Machine Zone: IPO or What?

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Machine Zone [MZ] is a Palo Alto-based, mobile gaming start-up with a massively popular Top 3 app store hit called “Game of War: Fire Age.” [GoW]

MZ describes Game of War: Fire Age as

“.. a real-time mobile massively-multiplayer online game and parallel chat-speak translation application that translates over 40 languages for its players in real-time, connecting game players around the globe at the same time in a single virtual universe.”

What makes this building simulation and war strategy game so innovative is the real-time play among the massive number of players (100,000+) online around the globe at the same time.

The other innovative feature is its messaging system featuring a 40+ language real-time translator, including a crowd-sourced library of game jargon. It’s like real-time SnapChat run through Google Translate finely tuned by an incentivized, crowd-sourced library of gamer jargon.

From a NYT review of GoW,

“The game’s most impressive feature is an instantaneous translation of text-based online chat. If someone writes “MDR” in French (for “mort de rire,” or “dying of laughter”), an English-speaking player sees it as “LOL.””

The game is also very social and hard to put down. Once a player joins a GoW “alliance” – similar to a “clan” in Clash of Clans — there is considerable peer pressure to continue playing for sake of the alliance. MZ’s early estimates were that players averaged 2 hours a day 7 days a week playing the game.

We estimate that the GoW’s current revenue run rate is $831M. The company is very profitable, with  a reported head-count of only 150.

Compare this with Zynga who manages a score of mobile and browser games none of which have cracked the Top 10, a headcount of 2,000 (but falling), and a similar revenue run rate (but falling).

Yet, MZ’s prospects for a 2014 IPO are dim because it is viewed as a “one hit wonder”.

This is in contrast to Kabam, the other US mobile gaming start-up most likely to do an IPO in the next year.  Kabam’s interviews with press are peppered with the quotes about how diversified they are with 3 hit games with lifetime revenue over $100M and three more potential hits on the way based on the blockbuster movies The Hunger Games, Lord of the Rings, and Mad Max.

There is also investor wariness of mobile gaming IPOs due to the post-IPO stock performances of Zynga (ZNGA) and King Digital (KING). However, as we write this, King has climbed back finally to its opening price three months after its IPO, so the bad feelings about King have diminished.

MZ is not a “one hit wonder”. We believe CEO Gabe Leydon’s claim that MZ has developed a “game engine” that can be “re-skinned” to create other genres of games with the same underlying play and communications innovations.

MZ, along with with Kabam and the mobile division of Electronic Arts [EA], are in the running  to become the preeminent US-based mobile gaming company – “The Pixar of Mobile Gaming”.

MZ just needs diversification that will come with a second hit, preferably in a different genre, that boosts its revenue run rate over $1,500M.

It would be a shame for MZ to sell out now as it has enough cash for working capital and new development teams. Their total venture capital to date is reportedly only $16M so there is no urgency on the part of VC’s to cash out.

This is in contrast to Kabam with over $125M in VC money and higher cash burn rate from a reported headcount now of 800.  No wonder it is Kabam, and not MZ, who is always talking to the press about IPO plans and the damage caused by the Zynga and King IPO debacle.

But, MZ could use additional investment in 2014 to pay a dividend or to buy some of the shares of existing employees as shareholders. This would take the edge off the IPO wait.

King did something similar by paying out $504M in dividends over the two quarters before it went public. However, the taxation of dividend income might be quite a bit less in the UK than in the US.

What follows is an estimate of MZ’s current revenue run rate and valuation. We are doing this to quantify the outstanding financial performance of this company and to place it along side the elite companies in the mobile gaming world.

We use the same methodology to value MZ as we have employed in previous papers to value King, Zynga, and the start-up Kabam. We have used it also to make prescient buy recommendations of two undervalued Japanese mobile game companies – Mixi [TYO:2121] and Klab [TYO:3656].

There are two pieces of data used in our analysis: (1) app store download and revenue ranking charts provided by data analytics company App Annie; (2) a mapping of App Annie revenue rankings to current revenue run rates.

Launched in July 2013 on iOS Apple store, GoW took only one month to become a Top 20 revenue ranking game on the App Annie charts. By September 2013, it cracked the Top 10 and remained there for the rest of 2013. In 2014, GoW has remained a Top 3 game on the App Annie charts.

Launched 9 months later on Google Play in May 2014, GoW shot up quickly to #6 on the revenue ranking charts and has remained there since.

Game of War   Fire Age   all time

(Source: App Annie)

Game of War   Fire Age   Jan 1 ios

(Source: App Annie)

Game of War   Fire Age   google play since may

(Source: Appie Annie)

GoW seems destined to join the elite “Billionaire Game Club” along with Supercell’s Clash of Clans, King’s Candy Crush Saga and GungHo’s Puzzle and Dragons. The first two games have remained a #1 or #2 revenue ranking game in the US now for a 1 ½ years and counting. However, Candy Crush’s downloads have been in decline for a year even though its revenue rank remains at #2.

The next step in valuing MZ is a mapping of app store revenue rank to revenue dollar run rate. GoW is a free to play game with in-app purchases. Downloads and purchases are primarily made via iOS Apple store and Google Play.

