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Who’s Winning in Digital Advertising With Brad Freeman

On today's 7investing podcast, 7investing CEO Simon Erickson chats with Brad Freeman about the winners and losers in digital advertising and two leaders in financial services.

August 18, 2022 – By Simon Erickson

For much of the past decade, digital advertising has been dominated by two companies: Google and Facebook. These two titans each had billions of users that allowed them to command the vast majority share of a market that was approaching nearly half a trillion dollars globally.

Yet these two thoroughbreds have both now changed names (now Alphabet (Nasdaq: GOOGL) and Meta Platforms (Nasdaq: META)) and are expanding into new opportunities (cloud computing and the Metaverse). As the digital ad market matures, it’s giving new entrants an opportunity to introduce innovative new solutions. Perhaps these ‘walled gardens’ aren’t as high as they used to be, and that gives an opportunity for investors to profit from the industry’s changes.

In today’s 7investing podcast, 7investing CEO Simon Erickson chats with Brad Freeman about the changes taking place in digital advertising. Brad is a huge fan of The Trade Desk (Nasdaq: TTD), who is capitalizing on the market’s shift to a more privacy-centric and open internet. The two also discuss why changes in technology have negatively impacted Snap (NYSE: SNAP) and ROKU (Nasdaq: ROKU), and why larger publishers like Netflix (Nasdaq: NFLX) and Disney (NYSE: DIS) are suddenly becoming interested in ad-supported subscriptions.

In the second segment, Brad also shares his thoughts on Upstart Holdings (Nasdaq: UPST) and SOFI Holdings (Nasdaq: SOFI). These are two financial services companies who have been negatively impacted by the short-term macro, but are developing innovative platforms that might break late as the race marches onward.

Publicly-traded companies mentioned in this interview include Alphabet, Apple, Disney, Meta Platforms, Netflix, ROKU, Snap, SOFI Holdings, The Trade Desk, and Upstart Holdings. 7investing’s advisors or its guests may have positions in the companies mentioned.


Simon Erickson  00:00

Welcome to the 7investing podcast, where it’s our mission to empower you to invest in your future. I’m Seven investing founder and CEO Simon Erickson. I’m very excited to be joined today by Brad Freeman. Brad is the writer of the Stock Market Nerd newsletter. He has commentary on a lot of stocks. He has some incredible insights that I’ve enjoyed following him for several years now. You can follow his news newsletter at stockmarketnerd.com. Brad, I’m really excited to welcome you to the program. Thanks for being a part of our 7investing podcast today.


Brad Freeman  00:26

Yeah, the feeling is very mutual, I’m a big fan of what you guys do at seven investing. So glad to chat about what we’re about to chat about. But I don’t know if I’m supposed to give that away at this point. But we’re going to chat about something.


Simon Erickson  00:36

We are. We’re actually going to chat about the advertising industry today. Brad and I were talking about what was the topic that we both knew a thing or two about that was undergoing some changes, and we came up with digital advertising. So the first part, we’re going to talk about some of the companies that are benefiting from the changes that are taking place, and others that maybe are on the wrong side of the changes that are taking place. And then in part two of the program, we’re also going to see if Brad can spot us up with a couple of other companies that he’s been following. Like I said, he’s got some great insights on a whole bunch of companies. We’re gonna pick his brain a little bit on a few that are on his radar. Brad, are you ready to get started?


Brad Freeman  01:11

I’m ready. Let’s do it.


Simon Erickson  01:12

So Brad, let me cue you up with a couple of statistics about the digital advertising industry right now. This is an industry that has kind of gone through a tough year recently. There’s COVID pandemic going on. There’s an upcoming potential recession that’s going on, there’s inflation, and kind of a confluence of all these, it’s been really tough on the consumer spending part of the economy. And of course, digital advertising, where companies are paying to advertise for consumers is one of the hardest hit sectors out there. But it’s not across the board that all digital advertising companies are doing poorly. Some have been much more affected by this than others. And so I wanted to talk about some of the glass half-full opportunities and the companies that we think are doing well. And perhaps some of those that we think are getting impacted either by short term events, or long term changes in this. But Brad, one that you and I both were talking about, we’re both actually fans of, the green light, the good news, the positive spin on this has been the company called The Trade Desk. This is a company on the demand side, they are helping the larger advertisers place ads within different publishers sites. Maybe I can hand it to you to tell us a little bit about the trade desk. I know you’ve followed it for a long time, and maybe tell us a little bit about why you like it.


Brad Freeman  02:27

Yeah, so they’ve become over the last few years, and I think that’s been four to five, the de facto platform for the open internet on the demand side. So what they do is they take advertisers, but they really do it through agencies. So they do represent the ESPN’s of the world, but they’re doing it through global agencies who are really representing ESPN  as sort of the middlemen. But what they’re doing is kind of transforming this ad placement industry into something that is really just been predominantly called upfront markets where several months in advance, you have to purchase millions and millions of impressions based on sort of an educated guess of what the traffic is going to look like and how relevant it’s going to be for your ad conversions. And they’ve kind of morphed that into a live bidding platform where you can, based on all the data algorithms that Trade Desk has been seasoning for over a decade, based on the massive list of first party partners they have that they plug the data into, to kind of augment their decisioning. What they do is really uncover the granular value of an impression for a specific advertiser so that they can spend that next dollar as effectively as possible and they really allow them to do that. They do participate in in linear TV and upfronts. They they do it in a little bit of a more sophisticated way. But really their bread and butter is connected TV, it’s audio and mobile and podcasts and espn.com, and really anywhere outside of these walled gardens of maybe Google is a great example is really where Trade Desk traders really dominates. And they do participate a little bit in walled garden placement with Google and Apple, but predominantly, they are very much that open internet player, which has served them well, and I’m sure we’ll get into why later on.


