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Kabam: An $800 Million Bid That Is Both Lifeline and Death Knell

Lawrence Abrams No Comments

Kabam (Private:KABAM) is a mobile game startup based in San Francisco that had early success at developing games based on movie IP licensed from major studios like Disney’s Marvel studio, Warner Bros., and Lionsgate.

Beginning in 2014, Kabam started timing new releases to coincide with the releases of mega-hit movie sequels like Fast and Furious and the Hunger Games. The games had no long-term engagement value and “freemium” revenue plummeted within a few months after release. The result was a disastrous string of five failures and one success.

The one success was Marvel: Contest of Champions, a massively multiplayer online (MMO) game developed by Kabam’s Vancouver studio. It is the only game currently producing significant revenue and has a reportedly generated revenue totaling $471 Million since its late 2014 release. In July 2016, we wrote an article for SA saying that ” Kabam would be dead today” had it not been for the Marvel game.

On October 18, 2016, Venturebeat reported that Kabam received an unsolicited offer of $800 Million for its Vancouver studio. A day later the Wall Street Journal reported that Kabam has received multiple bids between $700 Million and $800 Million from Asian and U.S. gaming and media companies.

The bids are an opportunity that Kabam’s Board of Directors cannot refuse and represents both a lifeline and death knell.

The $800 Million bid implies a special value for the Vancouver studio of 100+ developers because our estimated (see derivation below) value of the whole company is at $775 Million, which, in turn, is below the previous $1 Billion valuation attributed to it by Alibaba in August 2014 when it invested $120 Million in the company.

We would be comfortable with the argument, presented in more detail below, that this “cherry-picked” bid implies minimal value for the company’s founders and C-suite executives based in San Francisco and Beijing. We would be comfortable with the argument that the work-in-progress and underlying game platforms coming out of Kabam’s other studios in San Francisco and Beijing, but not Los Angeles, also have minimal value.

In terms of return on investment, we will argue below that the proceeds from $800 Million should be paid out to stockholders rather than reinvested in either the Beijing or San Francisco studios.

In the rest of the paper, we will provide detailed answers to the following questions:

(1) What is current valuation of Kabam as a whole?

(2) Why might it be hard for Kabam to peel off the Vancouver studio?

(3) Who the likely bidder?

(4) What is likely to happen to the rest of the company?

What Is The Current Valuation of Kabam as a Whole?

Compared to other tech companies, valuation and revenue forecasting of mobile game companies is an order of magnitude easier due to the fact that analysts have access to monthly download and revenue rank data provided by such app analytics companies as App Annie. It is equivalent to the 1970s era of pure play movie studios where analysts had access to weekend box office data published by Variety.

We have developed a methodology for valuing and revenue forecasting of pure play mobile game companies based on three pieces of data (1) IOS Apple USA app store game revenue rank published by App Annie; (2) an estimate of a power function relation between annualized global revenue run rate (NYSE:ARR) and IOS Apple USA revenue rank; and (3) “market-derived” valuations of pure play mobile game companies as a multiple their ARR.

We have used this methodology to publish a number of articles on SA:

Kabam: A Mobile Game Unicorn No More?, July 2016

Kabam’s IPO Plans are Kaput, January 2015

Machine Zone: IPO or What?, July 2014

Zynga Is A Dog Without A Top 10 Mobile Hit, June 2014

Klab: An Undervalued Japanese Mobile Gaming Stock, June 2014

Mixi: A Rare Undervalued Mobile Gaming Stock, May 2014

We start with a screenshot of the revenue rank trend for Kabam’s Marvel game since its release in late 2014.

 

 

 

 

 

 

 

 

 

 

It shows 12 month run between mid-2015 and mid-2016 as a steady #5 to #10 revenue rank game. Based on an average #8 ranking, we estimate that this translates into a $350 Million ARR.

However, the graph reveals some slippage since mid-2016, possibly because of the Pokemon phenomenon. Because of the power function relation between revenue rank and revenue, a single digit slip to an average #9 ranking translates into a $250 Million ARR, which we use for our current valuation below.

This recent slippage is the kind of insight available to financial analysts of the mobile game industry that is unmatched elsewhere in the tech business world. Can you imagine having access to similar trend lines for Uber, Airbnb, Palantir, or Pinterest?

In terms of what multiple of ARR to use for valuing Kabam, we offer the latest “market driven” multiple for a pure play mobile game company. This is the June 2016 Tencent acquisition of Softbank’s 84.3% ownership of Supercell for $8.6 Billion. This put the full 100% valuation of Supercell at $10.2 Billion.

Even though Supercell is a private company based in Finland, it is required by law to report annual revenue to the government. In 2015, Supercell reported revenue of $2.326 Billion based largely on its hit games of Clash of Clans, Hay Day and Boom Beach. Now with the addition of #6 Clash Royale, we estimate that Supercell’s current ARR at $2.9 Billion, implying a valuation of 3.3 times ARR.

