Premium: AppLovin back on track

Q2 was AppLovin’s first real stumble after a long run of substantial beats, raising concerns about management’s execution and credibility after sequential revenue growth slowed to an incredibly weak +4.4%. The muted growth and expense timing also impacted FCF, and the associated share repurchases.

I thought it was very positive in how mgmt immediately accepted the blame and had already implemented the solution. The CEO noted the shortfall came from the lack of meaningful model improvements during the (already seasonally weakest) quarter, then pivoted to how they were already back on track with a major model upgrade arriving just after quarter-end.

CEO in Q2 remarks: "We've always managed this business with the goal of outperforming our own expectations, and this quarter, we fell short of that standard. What matters is that we know what happened, and it's already been addressed. Q3 is off to a strong start, and the business is back on the trajectory we expect.

... This quarter came down to timing. Our pace of meaningful model improvement was lighter than normal during the quarter, and the next step up in model performance landed just after quarter end. Importantly, nothing we saw suggested weakening advertiser demand or a change in the competitive environment. In fact, MAX publisher earnings grew double digits quarter-over-quarter, and our share of publisher waterfalls remained consistent. With those improvements now live and heading into what is a seasonally stronger part of the year, the business is re-accelerating."

I held steady but wanted to see mgmt restore its historical beat cadence, push seq growth back above 11%, keep YoY growth in the low-50% range, and see a rebound in int'l growth and FCF margins – all of which would prove that Q2 was a hiccup rather than a structural issue. AppLovin turned all of these around in Q3. The market cheered, with shares rising +30% the day after earnings and is now up over +77% in the past week.

• The next generation of Axon models is here, but only partially rolled out. Look for continued performance improvement into Q4 and even Q1. Management says the new model architecture provides better paths for optimization and delivers its biggest gains where advertiser data is sparse.
• They had a strong rebound in growth over the weakness seen in Q2. AppLovin got back to beating its guide, and int'l sequential growth snapped back.
• FY26 revenue growth should remain over 50%, and guidance for Q4 was likely conservative with the continued Axon 3.0 rollout and consumer holiday season.
• Core gaming reaccelerated to +50%. Consumer ad spend grew triple digits YoY and double digits sequentially.
• Free cash flow & buybacks recovered. AppLovin repurchased $1.38B of stock and has $3.6B authorized from here.
• From here, Axon 3.0 should help newer self-service advertisers prove returns sooner, as it gives better performance with less historical campaign data.  
• Their generative AI tools aren't released yet. This will help drastically improve platform adoption of new advertisers in self-service, plus enable existing advertisers to improve ad performance through creative expansion.
• Connected TV is back in focus for FY27 and is now seeing pilot campaigns. Axon 3.0 looks like it will help improve ad performance here too.
• I also take a competitive look at Unity, which has been heavily reaccelerating over the past few quarters after drastically improving its ad platform and AI models (Vector). Unity’s Grow Segment is growing fast, but it depends heavily on AppLovin's MAX.