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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.
(Source: App Annie)
(Source: App Annie)
(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.
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.
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.