However, Supercell is a very profitable company with multiple hit games and an employee headcount reportedly less than 200. Kabam is currently a one hit game company with a current total ARR of around $310 Million and current employee headcount of around 689. Supercell’s ARR/employee is $14.5 Million, which is 32 times that of Kabam’s $.45 Million ARR/employee.

Since the mid-2016 slippage in the Marvel game ARR, we believe that Kabam is no longer profitable on a EBITDA basis and now is very likely running cash flow negative. With the IPO window closed, and tellingly, no new VC investments in two years, a $800 Million bid for the Vancouver studio is a lifeline that its Board cannot refuse.

There is no way you can value Kabam at Supercell’s 3.3 times ARR. We believe our often used 2.5 times ARR is appropriate here. We estimate Kabam’s current valuation at $775 Million, just below the reported top bid of $800 Million for the Vancouver studio.

 

 

 

 

 

 

 

 

Why might it be hard for Kabam to peel off the Vancouver studio?

The Vancouver studio started out as Exploding Barrel Games, which Kabam acquired in early 2013. The terms were not disclosed. The studio had 35 developers at the time and it was this core group that developed the gameplay engine for the Marvel game.

The CTO of Exploding Barrel Games was Jeff Howell. He is still with Kabam and has gone on to become Kabam’s first CTO. According to aKabam press release of his appointment in Nov 2, 2015, ” he also will continue to lead the development and implementation of Kabam’s proprietary technology engine “Fuse & Sparx.” (cute…Fuse & Sparx…then Kabam!!) Kabam also has announced that the Vancouver game engine would be deployed company-wide as the platform of all future MMO game development.

The bid obviously has to include CTO Jeff Howell and the game engine. Kabam has announced a planned 1Q17 release of a MMO game based on Transformer IP licensed from Hasbro. This game is currently in development at its Vancouver studio. The question is who gets the Transformer game? If Kabam retains the rights, how can it continue development at one of its other studios without the help of CTO Howell, the Vancouver team, and a copy of the game engine? These decisions will occupy Kabam’s Board as much as the actual bid amount.

Who the likely bidder?

The Wall Street Journal article mentioned that Kabam has multiple bids from Asian and U.S. gaming and media companies. The obvious guesses are the USA console gaming companies Electronic Arts or Activision Blizzard looking for a $1 Billion MMO mobile game to rival those of Supercell and Machine Zone (Private:MZ). Softbank is an unlikely bidder as it has been raising cash by shedding mobile game assets to make up for the losses of its Sprint acquisition. China’s Tencent would be another guess, although we think that Alibaba would be uncomfortable selling to its arch rival.

We would like to offer another likely bidder that has “one degree of separation” from the Vancouver studio and could seamlessly step in and run the studio. That company is the Tokyo-based gaming company Nexon (OTC:NEXOF) listed on the Tokyo stock exchange (T:3659). Nexon, founded in Korea in 1994, moved to Japan 12 years ago, went public 5 years ago, and is growing 20-25% a year. It currently has 4 of the Top 10 mobile games on the South Korean app store charts.

Nexon’s CEO is Owen Mahoney who has been VP of Corporate Development at Electronic Arts from 2000-2009. Nexon’s estimated 2016 revenue is around $1.7 Billion USD. Mahoney has said that Nexon is focused on expanding its mobile presence in the West. While the $800 Million price tag for the Vancouver studio would be a stretch for Nexon, the acquisition would be good fit.

Here is where the “one degree of separation” comes in. Two co-founders of Exploding Barrel Games — its President Scott Blackwood and General Manager Heather Price — plus the Kabam VP that led the Exploding Barrel Games acquisition — Chris Ko –left Kabam in 2015 to start an independent mobile game studio called The Game Studio. The studio is based where? Vancouver. Their mission is what? AAA mobile game developer. And who has recently signed on to become its global publishing partner? Nexon.

It would make perfect sense, and be almost a fairy-tale ending, if Nexon purchased Kabam’s Vancouver studio and re-united it with its original leadership led by creative director Scott Blackwood.

What is likely to happen to the rest of the company?

Kabam’s website lists eight on its Board of Directors with the majority of five being VC partners of investing firms. The VCs are in control here so founder and C-Suite job security would not be the dominant factor in this decision. Given the dearth of tech IPOs generally in the past two years, there is pressure on the Kabam’s Board to accept a bid, regardless of the difficulties it might present for the future success of the remaining company.

As we said earlier, the bid price is the least of Kabam’s Board worries. We discussed earlier the thorny issue of how to peel off the Vancouver studio and its game engine without crippling development in the rest of the company going forward.

A more thorny issue is what to do with the $800 Million cash, assuming it is cash and not stock. The basic decision comes down to return on investment with the choices being stock repurchase versus reinvestment in the remaining three studios.