VC firm Andreessen-Horowitz’s mobile guru, Benedict Evans, has estimated that the current global ratio of monthly active users (MAU) of Android to Apple iOS is 1,000M to 470M or 2:1.

The reverse is the case for app store purchases. Evans has estimated that the trailing 12 month Apple iOS to Google Play app store revenue, which excludes presumably Apple’s and Google’s 30% cut, is $10B to $5B, or 2:1

According to App Annie, 75% of app store revenue is mobile games or $11.3B. So, roughly the trailing 12 month revenue for mobile game app store revenue is $7.5B for iOS and $3.8B for Android.

Combine this with MAU numbers results in an average iOS to Android yearly spend per MAU of $15.96 to $3.80 or 4:1.

However, this is an average of “whales” and “zeroes” who spend nothing. According to a Swrve report, “zeroes” make up 98.5% of mobile game users. Disaggregating the weighted average of 1.5% “whales” and 98.5% “zeroes”, yields an average of $1,333 mobile game spend per MAU on iOS for those who spend at all.

Obviously, the Swvre number is based on all users not MAUs. Assuming MAUs are only 10% of Swrve’s number still yields an iOS average of $133 yearly mobile game spend per MAU who spends at all. Wow!

Getting back to valuation of MZ, we use the macro numbers above to scale up a “power function” relation developed by Think Gaming, Inc. between revenue and revenue rank for iOS Apple Store in the US.

We then test the relationship for reasonableness by comparing points on the curve with game-specific revenue disclosures by King for its three Top 15 hits.

Below is our latest effort at mapping Global app store revenue rank to estimated 2014 revenue run rate in $ Millions.

mapping update

Spreadsheet update

When we plot the log of both numbers, the relation is not linear, but kinked up at #3. Hence, it is not a pure power function. Mobile game revenue is very concentrated at the top and the long tail is very thin after game ranked 10,000.

This is in contrast to the original “long tail” work using bookstore data which came to the conclusion that excluding the book “long tail” from a store – books with revenue rank >10,000 — meant excluding 30%+ of sales.

For mobile games, it might turn out that excluding the mobile game “long tail” – mobile games with revenue rank >10,000 — might mean excluding only 5% of sales. By removing these games, mostly IP rip-offs, you lose only 5% of revenue but improve app discovery. Take note of that Apple and Google.

Because of a “power function” relation between revenue and revenue rank, a GoW at #3 is not really knocking on the door of the “Billionaire Game Club” but is still hundreds of millions of dollars away from #2.

The one well known example of a power function is the half-life relation. Another less well known example is the Zipf function named after a 1930’s linguist who mapped out word count in literature as a function of rank.

I like to characterize the top three global ranking games – Clash of Clans, Puzzle and Dragons, and Candy Crush Saga –as the “the-of-and” of mobile game revenue ranking. BTW, the last phrase is meta-Zipfian.

The final step in valuing MZ is to pick an appropriate price/sales (P/S) ratio. Below is a spreadsheet of the pre-IPO and current P/S ratio of King and Zynga.

trailing PS

Given the disappointing post-IPO stock performance of these two companies, we believe that investors in mobile gaming companies would never again pay the pre-IPO P/S ratio of King at 3.76 or Zynga at 6.82. We believe that the current P/S ratio of King today at 2.46 is an appropriate number to use in valuing a US mobile game company today.

Valuing MZ at a P/S ratio of 2.46 and a run rate of $831M produces a current valuation of $2.04B.

A year from now with the launch of a second hit and a run rate of $1.5B, we would up the P/S ratio to 3.0 and value MZ at $4.5B. An investment now in MZ has the potential to double in a year.

We estimate that MZ must be sitting on between $200M and $300M in cash, given its run rate and relatively small headcount, and the fact that mobile gaming companies have little cash tied up in receivables and inventory.

And MZ’s venture capitalists have no immediate need to recover its investments as total venture capital in MZ is reportedly around $16M with Y Combinator as seed investor, Anthos and Baseline in the Series A, and Menlo in the Series B.

The only need for MZ to seek outside investment in the neighborhood of, say $200M, would be to take the edge off the IPO wait of employees/shareholders by paying them a dividend or by buying some of their shares.

The best option would be to finance this through a Series C venture capital round.

A less preferred source would be a minority stake from a strategic partner like Softbank or TenCent who could open doors in the Asian market. But, Softbank is the majority owner now of both GungHo Online and Softcell, both of whom compete with MZ for gamers. A majority investment by Softcell could raise all sorts of conflict of interests.

The least preferred would be an outright acquisition by another publicly held gaming company.  Zynga is drowning since the tepid response to “FarmVille 2: Country Escape”. CEO Don Mattrick has admitted that Supercell’s similar  farming game Hay Day has “eaten our lunch”.

There is a single intriguing buy-out candidate in Electronic Arts [EA], with its mobile division on the rise. It now has “The Simpson: Tapped Out” at #7 and  “The Sims: Free Play” at #18. GoW would double that division’s revenue and boost mobile’s share of EA revenue to between 20% and 30%.

There could be some really interesting synergies between these two companies with MZ’s strength is massively global real-time play and communication and EA’s yet untapped ability to “put petal to the metal” .

