Netmarble is the largest mobile game publisher in South Korea.
The company has just secured investor commitments to buy 16.9 Million shares worth $2.3 Billion in a May 2017 IPO on the Korea KOSPI stock exchange.
This IPO would value the company at $11 Billion based on investor demand at the high end of the offer range of $138 USD / share (or 157,000 Korean Won / share)
This is a very big deal. It would be the largest IPO on the Korean exchange since 2010 and second largest tech IPO in the world in the last two years after Snap and ahead of Line.
We will show in detail below that this is a highly speculative IPO, even for mobile game companies who are often dismissed by investors as being one hit wonders.
This IPO is unlike the disappointing mobile game IPOs of King Digital Entertainment in 2014 and Zynga in 2011 where both companies had enough audited numbers in their S-1s to suggest that their best days were behind them.
On the contrary, Netmarble’s best days are ahead of them. But, investors are insane to give this company such a lofty valuation based entirely on unaudited revenue numbers of a single new game launched only four months ago.
We will present evidence hinting that early annualized revenue run rates (ARR) for the game have slipped noticeably in March 2017 — the third month since launch. We predict that once investors realize this, the stock should drop 30+% from its expected IPO price.
Evidence of a Drop-off in ARR
On December 13, 2016 Netmarble launched a mobile role-playing game called Lineage ll: Revolution (L2R) based on licensed IP from NCSoft’s legendary PC game Lineage. According to app analytics company App Annie, the game immediately rose to #1 on the S. Korean iOS Apple revenue rank charts and has remain so to this day.
Just because L2R has remained ranked #1 on the S. Korean charts for the past four months, and likely will continue to do so for months, it is still possible that ARR has declined by $100s of Millions since release.
This is because there is a severe power function relation in the mobile game industry between ARR and revenue rank. Typically, at the top of the USA charts, there can be a $600 Million ARR difference between the #1 and #2 ranked game, say $2.2 Billion ARR for #1 and $1.6 Billion ARR for #2.
For example, below is a power function we derived in an earlier paper on the Netmarble IPO for top ranked games on USA iOS app store.
For the S. Korean chart now, it is conceivable that the gap between #1 ranked L2R and the #2 ranked Everybody’s Marble, also by Netmarble published on Kakao, could be $700 Million or more.
In January 2017, Netmarble told the Korean press L2R generated $176.6 Million in revenue between mid-December 2016 and mid-January 2017. That translates into $2+ Billion ARR.
Obviously, a $2 Billion ARR is not sustainable for the full year of 2017. This is because TOTAL Korean game revenue (mobile + console + PC) was only $4 Billion in 2016, according to Newzoo.
Netmarble has not made any official full year forecasts for L2R nor for the company as a whole. We do know that official 2016 revenue for the total company was $1.34 Billion.
In March 2017 analysts covering the company told The Korea Times that they expect revenue to double to $2.7 Billion, largely based on the early success of L2R. Assuming organic growth of around 25%, this implies that the 2017 forecast for L2R would be around $1 Billion.
We present two pieces of evidence that even a $1 Billion in total revenue for 2017 is unlikely.
The first piece of evidence is an App Annie trend chart showing L2R download rank. Note that while L2R was ranked #1 in downloads for the first month since release, downloads have steadily dropped below #30 by late March 2017.
It is doubtful this drop off was caused by a drop off in advertising by Netmarble. It is more likely due to a lack of strong word-of-mouth by early players that this is a great game.
The other piece of evidence of a drop off in ARR comes from a monthly summary report put out by SuperData listing the top grossing mobile games globally for that month.
For February 2017, SuperData reported L2R was the top grossing game globally. But, for March, it reported that L2R dropped to #10 (See below)
Valuing Netmarble Based on Realistic Expectations for L2R
As we stated earlier, Netmarble’s IPO is scheduled for May 2017. Investors have already committed to buying 16.9 Million shares at the top end of the offering range of $138 USD / share or 157,000 Korean won / share.
This values the company at $11.7 Billion. Dividing that valuation by analysts forecasts for 2017 revenue of $2.7 Billion, we arrive at valuation of 4.3 time forward ARR. This ratio enables comparisons with market-derived valuation ratios of publicly-held companies.
For example, in another paper of ours on the Netmarble IPO, we derived a valuation ratio for Com2uS of 2.61. Com2uS is a Korean-based mobile game company listed on KOSPI exchange. Com2uS is much better known than Netmarble due to its global hit mobile game Summoners War.
While Com2uS is growing slower than Netmarble, its future sales are more predictable. Based on this comparison, we concluded that Netmarble’s IPO was overpriced by 26%.
In the spreadsheet below, we also break down Netmarble’s 2017 overall revenue growth forecast into estimates of organic growth versus new sales from L2R — which we peg at $1 Billion.
The final spreadsheet presents “what if?” analysis of Netmarble’s value and stock price if more solid evidence starts showing up indicating that L2R’s 2017 ARR will be closer to $600 Million than $1 Billion.
Note that when revenue forecasts are significantly cut back, there is usually a corresponding compression in valuation ratios. So, we built into our “what if?” analysis a compression of Netmarble’s valuation ratio from 4.3 to 3.5 times forward ARR.
Official sales figures will start coming from Netmarble a month or so after the end of its 2Q17 quarter in June 2017. We expect management to guide 2017 revenue well short of initial forecasts of $2.7 Billion due to L2R’s ARR well below $1 Billion.
The stock should fall well below IPO prices. We predict a decline on the order of 33% by July or August 2017.