Tag Archive mobile games

Netmarble IPO: A Pattern of Greed Will Hurt This Company’s Performance

Lawrence Abrams No Comments

Netmarble is the ninth largest mobile app game publisher in the world and the largest in South Korea.

The company is seeking to sell 17 million shares on the Korean KOSPI stock exchange in early May garnering proceeds of between $1.8 Billion and $2.4 Billion USD (all USD figures converted from Korean Won at .00088 USD / Won). Roughly half will be used for new acquisitions and half will be used to retire debt.

This is a big deal IPO by both Korean and USA standards.

It represents the largest IPO in S. Korea in 7 years. It would rank as the one of the largest tech IPO globally in last 2 years.

In January 2017, Netmarble launched a mobile role-playing game called Lineage ll: Revolution 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 revenue rank charts.

Netmarble told the Korean press that the game generated $176.6 Million in revenue in the first month. That translates into an annualized revenue run rate [ARR] of $2+ Billion.

Obviously, that run rate is not sustainable. But, even if the game managed to produce $1+ Billion in revenue during 2017, it would place Netmarble in the rarefied company of Niantic, Supercell and MZ (formerly Machine Zone) as the only companies that released a $1+ Billion Dollar game in the last 2 years.

The IPO will be watched closely by the mobile game industry given the poor post-IPO performances of King Digital Entertainment in 2014 and Zynga in 2011.

A case could be made that these IPOs were anomalies and not a fair test of how a mobile game stock is capable of performing. Both Zynga and King Digital had enough numbers in their S-1s to suggest that their best days were behind them at the time of their IPOs.

However, there is absolutely no question that Netmarble’s best days are ahead of it. There is no question that its revenues and profits will soar in 2017 if Lineage II manages to sustain an ARR greater than $1+ Billion.

Lineage II is not all that Netmarble has going for it in 2017. In February 2017, the company completed a $700+ Million acquisition of the Vancouver studio of the USA mobile game company Kabam.

If managed properly (questionable as we will argue below), Netmarble could generate a fresh $100 to $300 Million in revenue from two Kabam game. One is Marvel: Contest of Champions which has been a long running Top 15 revenue rank game in the USA. The other is the recently released game Transformers: Forged to Fight based on IP licensed from Hasbro.

No question, 2017 will be a spectacular year for Netmarble. The Korea Times has reported that analysts there expect Netmarble’s forward 2017 revenue to be around $ 2.7 Billion, a whopping 107% YoY increase. This is a far cry from Zynga’s and King’s anemic post-IPO YoY revenue growth rates of 12% and 20%, respectively.

The question is has all of this been priced into Netmarble’s IPO price and valuation?

Our analysis will show that expectations for revenue doubling in 2017 has been fully priced into the IPO. Netmarble’s IPO is priced for perfection.

Furthermore, there is a pattern of greed on the part of Netmarble’s management that has not served it well. It includes:

While Netmarble’s short term prospects are tied to the performance of Lineage II in Korea, its long term prospects are tied to success in the West.

The company has announced that it intends to localize and release the Lineage game in China but those prospects are uncertain, even with Tencent (TCEHY) as a significant minority stockholder.

The uncertainty is result of China’s recent freeze on licensing new games from Korean companies due to geopolitical tensions between the two countries.

In our opinion, Netmarble’s greedy handling of the Kabam games causes us to believe that Netmarble’s current and future acquisitions will underperform due to employee and player defections.

We start with a summary of the IPO — the expected price range, and the expected post-IPO valuation based on those prices.

The next spreadsheet is our valuation of Netmarble as a multiple of 2017 forward sales. We have been unable to find any official company forward looking revenue statement. If there is one in the Korean version of their S-1, we have found no reference to it by the Korean financial press.

Lacking official numbers, we use $2.7 Billion for Netmarble 2017 forward sales, a number reported by The Korea Times that analysts there expect.

Any lesser number would only increase our estimated price / forward sales ratio (P/S), which is already high. Any greater number would be incredulous as Newzoo has reported that TOTAL Korean game revenue (mobile + console + PC) was only $4 Billion in 2016.

Moreover, given the $4 Billion Newzoo figure, it seem incredulous that there would be enough demand in Korea to sustain any single mobile game at an $1+ Billion ARR.

The next spreadsheet is a comparison of the valuation / forward sales (P/S) ratios of Netmarble — 3.3 — with Com2uS — 2.61.

Com2uS is a Korean-based mobile game company listed on the Korean KOSPI exchange. Gamevil, a smaller publicly-held Korean game company, holds controlling interest in Com2uS.

Com2uS is much better known in the USA than Netmarble due to its global hit mobile game Summoners War. The game was released in the USA in June 2014 and has maintained a remarkably consistent Top 20 revenue rank in the USA for the last two years.

Based on this comparison, we believe that Netmarble’s IPO is overpriced by 26% at its announced price range of $106 to $138 USD or 121,000 to 157,000 Korean Won.

We believe that it would be a buy only around $84 USD or 95,250 Won.

You might argue that Netmarble’s upside potential is higher than Com2uS. That is true. But, we are not talking about financials, but stock prices whose movement is based on perceived and actualized performance that has not already been built into the current prices.

Netmarble is a buy at the announced IPO range if you believe that it will exceed an expected 107% in revenue growth this year. We think not.

Netmarble is a buy if you think it can successfully localize and release the Lineage II game in China in late 2017 or 2018. We say wait a half year before you invest to get a better feel for geopolitics between S. Korea and China.

Finally, Netmarble may be a buy if you believe that the newly released Transformer: Forged to Fight game will become a Top 8-10 hit like its cousin Marvel: Contest of Champions. We think not.

Our four years of reading App Annie charts suggests that there are no more “late bloomers” in the mobile game world. If a newly released game does not crack the top 50 in the first few days, it will never crack the Top 10.

Our reading of the App Annie chart says that the Transformers game is a bust.

(Source: App Annie)

While the Transformer game began development under Kabam, the final architecture and release schedule came under Netmarble’s watch. Both reflect a greediness that we believe has resulted in its quick bust.

The game was rushed into global release on April 5th after a relatively short two month soft-launch shakedown in Singapore and Canada.

Experienced early players of the game report that it is “too complex to play” and there is “kitchen sink” approach to development with a mashup of game genres and a mind-numbing complexity to scorekeeping and purchasing. To us, this suggests that the priorities are early monetization over long term player engagement.

In sum, Netmarble in not a buy at the announced IPO price range. Wait at least six month and evaluate its performance then.

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: IPO or What?

Lawrence Abrams No Comments

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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.

 

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

KLab: An Undervalued Japanese Mobile Gaming Company

Lawrence Abrams No Comments

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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.

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