Crunchbase has reported that Kabam has received a total of $244.5 Million from investors — $120M from Alibaba, and the remaining $144.5 Million from venture capitalists. Given the hunger for realized returns by VCs these day, we believe Kabam’s Board has to return a minimum of 2X to investors or $489 Million sooner than later.

In our opinion, we don’t see much remaining at Kabam that merits an investment, (details below) assuming the Vancouver game engine and the rights to the Transformer game goes with the winning bid. A minimum 2X payout still leaves $311 Million, which is way too much to reinvest in the company. We could see the company keeping only $150 Million, and paying out another $150 Million.

The company has announced only one other game in development — a MMO game based on Avatar IP licensed from James Cameron, the film maker who gave us Avatar, Titanic, Alien, and Terminator. The game is being developed by Kabam’s LA studio. It is scheduled to be release in conjunction with the release of Avatar 2 movie. It is not clear what game engine is behind this development.

On the one hand, investing in any creative project based on James Cameron IP seems like a winner. But, Cameron is known for being very fickle. The release date for Avatar 2 has been in a constant state of flux and has been pushed back another year to December 2017.

Also, it is hard for us to conceive Avatar as a MMO battle game like the hit games from Supercell or MZ. Avatar seem better suited as MMO role playing game, which does well in Asia, but not so well in the West.

Also, who’s to say that Cameron might change his mind and want a VR game instead of a MMO mobile game? Still, saving the LA studio of 80+ developers and reserving plenty of cash for the Avatar game seems like a good investment.

We have no clue what Kabam’s Beijing studio of 200+ is doing these days. The spectacular failure to localize the Marvel game for the Chinese market puts it at the top of our list for closure. This includes exits for two of Kabam’s co-founders — long time studio head Michael Li andHolly Liu who moved to Beijing in 2015 to help manage the studio.

The Chinese Marvel game did hit #1 on the Apple iOS China download charts — for one day. And Kabam cajoled Dean Takahashi of Venturebeat into writing an article with this headline: “How Kabam Self-Published Its Marvel Mobile Game in China — and Hit #1”

But, the game never caught on and has been on a steady downtrend with a current revenue rank around #250 on Apple’s iOS China app store.(see chart below).

 

 

 

 

 

 

 

 

 

 

The failure of Kabam to localize the Marvel game has reduced the likelihood that its leading investor Alibaba, or any other potential Chinese investor, to pour more money into the company.

Finally, what should Kabam’s Board do with its San Francisco HQ run by CEO and co-founder Kevin Chou and its studio numbering 279+ developers and support personnel?

The studio itself is responsible for three of the recent failed releases. Plus, we have argued that the cause of Kabam’s failure to release games with long-term engagement value has been a short-sighted, “talk the talk” culture coming out of its San Francisco HQ.

CEO Chou has admitted as much now saying that the company is focused on “bigger, bolder, fewer” game releases. But, in our opinion, he still doesn’t understand what it takes to create long-term player engagement. He thinks it is through mobile games with AAA console graphics including 3D. In our opinion, it is through “metagame” starting with a real-time, crowd-sourced chat translator similar to what MZ (formerly Machine Zone) developed three years ago.

For these reason, we could see the $800 Million bid as the death knell of Kabam’s San Francisco operations with a massive layoff numbering 250+ coupled with golden-parachute exits by CEO Kevin Chou and COO Kent Wakeford. Kabam could then downsize its HQ and relocate it in LA with the company headed by President of Studios and Chief Creative officer Mike Verdu.

Machine Zone (MZ): A $10 Billion Dollar Unicorn in the Making

Lawrence Abrams No Comments

congestion

 

 

 

 

 

 

 

(Our suggested “moonshot” for MZ: ending urban traffic congestion via a real-time pricing platform + “connected car”)

(Our suggested new tagline for MZ: “put a price on it.”  Shoutout to Portlandia for its “put a bird on it” tagline for a hand-crafted gift store capturing its big picture strategy)

In a year when valuations of so-called Unicorns — startups valued at $1+ Billion — are being marked down by investors, we will present the case that Machine Zone, recently rebranded as MZ, is a $10 Billion Unicorn in the making.

This is audacious claim. A January 2016 Unicorn list compiled by Fortune Magazine assigned a $3 Billion valuation to Machine Zone based on a WSJ report in June 2014 of a funding round of $250 Million led by JPMorgan Chase. There was second hand confirmation of this in Pitchbook.

Machine Zone was not even listed on any Unicorn list a year ago simply because such lists required that valuations be based on reported equity financing with implied valuations of $1+ Billion. Machine Zone’s last reported funding round listed in Crunchbase was a Series B done a full four years ago when Machine Zone was just beginning.

We found Machine Zone’s absence from 2014 Unicorn lists both perverse and ironic. It was perverse in that Machine Zone didn’t need financing so it was excluded from successful startup lists. It was ironic because, unlike most other Unicorns, Machine Zone’s revenue levels and revenue trends are observable daily via app store data reported by analytics companies such as App Annie or Thinkgaming.