Simon Erickson  04:13

That’s exactly the question that I wanted to segue into next as you mentioned open Internet, you mentioned walled gardens. What do those terms mean? Why are they important? And how is Trade Desk on the right side of this trend?


Brad Freeman  04:24

Sure, so walled garden, Google, Meta, even Pinterest and Twitter are considered walled gardens, but they’re a bit smaller, and the walls are a very fitting symbol of what they are. They’re trying to wall in or keep in as much data and as much information as they possibly can to ensure that there’s no data interoperability, and they’re not losing their first party data edge with other players in the internet. So they’re not allowing tiny players to match the data skill that they have by really keeping these data silos and keeping them very closely intertwined in their own ecosystems. So they’re not allowing for open sharing, and really, another side effect of this is that, especially for Google, which was Jeff Greene, the CEO of trade desk, which I know, you know, but in case anyone else doesn’t know, one of his complaints is they do all of their own measuring, they do all their own return on ad spend metrics. So Google is telling you, without sharing any of the data, without sharing any of the evidence, here’s how it did and just just believe us and trust us, because we’re Google and you can’t go anywhere else. So that’s really how walled gardens play.They try to take advantage of their data scale and their user scales, rightfully so, as much as they possibly can to differentiate themselves and to kind of tilt the playing field in their favor. And conversely, in the open Internet, these data silos do not exist. It’s very much so especially in the programmatic space, a live bidding platform where you really have several demand side players being matched with supply side players, and matching ad impressions and ad costs in the most effective way possible for everybody. So it’s it’s a wonderful idea, and it’s very rah rah and make the world a better place and all those wonderful things. But what it does, is it leaves you very vulnerable to these third party walled gardens who inherently have access to more money, have access to more data, have access to more users, have access to more everything than you do. And it becomes very difficult to target when they’re not really playing ball, which, in recent years, they’ve stopped playing ball even even more. Third party cookies degradation, Apple’s inner app tracking and targeting via IDFA kind of going away, has really put the ball in the court of these other players in the open internet to overcome all this signal loss and to create this compelling return on ad spend. And within the open internet that has made scale so important, which is why I gravitate to The Trade Desk because they really are in my mind the only open Internet player in charge of their own destiny. Because Google can get rid of third party cookies degradation, which by the way only impacts them in one channel really, which is web and not really anywhere else where they play, Apple can get rid of signal, can get rid of interoperability signaling, and everything else to piss off Facebook. Sorry, I don’t know if I can say piss off, but to upset Facebook. And then really to upset everybody else and the ad space at the exact same time. So The Trade Desk needs Washington Post, and Walmart, and Target, and Costco and these massive players to plug their own data, their own first party data treasure chests really, into The Trade Desk platform, so that it can continue to create this compelling return on ad spend within the open internet, when walled garden players aren’t allowing them to use their data as freely as they once did. So really, if you’re big and massive, and aren’t relying on Google and Apple, like The Trade Desk uniquely isn’t, you’re rather insulated from all these changes that are happening in the ad land. And I might be conflating two topics right now, because there’s a lot of changes going on in ad land, and I’m sure we’ll discuss, but it’s really The Trade Desk’s ability to plug into everyone else in the industry that allows Apple and Google not to be important to them, and whatever they do to sort of be irrelevant to them. Especially because Google’s third party cookie degradation may actually, maybe I should stop there because I’m about to go into a totally new topic that I’m sure you’re about to ask about next,  so leave it there for now and I’m sure we’ll circle back to that point.


Simon Erickson  08:34

Brad, I think you’re very good at reading my mind, and actually anticipating the next questions I’m going to ask, because that was the next one. So I wanted to talk about those topics. And maybe just to kind of key everyone up for the next segment here is that there’s been some higher level technology changes, several of which, like Brad just mentioned, that are going on, they’re impacting the advertising industry as a whole. The third party cookie being deprecated, being phased out, which means you can’t just be followed around the internet like you used to because the privacy concerns and a lot of the other things. That has an impact on the companies that were reliant on that, you know, Meta platforms, Facebook, is down 48% year to date, Snapchat down 75% year to date. These were companies that were reliant on the technology that existed before. It’s been interesting to see The Trade Desk play by their own rules, not be reliant on the cookie, but actually creating their own identifier that in many ways is kind of bypassing several of those limitations. Is that where you wanted to go with this, Brad? Is that a fair setup for you to spike a next level?


