The "satisfying story" Applovin Grand Reveal: A Sure Win Planned for Five Years

$AppLovin(APP.US) The story of a tenfold increase in one year is something everyone has heard of. Dolphin has always been particularly curious about the "real" reasons behind AppLovin's success. The underlying algorithm model AXON seems to be a technical black box. How exactly does it achieve improved advertising ROAS efficiency? Why haven't industry giants like Google Admob and Meta Audience, which have stronger technology, been able to suppress AppLovin's rise? After reviewing a lot of information, Dolphin has some thoughts of his own.

Source: Longport

Unlike the market's consensus on the explosive turning point—the launch of AXON 2.0—and the hype around AI's saving effects on AppLovin, Dolphin believes that the real reason for AppLovin's stunning transformation lies in 1) a "years" accumulation of technology rather than merely benefiting from this round of Gen-AI, having prioritized privacy policy issues early on; 2) a business focus on ecological closure, full industry chain layout, and quick decision-making and execution when competitors make mistakes, which together have deepened AppLovin's moat.

AI for AppLovin, more accurately, is the icing on the cake, rather than the core key to this turnaround. However, AI is not unimportant; in the future, as they step out of their comfort zone and navigate the e-commerce advertising chess move, AI is expected to play a more significant role. Compared to the $30 billion app installation and $90 billion game advertising markets, the trillion-dollar e-commerce advertising market can indeed be described as a vast ocean of stars, and it is worth AppLovin starting to actively increase some investments.

But Dolphin also believes that whether in e-commerce or other non-gaming fields, AppLovin no longer has a significant data advantage. Even if AI is powerful, noticeable progress may take some time, and it certainly won't be as smooth as AXON 2.0 in the gaming field, where results come quickly.

On the other hand, compared to the high valuation, with AppLovin reaching a market value of $100 billion, Dolphin is more concerned about whether Unity can truly achieve a rebirth this year. After all, as one of the leading players that AppLovin has caught up with, Unity is still a platform that can reach a user base of 2 billion. Despite two years of turmoil hindering development and causing temporary technological lag, the mismanaged leadership has already left, and Unity's mobile 3D ecosystem remains. This article will mainly focus on the successful path of Applovin, outlining the industry situation, Applovin's operational advantages and key decisions, and summarizing the main driving factors behind its remarkable transformation. In the next article, Dolphin Jun will directly compare the current situation of Unity, discussing the possibility of Unity replicating Applovin's successful path and the corresponding valuation imagination space.

1. Applovin: A Rare Player with Full Industry Chain Layout

Since Applovin provides B2B services and does not directly cater to C-end demand, the user-side perception is not as clear-cut. Therefore, before diving into the discussion, Dolphin Jun believes it is necessary to briefly outline Applovin's business situation and industry position.

In simple terms, Applovin is an "advertising intermediary," primarily serving small and medium-sized app developers by providing a mobile marketing platform that facilitates customer acquisition, activation, and monetization.

In the mobile marketing industry, the two ends of the industry chain are the actual supply and demand sides—advertisers (Advertiser) with advertising placement needs and publishers (Publisher) with ad inventory.

The middle segment of the industry chain is the "intermediary platform (Ad mediation)" that matches demand. Depending on the services and functions provided, it can be further divided into ad networks (Ad Network), sell-side platforms (SSP) serving publishers, demand-side platforms (DSP) serving advertisers, and programmatic trading platforms (Ad exchange) that facilitate bidding between buyers and sellers. Currently, Applovin offers almost complete advertising intermediary services.

From the perspective of Applovin's core product segmentation:

MAX serves publishers with advertising inventory, while AppDiscovery focuses more on developers with customer acquisition needs. ALX, or Applovin Exchange, provides a programmatic trading platform.

However, from the perspective of specific developers, Applovin covers the entire product lifecycle process. Conversely, by providing such end-to-end services, Applovin can also utilize user data from these apps to train and optimize the underlying algorithm model AXON.

