Should We Buy the 14% Drop? A Reverse DCF Valuation

AppLovin (NASDAQ: APP) dropped 14% yesterday following a Bloomberg report that the SEC is investigating the company's data-collection practices. For long-term investors who've watched this stock surge over 700% in 2024 and another 80% year-to-date in 2025, the question isn't whether to panic—it's whether this correction presents a buying opportunity.

The Short Answer: This appears to be noise, not signal. The SEC probe is examining allegations already aired by short sellers in Q1 2025. The company's fundamentals remain exceptional. However, our reverse DCF analysis suggests the stock is still pricing in heroic assumptions about future growth.

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Understanding the SEC Probe: Old News in New Packaging

What's Actually Happening

The SEC's cyber and emerging technologies enforcement unit is investigating whether AppLovin violated platform partners' service agreements to enhance its targeted advertising capabilities. Specifically, the probe examines allegations that the company improperly collected or used data in ways that contradicted agreements with partners like Meta, Amazon, and Google.

Why This Feels Like Déjà Vu

Here's what makes this investigation less concerning than the market reaction suggests:

February 26, 2025: Fuzzy Panda Research and Culper Research released short reports alleging AppLovin was:

• "Stealing data from Meta" for e-commerce expansion

• Using unauthorized "fingerprinting" to track users across apps

• Violating Google and Apple app store policies

• Operating a "House of Cards" built on fraudulent advertising tactics

The stock dropped 12% that day.

March 27, 2025: Muddy Waters Research doubled down with another short report, alleging the company's ad tactics "systematically" violate app stores' terms of service. The stock plummeted 20%—its largest single-day drop on record.

CEO's Response: Adam Foroughi published a blog post defending the company's technology, calling the short sellers' claims "false and misleading." He emphasized that AppLovin had built "sophisticated AI models" and that claims could be "easily disproven by AI models like Grok in minutes."

The Investigation: According to Bloomberg, the SEC probe was triggered by a whistleblower complaint filed this year and the short-seller reports. Notably, neither the company nor its officials have been accused of wrongdoing.

What This Means for Long-Term Investors

The Good News:

1. Already Known Issues: The allegations have been public for 7+ months. If there were smoking guns, they'd likely have surfaced by now.

2. No Charges Filed: The SEC is investigating, not charging. Many investigations conclude without enforcement action.

3. Business Performance Unaffected: AppLovin continues to deliver exceptional results, suggesting customers don't share the concerns.

4. Platform Relationships Intact: Meta, Google, and Apple haven't deplatformed AppLovin—a critical sign that the alleged violations may not be as severe as portrayed.

The Risk:

• SEC enforcement could result in fines, mandated changes to the advertising engine, or restricted data access

• Platform relationships could deteriorate if violations are proven

• The company's competitive moat—its AI-powered targeting—could be partially dismantled

The Probability: Based on the pattern of short-seller allegations followed by continued strong business performance, this appears to be a regulatory formality rather than an existential threat. However, the risk isn't zero.

The Business: Why AppLovin is a Compounding Machine

Before diving into valuation, let's appreciate what makes this company special.

The AXON 2.0 Advantage

AppLovin's AXON advertising platform uses AI to optimize ad targeting with remarkable precision. The results speak for themselves:

2024 Full Year Performance:

• Revenue: $4.71B (+43% YoY)

• Adjusted EBITDA: $2.72B (+81% YoY)

• Adjusted EBITDA Margin: 58%

• Free Cash Flow: $2.1B

First Half 2025 Performance:

• Revenue: $2.42B (+74% YoY)

• Net Income: $1.53B (+164% YoY)

• Q2 Adjusted EBITDA Margin: 81%

The Flywheel Effect

AppLovin's business model benefits from powerful network effects:

1. More data → Better AI → Better targeting

2. Better targeting → Higher ROI for advertisers → More ad spend

3. More ad spend → More data → The cycle repeats

This isn't just theory. The company achieved 89% incremental flow-through from revenue to adjusted EBITDA in Q4 2024—meaning for every additional dollar of revenue, 89 cents flowed to EBITDA. That's exceptional operating leverage.