Brad Freeman  09:31

Yeah, and so the identifier you’re talking about, and again, I’m sure you know this, but I will put a name on it for all the listeners, is unified ID 2.0. So it is their response to cookies, but it’s really their identifier and their anonymous identifier across channels. So across CTV and podcasts and all these places where cookies was a bit more limited to that web discoverability niche. So really what UID 2.0 is doing is getting rid of pretty easily identifiable Gmail accounts, and some other data sharing that has been somewhat polarizing. But but we’ll focus on UID 2.0 for now. But what they’re doing is making hashed email addresses. So they’re using your email address, but then they’re hashing it, so anonymizing it, or encrypting it, so that you can be exposed to relevant ads, and things that you actually care about across the Internet to kind of allow that, and this is what Jeff Green always talks about, that quid pro quo of free content across the Internet, free premium content in exchange for relevant ads. So with the signal loss of third party cookies, that becomes much more difficult to do and you need this cross industry, cross channel identifier to really right size  ad demand, and relevancy so that you can continue to effectively place advertisements for a compelling ROAS, (return on ad spend), sorry for the acronym, without all this help from Google, and without all this identification help. So they’ve done that, and it’s really been their mission, their journey, over the last year to rack up supply side partners, to rack up technology partners like Snowflake and Salesforce, to rack up retail partners like Walmart, and Target, and Walgreens, and all of those bellwether companies in order to create effective enough scale. And it’s important to note that they don’t own UID 2.  They created it and essentially allowed other operators to own it. So there’s not this conflict of interest inherent in their model. And they can continue to be this open Internet provider, that equally services everybody without having this kind of de facto UID 2 that’s under their umbrella that they’re profiting from. They are profiting from it, but they’re doing it in a bit more of a clever way by kind  of rounding up all the support and then being in a prime position to capitalize off of it. So UID 2 is essentially third party cookies, but for web, and for streaming, and for podcasts, and for radio, and all of these other things, so that when third party cookies goes away, and they keep delaying it. It was 2023, now it’s gonna be 2024. You can continue to have that level of targeting, that level of precision, when you’re trying to place ad impressions that you had before Google, and before third party cookies degradation, and even arguably, I think, even beyond what third party cookies was providing, because now you are inviting all these other cross channels in to just augment the process and augment the targeting even more, because I mean, more relevant data points for a platform like Trade Desk, where all of this data is being ingested in an automated way, it just makes the targeting process better and better and better. So that’s what UID 2 is and they’re trying to have, I forget the goal, it’s by 2023, they’re trying to have a majority of their advertisers through UID 2, something like that. But the actual number isn’t important. What is important is, traction has been far faster, and far broader, and far more aggressive than they were expecting, and their expectations are usually pretty darn optimistic. So, it’s heartening for sure, and it really insulates them even more from anything Google wants to do in the future, or anything these walled gardens want to do in the future. Because now UID 2 is really the open Internet identifier, and it’s going through UID 2, and going through Trade Desk, and all that targeting is happening through their platform that just builds even more data scale and builds even more of a word I hate to use, but I’ll use it her,  a moat, because really in charge of their own destiny is the way to put it. And the only way they’ve done that is by becoming by far the largest, and UID 2 just kind of sets themselves up to continue being by far the largest, and by far the most relevant.


Simon Erickson  13:48

Very true Brad. It seems like the opportunity to follow the innovators are creating something new in the trailblazing their own path, versus just responding to something that’s created by others and being vulnerable when things like that change. Speaking of carving their own path, Jeff Green is not going to sit around and wait for things to change. He’s doing something new. Open path is a new initiative that you know is not getting a whole lot of press right now, but it does have some beta partners on board. Washington Post and USA Today have been two that have been beta testing. Tell us about what this is and whether or not you think it’s important.


Brad Freeman  14:20

Sure, so and we joked about this before the call, so we could joke about it again. This is Trade Desk not entering the supply side, and if you’re listening to this and not watching it, I’m using air quotes very sarcastically, because they could say it’s not their entrance into the supply side. But really what it is, is allowing the Washington Post of the world, or the supply side publishers who have the ability to do their own yield management, who have the ability to internalize their supply side operations, it gives them a direct integration into the demand side, so that these publishers are really able to, when they have the resources, to vertically integrate the supply side operation so that they’re just directly working with The Trade Desk to place ad impressions through their their publishing network. So no, it’s technically not a product that competes directly with Magnite, or PubMatic, or these other supply side players that Trade Desk likes to say nice things about, but it is very much so a threat to them, in that these massive enterprises who have the resources, who have the capacity, who have the know how to do yield management, now no longer need to plug into the supply side in order to plug into the demand side. Trade Desk and Open Path just created this open path, hence the term open path, where they can plug directly into the demand side. So selfishly, for me, I love it, and I want them to take as much of the pie as they possibly can within programmatic advertising. But the downside will be how these relationships with Magnite and PubMatic kind of morph, how they really blossom and evolve, because they can say nice things about Magnite and PubMatic all they want, but if they’re taking their revenue and their profit share, it will not be an amicable relationship, and you can take that to the bank. But that’s really what open path is. It’s Trade Desks first tiptoeing to the supply side and to servicing them directly. And they like to offer a preface or caveat any chance they get of we’re not trying to become the supply side, that’s not what we’re doing. But yes, they are. And this is, I think, step one, but we’ll see where it goes from here.


Simon Erickson  16:30

We are not entering the supply side in air quotes for anyone who can see it. Very true. Last but not least, before we move on, Brad, one last question. Trade Desk is up 71% during the last month, certainly refreshing for long term shareholders like you and I are for this company. 35% revenue growth year over year at a 37% EBITDA margin. Do you still like the stock here? Does it still have plenty of room to run, do you think?