On July 15, 2015, Bloomberg reported that the company was in discussions with investors for an additional $200 Million in funding at an implied valuation of $6 Billion. Dean Takahashi of VentureBeat also reported rumours of this new funding round. But, he reported that Machine Zone was seeking $500 Million at an unstated valuation — not the Bloomberg figures. Takahashi’s source also said that “the pitch has met with skepticism.”

Machine Zone has refused to comment on any venture capital interest or funding. As we blogged at the time, compared to most startups who would relish disclosing funding rounds that would confer Unicorn status, Machine Zone “walks the walk, not talks the talk”.

The Evolution of Machine Zone’s Identity

Until this year, Machine Zone’s CEO Gabe Leydon averaged about two interviews a year and never talked about revenue, valuation or IPO plans. He never talked about the state of the mobile game industry. In fact, he rarely talked about Machine Zone’s two hit successes Game of War: Fire Age or Mobile Strike.

Instead, he used rare interviews to advance the theme that Machine Zone was a technology company with software platforms whose applicability and marketability extended beyond games.

In a 2013 interview, Leydon said that Machine Zone had developed a “game engine” that could be “re-skinned” to create other genres of games with the same underlying play and communications innovations. This comment was designed to counter the perception that Machine Zone was a one-hit wonder deserving less of a valuation than mobile game rival Kabam with multiple Top 10 hits at the time.

In 2016, Machine Zone has done just what Leydon predicted in 2013. It had “re-skinned” their top revenue rank Game of War: Fire Age to release another Top 5 revenue rank game Mobile Strike, published by their downtown Palo Alto studio Epic War LLC. What is remarkable to us is that there does not seem to be much cannibalization going on between the two games.

In 2014, Leydon talked about Machine Zone’s real time, crowd-sourced chat translation engine. We wrote several papers speculating that this chat translator would be a valuable addition to Slack as it would open doors to large multi-national corporations.

In a March 2015 interview with Bloomberg’s Robert Kolker, Leydon identified what he thought was the “Wow” factor of its hit game Game of War: Fire Age — the low latency of the game play.

“…Game of War accommodates about 3 million users in simultaneous play, with what the company clocked as a 0.2-second response time…. This is the largest real-time concurrent interactive application ever built. There’s nothing even close to it.”

He also hinted at the marketability of this technology outside of gaming.

Shortly after than interview, we wrote a paper speculating that Machine Zone’s game engine must be a NewSQL database. This was based on job requirements posted on its website and a Michael Stonebraker YouTube video in which Stonebraker said that database requirements for today’s massively mobile multi-user online (MMO) games are the same as modern, cloud-based online transaction processing (OLTP) databases required by banks, airline reservations, order entry systems, real-time ad auctions.

It turns out that Machine Zone’s MMO game “purpose” shaved years of the development of a modern OLTP database compared to development path taken by Google and Facebook. The original “purpose built” databases of the likes of Facebook, Google, and Yahoo were designed to be massively scalable and globally distributed. They did not have to handle transactions.

Database design involves tradeoffs. As the online world’s need for monetization increased, especially real-time ad auction exchanges, a reversal in trade-offs has occurred. In 2012, Google made the often quoted declaration that if it had to choose between a NoSQL and a “NewSQL” database to handle OLTP, it would choose the latter:

“We believe it is better to have application programmers deal with performance problems due to overuse of transactions as bottlenecks arise, rather than always coding around the lack of transactions”

So, Google has morphed its “NoSQL” BigTable into Spanner, a “NewSQL”, which it now uses for its mission-critical sell-side ad platform.

An additional signal of Machine Zone’’s intent on being a fundamental technology company was a report in Las Vegas Sun that the data center builder Switch would be expanding its Southern Nevada facility to house an additional 4,000 servers paid for and managed by Machine Zone . This announcement came in the very month in which Zynga announced that it would begin selling off its own dedicated data centers and return to Amazon AWS as a cost savings move.

On February 18, 2016, Machine Zone and CEO Leydon had a “coming out party”. He broke out of his pattern of infrequent print interviews to give a full blown 39 minute video interview at the important Code/Media 2016 Conference.

In our opinion, it was here that Leydon first demonstrated his charm and ease at speaking as he mixed in fond memories of 90s skateboard videos with big picture views of the state of ad-tech. The interview was convincing evidence to us that Leydon was capable of leading an IPO and being the spokesperson for a publicly-held company.

Within the first minute of the interview, Leydon articulated a more focused view of Machine Zone as “real time” technology company. However, because the audience were media and ad-tech people, Leydon did not mention its database technology at all.

Instead Leydon startled the crowd with sharp criticism of 3rd party buy-side ad-tech platforms and the state of ad-tech in general. He casually revealed that Machine Zone had developed it own ad-buy platform specifically tailored to the acquisition and retention of freemium game players aka “whale targeting and retention”.