That is, EA should be the early leader in porting graphics intensive games via its Frostbite 3D engine to the soon to be released iOS 8 featuring a new graphics API called Metal that taps directly into “metal”  – the 64-bit A7 CPU — achieving a reportedly 10-fold speed increase in 3D graphics rendering over the previous iOS graphics API called OpenGL.

 

Markit IPO: Buy the Moat and Be Better than Buffett

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Summary:

• Markit’s IPO is set for Wednesday, June 18th. It is a buy. Its core product are prices and indices that facilitate the buying and selling of credit default swaps.
• Its biggest threat is its own Board of Directors – a bank cartel which wears multiple hats as supplier, customer, dominant shareholder, and underwriter.
• We use a game theoretic approach to analyze Markit’s prospects, suggesting that this moat’s moat is a doomsday machine defense.
• Even at our estimated trailing P/E ratio of 30, it is a buy.
• In doing so, you will be able to brag that you outdid Buffett because you are buying the moat instead of a company with a moat.

“In business, I look for economic castles protected by unbreachable moats.” – Warren Buffett

Markit’s (MRKT) core product are prices that facilitate the buying and selling of credit default swaps (CDS) – insurance on complex heterogeneous debt called asset-backed securities (ABS) and collateralized debt obligations (CDO).

They also have created a series of branded indices, representing particular classes of ABSs and CDOs, much like the S&P index, that are traded. This includes the well- known brands Markit CDX™, iTraxx®, and iBoxx®

Their business is impenetrable, with both definitions of this adjective applicable: (1) impossible to enter; (2) impossible to understand.

So, don’t spend too much time trying to figure out what Markit does or poring over their financials, which I will summarize below. Just buy it. (Swoosh)

For those financial wonks that want a deeper dive, I recommend a paper by Robert E. Litan called “Derivatives Dealers Club” published by The Brookings Institute. Needless to say of a Brookings-sponsored publication, the conclusions are anti-laissez faire.

By adding Markit to your portfolio, you will be able to tell friends you outdid Warren Buffett’s mantra of buying companies with moats, because you just bought the moat.

Indeed you will be buying the mother of all moats, as Markit protects a cartel of twelve of the most powerful banks in the world who make lucrative commissions brokering over-the-counter [OTC] two party trades with an estimated yearly value of $57 TRILLION DOLLARS in 2011.

Markit acts as a moat for the bank cartel by refusing to sell its data to entities who wish to start up a CDS exchange as an alternative to the banks’ less transparent, more lucrative OTC way of doing business. The reason Markit refuses is…guess?

The bank cartel owns a dominant share of Markit’s stock and sits on its Board of Directors.

Another reason to add Markit to your portfolio is that you will be adding a rare buy-and-hold stock that will around three decades from now and still be appreciating.

You can have confidence in a buy-and-hold strategy for Markit that you can’t have for tech stocks with alleged moats as evidenced by the performance of the likes of Intel, Microsoft, Cisco, and Oracle.

In some ways, Markit is similar to bond rating companies. A 30 year buy-and-hold strategy seems reasonable given these founding dates: Standard & Poor’s (1860), Moody’s (1909) and Fitch (1913). CDS will last as long as bonds and so too will the data analytics companies that first rate these financial instruments.

We wish to address now the threats to Markit’s financials. In other words, what is this moat’s moat? We think the primary threat is not the government, or potential competitors, but its own Board of Directors.

As we will summarize below, Markit is profitable with the latest FY2013 GAAP profit margin of 15.5% and an adjusted EBITDA margin of 44.4%  (See F-1 filed with the SEC in conjunction with its IPO).

But, we ask ourselves, given its critical role in the smooth functioning of a $57+ Trillion market, why is Markit not more profitable?

The answer starts with the fact that a dominant share of Markit’s stock is owned by twelve of the largest banks in the world who both broker CDS trades and supply Markit with ongoing trade data.

Markit’s financial engineers then slice and dice this data creating synthetic prices and indices, whose value is in reducing the price discovery costs of those who buy and sell CDS. Markit then licenses its products back to banks and other financial institutions including hedge funds.

The banks wear an unprecedented 4 different hats when relating to Markit: Supplier / Customer / Stockholder and Board Member / Underwriter.

From Markit’s F-1 on reducing the banks’ rights to sit on its Board:

“Reduced engagement from these financial institution customers after this offering due to their loss of a right to designate a member of our Board of Directors, or the reduction in the level of their equity ownership in us in connection with or following the completion of this offering, may cause them to reduce or discontinue their use of our products and services, their desire to work with us on new product developments or their willingness to supply data and information services to us..”

From Markit’s F-1 on customers as shareholders as underwriters:

“We have historically earned a substantial portion of our revenue from and have worked on new product and service offerings with financial institution customers that are also our shareholders. For the years ended December 31, 2011, 2012 and 2013, 43.8%, 44.7% and 42.6% of our total revenue, respectively, was generated by payments from financial institutions or their affiliates that are also our shareholders, some of which are underwriters of this offering.”

There are 3 groups who are a threat to Markit: (1) its own Board of Directors; (2) government antitrust regulators; and (3) data analytics competitors. We have no real insight into Markit’s strategy for (3).

