Cabot Small-Cap Confidential Issue: May 2, 2024

The Big Idea

Digital marketers have had a tough go of it lately. Society and consumer demands have pressured large tech companies to give us all more privacy and control over our digital data.

I think that’s a good thing for the world at large. But not exactly for those who are paid to tell their clients what products and services we’re likely (or not) to buy.

It began a few years ago. Both Apple’s Safari and Firefox made blocking third-party trackers, a.k.a. “cookies,” the default setting.

Now Google has begun to do the same. Third-party cookies will be eliminated for all Chrome users by the end of this year as a new “Privacy Sandbox” initiative takes over.

This loss of tracking cookies – arguably one of the most valuable pieces of online tracking technology for marketers – is a significant blow. But that’s just part of the story.

With the iOS 14 update in early 2021, Apple pretty much killed another tracking technology, the IDFA (identifier for advertisers) by making it an “opt-in” situation. That meant people had to click the “Allow Creepy Technology to Track Me” button (or something like that).

If you have an Apple device you’ve likely seen this screen.

IDFA sharing was the only way advertisers could precisely track users within apps (i.e., outside of a web browser) on iOS devices.

In response to the evolving privacy landscape, companies both large and small have been scrambling to find new digital marketing solutions that let them know what types of products and services we’re all likely to buy.

That’s where today’s featured company comes in.

It has been quietly buying up data collection assets that require people to opt in.

It’s also built out proprietary technology that anonymously tracks an individual’s online and in-app activities, without running afoul of new privacy rules and regulations.

Lastly, this company has layered in AI and Machine Learning technology that allows it to slice and dice the data accurately enough to create and deliver personalized marketing messages.

Suffice it to say, the company has attracted a lot of attention from the biggest companies out there.

It has beaten expectations in the 11 quarters since it went public, and in the last two quarters has reported record requests for proposals (RFDs), larger deal sizes, and record revenue.

The Company

Zeta (ZETA) is a marketing software company that provides consumer intelligence and marketing automation software to enterprises.

Its platform allows clients to create and execute personalized marketing programs across all relevant channels including email, social media, web, chat and connected TV.

Zeta’s data intelligence solution is called the Zeta Marketing Platform (ZMP).

Zeta’s tools help marketers better understand consumer intent and target them with ads they’ll identify with. Understanding “intent” means Zeta clients are better able to answer questions like:

What does a consumer intend to buy next?

Do they intend to leave a platform?

Do they intend to buy another product or service that the Zeta client sells?

At the end of the day, clients pay for Zeta’s platform because it can answer questions like these, ultimately helping them acquire and retain a customer base, grow customer spend over time, and do it all at an attractive Return on Investment (ROI).

Management says Zeta can lower a marketer’s costs to acquire and maintain customers by an average of 50%.

One of the differentiating attributes of the ZMP is that it is not being negatively affected by all the changes in the marketing industry, including IDFA, third-party cookies, etc. In fact, these changes appear to be a net positive for Zeta and are driving new client inquiries.

In 2023 Zeta added 87 new customers (+7.5%), including 49 spending over $100,000 (scaled customers) and 28 spending over $1 million (super-scaled customers). Super-scaled customers include Agency Holding Companies, which typically represent 10 – 30 enterprise clients.

At year end the company had 1,242 total customers, including 452 scaled and 131 super-scaled.

The company has a market cap of $2.7 billion and was founded in 2007 by David Steinberg (current CEO) and John Sculley (current Vice Chairman and Director), who was previously PepsiCo president (1977 – 1983) and Apple CEO (1983 – 1993).

Zeta Marketing Platform

The Zeta Marketing Platform (ZMP) combines software, services and media and is designed to be a single solution for enterprises to acquire, grow and retain customers.

The technology relies on machine learning (ML), artificial intelligence (AI) and the industry’s largest opted-in data set. Data includes things like a credit score and a person’s affinity toward a certain brand.

Zeta’s platform isn’t adversely affected by all the changes in the digital marketing world (IDFA, third-party cookies, etc.) because it uses a variety of opt-in data collection assets. People have granted permission to be tracked.

