Market Overreaction to Q2 Presents Attractive Entry Points

• Q2 revenue fell 12% YoY, missing our estimate by 10% due to lower-than-expected ad spending. Despite lower revenue, EPS improved YoY, driven by higher gross margins and lower G&A expenses. 
• In Q2, major digital ad platforms experienced slower YoY spending growth relative to the previous quarter. For instance, YouTube (NASDAQ: GOOGL) and  Meta (NASDAQ: META) saw their ad revenue growth decelerate to 13% and 22% YoY, respectively, down from 20% and 27% in Q1.

• That said, ad spending is expected to rise in Q4, amid cooling inflation and proposed rate cuts by central banks. eMarketer forecasts global digital ad spending will grow by 12.2% this year (revised from 13.2%), up from 12.0% in 2023.
• Management is forecasting record Q4 revenue this year. Note that H1 usually comprises only 30%-35% of annual revenue.
• We believe KIDZ is poised to benefit from the stricter ad regulations imposed by the recently introduced U.S. COPPA 2.0 regulations. By expanding privacy protections to teens and imposing tighter controls on data handling and targeted ads, we believe COPPA 2.0 creates a more complex landscape for advertisers. As a result, advertisers will likely turn to companies like Kidz that specialize in kid-friendly advertising.
• KIDZ maintains a healthy balance sheet, with no debt.
• Q2 results, weighed down by lower revenue, triggered a sharp 50% decline in the share price today. We believe the market overreacted, overlooking the improvements in gross margins and EPS, and the projected robust global ad spending growth in H2 2024.
• KIDZ’s forward EV/R is 0.9x vs the sector average of 3.3x, a 74% discount. 

KIDZ Price and Volume (1-year)

Financials 

Q2 revenue was down 12% YoY, missing our forecast by 10%. However, gross margins increased 6 pp YoY to 50%, driven by higher direct vs reseller sales, aligning with our estimate

G&A expenses were down 1% YoY, and in line with our estimate. As a result of higher gross margins, and lower G&A expenses, EPS improved, despite remaining negative

Healthy balance sheet, with no debt. No outstanding options are in-the-money

Sector Outlook

It is estimated that global digital ad spending will grow 12.2% this year (previously 13.2%), compared to 12.0% in 2023, and 9.3% in 2022

FRC Projections and Valuation

From 2021 to 2023, KIDZ's revenue growth outpaced global digital ad spending growth by 1.3x on average

As Q2 revenue was lower than expected, we forecast KIDZ’s revenue growth at 1% for 2024 (previously 13%), and 17% for 2025 (previously 15%), trailing global digital ad spending growth by 0.7x (previously 1.2x)

We are lowering our EBITDA and EPS estimates accordingly. As a result, our DCF valuation decreased from C$0.98 to C$0.83/share

Digital AdTech Companies

KIDZ’s forward EV/R of 0.9x (previously 1.6x) is significantly lower than the sector average of 3.3x (unchanged)

Our comparables valuation decreased from C$0.52 to C$0.46/share, driven by our lower revenue estimate

We are maintaining our BUY rating, and adjusting our fair value estimate from C$0.75 to C$0.65/share (the average of our DCF and comparables valuations). While Q2 revenue fell short of expectations, we remain positive on the stock, given its steeply discounted EV/Revenue, and our robust outlook on the sector.

Risks

Maintaining our risk rating of 4 (Speculative) 

We believe the company is exposed to the following key risks:

• Operates in a highly competitive space 
• Unfavorable changes in regulations
• Ability to attract publishers and brands will be key to long-term growth
• FOREX

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