But, Markit’s defense for threat (1) and (2) comes straight out of game-theory whose foundation is based on the work of John von Neumann and John F. Nash (A Beautiful Mind).

The defense is known as “the doomsday machine” defense, a form of Nash equilibrium in which neither side, once armed, has any incentive to initiate a conflict or to disarm.

What Markit can do is let potential threats know that if attacked, Markit will trigger a “doomsday machine” with mutual assured destruction [MAD], an acronym first coined by the great John von Neumann and made popular by the movie Dr. Strangelove.

We have become familiar with a particular application of this defense called the “too big to fail” defense that these same banks used to persuade the Federal Reserve Bank to buy its distressed ABSs and CDOs back in 2008.

Markit can turn the tables this time and use this defense against its Board of Directors.
For example, in response to a Board (bank cartel) refusal to approve a large price increase to customers (same bank cartel), Markit CEO could respond by having its systems engineers delay transmission of data, halting multi-billions of dollars of CDS trades.

The same doomsday defense is available both to Markit and its Board should governments try open up CDS trades to any newly formed, more transparent exchange as an alternative to the opaque, more lucrative, OTC trading favored by the banks.

The threat comes as a suggestion that, while imperfect, OTC trading is a known quantity. Moving CDS trading to a transparent exchange might wreak havoc on world financial markets with resulting MAD.

Compared to a game-theoretic approach to Markit’s prospects, a financial analysis of its IPO is downright dull.

Markit is very profitable, but not insanely so given its “mother of all moats” position. Its top line growth has slowed since the crisis of 2008. But, as a believer in the Minsky theory of the inherent instability of capitalism, I am confident that Markit can look forward to a “Minsky moment” every 10 years or so.

Some analysts have said that Markit’s profit levels and margins are in decline. But they are looking at GAAP figures, not EBITDA, which is on the rise.

Markit has been doing a lot of investing lately in businesses outside its core. This has resulted in poor cash flow and substantial amortization that cut GAAP numbers. Markit explicitly states that it does not intend to pay a dividend in the foreseeable future.

There is also the question of its incorporation in Bermuda, but the implications of this are beyond our expertise.

The IPO will not yield any cash for Markit as it consists totally of stock of existing shareholders. If successful, there is likely to be follow-on offerings of new stock because Markit needs cash to continue diversification through more acquisitions.

It could also be part of its doomsday machine defense as by expanding its shareholder base, it can point to more innocent bystanders that will be destroyed if attacked.

For example, it has reported that the Canadian Pension Plan Investment Board plans to invest up to $450M in this IPO. Markit could use more civic-minded stockholders like this as they could rally them in defense should anti-trust regulators encroach.

The IPO is slated for Wednesday, June 18, 2014 and is expected to be priced between $23 and $25 a share. At the mid-point price of $24, we have estimated that Markit’s trailing price-earnings ratio will be 30. The IPO price is not cheap.

But, how often do you get an opportunity to one-up Buffett by buying a moat instead of a company with a moat?

The following graphs based on its F-1 summarize Markit’s financials for the last five years.

Revenue and Profit

 

Margins

 

EPS Trends

Kabam: Mobile Gaming Company IPOs after King and Zynga

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Kabam is a San Francisco-based mobile gaming company with three hit games each of which has reportedly grossed over $100 M since launching.  In a recent interview with the Wall Street Journal, Kabam’s CEO Kevin Chou disclosed that

“Kabam has raised $125 million from investors including Canaan Partners, Redpoint           Ventures, Intel Capital, Pinnacle Ventures, Google Ventures and SK Telelcom                     Ventures. The company increased revenue 100% to more than $360 million in 2013           and expects to generate between $550 and $650 million in 2014.”

Chou said that it “is still gunning for an IPO despite King Digital Entertainment’s (KING) disappointing debut”.

A similar sentiment might have been elicited a year ago from King Digital’s CEO to the effect that King was gunning for an IPO despite Zynga’s (ZNGA) disappointing debut in 2011.

The US mobile gaming industry cannot afford another disappointing IPO.

I am a fan of the US mobile gaming industry. I think the long term prospects are bright. But, the industry has a problem. The problem is NOT that the financials are hit-driven and spiky. The problem is a bad track record of pricing and timing of IPOs.

Right now Kabam and Palo Alto-based Machine Zone are two mobile gaming start-ups with hit games and yearly revenue run rates exceeding $500M. Both are very profitable and deserve to go public.

Like King, these two very successful start-ups are sitting on plenty of cash — estimated at roughly $200 M to $300 M each — generated from these hits. The need for an IPO is not for working capital or even for acquisitions.  The need is to provide liquidity to existing investors and employees with stock options.

There are important lessons from the disappointing IPOs of King and Zynga to be considered ahead of the next IPO:

(1) Don’t price (buy) a mobile gaming IPO at much more than 2 time trailing price-sale ratio.

(2) There is a small window to go public (buy into) successfully. It is between month 4  and month 7 during which a hit game is consistently among Top 10 on the iOS Apple store US revenue ranking charts.