These properties include Disqus, the world’s largest commenting platform, ArcaMax, one of the biggest opt-in newsletters out there, and WhatCounts, an Email Service Platform, to build its identifier database, among others.

The ZMP assigns these individuals a Zeta ID, which allows the tech to recognize them across more than 5 million publisher platforms. Or, as Zeta management puts it, basically the entire internet. Identifying data is never sold or given to customers.

There are four main parts of the platform:

Opted-in Data Set: Zeta believes it has the largest opted-in data set in the industry, which comes from over half a billion opted-in global individuals contributing over 1 trillion consumption signals per month. Data is a mix of proprietary data and data gathered from public sources and/or partners.

AI Engine: The second is an AI engine that collects, ingests, analyzes, segments, scores, personalizes, etc., the data. This technology makes sure data adheres to data governance regulations and slices and dices it to create intent-based graphs, audiences, outcome forecasts, channel & content recommendations, etc.

Omnichannel Engagement: The ZMP integrates with a variety of other third-party platforms so customers can bring in outside data as desired/necessary.

Performance: Zeta’s dashboard gives customers real-time results so they can manage advertising and marketing programs with current data at their fingertips.

Zeta currently packages these technologies into three distinct products and a suite of five different Agile Intelligence modules:

Messaging (ESP): Zeta Messaging drives consumer engagement across channels (email, social, mobile, etc.) and helps clients better understand their customers in terms of past purchase behavior, what channels they use and current interests. Zeta’s AI tech can help clients select customers to target, optimize content and automate campaigns.

Data Management (CDP): Zeta Data Management functions as a client’s customer database. It can organize and score data, pull in data from external databases/data feeds and, when combined with Zeta’s proprietary data, help identify anonymous website visitors.

Activation (DSP): Zeta Activation is a highly precise marketing tool used to optimize media spend across channels (email, mobile, social, etc.). It is backed by one of the largest proprietary data sets in the U.S.

Agile Intelligence Suite: The Agile Intelligence suite leverages proprietary data and AI tech to present Zeta clients with timely and actionable marketing/advertising opportunities. There are five modules within the suite – MarketPulste, CustomerPulse, DMAPulse, AudiencePulse and CompetitorPulse – with tools to do everything from visualize consumer sentiment and identify markets to scale up/down investment to take action to gain and/or defend market share.

Growth Initiatives

Macro Improvement: Referencing conversations with senior marketing executives at the Consumer Electronics Show in January, CEO David Steinberg recently said that people were “... probably the most positive I have seen ... in marketing in three years” and that “... everyone was talking about growing nicely this year.” Zeta has been growing about twice as fast as its market so a solid macro backdrop should be very supportive of continued growth.

Growing Demand For “Alternative” Tracking: As third-party cookies, IDFA and other historical tracking technologies fall away, demand for the next generation of alternative tracking solutions, including those from Zeta, is growing.

New Mobile Solution: Zeta never used the IDFA, Apple’s tracking mechanism inside the iOS environment, so wasn’t affected when it was eliminated and people had to opt-in to be tracked. Instead, Zeta cracked the code to figure out how to use the Zeta ID to track and identify a person within the iOS and Safari ecosystems. This breakthrough technology creates a major opportunity for Zeta and will hit the market in the middle of 2024.

Grow Agency Partnership Business: Zeta is growing quickly with the big Agency Holding Companies, each of which represents numerous sizeable customers (15 – 30) and manages over $100 billion a year in marketing and advertising spend. It now counts four out of the big six agencies as clients (it had none four years ago). The only downside is these customers take a year or so to get up to gross margins on par with non-agency clients.

Election Year, Insurance Recovery: Zeta has a political component to its business which should do well this year given the presidential election (around a 2% bump). A recovery in auto insurance is also a likely tailwind.

Lower Private Equity Ownership: PE ownership was roughly 24% when ZETA came public in 2021. It’s now roughly half that. Lower selling pressure from PE firms coupled with growing interest/awareness from other investors should help the stock.