This platform was an alternative to relying on outside platforms like Chartboost and Tapjoy, used by Machine Zone’s rival Supercell and other top mobile game companies. According to Crunchbase, Tapjoy has received a total of $2.47 Billion in VC funding over the years.

Once again, by building its own buy-side ad-tech platform, Machine Zone has set itself apart from other mobile app Unicorns. Supercell, its chief rival in the mobile game industry, uses Amazon AWS for infrastructure and Tapjoy for ad-tech. Supercell does not have any internal chat function for players to communicate.

On April 4, 2016, Machine Zone issued a press release stating that it had changed its name from Machine Zone to MZ to underscore its new identity as a “real time” technology company. It also announced that it would begin licensing its real time transactional database, branded as RTplatform™. Leyton suggested in a follow-up conversation with Venturebeat that RTplatform ™ had wide-spread applicability ”from financial service companies to connected car companies to government institutions”

Valuing MZ’s Mobile Game Business

What follows is an estimate of MZ’s current valuation based solely on its mobile game business. There are three pieces of data required: (1) App Annie revenue ranks for MZ’s games; (2) an estimate of a power function relation between annualized revenue run rate (ARR) and app store revenue rank; and (3) “market-derived” valuations of pure play mobile game companies as a multiple their ARR.

For example, Activision Blizzard recently bought King Digital for 3.08 times ARR. Using that as a comparable and an estimate of MZ’s mobile game ARR of $2.0 Billion, we would arrive at a valuation for MZ of 3.08 * $2.0 Billion = $6 Billion.

We have used this methodology to value MZ over the past 2 years: Machine Zone: The $4 Billion Unicorn that Walks the Walk ; Machine Zone and the Perversity of Unicorn Lists and Machine Zone: IPO or What? (for Seeking Alpha).

We used the same methodology in articles to value other publicly-held mobile game companies — King Digital, Zynga and GLU Mobile — and the start-up Kabam. Finally, we have used the methodology to make prescient buy recommendations for two undervalued Japanese mobile game companies — Mixi and KLAB.

Below are two “market-derived” valuations of pure play mobile game companies as a multiple of ARR. The first is a valuation of 3.08 * ARR that Activision Blizzard paid to acquire publicly-held King Digital in late 2015. Using King’s ARR, as reported in 10-Qs to the SEC as a checksum, we present below an estimate of the distribution of King’s ARR by individual game revenue and associated revenue rank as reported by App Appie.

 

king-valuation

 

The second is a market-derived valuation for Finland-based Supercell. While the company is not listed on a stock exchange, it is required by Finnish law to report financials once a year. In 2015, Supercell reported revenue of $2.326 Billion. We coupled that with a reported $5.5 Billion valuation that Softbank placed on Supercell when it bought an additional 22 percent stake in Supercell (bringing its ownership to 73 percent) in mid-2015.

As with the King valuation, we use Supercell’s reported 2015 revenue as a checksum when estimating the distribution of Supercell’s ARR by individual game revenue and related revenue rank.

supercell-valuation

 

For our valuation of MZ here, we chose the lower, more conservative, Supercell valuation of 2.36 * ARR. The higher 3.08 * ARR that Activision-Blizzard paid for King Digital was 20% higher that the market value of King at the time. Plus, most financial pundits felt that Activision-Blizzard paid too much for King.

In past valuation of MZ, we chose 2.5 * ARR based on market-derived valuations of publicly-held Japanese gaming companies. Given, the general downward drift in Unicorn valuations, the use of the lowest multiple of 2.36 * ARR seems appropriate today.

Based on the estimates above of individual game revenue associated with various iOS Apple USA revenue rank as reported by App Annie, we derive an estimate below of a 2016 power function of global ARR vs iOS USA revenue rank.

power-function-2016

 

We now present a current valuation of MZ based on its two hit games alone which rank #2 and #3 on the App Annie iOS USA revenue charts.

mz-valuation-april-2016

 

Note: during the writing of this paper in April 2016, Supercell’s Clash Royale and MZ’s Game of War have traded #1 and #2 positions multiple times. We are being conservative in our valuation here by using the lower #2 ranking for Game of War. Had we chosen #1 for Game of War with an associated ARR of $2.1 Billion, our valuation for MZ’s game business would have come in at $7.3 Billion instead of $5.7 Billion

Using “top-line” metrics like sales or monthly active users to value Unicorns has become suspect today. Observers of the startup scene have come to the realization of the futility of growing the top line if unit margins are negative and not likely to turn positive with scale. A freemium mobile game company has zero value if the advertising costs of acquiring a new user are greater than a user’s long term value (LTV), as measured by the discounted present value of money spent. Valuations based on solid top-line data have a greater validity if they are supplemented with some rough estimates of what a Unicorn’s full P&L looks like.

