In Royce Small-Cap Opportunity Fund, we first identified an attractive opportunity to invest in advertising technology, or Ad Tech, companies in early 2023, when the entire group’s valuation was depressed due to a cyclical decline in advertising spend.

Ad Tech companies are generally technology intermediaries in areas such as 1.) Demand Side Platforms (“DSP”) that help ad buyers programmatically buy the right mix of digital media with good returns on their ad spend; 2.) Supply Side Platforms (“SSP”) that help digital media owners maximize revenues for their ad inventory; 3.) verification platforms which ensure that a digital ad was viewable and displayed in a brand-safe context; 4.) data collaboration platforms that enable buyers and sellers of ads to share their first party data for better online consumer targeting; 5.) Retail Media platforms that enable retailers (e.g., Best Buy) to reach potential customers during moments of high online purchase intent and induce them to transact with them over their competitors (e.g., bestbuy.com versus amazon.com); and 6.) ad servers that transmit the creative content from advertisers to viewers.

Although the cyclical downturn is what originally drew us to the Ad Tech landscape, we found several structural growth drivers associated with the overarching shift in ad spend from analog media, such as cable TV and print, to digital media, such as Connected TV (“CTV”), social media, and search, that was being overlooked and, in our view, undervalued by investors owing to the bearish sentiment in the market at the time.

• A shift in spending from linear TV to CTV, which was still in its early stages
• The emergence of Retail Media as a channel for advertisers to target potential customers on the internet
• The growing need for data collaboration between ad buyers and sellers due to the impending deprecation of Google’s third-party cookies—which would eliminate an important tool used by advertisers to target potential customers.

We also identified the need for consolidation within this extremely fragmented industry to enable higher mid-cycle returns on capital for the ad tech sector as a whole. Our consolidation view was informed by our observation that advertisers were increasingly focused on driving higher returns on ad spend and were seeking to consolidate their ad spend onto the tech platforms that generated the most tangible value. To try to best capture this opportunity, we invested in five companies that were the scale players in their respective sub-sectors. We further believe that they were the technological leaders in their sub-sectors and would not only benefit from a cyclical recovery in ad spend but can also be the natural winners if the industry consolidates as we suspect it will.

Magnite is the largest SSP that would be an outsized beneficiary of the shift from linear TV to CTV. Similarly, Criteo offers the largest Retail Media platform and was trading at an attractively cheap valuation because of overblown fears around the existential risk to Criteo’s legacy re-targeting business if and when Google discontinued third party cookies. When we first invested in Criteo, the company was receiving little to no credit for building the world’s largest Retail Media platform with several marquee customers.

LiveRamp Holdings is a data collaboration platform that would see accelerated adoption if third-party cookies go away. Viant Technology is a DSP that was growing strongly by helping smaller advertisers shift their spend to digital channels—a part of the market that industry leader The Trade Desk was not interested in going after. Innovid is a digital ad server that has a technologically superior product that competes effectively with Google’s ad server.

Since our initial investments in these five stocks in early 2023, ad spend has been recovering, and CTV has gone from less than 20% of TV ad spend to roughly 33%, which Magnite has capitalized on successfully. Retail Media has not only grown as a preferred advertising channel for advertisers and retailers but has also started gaining share from other digital media such as search and social media, as evidenced by Criteo’s strong growth. LiveRamp has returned to growth and improved profitability, driven by increased adoption of its data collaboration platform and related services, while Viant has staked a claim as a credible second player after The Trade Desk and has started migrating up market from serving very small businesses to winning larger businesses as clients. In addition, Innovid was acquired for its technology by a strategic acquirer at a hefty premium as several sub-scale ad tech players have exited the market, thereby improving the market position of the companies we currently hold.

While our investments in these companies have proven to be profitable so far, we believe that their growth potential has not yet been fully realized. CTV is still only one third of TV ad spend, although it accounts for 50% of the time spent viewing. We therefore think it is rational to expect that close to 100% of TV ad dollars will follow audiences to CTV over time. We have also seen that Retail Media offers a very high return on ad spend due its innate ability to target a customer when his/her purchase intent is at its highest and due to its ability to measure the efficacy of marketing to said customer based on whether he/she made a purchase in response to an ad. We expect more dollars to shift to Retail Media from other forms of advertising as the channel matures.

While the largest advertisers responded preemptively to the possible deprecation of cookies, smaller industry players adopted a wait and see approach. Google’s proposed new strategy of allowing its users to decide whether they want cookies or not has added a new layer of uncertainty—which is driving increased adoption of LiveRamp Holdings’ data collaboration offerings, resulting in a long runway of growth for the company. Google’s proposed new strategy also means that Criteo will be able to retain more of its high margin legacy retargeting business, to the extent that users still allow cookies to reside on their browsers. Against this favorable backdrop, we think valuations for all five stocks remain attractive. Consequently, we continue to hold positions in each of them.

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