The Business Model

Zeta is both an advertising and marketing technology company, which pits it against large players in both pools. Products (CDP, ESP, DSP) and Agile Intelligence modules can be purchased together, or independently. Like most software companies, Zeta tries to get new customers up and running with a few solutions and then sell them more over time. Often, new solutions are initially offered at a steep discount (or for free). Net revenue retention rate has been hovering around 110%, showing that clients are growing their spend with Zeta.

The Bottom Line

Over the last four years, Zeta has grown revenue and adjusted EBITDA margins at an average annual rate above 20% and 40%, respectively.

Revenue grew by 23% to $729 million in 2023 while EPS of -$1.20 improved by 40%. In 2024 revenue is expected to grow by 20% to $875 million while EPS loss should improve by over 80%, to -$0.23.

Management is guiding for 20% revenue growth this year. The first year of profitability should come in 2025 when Zeta’s revenue should easily top $1 billion.

Next Monday Zeta will report Q1 results, which are typically slower than Q2 through Q4. The hurdle is revenue of $187.2 million (+18.8%) and EPS of -$0.25 (34% improvement).

The company has established a cadence of “beat and raise” reporting. Based on recent commentary from management, that pattern should continue.

Risk

• Zeta is a small player going up against large, established vendors.
• Violating data privacy rules and regulations could lead to reputational risk.
• Zeta’s data collection properties may not continue to be effective.
• ZETA stock has been a decent performer lately, and Q1 earnings on Monday represent a near-term catalyst that could be positive, or negative.

Competition

Adobe (ADBE), Salesforce.com (CRM), Oracle (ORCL), SAP (SAP), LiveRamp (RAMP), Trade Desk (TTD), Twilio (TWLO), Epsilon, Blueshift, BlueConic.

The Stock

Trading Volume: ZETA trades an average of 1.5 million shares a day. With a share price between 12 and 13, that’s roughly $18.5 million worth of volume daily. We aren’t likely to have much of an impact on this stock.

Historical Price: ZETA came public in April 2021 at 10. It wasn’t a great time to go public and shares had a volatile couple of years, first selling off to below 6, then rallying to over 13 before falling back below 5 by mid-2022. Things have been less volatile over the last twelve months. ZETA spent most of last summer and fall bouncing around in the 7.3 to 9.8 range. The stock began to challenge the 10 price level in January and since then a nice pattern of higher lows and higher highs has been established. In the last week, ZETA has challenged the 13 level for the first time since early 2022. A little dip here should be completely expected, and if the stock’s trading pattern holds, (the Q1 report Monday will likely determine this) we should see new highs before long.

Valuation: ZETA trades with an EV/Estimated 2024 Revenue multiple of 2.3. That’s not expensive given the expected growth rate and expected near-term profits. That multiple could move up to 4.0 given what we expect now, or higher if things pan out better than expected.

Short-Term Buy Range: Expect to buy the first half of your ZETA position in the 12 to 13 range over the next two days. We’ll see how the market digests yesterday’s FOMC meeting and this coming Monday’s Q1 earnings report before we think about buying the second half. BUY HALF

The Next Event: Confirmed Q1 2024 earnings date is Monday, May 2.

Current Recommendations

Please email me at tyler@cabotwealth.com with any questions or comments about any of our stocks, or anything else on your mind.

Glossary

Buy means accumulate shares at or around the current price.
Hold means just that; hold what you have. Don’t buy, or sell, shares.
Sell means the original reasons for buying the stock no longer apply, and I recommend exiting the position.
Sell a Half means it’s time to take partial profits. Sell half (or whatever portion feels right to you) to lock in a gain, and hold on to the rest until another ratings change is issued.

Disclosure: Tyler Laundon owns shares in one or more of the stocks mentioned. He will only buy shares after he has shared his recommendation with Cabot Small-Cap Confidential members and will follow his rating guidelines.

The next Cabot Small-Cap Confidential issue is scheduled for

June 6, 2024.

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