In 1885, the first modern roller coaster opened to the public. “Gravity Pleasure Road” was an instant success, generating $600 a day in revenues – roughly $20,000 in today’s money. The Coney Island ride featured a lift hill that would pull a bench-like car up a slope, and then release it downhill to the delight of its thrill-seeking riders.
Of course, roller-coaster rides are far less amusing when personal wealth is involved. This week, shares of Nvidia Corp. (NVDA) plunged more than 10%, wiping out $260 billion+ in market capitalization. The financial equivalent of 140 JetBlue Airways Corp. (JBLU) had simply vanished off the face of the earth! Professional traders have been reducing their risk exposure since late July, and retail traders have been conspicuously absent from this latest stock dip. No one wants to say they bought Nvidia near the top.
The AI Giant Hiding in Plain Sight
Earlier this year, Meta Platforms Inc. (META) Chief Financial Officer Susan Li quietly announced her firm would spend $37 billion on digital infrastructure in 2024 – $2 billion more than expected.
At first glance, that seems like an odd choice. Unlike Amazon.com Inc. (AMZN), Alphabet Inc. (GOOGL), and Microsoft Corp. (MSFT), Meta doesn’t sell cloud products to outsiders. Nor does it have any plans to. So why would the social media firm become the fourth-biggest spender on AI hyperscale data centers behind those three public cloud providers?
The answer might be hiding right under your nose… or at least the noses of others.
In 2023, Meta inked a deal with Ray-Ban owner EssilorLuxottica SA (ESLOF) to create a line of smart glasses. Their current product only weighs five grams more than regular sunglasses and have become an unexpected hit, especially among visually impaired users. These buyers have found that AI-enabled glasses can snap pictures of what they’re seeing and describe it back to the users… all within seconds.
Meta hasn’t stopped there. In April, the Magnificent Seven firm launched its latest large language model (LLM), Llama 3, and quickly incorporated better translation and advanced image recognition into its smart glasses and other products. Meta’s most recent LLM version – Llama 8b – is now considered the fastest and most affordable of all current-generation LLMs.
This is excellent news for people who have long viewed Meta as a one-trick pony. As the operator of social media sites Facebook, Instagram, WhatsApp, and Threads, it has long relied on digital advertising for the grand majority of sales. The unexpected success of Llama has suddenly given Meta new upside in the LLM game. Many of its plans through 2027 (which include new Quest headsets, augmented reality (AR) glasses, and a “neural interface” smartwatch) no longer look like such longshots.
Of course, Meta’s near-term valuation will remain rooted in the digital advertising market, which should continue doing well over the next several months. Election years typically see a large jump in advertising spending, which benefits both traditional and digital players. Analysts expect Meta’s revenues to rise 17.5% in the third quarter, and for profits to increase even more.
Still, that means investors buying Meta are essentially paying a fair price for a modestly growing digital advertising business… and gaining an option-like exposure to what could be the world’s next big-hit smart wearable devices.
The Acquisition Target
Informatica Inc. (INFA) is an AI-powered cloud data management company that has seen steady growth since going public in 2021. Revenue growth has averaged 6.4% over the past three years, and analysts expect growth rates to accelerate to 9% through 2027.
Meanwhile, Informatica’s share price has been a roller-coaster ride. The stock traded as high as $40 this April before cratering to $23. It now sits just above $24.
Value investors should sense a deal. Informatica’s free cash flows are expected to hit $431 million this year ($1.43 per share), and applying a three-stage discounted cash flow (DCF) model to this stream gives a justified value of $40 to $50 a share. This 90%-plus upside makes Informatica one of the most undervalued AI companies on the market today.
Growth investors will also see an opportunity. Informatica provides an AI-powered Intelligent Data Management Cloud (IDMC) platform, and the firm has one of the best net retention rates in the fast-growing business. In the second quarter, Informatica reported a 126% net retention rate, and so revenue growth will naturally accelerate as other legacy segments shrink as a percentage of sales. Enterprises are only using more cloud storage… more compute power… more AI… and companies like Informatica are essential in managing data and keeping costs under control.
Together, that makes Informatica a tempting acquisition target for any firm with enough resources to integrate the platform. Its industry is consolidating fast, and companies like Salesforce Inc. (CRM) know there’s a closing window of opportunity to get into the cloud data management business. Expect any acquirer to offer at least $35 per share.
Policing Rogue AI
Earlier this week, the FBI announced they took down a multimillion-dollar AI streaming fraud run by a North Carolina-based musician. Michael Smith, 52, allegedly used AI to create hundreds of thousands of songs for made-up bands (which is somewhat illegal) and then used AI bots to create fake listeners of the music (which is clearly illegal). The seven-year scheme involved using complex software to play the AI-generated music on repeat, forcing firms the likes of Spotify and Apple Music to pay out millions in royalties. As Ars Technica reports:
To avoid detection, Smith spread his streaming activity across numerous fake songs, never playing a single track too many times. He also generated unique names for the AI-created artists and songs, trying to blend in with the quirky names of legitimate musical acts… The NYT reports that in an email earlier this year, he boasted of reaching 4 billion streams and $12 million in royalties since 2019.
The use of fraudulent AI will only increase. AI makes it easier for bad actors to mimic humans, and industries like media streaming and online advertising are particularly susceptible to fake clicks. Juniper Research estimates that losses to click fraud will rise from roughly $84 billion today to over $172 billion by 2028.
That’s where DoubleVerify Holdings (DV) comes in.
DoubleVerify is one of the leading traffic-verification firms in the ad-tech space. The $3 billion firm works with advertisers and brands to help safeguard against invalid digital traffic.
From a high level, the process looks much like uncovering credit card fraud. DoubleVerify uses AI-backed technologies to analyze roughly 2 billion impressions per day, and the system flags suspicious behavior like bot fraud and injected ads. These are then either automatically or manually reviewed, and the output is used to improve future predictions.
That makes scale incredibly important. Having more customers (and greater access to click information) makes it more likely that DV will detect a new cluster of fake users, and the findings can be used to protect other customers. This “shared immune system” also explains why larger cybersecurity companies tend to dominate.
DoubleVerify is also doing well from a bottom-up standpoint. The company has continued to expand its offerings with bolt-on acquisitions, and now even counts Spotify Technology SA (SPOT) as a client. Analysts expect revenues to rise 17% annually through 2027, and net income to almost double over that same period.
That makes DV’s recent selloff an incredible opportunity to invest. Shares are now down 47% since the start of the year and trade almost a full standard deviation under their mean. If Luke’s outlook is any guide, September could mark the start of a strong turnaround.
The “Gravity Pleasure Road” roller coaster I mentioned earlier happened to be the first one in the world that featured a continuous oval track and the ability to pull itself back up the hill. So, every downhill roll would be followed by an uphill ride. Today’s stock market looks primed to do the same thing.
Regards,
Thomas Yeung, CFA
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Source: Investor Place