Brad Freeman  16:51

So where it goes in the next few weeks, I’m sure most of our listeners can offer more intelligent opinion there. But I will just say, and you brought this up in our spaces yesterday, but it will be a different day, I’m sure, when this gets published, that companies when they scale and when the revenue bases grow, you don’t often see revenue continue to accelerate quarter after quarter. And I guess this company is the anomaly. So really, we’ve seen Snapchat do very poorly in their results, and I’m not going to pick on them because there are some very real macro headwinds, and there’s some things to like about the company, and I’m sure there’s a very formidable bull case, but but for The Trade Desk specifically, it’s a matter of two things. So that channel diversification that we spoke on, that really allows them to kind of, and one of the channels, so the most important channel is connected TV. And connected TV is very supply constrained in terms of the demand side wanting to place impressions within streaming platforms. So, there is some room for demand destruction, which we’ve gotten a little bit of, but not a lot of other than connected TV. Interestingly, because of how granular, and because of how targeted, and how profitable these impressions are for everybody, compared to linear TV, and buying again millions of impressions several months in advance. But really, it’s been this perfect storm within connected TV of Disney’s now embracing AVOD, and HBO Max is now creating a new tier that’s ad supported, and Netflix, which Jeff Green has been telling us is going to happen for a decade, is now finally embracing AVOD. And they’re going to plug in to Microsoft Zander on the supply side, which is an intimate partner for The Trade Desk. So very good news for them there. So that’s really allowed them, and CTV is more than 40% of their business, so it really is the bread and butter, and it really has allowed them in this world that’s separated from IDFA, that’s separated from cookies, that’s separated from all of these places. It’s allowed them to continue to thrive, and I just want to offer the side note that even if cookies was capable of degradating signal within CTV, again, The Trade Desk is not reliant on them. But it does help when they’re in this independent environment, when there’s no market power leader with 99% share of search. So there’s actually a competitive open market for bidding and The Trade Desk really thrives on that. The other thing that has really allowed them to kind of outperform on a relative basis is what their business model is based on. So they’re not an impression company, they are a return on ad spend company. So their goal, their guiding principle, their Northstar is to make that dollar that you just spent on marketing, turn into $1.50, or $1.60 or $1.80, and to show you exactly how that happened in terms of tangible sales. So when marketing budgets tighten, when macro starts to deteriorate, marketing budgets don’t go to zero, they shift away from the fringe marketing dollars that they were spending to barely get that new dollar and growth, and they tighten their belts to focus on the highest return on ad spend. Which they need to do even more so when things get tough and when marketing budgets shrink. And when that happens, they switch to The Trade Desk. We saw anecdotally in 2008-2009 when Trade Desk was just getting its feet wet, that happened, and they accelerated growth and market share, just like they did this past quarter. That happened during the taper tantrum, when very briefly, people were freaked out and the ad market had a brief blip. It was very brief, but we still had a few weeks of data points pointing to The Trade Desk continue to outperform and thrive. And it’s because they allow these companies to do the cliche we always hear, they allow these companies to do more with less. And when resources become more finite, doing more with less becomes more valuable. And that’s really where The Trade Desk, that’s where they shine. So this combination of where the value prop is coming from, where they’re selling into, not to mention the fact that they’re a key beneficiary of midterm election spend, which is going to add about 5-6% to their growth in the second half of the year. So really, I hope Trade Desk starts reporting before Snapchat, and Twitter, and all these other companies, because it seems like every three months, we get these social media platforms that maybe have their bread and butter surrounding we have large user networks, and maybe we’re not great at targeting, or maybe we’re not great at return on ad spend, and so they kind of fall by the wayside. And The Trade Desk, it does not and it has not over several cycles. So that’s really where I kind of see its insulation. Another growth lever that we could talk about more, if you’d like to, is that retail media buying partnership that they have with Walmart that’s now expanded into (Inaudible) and Home Depot and all these other places, just giving them so many growth levers to pull when one growth lever looks a little less promising. And no other company within ad tech has all of these growth levers to pull. And they’ve really just been able to seamlessly reallocate and pivot and shift resources to where the highest return is, and do so very seamlessly. So Jeff Green, if you’re listening to this, you rock and thank you for making the company so easy to own for me. But it did,  the last thing I’ll say, is it did jump from 38 times earnings to 58 times earnings or something like that, right after the earnings report. I did take the opportunity to trim 5% of my position, but it was 5% of my position. I still remain predominantly invested and I’d love to put that 5% back in if we get any kind of turbulence, not really expecting that turbulence, just saying I will react to it accordingly If we do get it.  I’m a market reactor and I’m not a market timer. So that’s the plan,  but I digress and we can go to the next question if you’d like.


Simon Erickson  22:23

It’s fantastic, Brad, thank you for this incredible insight. And one thing I wanted to double click on is connected TV. You mentioned that a couple of times. Let’s put this as a horse race, right? It’s a connected TV horse race. And certainly The Trade Desk is one of those thoroughbreds. It’s breaking far beyond the other horses in this part of the race. But I want to talk about one of the other horses that seems like they broke fast out of the gate, but has slowed down and it’s kind of falling back into the rest of the pack as competition has caught them. And that is Roku. Because I think that Roku is one of those companies that really embraced and saw the opportunity for connected TV, video on demand, as you mentioned earlier. A lot of companies were kind of experimenting with digital streaming, they were creating their own connected TV platforms, they were getting first party data of people that were either subscribed to them, or at least giving them an email address and some  personal data that they could use to match up with advertisers. It seemed like Roku was one of those early leaders that was matching people that wanted to watch connected TVs, it was embedded as an operating system within the Samsung TV or whatever it was you were buying, and then was matching up to their own platform with the advertisers. But Brad, Roku has had kind of a tough go here in the last couple of years. For a horse that broke fast. It seems like they might be slowing down as competition is catching up with them right now.


