Investors in ad-tech specialist Rocket Fuel have been on quite a thrilling ride. Drawn by the buzz of the company’s automated platform, which uses artificial intelligence and big data analytics to purchase ad spots on digital exchanges, traders last September rushed into the IPO: the stock was priced at $29 and opened at $59.95.

Rocket Fuel shares by late January were at a new post-IPO high of $71.89, a gain of 147 percent from the offering price. Today, they change hands at around $14.50.

So what caused Rocket Fuel to run out of gas?

Rage Against the Machine

On the surface, the company’s growth story appears to be intact, with 2013 revenue up 126 percent to $240.6 million. In the second quarter, revenue rose 70 percent to $92.6 million, with international revenue gaining 146 percent to $14.7 million, representing 16 percent of total revenue, up from 11 percent in the year-ago period.

Importantly, revenue from new channels (mobile, social and video) in the latest quarter jumped 317 percent to $40.8 million, representing 44 percent of total revenue, up from 39 percent in the first quarter. The supply of video ad space on the platform tripled. Revenue from the mobile category alone made up 31 percent of total revenue versus 26 percent in the first quarter and 19 percent in the fourth quarter of last year.

The company now has 1,445 active customers (up from 784 a year ago), including 60 of the Fortune 100 and 84 of the Ad Age 100. Customers seem to be satisfied, as the revenue retention rate for the trailing 12 months was 149 percent (although down from 161 percent in the first quarter). Rocket Fuel has 14 customers that have spent more than $5 million over their lifetime with the company, with one at more than $10 million.

But Rocket Fuel’s very success is rankling some on the ad agency side, with firms starting to push back against machines doing their jobs. Rocket Fuel shares earlier this month fell 31 percent in one session after the company lowered its revenue-growth outlook for the year, saying ad commitments for future campaigns had come in below its internal forecasts.

Quality Concerns

The reason for the guide-down: Agencies are deciding to maintain control of more of their clients’ ad dollars. That's mainly because they want to keep the business for themselves, but also based on concerns about ad-inventory quality on exchanges. The IAB estimates that between 25 percent and 50 percent of digital spending this year could be wasted on ads that humans will never see. As it turns out, the ad-buying robots might be too smart in that they’re a threat to the agencies, yet not smart enough.

Rocket Fuel maintains it's exploring ways to work more closely with ad agencies, potentially cutting a greater number of these firms in on its deals. It’s also focusing on making brands more aware of the positive return on investment (ROI) over time when it comes to automated buying.

Rocket Fuel’s argument: Agencies should have their brand customers’ best interests at heart and therefore want to use the latest and most promising technology.

A Potential Downside

The problem with increased agency licensing arrangements is they will hurt Rocket Fuel’s gross margin, which in the second quarter managed to hold steady at 49.4 percent on a sequential basis. Rocket Fuel CFO Peter Bardwick recently acknowledged the company needs to close larger deals at volume discounts, trading off margin for growth.

On the positive front, there could be some gross-margin clawback over time thanks to sales and marketing expense reductions associated with larger agency deals.

When it comes to ad quality and placement, Rocket Fuel management says its system aggressively filters out ads by looking for bots, discarding roughly a third of all potential impressions. The company is continuing to invest in anti-bot technology and is working with more forensics partners to weed out bad ad buys.

Another concern for investors: Rocket Fuel, concurrent with the release of second quarter results, announced the relatively big acquisition of [x+1], a privately held provider of a cloud-based data management platform used in conjunction with digital marketing efforts.

Made up of $100 million in cash and 5.4 million shares of Rocket Fuel, the deal at the time of the announcement gave [x+1] an enterprise value of $230 million. Rocket Fuel’s recent market cap is just $520 million. In February, Oracle paid an estimated $350 million to $400 million for BlueKai, a direct competitor of [x+1].

Defending the Purchase

Rocket Fuel management on the second quarter earnings conference call defended the acquisition (expected to close in the early part of the fourth quarter), saying that in this case it was faster and more efficient to buy than build, estimating that the purchase right off the bat expands its total addressable market by 40 percent.

The idea is marketers using [x+1] technology will be able to organize all of their consumer-interaction data in one place and then use the data to better craft personalized digital marketing campaigns, hopefully via Rocket Fuel’s platform.

Investors negatively interpreted the acquisition as a way for Rocket Fuel to help prop up revenue at a time when the company’s core business is experiencing some deceleration. But even at [x+1], top-line growth is headed in the wrong direction: The company’s revenue last year expanded 35 percent to $72 million, while Rocket Fuel management estimates (conservatively, it says) 2014 growth at 20 percent to 25 percent. And gross margin at [x+1] is around 25 percent, well below that of Rocket Fuel.

On a standalone basis, Rocket Fuel for 2014 now forecasts revenue of $385 million to $405 million, still-impressive growth of 64 percent at the midpoint, but below previous guidance of $420 million to $435 million. Including a partial contribution from [x+1], revenue this year is expected to come in at $403 million to $427 million; Wall Street is a little suspect though: the recent 2014 consensus revenue estimate of $398.1 million is below the combined guidance range.

Down But Not Out

Rocket Fuel shouldn’t be counted out, as it operates in a fast-growing segment and has a talented management team that has been expanding the customer base and increasing the company’s presence in the important mobile segment and across international markets.

As it stands now, the 2015 consensus revenue estimate indicates solid growth of 49 percent. But is this growth rate actually achievable or will there be more guidance reductions in the future?

These days, Rocket Fuel’s story involves more crosscurrents and moving parts, increasing the risk level. Concerns about ad quality could linger and sizable acquisitions by smaller companies often never get fully integrated as planned. If management is able to make this work, the stock can bounce back. But it’s going to take a few more quarters for this play out, causing many big investors to hold off on deciding that the risk/reward balance favors getting back on this ride.

Title image by Maciej Bledowski/ Shutterstock.