The year's top tech stock isn't Zoom — it's not even a cloud company

Published Wed, Dec 16 20203:40 PM EST

(This story is for CNBC PRO subscribers only.) Only one U.S. tech stock has outperformed Zoom this year, and there's a good chance you've never heard of it. Shares of Digital Turbine , a 22-year-old mobile phone software provider based in Austin, Texas, have climbed 573% in 2020, topping Zoom's 487% gain, as of Tuesday's close. The company's market cap started the year at a little over $600 million. It's now $4.3 billion. Here's how Digital Turbine's business works. The company's software gets pre-loaded onto Android phones sold by carriers like AT & T and Verizon . Developers such as game makers, digital music companies and even restaurants pay Digital Turbine for slots on the phone so their apps are automatically available to the consumer upon activation. Digital Turbine gets paid an average of about $3 per phone sold and remits $1.80, or 60% of the transaction, to the carrier. For the fiscal year that ends in March, Digital Turbine's revenue is projected to double to $276.6 million. Bulls are betting that the company is just scratching the surface of its potential given that its software has only reached about 15% of Android phones globally and is rapidly being deployed by more distribution partners around the world. Digital Turbine is playing into the 5G upgrade cycle, gaining traction as consumers buy new devices to take advantage of faster network speeds. Anthony Stoss, an analyst at Craig-Hallum Capital Group, likens Digital Turbine to " Roku for smartphones." He says the technology is important to mobile phone companies because it gives them a way to make money off content on their devices, whether it's Starbucks promoting a loyalty program or a news publication driving traffic to its site. "The carriers make a lot of money — they're probably making more money on the apps than they're making on the profit margin on the handset that they're selling to the end consumer," said Stoss, who recommends buying the stock. "There's a long long road ahead for Digital Turbine for how big this can become." Once a sleepy business in a niche corner of the mobile market, Digital Turbine's revenue jumped 93% in the three months ending in June. That was followed by 116% growth in the September quarter, with analysts expecting another increase above 100% for the December period. Digital Turbine's wild rally is even more remarkable considering the stock lost about half its value at the start of the year. From the beginning of January to mid-March, the shares plunged from $7.31 to $3.73 as the spreading coronavirus led to concerns that consumers wouldn't go to stores to buy new phones. As analysts at Canaccord Genuity wrote in a report on March 30, "The U.S. is dealing with several state lockdowns and therefore its retail channel for smartphone sales is being hit." No Covid slowdown But Digital Turbine and its 300 employees have powered through the crisis, largely through international expansion. While in the past the company counted on Verizon and AT & T for the bulk of its revenue, it's partnered recently with large carriers outside the U.S. like Telefonica and Telecom Italia . The company also boosted sales through Samsung — increasing its reach to over 50 countries, up from 12 before this year — as well as Nokia and Xiaomi . "The international application revenue opportunity is still just getting going, though newer partnerships with high profile customers seem to be contributing in a meaningful way already," wrote Austin Moldow, an analyst at Canaccord Genuity, in an Oct. 29 note, just after Digital Turbine's latest earnings report . "We think the company continues to go after a very large opportunity that seems to keep growing with further diversification and expansion among new products, partners, and geographies." One such new product came through the March acquisition of Mobile Posse , whose technology helps phone operators deliver news, weather and sports, all segments that are ripe for advertising. For now that relationship is only with T-Mobile , but the company plans to bring the technology to its existing customer base. Amid all the investor excitement, Moldow and the other analysts covering the stock haven't been able to keep up with the gains. Moldow recommends buying the stock and raised his target price in October to $35 from $24. Since then the shares have surged another 60% to $48.02, soaring past his 12-month target. Among the six analysts tracked by FactSet, the highest price target is $47 from Oppenheimer, even though all but one have buy ratings on the stock. Investing at these levels requires a strong stomach. On six separate occasions in the back half of the year, the stock has dropped 8% or more in a single session, including a 10% decline on Oct. 30, after better-than-expected quarterly results. Seven times over that stretch it's notched double-digit gains. "It's been very volatile on the upside as well as the downside," said Gregg O'Keefe, executive vice president of Boston-based Congress Asset Management, which oversees more than $14 billion and is Digital Turbine's 13th-biggest institutional investor. "If they