So, to add weight to our $5.7 Billion dollar valuation, we present below a rough estimate of MZ’s full operating P&L. First, our estimates shows that MZ has been responsible in growing headcount consistent with revenue.

headcount-comparisions

 

 

mz-pl

 

Our estimates for MZ’s contribution margin (sales — advertising cost) is a healthy positive number. It is likely that MZ has THE highest contribution margin in the mobile game industry given an estimated average annual in-app game spend of $550 per MZ game player.

It is likely that MZ currently is showing a small operating loss as measured by GAAP, but it would be positive if non-cash, stock-based compensation were backed out. The company is likely cash flow positive from operations. Because MZ as a mobile game company has no inventory or material accounts receivable, it does not need cash for working capital.

As CEO Leydon has observed, mobile games are the most efficient cash conversion operation in the history of modern business. At the Code/Media  2016 Conference, he observed that there can be a 120 second turn-around from cash out for an “call to download” ad to a new user download of a game to the first payment for in-app boosts posted to MZs cash account at the app stores.

MZ does not need cash for working capital or to cover operating losses. It has been reported that their new data center in Nevada is costing them $50 Million, and we could see them needing $100 Million per year for the next 5 years to expand data centers globally.

Use Cases for RTplatform™

We place the MZ’s valuation today at $9.1 Billion as a fundamental technology company. We think the valuation for its ad-tech platform is fair at $1.0 Billion, give that VC’s have poured over $2.7 Billion so far into Tapjoy, a comparable platform. We think the licensing value of its chat translator is fair at $400 Million, given the doors it might open for Slack. There might even be interest in the chat translator from Facebook or Microsoft, given the current interest in text messaging as a replacement for apps and mobile OS.

valuation-of-mz-as-a-tech-co

Admittedly, our $2.0 Billion valuation for RTplatform™ is the most speculative component as no comparable market-derived valuations are offered. One factor that caused us to value it so highly was the very fact that MZ hyped it. Here was a Unicorn company and CEO who had “walked the walk” for years and never made comparisons. Suddenly, it started “talking the talk.” as in “our specs crush your specs” and “ our new specs crush our old specs.” We believe the company can make good on the hype, given their amazing string of accomplishments.

According to the Venturebeat interview on the day of the launch, the company said its platform was “much more scalable than what is currently available in the market from rivals like Amazon or Google…” Leydon said PTplatform™ was “100 times bigger” than its current platform running Game of War.

The other factor underlying our high valuation was the use cases and market potential we were envisioning for a platform described by the company as a

  • massive platform for doing high-fanout data processing,”
  • many-to-many applications
  • an infrastructure that allows you to do some extremely large things in real time at scale.”
  • “unique ability to interconnect ‘billions’ of endpoints worldwide and transmit data at low latency”

In the Venturebeat interview, the company hinted at use cases “from financial service companies to connected car companies to government institutions”. In earlier interviews, Leydon hinted that its game engine was transactional with ultra low latency, which we speculated as meaning NewSQL. He compared it to platforms required for high frequency trading.

We present the following broad use cases for a real-time pricing or auction platform coupled with the “connected self” or the “connected car”:

  1. eliminate information asymmetry and “moral hazard” between insurers and customers;
  2. eliminate the “tragedy of the commons” like urban traffic congestion or overfishing;
  3. eliminate transactions costs causing “sticky prices” for services whose performance over time is uncertain;

A specific use case for (1) would be real time auto insurance pricing. In 2014, consumer auto insurance had been estimated to be a $190 Billion market. MZ should be targeting one of the top 4 auto insurers — State Farm, Geico, Allstate, and Progressive — as an exclusive licensee. They should aim for an announcement within the next three months, with a roll-out and initial monetization within a year.

This “early win” will shock the auto insurance industry, impress the VC investment community, and finally clue tech writers that MZ should listed along with handful of unicorns — Uber, Airbnb, Palantir and Slack — as having the greatest upside potential.

A specific use case for (2) would be a real-time auction for peak commute time on urban freeways. There is an article in Forbes citing a report which estimated the direct and indirect costs of traffic congestion at $124 Billion in 2013.

There was also something called the Millennium Project out of UC-Berkeley in the mid-2000 which used (then novel) mobile phones to gather data on drive times and traffic congestion in the Bay Area. In 2011, there was a report which presented in detail the problems in ”scaling up the Mobile Millennium traffic information system using cloud computing and the Spark cluster computing framework”.

Surely, the 2016 RTplatform™ would be a prime candidate to underpin any solution to urban traffic congestion. Needless to say, solving this problem would require government sponsorship so monetization by MZ for this use case might be a 5+ years off. But, announcing that it would be involved in a project to end urban traffic congestion would place MZ alongside only a handful of companies undertaking a “moonshot” and “make a difference in the world” type of project.

A specific use case for (3) would be dynamic pricing for sporting and entertainment events. Many Major League Baseball team are setting aside bleacher sections with individual game day tickets that vary by day of week, opponent, and weather. The National Football League is also starting to set aside individual game day tickets that vary over the course of the season by attractiveness of the matchup.