The purpose of this article is to present data and charts supporting these two lessons. First, we present a comparison of IPO and current trailing price-sales (P/S) ratios of King and Zynga.

Trailing PS

(Source King F-1 and Zynga S-1)

King went public at the pinnacle of success of its “Billion Dollar Club” game Candy Crush Saga. At the time of its IPO in early March 2014, its Q/Q revenue was flat for 2 quarters.

Zynga went public on the cusp of the transition from PC browser-based games accessed from Facebook to native smartphone games downloaded from app stores. Its stock has dropped 66% since the IPO, caused by the multiplicative effect of declining revenue and a declining P/S ratio.

Based on these two disappointing post-IPO performances, I believe that the next mobile game company IPO should be priced with a reasonable assurance of stock appreciation post-IPO. It should be a win-win, not a win-lose transaction between existing and new investors.

The current trailing P/S ratio of King is 2.23. I think that 2.23 is a win-win standard for pricing the next mobile gaming IPO.

The Wall Street Journal reported that in July 2013, Kabam employees sold $38.5M worth of stock in a private transaction that implied a $700M valuation for the company. According to the Wall Street interview cited above, Kabam estimates that its 2014 revenue will be between $550M am $650M. (We peg it at the low end due to the declining revenue trend in its latest hit game The Hobbit: Kingdoms of Middle-earth.)

Priced reasonably at King’s current P/S ratio of 2.23 and a current yearly revenue run rate of $550M, Kabam’s IPO value would be $1.23B, up nicely 75% from the previous valuation 2013.

A more reasonable pricing of an IPO is not enough. Timing of the IPO matters. The rising revenue trajectory of a hit game is not likely to last beyond 12 months. And while great gaming companies like Kabam, Machine Zone, King, and Supercell have demonstrated an ability to launch multiple hits, the launch dates are often a year or more apart. Mobile gaming companies have just one small window a year to go public.

We review first the timing of the King IPO in light of the disclosed financials in it pre-IPO SEC filing summarized below:

screen shot 2014-02-18 at 6.59.53 am

(Source King F-1)

People were horrified when they first saw this graphic depicting flat Q/Q revenue just before the IPO in March 2014. There was a sense of impending doom. And sure enough the stock dropped 16% the day of the IPO.

In hindsight, the time for King to do their IPO would have been in 2Q2013 (June-August) giving management and IPO investors a full 6 months of rising financials.

Before I evaluate the best time for a Kabam IPO, we need to present the results of an one of my earlier papers where I estimated the relation between a specific game’s revenue ranking on app store charts and its dollar revenue. I use revenue ranking charts for iOS Apple Store in the US which are available for free from App Annie.

Occasionally, publicly held companies like King (for the Saga series) and Glu Mobile (for Deer Hunter 2014) have reported quarterly revenues for specific games. This allows an exact correlation with the App Annie revenue rank at the time. Below is a depiction of the Zipf-like power function relation between app store revenue and revenue rank for 4Q2013 with 4 actual data points:

Power Function

Looking ahead to Kabam’s prospective IPO, we believe that it would be best for them to do it when they have a Top 10 hit on the rise. This would give them at least one game with a rising quarterly run rate of $50M or a yearly run rate of $200M.

Kabam seemed to have an amazing window to go public between January and April 2013. It had not one, but two Top 10 hits: Kingdoms of Camelot: Battle for the North at the pinnacle of its success and a rising star in The Hobbit: Kingdoms of Middle-earth. The Hobbit was just cracking the Top 10 at the end of the window in April 2012.

Kabam’s run’s rate in 1Q2013 was at least $100M. And there was some significant revenue upside post-IPO. Of course, no one knew for sure during 1Q2013 that the rest of 2013 would be so good for Kabam. But, a mobile game that cracks the Top 10 and stays there for 4 month is a sign of some “addiction” and I think that Kabam executives and board members knew that 2013 would be year of rising financials.

Trailing revenue by Kabam’s own account was around $180M for 2012. Valuation of the hypothetical IPO at our recommended 2.23 P/S would have only been only $400M.

Remember, the above the reference to an actual private sale in July 2013 valuing the company at $700M. Assuming a trailing revenue run rate at the average of 2012 and 2013 = (360+180)/2 = $270 M,  the implied trailing P/S at the time of this private transaction was only 2.59 — greater than my suggested standard of 2.23, but less than King’s later IPO value of 3.76.

Maybe, it was premature for Kabam to go public in 1Q2013 with such a good year ahead of itself in 2013.

But, those venture capitalists, employees with stock options, and IPO investors would be holding stock in a company with rising revenue and profit throughout 2013. Trailing revenue at the end of 2013 would have been $360 M. With an increasing post-IPO P/S of, say 3, Kabam would have been valued at $1.08 B by the end of 2013.

Kabam management and board would have been celebrating New Year’s 2014 with a bunch of happy stockholders and employees as the stock would have appreciated 250% post-IPO. And importantly, stockholders would have the liquidity to reduce their holding  if they had a bad feeling about King IPO later in 2014.

Alas, Kabam missed a great window of opportunity to go public between January and April of 2013.

