital video, and more broadly the IAB projects digital video ad spend to grow 16% in 2024. While we view this sentiment towards video as a positive macro indicator, the mismatch between PERI’s video revenue performance and the broader market in Q1 suggests to us that the market-wide projected strong growth for 2024 may not necessarily translate into the same for the company.

This weakness in video, combined with a 7 percentage point contraction in contribution margin, resulted in a 35% year-over-year decline in EBITDA in Q1 2024. It is important to note that the impact of the changes to the Bing contract has not yet been felt in Q1 – Search Advertising still grew 26% year over year. Next quarter will likely see the bulk of the impact flow through to Search Advertising revenue, where we expect a c.70% decline to align with management guidance for the full year.

Understanding the Current Valuation

Perion currently holds a net cash balance of $473 million. With 49,541,695 shares outstanding (fully diluted) as of Q1 2024, that translates into about $9.55 in net cash per share, which is just 25% short of the company’s current share price. This means that the market is currently ascribing a value of $3.16 per share, or $157 million, to a business expected to generate this year about $600 million in revenue and $80 million in EBITDA. Furthermore, as of April, the company has upsized its buyback program from $50 million to $75 million, expected to start at the end of May, and to start being visible on the balance sheet in Q2 2024. This program amounts to about 16% of the company’s net cash, the value of which has consequently been locked in as shareholder distributions.

To underwrite Perion at the current valuation, investors need to believe that an increasingly diversified (pro-forma for the impact of the Bing renegotiation) adtech business operating in a structurally growing market deserves an enterprise value to current year revenue multiple of 0.3x, or an EBITDA multiple of 2.0x. To put things in perspective, this is about 12% of Magnite’s (MGNI) EBITDA multiple, 9% that of PubMatic (PUBM), and 2% that of The Trade Desk (TTD).

Preparing for a Downside Scenario

Despite the harsh adjustment that already took place on the Bing contract, Perion remains vulnerable to a further deterioration of the terms, or even an outright termination of the contract, which would practically wipe out its Search revenue. Additionally, while macro trends are positive for Advertising Solutions, we have questions about the sustainability of CTV growth (up 108% in Q4), and the projected comeback in video in H2.

For these reasons, we modelled a worst-case scenario where Search revenue drops to zero in Q2-Q4 2024, and Advertising Solutions revenue remains flat versus 2023, at around $398 million. Applying management’s projected 13% margin for FY2024 to our estimated revenue of $474 million (noting this is conservative, as Advertising has a higher profitability profile than the presumed-dead Search segment), we land on an EBITDA of $52 million. This means that even if an investor completely writes off the Search segment, and believes that the remaining business lines will stagnate, any EBITDA multiple above 3.0x would be in-the-money versus the current share price.

Needless to say, we do not see Search being completely wiped out, even if it may suffer further pricing pressure, and we certainly see Advertising Solutions in the long-run continuing to grow at an average yearly rate between the mid-single-digits and mid-teens. We also do not believe that a low-single digit EBITDA multiple is sustainable for a growing adtech business, once there is clarity on the outcome of the Bing negotiation process, and greater visibility on the use of the company’s massive cash pile. Combining all the factors above, we envision Perion trading above $20.0 within the next 18 months.

Key Risk Factors

As stated in our previous note, despite its Israeli roots, we do not see geopolitics as a major risk given the company’s geographically diversified revenue base and operations. We also do not place significant weight on technology risk, as the company benefits from a range of cookie-free solutions and partnerships with first-party data-rich platforms.

Now that the Microsoft Bing Risk has materialized, the key risk that remains is that the company’s valuation remains disconnected from its financials and its true potential for an extended period. As we previously wrote, in such a scenario, we believe that management is prepared to enforce valuation convergence through cash distributions, as evidence by the recent upsizing of the company’s buyback program. While on the earnings call the company pointed to M&A as the next priority for its cash pile after the $75 million buyback program, we believe that in practice management would be responsive to the share price if it continues declining.

Conclusion

The investment case for Perion is extremely compelling at the current valuation, with a significant cash position buffering the company’s market price. This financial cushion, alongside a diversified adtech business model in a structurally growing market, presents a strong case for an imminent revaluation upwards. The immediate risks posed by the recent contractual adjustments and sector-specific challenges are there, but are offset by the intrinsic value offered at the current price. Investors willing to endure short-term volatility for potential medium-term gains will find Perion an interesting addition to their portfolio as the market begins to recognize its under-priced potential.