Brad Freeman  23:36

Yeah, and I will preface all this by saying my knowledge of Roku is a bit more surface level than The Trade Desk. So Simon, if you have anything you’d like to add here, I’d love to hear your thoughts as well. But to me, Roku, their reliance, and they’re getting away from this and rightfully so, but their reliance on a large chunk of their operations coming from hardware and hardware sales. It always made me a bit nervous, especially when you have Google selling or giving away YouTube TVs for free, and I know Roku, It is a better product. I’ve used Amazon’s, I’ve used Apple’s, I’ve used Google’s, and I’ve used Roku’s, and Roku is a better product. But free is more of a differentiator to me then then a slightly better product. So Roku, they’re doing a lot more with trying to internalize a lot more content, and trying to bring a lot more content onto their platform. but to me that hardware focus puts them in a lot more precarious of a situation, that while they shift to trying to emulate a bit more of the programmatic demand value proposition in niche of maximizing return on ad spend through their platform. It’s a transition and we’re seeing those growing pains manifest again with very surface level macro issues, record inflation, record low consumer confidence. Maybe I will go to that for YouTube TV instead and sacrifice maybe a little lower utility, or a little lower quality of product than I would for Roku. But in terms of what they’re doing on the software side, programmatic advertising, my knowledge there is not super dense. When I was researching Roku and deciding on where I wanted my programmatic advertising exposure to come from, that’s really what gave me initial pause, because Trade Desk is just this pure software play lacking any kind of conflict of interests within the industry that allows them to partner with and work with everybody, and Roku’s niche and business model is a tad less camaraderie. They’re less of a comrade and more of a competitor to these companies. And it’s sort of manifesting in those results. But again, surface level knowledge and Simon, if you have anything to add, I’m sure you can speak on it more intelligently than I can here.


Simon Erickson  25:54

Not really, Brad. All I can do is offer some fun trivia questions. Which is Do you know what Roku means in Japanese?


Brad Freeman  26:02

Oh, I know Anthony Wood, It’s like his sixth or seventh company. Does it mean six or seven? I know it means that.


Simon Erickson  26:11

You got it, nailed it.. It’s six in Japanese and it’s symbolic of Anthony Wood’s like you mentioned, sixth company. He’s kind of a serial entrepreneur. He got an early start on this. But you know, it’s kind of interesting, the history of Roku. They shared the complex with Netflix, actually early days, they never made any money off of Netflix, they were using it for the volume of people coming into the Roku ecosystem, signing up for Netflix. Of course, at that time, Netflix had no interest in advertising at all. YouTube was the second most subscribed to on the Roku platform, not making money off of that because YouTube wanted to control the advertising experience themselves. So this is kind of always where Roku has been the second fiddle. Now you see other companies like Disney talking about advertising or even Apple figuring out its own advertising. It’s always been the larger platforms are going to want to control that experience, and monetize, and not be the comrade, and what was it, the camaraderie, the word that we were saying? Roku is second fiddle and not in the middle of where the action really is.


Brad Freeman  27:11

No, I think that makes sense, and I agree. So I’ll stop there.


Simon Erickson  27:16

I’m impressed that you knew that Roku was six in Japanese by the way. I did not expect you to know that. You delighted me with your response. Very impressive Brad.


Brad Freeman  27:24

Random fun fact knowledge for the win.


Simon Erickson  27:26

The platform is the last thing I wanted to ask about before we move on to the second segment of the podcast. Everything that we talked about, there’s a lot changing in digital advertising right now. We talked about a couple of companies, talked about Trade Desk, we talked about Roku. We briefly mentioned Meta and Snap, Apple and Google  (Alphabet) seem very exposed to this too. Is there any other final thoughts you have about this massive industry that is advertising, that’s increasingly going online, and increasingly going to televisions, and all the technology changes? Any final thoughts about where this is going before we move on?


Brad Freeman  28:00

Sure. I think I’ll take this in the direction of a kind of level setting where the digital advertising market is right now. Because not only, and you spoke on this, or alluded to this very briefly, but when things get very tough from an economic standpoint, one of the first budgets to get cut is discretionary spend on growth, and marketing, and promotion, and all those things, because you want to preserve your business and you’re less focused on growing it. So not only are they dealing with a more fragile advertising market via all these macroeconomic headwinds that we don’t need to get into right now. Not only are they dealing with continued supply chain issues with China reopening and closing, and reopening and closing, which makes advertisers less hesitant to advertise because they’re less confident in their ability to match supply with demand and have that inventory ready to go. Not only are they dealing with all of that, but then Google third party cookies degredation, and IDFA, which really, what it does, it pretty much prevents inter app data sharing and tracking which companies like Snapchat and Meta were just intimately reliant upon. That powered the vast majority of their ad impression calculation pricing. I didn’t say that correctly, but but you get what I’m saying. And so that went away at the exact same time all these macro issues manifested, and at the exact same time when we had Tik Tok storm onto the scene and start taking all these advertising dollars from everybody else. And at the same time from from Meta specifically, where they’re dealing with this reels content transformation, where reels doesn’t monetize very well at all right now, but that’s what people want to see all the time on Facebook. So they have to transition to reels, which is raising engagement, but it’s lowering monetization, because it’s going to take them a long time to ramp that in line with with news and feeds. There’s just so many headwinds blowing against this field right now and I think it just needs to be considered. I own, in the space The Trade Desk, I own  Meta, Match Group sort of plays in the space as well in terms of advertising, but it’s been a very consistent theme of very fragile advertising budgets, very fragile advertising appetites. And when you see all these things kind of play out, I think it makes sense that Snapchat had a terrible quarter. It makes sense that Facebook is doing really poorly, and I don’t think it’s as permanent as maybe some people are extrapolating it to be, because I do think reels will season and mature eventually. I do think inflation will come down. I do think consumer confidence won’t remain at generational lows. I do think supply chains will figure themselves out, and there’s just a lot of things going wrong, going incorrectly. I’ll use the correct grammar there, going incorrectly for them right now, where there’s this massive wall of worry for them to climb. And as we continue to climb this massive wall of worry with all these intimidating headwinds kind of falling by the wayside, it’s gonna take a while for that to happen. Things could look a lot better for these companies, things could look a lot more encouraging for these companies. And that’s kind of how I expect things to play out. I do avoid a lot of the companies in this space and just flock to the cream of the crop because I think The Trade Desk is kind of showing why that’s important as macro cycles cycle. But that’s where I’m at right now. I want to hold the hand of the advertising industry and say it’s going to be okay, because it’s just everything that can be going wrong for them right now is going wrong for them, and I don’t think that’s going to last forever.