Therefore, any small and medium-sized app developer is a potential customer for Applovin, especially game apps that primarily monetize through advertising (rather than user payments). To better serve its users, Applovin has also acquired several casual game studios with a large user base in recent years, to provide more advertising inventory for developers with customer acquisition needs and to use user data from these casual games for optimizing the AXON model Therefore, Applovin's revenue structure is relatively clear, mainly consisting of two parts: (1) Advertising intermediary service revenue, primarily recognized as net income based on the price difference (AppDiscovery - accounting for about 30% of gross income) and a commission (5% deduction from using the MAX platform); (2) Monetization of proprietary apps, including in-app advertising and user payments.

Before 2022, revenue from proprietary apps accounted for the majority. However, since the development of the AXON underlying algorithm model, revenue from advertising intermediary software services has begun to rapidly support income, reaching 70% of total revenue by 3Q24. This also means that the advertising industry has an increasingly significant impact on Applovin's performance.

In the mobile marketing industry where Applovin operates, 80% is in-app advertising, and among in-app advertising, nearly 15% consists of app install ads, which currently represent a market size of less than $30 billion.

This small sub-sector of less than $30 billion is mainly dominated by the three giants Apple, Google, and Meta, which rely on their own traffic advantages to capture 60% of the market share, while the remaining small and medium platforms occupy 40%. Although Applovin mainly relies on external traffic from the Max aggregation platform, its growth rate is rapid. Two years ago, in 2021, its market share was less than 4%, and by 2023, it has reached 9%.

Of course, Applovin's ambitions extend beyond just app install ads, targeting the entire $200 billion mobile marketing market, or at least the nearly $150 billion in-app advertising market. However, in 2023, Applovin's market share is still very small, even less than 1%.

Therefore, despite Applovin's market capitalization exceeding $100 billion, its revenue for the past 12 months as of 3Q24 is only $4.3 billion. Excluding revenue from its own game apps, the advertising intermediary revenue is only $2.8 billion. According to current market consensus, Applovin's current market capitalization of $115 billion implies a valuation of EV/Sales = 20x, which is generally higher than its advertising peers.

II. How did Applovin make a stunning transformation?

The high valuation naturally implies the market's expectation for Applovin's future high growth, but this growth does not come from its own game apps, but rather from its software services as an advertising intermediary. Therefore, what Dolphin is more concerned about is how Applovin's advertising services actually took off?

After all, before 2022, Applovin's total advertising revenue (software services + in-app advertising) was less than half, and it couldn't even be considered a mobile marketing platform. Therefore, Applovin's successful experience is key for us to judge whether Unity can replicate it.

From the rearview mirror of stock price changes, the market believes that the operational turning point is the underlying algorithm model of AXON (which can better predict and match users related to advertising content), especially with the launch of version 2.0 in 2023. However, after sorting out Applovin's development process, Dolphin believes that the power of AXON 2.0 cannot simply be attributed to this round of Gen-AI. AI actually provides Applovin with the infinite possibilities of continuously building high barriers and expanding into non-gaming markets "in the future."

However, the "slow start" at the end of last year and the beginning of this year is more about Applovin's "thick accumulation" since 2018, including the stacking of technology and seizing multiple opportunities during critical competitive periods.

1. Starting Point: Taking an Unconventional Path

Generally speaking, internet advertising platforms have obvious scale advantages. In addition, tech giants with technological advantages also possess higher natural monopoly capabilities, leading to a "80/20" or even "90/10" competitive landscape.

However, small and medium platforms are not completely without a way out; by focusing on niche areas or innovating technology and business models, they can also have opportunities to stand out. The innovation of giants is often limited by the current relative cooperative ecosystem, lacking sufficient courage to break the status quo.

Applovin's beginnings reflect a similar situation. In 2011, although the smartphone era had just begun, programmatic advertising had already entered the market. Programmatic advertising can be divided into waterfall (which has relatively closed bidding information) and in-app real-time bidding (which has more transparent bidding information) based on the matching method.