stub their toe, the stock is going to take a hit." Shareholders also have to get their arms around the growth story starting in the back half of next year, when comps get much tougher. Revenue growth in the June quarter is expected to dip into the mid-20s and then into the teens in two periods after that. O'Keefe helps manage Congress's $213 million small cap growth fund , which counts Digital Turbine as its top holding at over 5% of the fund as of September. He said his firm made the purchase in the second quarter at under $10 a share, after the company proved it wasn't experiencing a Covid slowdown. What O'Keefe's team was seeing was Digital Turbine's growth opportunities playing out in a big way with foreign carriers. And as consumers have become reliant on their phones for everything from food ordering to watching movies, Digital Turbine is getting more opportunities to make additional money per device. Still, O'Keefe admits that it's rare to see these kinds of returns from an investment. The stock has quintupled in the half year that he's owned it. "Clearly this is one of the strongest, quickest growth names that we've had," said O'Keefe. "Given the growth rate and if they continue to experience quarters like they have the last couple, we're comfortable with it." Not a straight path Digital Turbine has been through a number of iterations since it was created in 1998 as eB2B Commerce. It changed its name to Mediavest in 2005 and then through a series of mergers and brand changes became Mandalay Digital two years later. Peter Guber , the longtime entertainment executive and co-owner of the Golden State Warriors and Los Angeles Dodgers, was a principal shareholder and chairman. In 2015, Mandalay Digital changed its name to Digital Turbine, moved its headquarters from Los Angeles to Austin and started trading under the ticker symbol "APPS." Bill Stone, who had the Digital Turbine unit inside Mandalay Digital, took over as CEO of the company and has held that position since. Guber is no longer involved. Unlike so many fast growing software companies in Silicon Valley, Digital Turbine is focused on profitable expansion. While sales and marketing and administrative costs almost doubled in the latest quarter, about inline with revenue expansion, product development expenses only increased 54%. That helped Digital Turbine produce net income of $373,000 in the third quarter, after losing $1.4 million a year earlier. For the fiscal third quarter, Digital Turbine expects adjusted earnings of $17 million to $18 million, up from $5.6 million a year earlier. Brian Bartholomew, Digital Turbine's senior vice president of capital markets and strategy, said the company is generating solid enough earnings that analysts are now valuing it based on profit rather than revenue. "That differentiates us quite a bit," Bartholomew said, referring to many of the high-flying cloud software companies that have seen big pops this year despite hefty losses. Based on estimates for fiscal 2022, Digital Turbine trades at around 50 times forward adjusted earnings. That's too high for analysts at Ladenburg Thalmann, who wrote in October that the company should be valued at about 35 times adjusted 2022 profit. They lowered their target to $31.50 despite what they called "another impressive quarter." Bartholomew said he frequently has conversations with investors on this topic and where future gains get produced after such an outsized rally. Large institutions are buying the story. Fidelity, which owns about 11% of outstanding shares, purchased more than half its stake in the third quarter, according to FactSet, as did D.E. Shaw, which owns 3.3%. "We think it's still very early in this game," Bartholomew said. He added that investors like the competitive environment, or lack thereof, relative to what Roku faces. The TV streaming market is somewhat of a bloodbath. Roku goes head to head with Amazon , Google and, to a lesser extent, Apple , all companies worth over $1 trillion. For Digital Turbine, Apple has its own walled garden, but the Android universe is fairly wide open. "We have first mover advantage," Bartholomew said. "And there are not a lot of players doing this." WATCH: Inseego CEO says T-Mobile deal is a testament to its 5G products

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(This story is for CNBC PRO subscribers only.)

Only one U.S. tech stock has outperformed Zoom this year, and there's a good chance you've never heard of it.

Shares of Digital Turbine, a 22-year-old mobile phone software provider based in Austin, Texas, have climbed 573% in 2020, topping Zoom's 487% gain, as of Tuesday's close. The company's market cap started the year at a little over $600 million. It's now $4.3 billion.

Here's how Digital Turbine's business works. The company's software gets pre-loaded onto Android phones sold by carriers like AT&T and Verizon. Developers such as game makers, digital music companies and even restaurants pay Digital Turbine for slots on the phone so their apps are automatically available to the consumer upon activation. Digital Turbine gets paid an average of about $3 per phone sold and remits $1.80, or 60% of the transaction, to the carrier.