Simon Erickson  31:27

It is going to be okay, it’s not gonna last forever. The macro is certainly working against the digital advertising industry. Pat on the back, it’s gonna be all right. Hang in there. Thank you to Ycharts. Our partner, by the way, for powering the year to date returns numbers. You can follow them in data visualization, great for fundamental analysts. They are @Ycharts on Twitter. And again, our guest today for the podcast is Brad Freeman. Brad’s has The Stock Market Nerd Newsletter, you can check that out at stockmarketnerd.com if you want to follow his analysis. Brad, we’ve been chatting about digital advertising, but let me key you up with a couple of companies that you also really like, not necessarily in this space. So maybe the segue is Alphabet, because this company’s founders came from Google before Upstart. Upstart was another company that I know that you follow, and you’ve been chatting about recently because they’ve kind of had a management pivot recently. What’s going on with Upstart right now?


Brad Freeman  32:18

Yeah, so level setting this with Upstart plays in that subprime borrowing field. They’re trying to infuse more data in the loan origination decisioning to uncover more of those hidden prime borrowers, and enhance risk quantification, and they give these tables on, here’s FICO bands, and how much risk in defaults vary by FICO band versus our risk bands, and it’s been consistently a lot better for the last, almost decade now. And we’ve gotten a massive credit shock in our back pocket to use now … is a lot more insight. And it’s held up relatively well for their partners specifically. But for Upstart, the issue for them is that only about, and it got up to 33% this quarter, but it’s gone from 25 to about 33% of their loan volume is retained and stored on the balance sheets of their actual partners. So what that means is they are very reliant on institutional funding for the other two thirds of their loans to actually fund these originations that they’re facilitating through their marketplace. So how they did this throughout 2020, and 2021, because this program started in 2018, so it’s relatively new. But when asset backed security markets were absolutely rocking and rolling, and with all this access to liquidity sloshing around in pockets, they leaned heavily on ABS asset backed security markets to place a massive amount of volume through fast money hedge funds, through private equity firms, through financial institutions that don’t typically play in this space, but were able to in 2021, because they were buying a loan at par value and selling it at 108% of par value in two days. So they were making an 8% yield with essentially no balance sheet risk, and that really revved up the Upstart engine and allowed them to ridiculously grow throughout 2021. Now in 2022, and this is where I think that Google context is important, because this entire leadership team is technology based.There’s not a lot of financial institution background or experience there, which means the amount of experience with dealing with monetary cycles or credit cycles, maybe has been a little lacking, and maybe it’s shown up in their last few quarters of results, because two quarters ago after they got yelled at by Jim Cramer on Mad Money, and they caved, which they shouldn’t have, but they caved. They said we’re not going to use our balance sheet to fund loans anymore, which meant


Brad Freeman  34:40

with as much access demand as they had in their platform from stimulus checks going away, and for credit demand rising, and coincidingly, they were turning down borrowers left and right last quarter. They were extremely funding constrained, and it’s frustrating as an investor because they had all this demand that they could have funded, but because they committed to not using their balance sheet, they essentially took a massive revenue hit. Now, they pivoted again to saying, Well, they did two things. So first, they said, We’re going to pursue longer term financing and institutional funding to make disruptions across credit cycles, a little less abrupt. To that, I thought, why were you not doing that from the very beginning? And again, I think it’s a byproduct of the entire team coming from Google and maybe not having a ton of financial institutional experience. But so they had to seek out longer term funding. But they also said that that’s going to be a transition, it’s going to take us a while to line that up. And the lack of funding availability in this time of macro economic turmoil is causing us to forego funding loans that could yield us with a high degree of confidence, 8-9%, and bolster our own profits, despite the fact that we’re using expensive warehouse facilities to fund them. So Upstart essentially pivoted and said, you know, screw this, we’re gonna use our balance sheet, we’re gonna fund the balance sheet, and if you don’t like it, Jim Cramer, you can go away and find another company to invest in, because we don’t care what you think. And good job, Dave Girouard for doing that. I appreciate that. But where I’m going with that is essentially Upstart said, we have all this demand. We know we can collect 8% yield on these loans if we fund them with our expensive warehouse facilities. So we’re going to do that not only to bridge the gap between now and when we have more funding, but also to build more of a proof of concept, and to give more data to their bank partners to show, here’s when things were really tough, and our loans continue to outperform. Because, for financial institutions, okay, great, your loans are outperforming in 2020. The question I always got about Upstart, and rightfully so, is what happens when things don’t look so good, and right now things don’t look so good. And so if they turn off the funding faucet, and just say, we’re not gonna use our balance sheet and let demand dribble, they lose a vital opportunity to build this data and this proof of concept out across very difficult times. So that when this next credit shock comes when we have this next credit cycle, and this next credit shock, they have all this data to show their banking partner saying, we did just fine throughout this entire downturn. We targeted minimum yields of 3%, which has been pretty consistent as a minimum for Upstart so far, which is in excess of what you can find, or maybe not anymore, but it used to be in excess of federal funds rate. So that probably needs to go up a little bit in order for them to remain competitive. Really, that’s a very long way of saying Upstart has embarked on this two pronged pivot, so pivoted to not using the balance sheet then pivoted to using the balance sheet, because they want to build this data treasure chest, because they want to collect this 8% yield, because they want to not be completely at the disposal of these financial institutions to be funding their loans. And this is really, this is the argument for a banking charter. This is the argument for why a banking charter makes sense, because another holding of mine, Sofi, is enjoying, and they deal with the high end of the credit spectrum, so it’s different from that respect. But how it’s not different is SoFi can use deposits in their ecosystem to fund these loans. They can use very low cost, vey high profitability funding when institutions back away. So they don’t need to say, well, we’ll just let our volumes drop by 50% because no one’s going to fund our loans. Screw that, we’re going to fund our loans, and we’re confident in our ability to do so. So that’s the benefit of a banking charter. But how this resolves itself for Upstart, and I’ll leave it there because I’ve been rambling for a bit. But how it resolves for Upstart is really, they need 1/3 of origination volume happening with partners to go to 50%, into two thirds, into three quarters, into the vast majority of that book. Because those are the durable funding sources. Those are the funding sources that have access to the lowest cost of capital, that can hold loans to maturity, that don’t need to flip like fast money hedge funds for immediate profit and no balance sheet risk. And that model of leaning on fast money hedge funds will work wonderfully in the 2021 type periods, and it will work horridly in 2022 type periods. And that’s really the whipsaw we’ve seen, and it’s played out in a very rosy 2022 guide given that since been greatly pulled back. But that’s really where Upstart is. I don’t think 2022 is going to be kind for this company. I think, I hope things have gotten as bad as they’re going to get in terms of exogenous forces and macro factors, and the sheer pace of the rise in the two year yield, which is how they benchmark their own loan pricing, which has cooled off a little bit, thankfully. But it’s really about Upstart transitioning from this company that will cyclically thrive or cyclically fall by the wayside, to one that can hold up throughout credit cycles, and that’s how they do it. They need banking partners to continue originating a larger portion of their volume. And this transition period is how they’re going to hopefully prove to them that it’s worth doing, regardless of how things look.