The waterfall matching method does not guarantee publishers the maximization of benefits, as advertisers' bids are based on the publishers' past platform performance ecpm. At the same time, publishers cannot see the bids from other advertisers' platform DSPs at the same time But real-time bidding allows multiple DSPs to submit bids at the same time, enabling publishers to increase their advertising revenue by going with the highest bidder.

At that time, advertising giants like Google, which owned both DSP and SSP platforms, mostly adopted a waterfall approach. In simple terms, it emphasizes an "information closed loop." This way, Google can leverage its platform influence to secure a higher position in the waterfall bidding, thus obtaining a higher matching probability, compressing ad space costs, and earning more from the price difference between buyers and sellers.

Therefore, Applovin's opportunity arose from its direct adoption of the real-time bidding model :

On one hand, it charges a 20%-30% commission for user acquisition services through its UA product AppDiscovery from advertisers;

On the other hand, it shares revenue by taking a 5% cut from publishers' advertising revenue through its aggregation platform MAX, which incentivizes Applovin to push more high-paying advertisers to publishers.

It wasn't until September 2023 that Google officially announced the abolition of the waterfall model and fully adopted real-time bidding for programmatic advertising. By this time, Applovin had already reaped significant benefits over the past three years. The MAX aggregation platform has climbed to the current second position in the industry, second only to Google's Admob. In the iOS ecosystem, Applovin has even become the industry leader.

2. Development: Three "brilliant" acquisitions

Applovin's path to development is inseparable from its continuous "buy-buy-buy" strategy; its self-operated games are purchased, and its advertising layout is almost entirely acquired. However, among nearly 20 acquisitions since its establishment in 2011, HaiTunJun believes that aside from the early acquisition of more than a dozen studios that amassed a large user base, advertising inventory, and publishing capabilities, there are two acquisitions in 2021 that can be considered "brilliant moves" that laid the foundation for Applovin's current success.

(1) Hundreds of proprietary game apps

From 2018 to 2019, Applovin concentrated its investments in over a dozen game studios, each operating 10-20 games, most of which are casual games with considerable DAU scale. Therefore, for Applovin, it essentially acquired a product matrix consisting of over 200 games, backed by a large amount of proprietary advertising inventory and nearly 500 million (in 2020) user traffic

(Source: Applovin official website)

Although before 2023, this segment of game apps contributed more than 50% of the revenue, Applovin's purpose in acquiring them was not to become a game developer, but to obtain more data on game players and operational data from developers, to better understand the needs of target customers (customer acquisition, monetization), in order to train underlying models and test advertising effectiveness through incentivized ads in similar games.

However, each mobile game has its own product lifecycle, especially casual games that are easily imitated and copied. Therefore, once the product development cycle is over and active users decrease, the usable value behind these game apps will also quickly diminish.

Since the second half of 2022, with the end of the pandemic bonus, the ultra-casual games quickly faded, and Applovin began its "sell, sell, sell" mode, reducing inefficient studios or shutting down games that were at the end of their lifecycle (as evidenced by the rapid decline in monthly active paying users of game apps). This disposal cycle lasted for two years, until this year when the entire industry hit bottom, and the disposal actions began to slow down.

(2) Attribution Platform Adjust

When it comes to Applovin's core technology, the market is more familiar with the aggregation platform MAX. There is actually not much discussion about Adjust, the attribution platform that provides advertising data analysis. However, we believe that by acquiring Adjust, Applovin obtained comprehensive data from game developers that few peers possess, including user data and the developers' own revenue and profit operational data.

Adjust is the second largest advertising data analysis and attribution platform in the world (the first is the Israeli company AppsFlyer), specifically designed to help developers evaluate the effectiveness of advertising during the customer acquisition process.

For example, suppose a developer uses CPC performance ads (paying for each successful click conversion) for customer acquisition. When the developer runs ads across multiple channels and successfully downloads a specific user, generally, the advertising cost will go directly to the channel where the user last viewed the ad and clicked to download.

