Perion Network Stock: Navigating High Risks For High Rewards (NASDAQ:PERI)

Introduction

Perion Network’s (NASDAQ:PERI) financial performance is impressive since the company’s revenue growth multiple times outpaced the overall digital advertising market expansion in recent years. PERI’s profitability is also expanding rapidly, and the company has a clean balance sheet. Perion is an innovative tech company, and its business model looks highly efficient. From the risks perspective, potential investors should be aware that Perion faces a substantial customer concentration risk. On the other hand, the stock is around 52% undervalued and has demonstrated robust momentum over the last three months. Overall, I think that PERI is a good investment opportunity for risk takers and assign it a “Buy” rating.

Fundamental analysis

Perion is a global, multi-channel advertising technology firm providing integrated solutions across key digital advertising avenues such as search, social media, display, video, and CTV advertising. All these channels intersect seamlessly within Perion’s intelligent HUB (“iHUB”).

The company operates in the expanding digital advertising industry. I see several positive shifts that will catalyze the industry’s sustainable growth. Despite tight monetary policies across developed economies, the global economy is still expected to expand by 2.4% in 2024 and 2.7% in 2025. As a result of the resilient broader economic environment, marketing budgets are also expected to expand and surpass $1 trillion in 2024. Furthermore, The ongoing global trend toward digitalization is significantly impacting the advertising industry, with the share of digital ads anticipated to increase by approximately one percentage point each year. With all these solid tailwinds, I believe that Dentsu’s recent report forecasting above 6% CAGR for the digital advertising market is fair.

From the above table, we can see that the global digital advertising market witnessed a robust 14.8% growth in 2022, and projections indicate a continued 6.3% year-over-year expansion in 2023. Notably, Perion has surpassed the industry average, achieving an impressive 33.8% revenue growth in 2022. Anticipated to maintain this momentum, PERI is forecasted for a remarkable 15.9% revenue growth for the full year 2023, significantly outperforming the broader digital advertising market. Outpacing the broader market growth is indicative of a company’s ability to capture an increasing share of the market, showcasing its competitiveness and appeal to advertisers. Wall Street analysts expect PERI’s revenue growth to outpace the broader digital advertising in 2024 and 2025 as well.

The company’s ability to deliver revenue growth outpacing the industry averages is impressive, but at the end of the day profitability dynamics is a more important factor affecting the stock price over the long-term. The chart below suggests a rapid expansion of the operating income, which outpaces the revenue growth as the operating margin also demonstrates an impressive upward trajectory. The free cash flow (“FCF”) has been volatile, but the dynamic is also positive. Another interesting positive fact is that Perion’s headcount has grown by about only 10% since 2019, while the operating income has increased by more than five times. This underscores the high efficiency of the company’s business model, which is good for investors.

Perion’s balance sheet is healthy, with a solid half-a-billion cash position as of the latest reporting date. Debt levels are also very low. Having a clean balance sheet and improving profitability increases the chances that Perion will continue investing in growth, and its R&D investments will also remain substantial.

Perion’s exposure to various digital advertising channels makes it a well-rounded strategic partner for clients. The company also provides advanced analytics across different marketing campaigns, channels, and screens. This likely creates superior value in terms of higher ROI for clients. Perion uses artificial intelligence (“AI”) capabilities to create more value with its offerings. The company’s SORT proprietary AI technology even won the Digiday Technology Award in September 2023.

Also, here are a few words regarding the upcoming Q4 earnings release planned for February 7. With the several EPS upward revisions over the last three months, I look optimistic about the upcoming earnings release. Wall Street analysts forecast an 11.5% YoY revenue growth for Q4 and the EPS expansion from $0.79 to $0.93. According to the earnings history, Perion very rarely misses consensus forecasts. Moreover, in Q1-Q3 2023, Perion delivered double-digit YoY revenue growth and notable EPS expansions. Therefore, I am optimistic about the upcoming earnings release.

In conclusion, Perion emerges as a promising player in the ad tech industry, placing substantial emphasis on customer value through innovation. The company’s robust financial performance, surpassing the broader digital advertising market, suggests that its strategic focus on innovation and diversification across various marketing channels is yielding significant benefits.

Valuation analysis

PERI reached its peak in April 2023 and is currently trading at approximately a 40% discount from last year’s highs. While it has underperformed the U.S. stock market in the past 12 months, recent short-term momentum is noteworthy, with the stock posting a gain of nearly 15% in the last three months.

To simulate the discounted cash flow (“DCF”) model, I use a 12.3% WACC. The TTM FCF margin is 18.42%, which I expect to be expanding by 50 basis points every year. I use a 19.6% projected by consensus revenue growth for FY2024, but for the next three years, I use a 10% estimation, which is more conservative than consensus expects. The constant growth rate for the terminal value (“TV”) calculation is a conservative 3%. There are around 47 million PERI outstanding shares at the moment.

The DCF model provides a fair share price of almost $46. This is substantially higher than the current share price and means a 52% upside potential. The valuation is very attractive, but when the stock is that undervalued, there might be some red flags priced in. Therefore, I am moving on to mitigating factors.

Mitigating factors

Perion has a search advertising contract with Microsoft (MSFT), which accounts for more than one-third of the company’s sales, according to the latest annual report. The contract is effective until December 31, 2024. There is no news regarding the contract renewal yet, which puts a notable portion of the company’s revenue under substantial threat. Having a contract with Microsoft is a solid reputational asset, but it also creates significant concentration risks for Perion. There were no updates from the management regarding the contract renewal during the latest earnings call, which creates more uncertainty for investors.

In May 2023, Spruce Point Management published a comprehensive 127-page report investigating the accuracy of Perion’s financial reports. The report is publicly available; I will not go into deep detail here. The report contains allegations that there might be material misstatements in Perion’s financial statements, given its abnormal profitability relative to industry peers, a notable decline in insiders’ ownership, and potential inconsistencies between impressive revenue growth and the proportion of sales allocated to growth (capex and R&D). The company’s external auditor is a well-known and reputable company, EY. Furthermore, there was an official response from Perion, emphasizing that as a public company, Perion is highly regulated.

Perion is a highly regulated NASDAQ company that makes all required disclosures and takes all compliance measures.

The report’s release had minimal impact on the stock price, with the current value remaining relatively unchanged compared to the day the report was made public.

Conclusion

In my assessment, Perion presents a compelling investment prospect with considerable upside potential that appears to outweigh the perceived risks. Despite the bearish report from Spruce Point Management, Perion’s extensive high-profile client roster reflects a commitment to maintaining a positive reputation, which mitigates the risk of intentional financial misstatements. With impressive performance across key financial metrics and favorable industry trends, Perion seems well-positioned to sustain its upward trajectory. The stock merits a “Buy” rating, particularly for investors in search of a high-risk, high-reward opportunity.