Simon Erickson  40:04

There’s a transition that’s needed, for sure. If you’re Dave Girouard right now, this is my last question about Upstart and then I want to move on. But if you have limited resources right now, you’ve got the option of using your balance sheet or do you buy back shares, knowing that your share price is down 90% from its high less than a year ago. What do you do as David Girouard right now?


Brad Freeman  40:23

What do you do?


Simon Erickson  40:26

I put the crown on you here, Brad. You make the decisions of what should Upstart spend its capital and use its resources for. Do you buy back shares, expand the business, you take on the balance sheet? Where do you go with this one?


Brad Freeman  40:36

So today, I would prioritize expanding the business and growing volumes over the buyback, for sure. I will offer the sort of caveat that this is a very cash rich company. It has been deeply profitable, and in this past quarter, which again, hopefully, but likely, macro forces are going to be as tough as they’re gonna get, they essentially broke even and raised their restricted cash balance. And they guided to adjusted EBITDA breakeven for the next quarter, which for them is a very good proxy for free cash flow. So they have the flexibility to buy back shares, to fund loans, to do all these things while continuing to bolster their balance sheet. But at the same time, a buyback this early on for the company 10 years in, when I’d like this to be, and it’s going to be extremely lumpy, not 30% growth a year, but I’d like this to be a 30% compounder over 5-10 years. It’s hard for me to believe that there’s not a source of investment, or a source of funds for maybe investing in the small business loan product, or maybe investing more heavily in auto, or mortgages, or payday loans. If they are conceding any spend in R&D categories, or growth at the cost of buybacks, I think it’s a terrible decision. And I don’t have much insight into their day to day balance sheet, I do have insight into their quarterly balance sheet, but how they’re managing cash on a day to day basis, and how undervalued they consider their shares to be or whatever you want to call it. But you don’t buy back shares when you’re a growth company pursuing several new opportunities. Unless and I don’t know if this is the case, they can do everything at the exact same time and continue to have a healthy balance sheet. To me, it’s a little hard to believe that they can. I don’t know, they did buy back some shares last quarter, they said they’re going to continue to, but that should be the very last priority of capital allocation in my view.


Simon Erickson  42:42

Great point, Brad. I also like the points you made about the management team coming from Google. They want to train the AI algorithms, and might not have as good of a financial backing, maybe it’s time for a shake up with the board directors, or at least some new blood that understands the industry a little, at least has a different perspective on it. Let’s go to the final company that we want to chat about. You mentioned it earlier. This is the one that has the banking charter, serves the higher end of the market for financial services, Sofi. Also has a very different leadership team than than the Google executives that went on to form Upstart. Tell us a little bit about Sofi. What do you like about this company?