However, the reality is that the user may have seen ads multiple times across different channels before making the final download decision. If only the last channel that displayed the ad and downloaded is compensated, it is clearly not fair. Therefore, the service provided by Adjust in this process is to help advertisers determine which channel's ad placement is most likely to have influenced the user, thus assisting in identifying which channel has the highest conversion efficiency for the developer. However, the premise of Adjust analysis is that developers need to authorize their full data for Adjust's use.**

Therefore, the massive operational data accumulated from developers over more than a decade is actually the core demand for Applovin's acquisition of Adjust. Especially after the ATT privacy policy, cross-platform tracking has been prohibited, and user data can only be obtained by the developers themselves.

Applovin, through the authorization obtained from Adjust, integrates these almost exclusive developer data, along with its own game app data, into the underlying AXON algorithm model, greatly optimizing the matching accuracy of ad content with different players, which is a significant data advantage among peers.

(3) Aggregation Platform Mopub

The merger with Mopub has greatly assisted Applovin's own ad aggregation platform MAX, and there is considerable introduction and analysis in the market regarding this, making it one of the acquisitions that Applovin is least likely to overlook in perfecting its industrial chain layout.

Before 2021, Applovin's advertising platform was more of an SSP that served publishers (who own ad inventory), with the core in-app ad bidding technology sourced from the acquisition of Max in 2018. To further expand its scale after mastering ad inventory, it needed to simultaneously grasp ad demand, and the best way to do this was to directly own a DSP platform, with Mopub playing the key role in filling this last gap.

In 2021, Apple officially implemented the ATT privacy policy in the iOS 14.5 version, which restricted the default tracking of the IDFA identifier, greatly affecting the ability of ad platforms to obtain user behavior data on third-party applications, thereby impacting the accuracy of ad recommendations.

It was at this time that Twitter changed its business strategy, gradually shifting its focus from advertising to paid application content/services (such as launching the Blue subscription). Under the high price temptation of $1 billion from Applovin, it sold Mopub, a core advertising solution provider acquired in 2013, to Applovin.

Since then, Applovin not only obtained the DSP it desired but also integrated Mopub's real-time bidding technology into its original in-app bidding solution.

In March 2022, Mopub was officially integrated into MAX, and the following year was a relatively difficult period for the advertising industry. Especially in the mobile advertising market, as the gaming frenzy faded, advertisers tightened budgets, and ad platforms faced multiple impacts from IDFA and other privacy policies, the growth rate of the U.S. mobile advertising industry fell to 9%, putting significant pressure on the revenue performance of several leading ad platforms.

However, Applovin's performance clearly outpaced its peers, with the revenue per download of its core product AppDiscovery maintaining counter-cyclical growth, while download volumes reflected cyclical declines due to the cooling of the hyper-casual category. Similar indicators, such as Meta's ad impressions and ad unit prices, and Google's click volume and revenue per click, did not show much counter-cyclical adjustment "superpower" compared to Applovin during the period from Q2 2022 to Q2 2023 。

In addition to the advertising inventory and advertiser demand directly brought by Mopub (in 2020, Mopub contributed approximately $180 million to Twitter's revenue), the revenue growth of Applovin in the following year (software revenue increased by over $300 million in 2022, while the industry grew by 11% during the same period) clearly shows that the combination of Mopub and MAX has created more value for Applovin than it originally had with Twitter.

From the results, Mopub is like a tiger adding wings to Applovin. But perhaps everyone is curious, why does Applovin continue to aggressively expand its mobile marketing ecosystem despite facing the same IDFA privacy restrictions? In other words, how does Applovin circumvent the impacts of Apple's ATT and Google's Privacy Sandbox?

In fact, Applovin has not circumvented privacy policies , but rather compensated for the impact of the user data gap on advertising recommendations and measurement accuracy through optimization of its underlying algorithm models. This is actually similar to Meta's situation and solution (using Advantage+ to optimize advertising ROAS). From HaiTun's understanding, the technical model is the apparent reason, but the real core factor lies in the vertical (gaming) data advantage :

Both Meta and Applovin not only originally possessed massive user data, but also, after being circumvented by ID tracking technology on the device side, can obtain user behavior data through other exclusive channels, such as Meta's in-app social data, while Applovin has user data authorized by developers from Adjust.