We could envision MZ’s platform taking this dynamic pricing of sporting events to a “real time” level by allowing both baseball and football fans to bid on game day seats inning by inning or quarter by quarter. Obviously, this use case seems ludicrous, but it does emphasize widespread instances of “sticky prices” due to transaction costs for a steam of services with uncertain, highly variable quality.

Kabam’s IPO Plans Are Kaput

Lawrence Abrams No Comments

Summary

  • Kabam is a mobile game startup with IPO aspirations and a reportedly $1 billion-plus valuation.
  • In early December, the CEO delayed IPO plans, blaming generally unfavorable conditions for a mobile game company IPO.
  • We show that the real reason for the delay was the disastrous performance of two of three new releases based on hit movie IP.
  • Kabam’s failures raise questions as to the sustainability of its headcount, its ability to produce hits based on movie IP and whether any mobile game company should do an IPO.

We are just a couple days into the New Year and already we have our first scratch – Kabam – from lists of technology companies most likely to do a 2015 IPO.

Kabam is a San Francisco-based mobile gaming company that had a track record of licensing movie IP (intellectual property) and producing top 25 revenue-ranking mobile games. But two new, highly-anticipated games based on The Hunger Games and The Lord of the Rings movie IP have had disastrous releases as evidenced by sub-200 App Annie revenue rankings.

As a result, Kabam’s plans for an IPO are kaput for now.

Kabam CEO Kevin Chou confirmed this day in a December 10, 2014 interview with the NYT. But, he blamed the delay on a generally poor environment for mobile game company IPOs created by the Zynga (NASDAQ:ZNGA) and King (NYSE:KING) post-IPO debacles.

In this article, we present App Annie revenue ranking charts of recent releases from Kabam showing terrible gamer response to two of its three most recent releases. In our opinion, this is the real reason for Kabam’s IPO postponement.

We wish to state at the outset that our definition of “plans to do an IPO” aredirect quotes from CEO Chou stating Kabam has plans to do an IPO. This is in contrast to a strict definition — filing an S-1, which Kabam has never done, as has been point out to us by the company.

We feel that of SA followers, and the investing world in general, are comfortable with the first definition and not the second. There are plenty of articles on SA talking about companies with “plans for an IPO” where a S-1 has never been filed. Uber and Airbnb are the most prominent.

If you are uncomfortable with our definition, please read no further.

So first, we want to present URLs where there is a direct quote from CEO Chou of IPO plans.

We start with a Bloomberg video interview way back in October 15 2013. Pay attention to segment 2:11 – 2:45

Interviewer: Are you thinking about an IPO”

Kevin Chou: “We are.”

Next a Wall Street Journal interview on February 17, 2014

“WSJ: You have said previously that you are considering an initial public offering. Any updates?

Chou: We had another very serious discussion about an IPO in our board meeting in January. Our revenue is growing rapidly and we have been profitable since 2012. We have over $70 million of cash in our bank account. We are at the scale, where we can actively consider an IPO. But we also want to do it when the time is right, and we don’t have a definitive timeframe yet.”

Finally, a Newslook video interview given around the time of the Alibaba investment in August 2014. Pay attention to segment 3:30-3:53

Chou: ” You know it could be as early as 2015″

In early 2014 interviews, CEO Chou was justified in saying that the an plans for a Kabam IPO would be unwise due to Zynga and King’s performance.

But even then, part of the blame was attributable to a 2014 revenue fade of its most successful game The Hobbit: Kingdom of Middle-earth, based on an IP license from Warner Bros. (a division of Time Warner (NYSE:TWX)).

Below is an App Annie revenue ranking chart of The Hobbit game, showing the game’s Top 10 revenue ranking in 2013 and the fade throughout 2014 to a Top 30 position today.

(click to enlarge)

The relation between revenue dollars and revenue rank is a severe power function. We have estimated that a #10 ranking game is associated with an annualized revenue run rate of around $250M worldwide where as #25 rank is associated with an annualized run rate of around $90M worldwide.

The power function ratchets up at #5. We estimate that the top 5 revenue ranking games worldwide today have an annualized run rate of between $800M and $1,500M – Clash of Clans (Supercell), Candy Crush Saga, Puzzles and Dragons (GungHo Online), Game of War-Fire Age (Machine Zone), andMonster Strike (Mixi).

In mid-2014, Kabam announced a series of IP licensing deals with Warner Bros., Lions Gate (NYSE:LGF) and Disney’s (NYSE:DIS) Marvel Division.

The company reportedly built up its headcount to 850 employees worldwide with 400 in San Francisco, 350 developers in its Beijing studio headed by co-founder Mike Li, and 85 developers in its Vancouver studio.

It accepted a $120M strategic investment from Alibaba that reportedly valued the company at more than $1B. This was on top of $125M in venture capital money raised previously from the likes of Google (NASDAQ:GOOG) (NASDAQ:GOOGL) Ventures, Intel (NASDAQ:INTC) Capital, Warner Bros., MGM and a number of other venture capital companies.