It is easy to second-guess management and the board.  The big negative at the time was the performance of ZNGA’s stock post-IPO.  The stock went from an IPO price of $10.00 in November 2011 to a high of $14.50 in March 2012 only to fall 86% during 2012 to a low of $2.09 in November 2012.  Ouch!

Maybe as a consolation for missing a golden (bears) opportunity, Kabam’s 4 cofounders – all UC-Berkeley alumni, paid the University $18M in December, 2013 for stenciling a big KABAM on the gridiron at Memorial Stadium.

Furthermore, as the charts show below, Kingdoms of Camelot has continued to fade and now is only a Top 50 game. The Hobbit has remained amazingly strong, but shows just enough fade this past month to suggest that the IPO window has closed for Kabam in 2014.

Not to worry, Kabam still has plenty of cash and cache. Its management can see the Kabam name on the Cal football field as they watch their beloved Bears get crushed once again. So what, they are living proof that the industry is not plagued by one-hit wonders.

If Kabam’s existing investors are impatient for an IPO, Kabam has plenty of cash from its hit games to pay millions in dividends.   King did this did this before its IPO, paying out $500 million in dividends in the style of a private-equity dividend recap.

And, it was last week that the Wall Street Journal  reported  that Kabam has struck a deal with Lions Gate to develop mobile games based on the hit movie “Hunger Games”.

It is likely that the next big Kabam hit will be launched in conjunction with the 3rd installment of the Hunger Games scheduled for release in November 2014.  Given their track record for developing hits, I expect a Kabam IPO in 1Q2015.

Kingdoms of Camelot: 2013

Kingdoms of Camelot 2013 Battle for the North ®   Rank History   App Annie

The Hobbit: 2013

The Hobbit  Kingdoms of Middle 2013earth   Rank History   App Annie

 Kingdoms of Camelot: January – May 2014

Kingdoms of Camelot 2013 Battle for the North ®   Rank History   App Annie

 The Hobbit: January – January – May 2014

The Hobbit  Kingdoms of Middle 2013earth   Rank History   App Annie

KLab: An Undervalued Japanese Mobile Gaming Company

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KLab (3656:TYO) is a Japanese-based gaming company that had been slow to switch from developing feature phone and browser-based games to developing native freemium app games for smartphones.

But, that all changed in April, 2013 when KLab released an innovative role-playing game called “Love Live! School Idol Festival”. The game’s name and theme was licensed from ASCII Media Works who has developed a multimedia franchise — music CDs, anime music videos, TV shows, and manga adaptions. According to a company press release

“School Idol Festival follows the story of the nine members of the μ’s (pronounced Muse) as they train to become the best school idols. In addition to the main story, the game features challenges in which players tap along to the rhythm of popular μ’s songs. Players will encounter and collect the different members of μ’s throughout the game and will be able to build a custom group composed of nine members. To progress in the story, players participate in musical challenges that feature popular songs by the members of μ’s. Players can also level up amassed members and unlock individual members’ sidestory.”

Love Live! the game is innovative in that it makes streaming music a central feature of game play.

According to charts developed by analytics company App Annie, the game has ranked around #15 in app store revenue for both iOS Apple and the Google Play in Japan. While not a megahit like GungHo Online’s (3765:TYO) (GUNGF) Puzzle and Dragons at #1 or #2, or Colopl’s (3668:TYO) Quiz RPG at #5, Love Live! has distinguished itself by relatively long and steady run at #15.

Klab from april 2013(Source: App Annie)

google revenue from beginning(Source: App Annie)

A more detailed look reveals an uptick in ranking to around #10 in the last month.

Klab ios from April revenue(Source: App Annie)

The purpose of this article is to present the case that KLab’s stock has not fully capitalized the future stream of revenue  from Love Live! The stock is a BUY now even with the 17% run-up on May 26, 2014 after KLab released its 1Q2014 earnings, which was only a confirmation of a guidance issued two weeks earlier.

The stock jumped about 20% when the game was first released on April 15, 2013 for iOS Apple store in Japan and it quickly shot up to #15 in revenue ranking.

But the real run-up started two months later going from 525 JPY a share on June 14, 2013 and peaking at 1,297 JPY on July 9, 2013 for 261% gain.

KLab Inc  3656.T  2 yrs

(Source:Reuters)

The cause is hard to pin down. It could have been the brief run-up in downloads  right after Love Live! was released for Google Play store beginning June 13, 2013.

google download june july 2013

(Source: App Annie)
It could have been a Reuters report that Microsoft had signed a deal with KLab to convert some of its franchise console games to native apps for smartphones.

But the downloads on Google Play quickly faded and the reported partnership with Microsoft was never confirmed. In any case, the stock plummeted to 854 JPY by August 2013 and continued its decline for the rest of 2013 even though the game’s revenue ranking remained steady at #15.

KLab’s stock continued its downward trend in the first four month of 2014. As reported by indie navie, KLab announced a lay-off of 22% of Japan-based employees and 7% of employees based in other countries when they reported full year’s losses on February 14, 2014..

But, based on continuing success of Love Live!, KLab announced three months later on May 13, 2014 an upward revision of its 1Q2014 (ending March 2014) revenue guidance by 10% from 4,050 M JPY to 4,425 M JPY and an upward revision in its operating profit guidance from a loss of 90 M JPY to a gain of 96 M JPY.