Capital Allocation Excellence

Management used $2.1B in free cash flow in 2024 to repurchase $2.1B worth of stock at a weighted average price of $83 per share. With the stock now trading at $587, that decision created tremendous value. The share count has declined from 340M to 339M shares—modest reduction, but at a stock price that has since increased 7x.

Strategic Focus: The Apps Divestiture

In February 2025, AppLovin announced plans to divest its Apps gaming business for $900M ($500M cash plus equity stake). This strategic move allows the company to focus entirely on its high-margin advertising platform, where the real value creation occurs.

Reverse DCF Analysis: What's Priced In?

Now for the critical question: At $587 per share (after the 14% correction), what does the market expect from AppLovin?

Methodology

A reverse DCF works backwards from the current stock price to determine what future cash flows are implied by today's valuation. This reveals what the market is pricing in—and whether those expectations are reasonable.

Key Assumptions:

• Current Stock Price: $587

• Shares Outstanding: 339M

• Market Cap: $199B

• Current Free Cash Flow (LTM): ~$3.2B (based on H1 2025 run rate)

• Discount Rate (WACC): 10%

• Terminal Growth Rate: 3%

What the Market is Pricing In

Scenario 1: Current Market Price ($587)

For APP to be fairly valued at $587, the company needs to achieve approximately:

• Year 1-5 FCF Growth: 35% CAGR

• Year 6-10 FCF Growth: 20% CAGR

• Terminal Growth: 3% thereafter

This implies reaching approximately $24B in free cash flow by Year 10.

To put this in context:

• Current run-rate FCF: ~$3.2B

• Implied Year 5 FCF: ~$14B

• Implied Year 10 FCF: ~$24B

This requires AppLovin to grow free cash flow 7.5x over the next decade while maintaining exceptional margins.

Alternative Scenarios

Scenario 2: More Conservative Growth

If we assume:

• Year 1-5 FCF Growth: 25% CAGR

• Year 6-10 FCF Growth: 15% CAGR

• Terminal Growth: 3%

Fair Value: ~$380 per share (35% below current price after the correction)

Scenario 3: Bull Case

If we assume:

• Year 1-5 FCF Growth: 40% CAGR

• Year 6-10 FCF Growth: 25% CAGR

• Terminal Growth: 3%

Fair Value: ~$750 per share (28% above current price)

Reverse DCF Summary Table

What Does This Mean for Long-Term Investors?

The Valuation Challenge

Even after a 14% correction, AppLovin trades at:

• 62x forward P/E (based on 2025 estimates)

• ~62x Free Cash Flow (based on LTM)

• 6.2% Free Cash Flow Yield

The company needs to compound free cash flow at 30%+ annually for the next 5 years just to justify current prices—and that's after the correction.

The Quality Premium

However, AppLovin isn't just expensive—it's expensive for a reason:

1. Exceptional Margins: 81% adjusted EBITDA margins in Q2 2025

2. Operating Leverage: The business scales beautifully

3. Proven Execution: Management has delivered on aggressive growth targets

4. Massive TAM: Global digital advertising market is $700B+ and growing

5. AI Moat: The AXON platform gets stronger with more data

Three Investing Approaches

For Aggressive Growth Investors:

• Action: Buy the dip

• Thesis: AppLovin is in the early innings of disrupting mobile advertising and expanding into e-commerce

• Risk: Valuation requires near-perfect execution

• Position Size: 2-5% of portfolio maximum

For Quality-Focused Long-Term Investors:

• Action: Wait for a better entry point

• Thesis: This is an exceptional business, but current prices require heroic assumptions

• Target Entry: $400-$450 range (30-35% below current levels)

• Strategy: Use any regulatory overhang or broader market weakness to build a position

For Value-Conscious Compounders:

• Action: Pass for now, add to watchlist

• Thesis: Even quality companies can become overvalued; opportunity cost is real

• Target Entry: $350 or below (40%+ correction from current levels)

• Alternative: Deploy capital in equally compelling businesses trading at more reasonable multiples

The SEC Probe: A Framework for Thinking About It

Base Case (70% Probability)

The investigation concludes with either no action or minor modifications to data practices. Stock experiences short-term volatility but ultimately continues higher as the business compounds.