Of course, this also illustrates a problem: hardware/operating system platforms that are closer to users and have thicker barriers stand at a higher position in the entire industry chain. Even top advertising aggregation platforms like Meta Audience and Applovin, which can reach billions of users, find it difficult to avoid the impacts brought by changes in relevant rules and policies from Apple and Google on the operating system.

3. Consolidation: Business closed loop, creating an increasingly deep moat

From the comparison of developers' usage, AXON 2.0 has indeed optimized its precise matching capabilities compared to 1.0, for example, reflected in the significantly shortened time period for Applovin to test advertising effectiveness before officially buying traffic, indirectly indicating that AXON 2.0 has higher matching efficiency.

But AI cannot "cook without rice." As mentioned earlier, "massive gaming data" is Applovin's most distinctive advantage compared to its peers, helping it optimize the underlying algorithm AXON and compensate for the negative drag brought by privacy policies Technology is certainly important, but the operation of advertising companies cannot be separated from the essence of business—“closed-loop ecology + end-to-end” product forms, and “flexible and adaptable” business strategies are the key reasons for helping to broaden the moat.

(1) Business Closed Loop + End-to-End: An Ironclad Ecology

Applovin's product matrix can actually be divided into three major parts: app games, advertising platforms, and underlying algorithm infrastructure. These three parts can drive each other to rotate as a business flywheel. In the advertising intermediary link, Applovin almost covers all nodes, and its own game apps can also provide advertising inventory and participate in bidding for user acquisition. In other words, Applovin has even penetrated the entire industry chain, which makes its ecology more closed-loop.

Moreover, in the products Adjust and Max, it has been found that Applovin also has the situation of “being both the referee and the player.” Although this is not entirely fair, it further raises Applovin's barriers—

a. MAX, as an advertising aggregation platform, can see the quotes from other platforms in real-time when receiving bids from external DSP platforms. However, at the same time, its AppDiscovery may also be bidding for the same ad space. Under the “highest bidder wins” bidding rule, how can it ensure that AppDiscovery, based on known competitor quotes, does not ultimately secure the advertising publishing rights by quoting just slightly higher than the competitor's price?

(Source: YouTube, MAX aggregates ad inventory from other advertising aggregation platforms such as AdMob)

For example, in the case mentioned above, with Applovin knowing that other DSP platforms are quoting $80, its AppDiscovery can secure the ad space by quoting $80.1, but in reality, this sacrifices the opportunity for publishers to earn more revenue.

Although this is difficult to avoid in practice, the management has repeatedly assured that Applovin does not have more information advantages in real-time bidding at a subtle level. Moreover, on other aggregation platforms, there will also be cases where the bidding success rate of its own products is significantly higher, but in Applovin's specific advantageous field—mobile gaming, developers seem to have no choice but to passively accept.

b. Adjust is an attribution platform and the second-largest industry leader globally, which should ideally be operated more as an independent third party. However, since it has been brought under Applovin, it is inevitable that Adjust will overly praise its parent company, which will further push clients towards Applovin (2) Flexible Competitive Strategies

No matter how Applovin downplays competition and denies the zero-sum game narrative, during the two years of soaring performance, the management could not escape repeated questioning about competition during earnings calls, including views on Unity's acquisition of IronSource, Unity being boycotted by clients, and Google’s antitrust lawsuits, among other industry issues.

This confusion from institutions is understandable. After all, following two years of pandemic-driven benefits, since 2022, paid spending in the mobile gaming market outside of China has not truly recovered. While in-app advertising can still barely maintain over 10% growth, the speed of cooling compared to 2021 has been too rapid. Moreover, Applovin's 1P games have seen both paid and in-app advertising revenues decline by double digits under the company's proactive contraction.

Although the industry has seen some recovery this year and Applovin's app portfolio has emerged from an optimization cycle, considering the ongoing intense competition, management stated in a recent conference call that Applovin's subsequent strategy for 1P games will still focus on profitability, adjusting the operational status of apps in the portfolio as needed.