The stock responded the next day going from 568 JPY to 624 JPY a share for a 9.9% gain, but dropped back down the next two days.

It was the actual release of 1Q2014 financials before the open on May 26, 2014 that propelled the stock 17% that day. Surprisingly, the actual results were not that much different than the guidance revision issued just two weeks earlier.

KLab Inc  3656.T  5 days

(Source: Reuters)

Even with this 17% run-up, we believe that KLab’s stock has not fully capitalized the future returns from Love Live! based on a comparison of the KLab’s current forward price sales ratio (P/S) with that of GungHo Online.
Below is a calculation of the trailing and forward P/S of KLab and GungHo Online. We have used GungHo Online’s estimated forward P/S of 3.31 as a benchmark for a mobile gaming company with a hit game with long running, steady revenue rank.

We estimate KLab’s forward P/S ratio currently to be 1.29, far below GungHo Online’s 3.31. At a minimum, we think that a forward ratio of 2.50 is justified by the long running, steady revenue ranking of Love Live!.

KLab is a BUY now for a potential near term price appreciation to 1,315 JPY per share for a 93% short term gain.

forward japan

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Mixi: A Rare Undervalued Mobile Gaming Stock

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Mixi (2121:TYO) had been the Japan’s leading social network site until Facebook started to take over.

In January 2011, Facebook had 2 Million monthly average users. By September 2012, it had surpassed Mixi with 15 Million monthly users and Facebook never looked back.

As a result, Mixi’s stock has been in a 5 year tailspin falling 86% from 8,540 JPY in December 2009 to a low of 1,190 JPY in November 2013.

But, out of nowhere, this social network company developed internally a Monster (literally) mobile game hit called  Monster Strike (MS). And the stock started to move from November 19th at 1,190 JPY a share to close at 9,060 JPY a share on December 10th for a 661% gain.

Reuters chart

(Source:Reuters)

But, before the stock opened on December 11th, Reuters reported that Goldman Sachs cut its rating on Mixi’s stock to “sell” from “neutral”.

Since the Goldman downgrade, the stock has been rocky. There was a 19% move on February 13th when the company revised upward by 44% its FYE2014 (ending March) revenue guidance from 8,000 M JPY to 11,500 M JPY. But that did not last. The stock today sits at 5,550 JPY a share.

I believe that Mixi’s stock is undervalued because it does not fully reflect the FYE2015 revenue of Monster Strike.

Mixi will be reporting its FYE2014 (March ending) on May 15th. It will also give its first guidance for FY2015 revenue. I have derived my own estimate of FYE2015 revenue which fully takes into account the revenue implications of MS now a megahit at #3 on the app store charts.

Implied by my estimate of FYE2015 revenue is a forward price/sales (P/S) ratio is 2.51. At the very least, Mixi’s forward P/S ratio should be equivalent to GungHo (3765:TYO) which I have estimated at 3.50. This translates into a stock price for Mixi of 7,662 – a 39% gain over its current price of 5,550 .

Mixi is a buy now BEFORE its earnings and guidance report on May 15th, 2014.

I present below how I arrived at a forward P/S ratio for Mixi of 2.51 and why Mixi justifies at the very least forward P/S equal to GungHo’s 3.50.

Underlying my forward P/S estimate for Mixi is an estimate of the relation between app store revenue ranking and revenue. Data points on this graph are estimated game revenue associated with revenue rankings of the following 3 publicly held Japanese mobile game companies and their hit games:

(1) Mixi – Monster Strike (MS)
(2) GungHo Online – Puzzle and Dragons (P&D)
(3) Colopl (3668:TYO) – Quiz RPG:The World of Mystic Wiz

There has been publicly available data provided by analytics companies like App Annie that track daily app store downloads and in-app purchases of mobile gaming companies. (Disclosure: I have not received any remuneration from App Annie.)

With a free account, you cannot download any data. But, you can take screenshots of graphs of daily rankings (1-1000) of mobile games by downloads and revenue where revenue is the sum of download revenue + in-app purchases. These graphs can be filtered by app store – iOS Apple Store, Google Play, and Amazon – and by country.

App store data does not include revenue from advertising. But, mobile games created by professional studios tend to be free-to-play (ftp) with monetization via in-app purchases of addicted players. This is the case for all three games analyzed here.

In the 2013-2014 period examined, all three games derived almost all of their revenue from Japan. In Japan, app store revenue is roughly divided equally between iOS Apple and Google Play stores. We only show revenue ranking graphs from iOS Apple Store – Japan to save space because views of Google Play revenue rankings were about the same as iOS.

Mixi’s Monster Strike was released on September 27, 2013. Its early upward trajectory on App Annie revenue ranking charts was inauspicious, rising to a rank of # 93 on November 19th when investors first began buying Mixi’s stock in volume with the expectation that MS would continue to rise up the charts. (see first chart below).

An excellent blog post of how Monster Strike has saved Mixi has been writen by Dr Serkan Toto. Indie navi has also covered the Mixi story as extensively as any English language site.