Investment Action: This dip is noise. For those with conviction, add to positions.

Middle Case (25% Probability)

SEC finds violations and levies fines of $100-500M plus mandates changes to data collection. This temporarily impacts growth but doesn't break the business model.

Investment Action: Stock could drop another 10-20%, providing a better entry point. Wait and watch.

Bear Case (5% Probability)

Major violations are uncovered, platform partnerships are severed, and the core AXON technology is fundamentally compromised.

Investment Action: Stay away. The investment thesis is broken.

The Bottom Line: Should You Buy This Correction?

For Most Long-Term Investors: Not Yet

The 14% correction doesn't make AppLovin cheap—it makes it less expensive. At 62x free cash flow, you're still paying a substantial premium for growth that needs to materialize flawlessly.

The SEC probe appears to be investigating allegations that have been public for months. If this were truly an existential threat, we'd likely see:

• Platform partners distancing themselves

• Customer defections

• Management exodus

• Deteriorating business metrics

None of these are happening. The business continues to execute brilliantly.

However, execution risk at current prices is significant. The market is pricing in 35% free cash flow growth for the next 5 years, followed by 20% growth for years 6-10. Any stumble—regulatory, competitive, or macro—could lead to significant multiple compression.

The Smart Play for Long-Term Investors

1. If you own it: Hold if it's a reasonable position size (under 5% of portfolio). The business is exceptional.

2. If you're building a position: Be patient. Use further weakness to scale in. Target entry points:

   • First tranche: $450-$500 (if we get there)

   • Second tranche: $350-$400 (if regulatory concerns escalate)

   • Final tranche: $250-$300 (if markets broadly correct)

3. If you're watching from the sidelines: Add to your watchlist. This is a business you want to own at the right price. A further 20-30% correction would make the risk/reward much more attractive.

The Opportunity

Here's the contrarian take: If the SEC probe is truly about allegations from Q1 that have been thoroughly investigated, and AppLovin emerges clean, the resolution could actually be a positive catalyst. The stock would have an overhang removed, short sellers would cover, and the business would continue compounding.

In that scenario, buying during the fear could prove prescient.

Final Thought

The best long-term investments are exceptional businesses purchased at reasonable prices. AppLovin is undeniably an exceptional business. After yesterday's correction, the price is more reasonable—but not yet reasonable enough for most investors.

The prudent approach? Watch, wait, and be ready to pounce if we get a better entry point. Quality companies don't stay cheap for long, but they do occasionally go on sale.

This could be the beginning of that sale. Or it could be a brief dip before new highs. Either way, long-term investors should be thinking in years, not days.

Key Metrics to Monitor

Watch these indicators to gauge if the investment thesis remains intact:

Business Fundamentals:

• Quarterly revenue growth (target: 30%+ YoY)

• Adjusted EBITDA margins (target: 75%+ for advertising segment)

• Free cash flow generation

• Customer acquisition and retention in e-commerce vertical

Regulatory Developments:

• Any official SEC statements or findings

• Changes to platform relationships (Meta, Google, Apple)

• Management commentary on regulatory matters

Valuation:

• Free cash flow multiple (currently ~62x)

• EV/Sales (currently ~41x based on forward revenue)

• Price targets from quality sell-side analysts

Competitive Position:

• Market share trends in mobile advertising

• Customer win/loss ratios

• Feedback from advertisers on AXON performance

For long-term investors seeking quality companies that compound over decades, patience is often rewarded. AppLovin may well be one of those companies—but the price you pay matters. Today's correction makes it more interesting, but not yet compelling for most portfolios.

The business quality is undeniable. The valuation requires conviction. I own APP shares both in my personal portfolio nd in our public ETF, which you can access in real-time in our community.

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