Therefore, in a three-year stagnant market, Applovin's excess growth should almost entirely come from seizing market share from competitors. The primary target is Unity, as this has historically been Unity's territory in Applovin's main gaming battleground. Secondly, while Google Admob and Meta Audience are indeed the kings of traffic, their own strict advertising rules (such as prohibiting cash incentive ads) to maintain the stability of the existing business ecosystem, along with their lack of data and experience accumulation in the gaming vertical compared to Applovin, have also failed to halt Applovin's progress.

Unity's acquisition of IronSource in 2022 was originally a strong alliance, although the premium was too high, there should not have been significant issues with business integration. However, the actual progress has been slow, and it even involved internal power struggles later on.

Ultimately, the IronSource management team took the money and exited, but Unity has faced inevitable performance declines due to Apple's ATT and Google's Privacy Sandbox without making significant technological advancements. Moreover, the entire business line underwent significant personnel changes over the two years, which has greatly negatively impacted the pre-sales and post-sales work connecting advertising business with clients. **

In this process, a portion of the customers turned to Applovin. Then, with another fatal operation in September 2023—the launch of the engine business "Run-time Fee," Unity faced a severe customer backlash. Although the issue stemmed from the engine business, most of Unity's advertising clients came from the extension of engine clients. Therefore, naturally, many customers switched to Applovin, and both times, Applovin successfully caught the windfall through its end-to-end comprehensive services.

Although the AXON algorithm optimization was very timely, due to a relative lack of data on the DSP side (which was only improved through the acquisition of Mopub in 2021), the early effects of AXON were not very significant. Thus, Applovin's ability to "rapidly" seize market share undoubtedly benefited from Unity's collapse.

However, Unity is striving for a rebirth from the ashes, and the problematic Run-time fee has already been canceled. The current focus is on optimizing Grow's advertising technology and repairing the impacts caused by privacy policies like ATT. Although the business restructuring has been pushed from the beginning of the year to the end of the year, the progress is not fast.

But the announcement in the second quarter shareholder letter of the joining of Jim Payne, one of the former founders of Mopub, caught the attention of the market. In the subsequent third-quarter conference call and the November Morgan Stanley small meeting, the CEO repeatedly expressed that they are actively utilizing a new round of AI technology to advance the development of machine learning algorithm models, and there are expectations that it may begin to drive the advertising business in 2025, which seems somewhat reminiscent of the story before the launch of AXON 2.0.

Will Unity replicate Applovin's successful path and regain everything lost by 2025? Compared to Applovin in 2022, what are Unity's current advantages and disadvantages? What are the main points of interest for Applovin and Unity in the next three years? What are the corresponding valuations for pessimistic/neutral/optimistic scenarios? These questions will be discussed in the next article, so stay tuned.

Dolphin Investment Research "Unity" Related Reading:

Earnings Season (Past Year)

November 9, 2024 Conference Call: Unity: Customer Relationships, Product Quality, and Execution (3Q24 Earnings Call)

November 9, 2024 Earnings Report Review: Soul Searching: Has Unity's "Bottom" Been Reached?

August 10, 2024 Conference Call: **[Unity: Discussing Goals Too Early, Execution is the Top Priority Right Now (2Q24 Conference Call Summary)]

August 10, 2024 Financial Report Review: Surge Without Reason, But "New" Unity Is Promising》

May 10, 2024 Conference Call: Unity: Customer Communication Has Improved, Business Improvement in the Second Half of the Year (1Q24 Conference Call Summary)

May 10, 2024 Financial Report Review: Unity: Is the Bone Scraping Therapy Coming to an End?》

February 27, 2024 Conference Call: Unity: Lighten the Load and Focus on Software》

February 27, 2024 Financial Report Review: Unity Plummets? Poor Management and Terrible Moves》

Risk Disclosure and Statement of This Article: Dolphin Investment Research Disclaimer and General Disclosure