The company even purchased for $18M, spread out over 15 years, for the rights to place “KABAM” on the football field of The University of California at Berkeley, the CEO’s alma mater. (A startup kiss of death?).

In May 2014, Kabam announced a deal with Lions Gate to make a game based on The Hunger Games movie franchise starring Jennifer Lawrence.

This game would be developed by its 300-person Beijing studio, headed by co-founder Michael Li. It was this studio that developed Kingdom of Camelot, Kabam’s first big hit, released in March 2012.

The Hunger Games game was released on November 5, 2014 and the results have been disastrous despite the fact that the movie has been a hit.

(click to enlarge)

In June 2014, Kabam announced a licensing deal with Warner Bros. to make another game based on The Lord of the Rings IP.

This game was released on October 15, 2014 and again the results have been disastrous despite the fact that movie has been a huge hit:

(click to enlarge)

Finally, In July 2014, Kabam announced that its Vancouver studio was at work on a game based on licensed IP from Disney’s Marvel Entertainment Division. On December 10, 2014, the Marvel-based game was released.

Only the Marvel game has performed decently with a current App Annie revenue rank of #33:

(click to enlarge)

Kabam still might recover in 2015 with scheduled releases of another Marvel-based game and a game based on Mad Max IP licensed from Warner Bros.

But, Kabam’s recent failures raise several questions for us pertaining to Kabam specifically and to the mobile game industry generally:

  1. Can Kabam afford to maintain its 850 headcount, especially the 300 headcount at its Beijing studio responsible for the poorly-received The Hunger Games game?
  2. Are the recent the poor results the specific fault of Kabam or the fact that basing games on hit movie IP is no longer a valid strategy?
  3. Given the dual difficulty of producing and sustaining a Top 10 revenue-ranking mobile game, might there be a better alternative for financing and providing investor liquidity than IPOs?

Relating App Store Revenue Rank to Revenue

Lawrence Abrams No Comments

From two of my recent Quora posts:

Question: How much money does the average mobile game make?

There are tons of games on the App Store and Google Play. Everyone seems to know about the hit games. How much revenue does the run-of-the-mill game generate? Is the revenue curve steady and flat? Do some genres do much better than others?

My answer:

Question should be rephrased:

How much money does the MEDIAN revenue rank game make.. ie game with revenue rank 100,000 out of about 200,000+ on iOS Apple US?

Answer: near zero.

Relation between mobile game revenue and revenue rank is a severe power function, more severe than the bookstore relation estimated 10 years ago and used to justify “long tail” inclusiveness in online stores.

I have estimated that top 10 revenue rank games derive 50% of revenue whereas the “long tail” of mobile game revenue ranks — games ranked 10,001 – 200,000+ derive only 5% of revenue. Long tail here is far smaller than books where revenue rank books 10,001 – 200,000 derive 30% of revenue.

To go back to the first question, I have a more precise answer. I have estimated that the trailing 12 month global mobile game revenue, less 30% cut from Apple and Google is $11.2B. Mobile game long tail — games ranked 10,001 to say 200,000 get 5% or $560M. Divide that by # of games in long tail — 200,000 – 10,001 = 189,999 560,000,000/198,999 = $2,847 is the AVERAGE yearly revenue of a mobile game in the long tail– with revenue rank > 10,000.

Question: How can you estimate the revenue of a mobile app based on its revenue rankings in App Annie?

There should be an exponential drop off, so if someone has done a study with a few data

My answer:

It is a power function with an upward kink at game rank #3-4

mapping update
As far as games, these are my current estimated revenue run rate after 30% store cut worldwide on iOS and Google (note portion of revenue is 4:1 iOS to Google)

Big 3 — what I call the “and, of, the” of a Zipf power function.

Clash of Clans $1.8B (Supercell)
Puzzle and Dragons $1.6B (GungHo Online)
Candy Crush Saga $1.0B (King)

Next 7
Monster Strike $900M (Mixi)
Game of War: Fire Age $600M (Machine Age)
Brave Frontier $400M (Alim/gumi)
Hay Day $400M (Supercell)
Farm Heroes Saga $350M (King)
Battle in Warring Games $200M (Sumzap)
Pet Rescue Sage $175M (King)

Top 10 World Wide Mobile Games by Revenue Rank receive estimated 50% of mobile game app store revenue >>> $6.5B out of $11B

In contrast, I have estimated “long-tail” of mobile game app store revenue — games ranked 10,001 + to 240,000 receive around 5% of revenue.

This is a lot less that the original “long tail” estimates for book sales of book ranked 10,000+ of around 30%

Not much loss in cutting out the “long tail” in mobile games on the app store in return for great gain in app store discovery and quality of merchandise.

RIP Long Tail Justification for Online Store Inclusiveness: 2004:2014

Kabam: Mobile Gaming Company IPOs after King and Zynga

Lawrence Abrams No Comments

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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