Microcap stocks can be risky investments, especially with the recent selloff in small cap stocks across the market. However, we feel there is a large margin of safety in DRCT warrants after their discrete Friday IPO due to short-term mispricing of the underlying warrants as they go through price discovery. The stock has yet to find support off its IPO pricing, but we will slowly be accumulating warrants in chunks around current levels.
For more information on the adtech sector (our new favorite growth sector in the stock market), refer to our latest post.
What is Direct Digital Holdings?
DRCT is an adtech company that provides buy and sell-side programmatic advertising capabilities to small and medium businesses in the U.S... this means they provide both DSP and SSP tools for their customers.
Some view this as a conflict of interest, but TRMR has been successfully navigating this conflict and positing massive growth. Additionally, DRCT is catering to much smaller companies than the larger, more specialized platforms
In September 2021, its sell side system served over 39,000 clients, with a focus on minority media investment and actively works to support underserved audiences, including African Americans, Latin Americans, Asian Americans and LGBTQ+ audiences
In the past, stocks that cater to these markets have been susceptible to large spikes in price when media coverage picks it up
Are the Warrants Mispriced?
We love when a company IPOs with warrants in their cap stack, as it provides an opportunity for us to get lots of upside exposure with smaller positions by taking on the minimal time risk
You can run a Black-Scholes model on warrants, just as you would an option, since they operate much the same way:
Here is some "back of the envelope" math to illustrate how mispriced these warrants currently are:
Current Stock Price (2/15/22): $2.54
Warrant strike price: $5.50
Implied Volatility: 95% *not yet available so we will be conservative and make it relatively high but not as high as most options would be based on the recent price action
Days to Expiration (2/15/22): 1,814 days
Interest Rate: 3% *estimate - not very important for this calc
This option calculator can also be helpful
Implied Price of Warrants: $1.62
Current Price of Warrants: $0.55
This means there is ~195% upside in a technical correction of the warrant price to properly reflect the efficient price of the option to purchase.. this does not include any increases in the stock price
This can happen in lightly covered micro cap IPOs for a short period of time, as the volume is low and price discovery can be drawn out and swing wildly
For many, this is reason enough to open a position, but we feel there is lots of upside in the stock itself, even amidst this steep selloff
Company Upside Overview
Founded in 2018, this company is still a baby, but in a rapidly growing industry that we want exposure to
Back in November of 2021, before the sharp market selloff, DRCT had plans to go public and raise over $40 million. However, in January they decided to cut the size in nearly half and price the IPO in the $7-$9/ unit range where a unit will consist of one share plus one warrant to purchase one share at the IPO price
If you look at a chart of any adtech company, you will see that this IPO was doomed, as the sector was trading even further down after hitting highs in February of 2021
By IPO day on Feb. 11, DRCT offered 2.8M units at $5.50 per unit, raising gross proceeds of around $15.4M.... this was well below their initial pricing expectations, due to poor market conditions
What's more, the stock and warrants then proceeded to trade down rapidly throughout the coming trading days, and now sits around $2.54/share and $0.55/warrant as of 2/15/22
There is almost no coverage of this stock and it seems to be misunderstood, so we think there is ample opportunity for stock price appreciation from here
A few operating metric highlights:
They are recently profitable!!.. Free cash flow during the twelve months ended September 30, 2021, was $3.6 million
Revenue grew 330% last year
Gross margin continues to grow rapidly and has now reached 53.1%
Check out this article from Donovan Jones re: the IPO for DRCT.. it has some good charts illustrating the financials YoY
This chart illustrates how cheap DRCT was valued even at an IPO price of $8, and DRCT is now down over 60% from here. TTD is not the best comp for DRCT, as it is a best in breed DSP and controls much of the market, but it still shows the magnitude of the discount one gets when buying DRCT this early.
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