Brad Freeman  43:12

Yeah, so Noto was a banking executive at Goldman Sachs, case in point, financial institution veterans. So kind of, a lot of this is gonna sound like the polar opposite of what I just said from from Upstart, because this company is killing it. And this company is killing it, despite the fact that their largest, most profitable business in student loans continues to be severely challenged by the moratorium, and they continue to beat and raise guidance anyway. So, how is that happening? Well, their average borrower has an annualized income of over $150,000, so stark contrast to the cohort that Upstart is servicing. And as a result, their delinquency rates and their charge off rates, while we’ve seen the industry kind of go in a very negative direction after stimulus faded away, continues to set record lows for this company because stimulus didn’t boost their cohort as much as it did for some of these other companies. And so coincidingly, that stimulus going away is not hurting them as much either. Now, also, what’s so important for Sofi is their product diversification. So they have mortgages, and they have other types of loans that do really poorly when rates rise, but they have an ability through, again through product diversification, to pivot resources away from mortgages to all their variable to fixed refinancing products, into their home improvement products, their personal loans that soar in demand when rates go up, and when when budgets get stretched, and people need to borrow more. And that really has allowed Sofi, in conjunction with its banking charter, which allows them to kind of plug gaps in an affordable way with their balance sheet, it really allows them to perform well, regardless of how the macro cycle looks. They’re performing as admirably, and they’re very different companies, but this is how I want Upstart to look in the next credit cycle. Follow the roadmap. Don’t follow the becoming a Super App, or the consumer facing app, or anything like that. But follow the funding diversification, and how Upstart does that is through pursuing longer term financing with institutions and building it’s proof of concept. But for Sofi, that proof of concept, it’s been built. And so, not only is the loan book looking extremely good, but they continue to sign bellwether clients. They didn’t offer that the name of the Brazilian bank, but Technisys signed a top five Brazilian bank last quarter. Galileo recently signed H&R block. They have Chime and Robin Hood, and all these Bellwether clients that are paying them for their B2B API services. And really, that allows Sofi, and if you listen to me talk a lot, this might sound a bit redundant, but it allows their growth to float in a more correlated manner with FinTech growth, which is supposed to be rapid for a long time, rather than them slowly leaning on Sofi and this consumer facing brand, in a largely commoditized space, to find all their success. It not only insulates them in that regard. But it vertically integrates their tech stack, so they’re not paying a 2% fee for their payment processing API. They’re not paying another 2% fee for their core banking and they’re pocketing all this money, and they’re creating new revenue streams by selling all these services to other companies as well, which just makes this such an interesting business, and how this all manifests from a consumer point of view, and I’m kind of lumping ideas together, but they really are all connected for Sofi, and they really all do go hand in hand. But this banking charter allowing them to have a more profitable loan book, paired with vertical integration of their tech stack, versus not even remotely close to vertical integration for their legacy competition, versus having this vertical integration and this banking charter without a massive network of fixed costs through having banking branches all throughout the United States with tellers and mass fixed costs. It makes Sofi very lean within financial services, and how that manifests is as a 2% yield on their high yield savings account, which other companies are trying to chase them, but every time they do, Sofi just raises theirs more. Because they’re really, they’re inviting, or doing whatever they can to bring direct deposits into their ecosystem, so that they can cross sell these personal loan, and student loan, and equity investing products. And they’re willing to sacrifice because they have all this cross selling potential, and because they have all of these vertically integrated cost savings, they’re willing to sacrifice a percent, or 2%, or 3%, on their net interest margin within their loan book, which Wells Fargo, and Bank of America, and JP Morgan, are not at all willing to do. They’re maximizing return on equity right now. They’re not focused on revenue growth, they’re not focused on anything else, but return on equity. And that really gives Sofi, kind of the leeway and the flexibility to stand out in a very hyper commoditized space, which I don’t generally like investing in, but Sofi stands out in all those ways and makes me comfortable doing so.


Simon Erickson  48:01

Brad, we chatted yesterday. So it’s two days in a row that I’ve gotten to hear your insights about this. But we talked yesterday about follow the leaders and how some of the market leaders can gain share during unfavorable macro conditions. Sofi came public through a SPAC, I believe it was last April or last May. It’s been a little bit more than a year now. Down about 30%, but based on everything you just said, it seems like they’re growing as a business, they’re going for the growth rather than just the profitability. Are you a fan of shares right here at $7 a share for Sofi.


Brad Freeman  48:29

Am I a fan of shares? Well, I own a large position, and I’m not willing to part ways with any of it at this point in time. And I am more so, I haven’t done any trimming recently, and I’ve been accumulating in the last few months, but that was more so around six bucks a share. So right now, pretty much just holding. But yeah, I mean, what you’re saying is, it’s just spot on. And it’s exciting, really, because I think we’re going to see a lot of sheer consolidation, go to The Trade Desks of the world in programmatic advertising, that go to hopefully, selfishly, for my sake, the CrowdStrikes of the world in cybersecurity, and go to, hopefully against selfishly, for my sake, the Sofis of the world in digital banking. Because you can’t fund, there aren’t venture capital firms looking to fund negative gross profit endeavors with terrible unit economics anymore just to get placement and growth at all costs. That’s gone away. So these companies that can deliver growth, while they’re delivering operating leverage, like Sofi  has shown they’ve turned deeply EBITDA positive over the last several quarters, and they’re supposed to get to GAAP net income positive next year. That’s really the combination that people are looking for. And it allows them to continue to invest aggressively because they’re not sacrificing burning through all the cash on their balance sheet through terrible unit economics of their operations. So, that was a very long way of me saying I agree, Simon


Simon Erickson  49:52

Well, once again, Brad Freeman is @stockmarketnerd on Twitter. Definitely worth a follow or check out stockmarketnerd.com to follow his newsletter. Brad, it’s always a pleasure. Thanks for being on the podcast this afternoon.


Brad Freeman  50:02

Always fun, really like your company, really like you, so happy to do it whenever.


Simon Erickson  50:06

Also, thank you to Luke Hallard for producing this episode of our 7investing podcast. Thank you, Luke. And thank you for tuning in to this edition of our 7investing Podcast. We covered a lot of ground, a lot of great insights from Brad here this afternoon. Really appreciate his time as always. We’re here to empower you to invest in your future. We are 7investing.

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