Unlike P&D and Quiz RPG, MS was slow to become a megahit. MS started 2014 at #25 and took a run at megahit status in January, but then backed down in February. But, on March 1, 2014, a new release (2.2.0) coupled with 3 TV spots caused the game’s revenue rank to shoot up to #3 and MS has stayed there solidly since. (See second chart below).

Monster strike from release                                                   (Source: App Annie)

MS Jan - May                                                (Source: App Annie)

It is important to note that MS’s megahit status at #3 contributed only to one month of its FYE2014 financials. It has contributed only two months to what FY2015 might look like. This is in contrast to the understanding of what P&D has, or will mean, to GungHo’s financials and to what Quiz RPG has, or will mean, to Colopl’s financials.

GungHo’s Puzzle and Dragons raced up to #1 within days of release on February 20th 2012 and has remained #1 or #2 on the Japanese charts now for 24 months and counting. It joined Western chart-topping megahit  Candy Crush Saga as the only mobile games in 2013 qualifying for the “Billion Dollar Club”.

Puzzle and Dragon From Release                                                   (Source App Annie)

The rise of Colopl’s hit game Quiz RPG was slower that P&D, but faster than MS. It was released on April 22nd, 2013 and 5 months later in September, it cracked the Top 5. It remained a Top 5 game another 5 months, but now has slipped to a Top 10 game in March and April 2014.

colopl app annie                                                      (Source: App Annie)

colopl jan thru may 6(Source: App Annie)

Now that we have established each game’s revenue ranking and the duration of each game’s megahit status, the next step in our analysis is to make the connection between quarterly revenue ranking and revenue.

The easiest is GungHo’s Puzzle & Dragons. It has been an unwavering #1 for the Jan-March 2014 period  and GungHo has reported that in April 2014, P&D generated 11,526 M JPY ($113 M USD) or 46,104 M JPY for a quarter.  For our graph, we use 45,000 M JPY as the January-March quarterly revenue associated with this #1 app store revenue ranking game.

Next is Colopl’s Quiz RPG. Its revenue ranking has wavered in Jan-Mar 2014. It was a solid #3 in January, but has slipped in February and March to between #5 and #10. We give it a quarterly average of #5. Colopl’s mobile gaming revenue is more diversified, benefiting from another Top 10 hit called Professional Baseball – PRIDE. Roughly, Quiz RPG contributed 65% to its latest quarter revenue of 12,359 M JPY. Thus, a #5 app store revenue ranking in Japan is associated roughly with quarterly revenue of 9,000 M JPY.

Finally, based on where Monster Strike now stands in comparison to P&D and Quiz RPG, I present an estimate of Monster Strike’s contribution to Mixi’s 1Q2015 (Apr-June) revenue before it reports FYE2015 guidance next week.

I think that the relation between Japan app store revenue rank and revenue is not just a long-tail relation, but a “double long-tail” relation. There are wide differences in revenue between games with revenue rank #1 and #3.

MS as a solid #3 for a full quarter should contribute more that Colopl’s Quiz RPG estimated 9,000 M JPY and less than GungHo’s #1 P&D at 45,000 M JPY. I peg MS’ next quarter revenue at 11,250 M JPY — it closer to Quiz RPG as the data suggest “half-life” relation and we modeled it that way: #1=45,000 M JPY; #2=22,500 M JPY; #3=11,250 M JPY..

Graph between Revenue Ranking and Revenue

The final two steps are to present a comparison of the trailing and foreward P/S rations for Mixi, Colopl, and GungHo.

Trailing PS

 (Source: Reuters)

I think that 4 times last quarter’s sales is justified for GungHo by the fact there seem to be no near term upside potential. P&D has been #1 for 24 months and counting and can generate no additional revenue from its core market in Japan. GungHo has no other games in the Top 10.

P&D’s only upside is a successful introduction in China, but iOS Store and Google Play generate app revenue nowhere near the revenue generated by app stores in Japan and the United States.

Estimate of Forward PS

Of the three, Colopl is a most prolific internal developer and the most aggressive dealmaker with announced tie-ins with Glu Mobile and TenCent. Quiz RPG had been a solid #3 for five months until February 2014.

It has another Top 10 game in Professional Baseball – PRIDE. I think that the combination of a slipping Quiz RPG and a rising PRIDE will keep Colopl’s revenue flat for the next 3 quarters so using 4 times last quarter’s revenue as an estimate of forward P/S again seems justified.

Mixi’s revenue over the next year has the most upside potential of the 3 companies. MS has only been at #3 for two months and it looks solid. I estimated earlier a full quarter at #3 translated into approximately 11,250 M JPY. Couple that with Mixi’s existing jobs listing business, and I estimate next quarter’s (Apr-June) QoQ revenue increase of 140%.

Even if MS begins to fade in the second half, I have estimated Mixi’s full FYE15 revenue at 36,425 M JPY, a YoY increase of 200%. This implies a forward P/S ratio of 2.51, below that of GungHo’s 3.34. At the very least, Mixi’s P/S should be on par with GungHo.

That would imply a stock price value of 7,662 JPY, a 39% appreciation over its current (5-4-14) price of 5,550 JPY.

Mixi is a buy now BEFORE its earnings and guidance report a week from now.