Archives October 2016

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

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.


Prop 61: Which Tony Soprano Bargaining Agent Do You Want?

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Summary:   A YES vote  is a vote for an honest, but a narrow-minded Tony Soprano style of bargaining. A NO vote is for a dishonest, but open-minded Tony Soprano style bargaining.

California Proposition 61 — a.k.a. The Drug Price Initiative  —  forces managers of  government employee prescription drug plans to get more rebates from drug manufacturers.   YES ads feature Bernie Sanders and his anti-big business mantra.  NO ads feature Veterans lamenting the possibility that this measure will increase their prescription drug costs.

No one has analyzed this proposition starting with the idea that there are two sides to any deal.  You have to ask the question:  Rebates in return for what?

You have to start with bargaining styles to understand the problem Proposition 61 seeks to fix.    Lowering prescription drug prices is all about changing the bargaining style of plan managers.  

A YES vote says you want the style used by the Veterans Administration (VA).  A NO vote say you want to maintain the status quo and keep the bargaining style used by contracted pharmacy benefits managers (PBMs) such as CVS Caremark, UnitedHealthcare’s OptumRx, and Express Scripts.

To better understand the implications of California Proposition 61, we need only look to the pilot episode of the HBO hit series The Sopranos.   In that episode, Tony complains to his therapist Dr. Melfi about the stresses of being a “waste management consultant.”  

His job, for which he and his supporting crew are paid handsomely,  is to manage the competing interests of various sanitation companies wishing to win lucrative garbage contracts put out to bid by suburban New Jersey municipalities.

Tony has no real insights into the complexities of bid submission.  Tony’s sells himself as an effective gatekeeper, creating value by limiting access to lucrative markets.  He collects a tariff from those whom are allowed in and sends his nephew Christopher to exclude the rest.  

No wonder Tony is stressed.  Sanitation companies put Tony in a schizophrenic double bind “damn if you do, damn if you don’t” situation.  If Tony does limit competition to a single sanitation company, the favored earns excess profits while the excluded curse Tony.   If Tony does nothing, all the sanitation companies bid so aggressively against each other that no one profits and they all curse Tony.  Either way, someone is cursing Tony.

The Tony Sopranos of Prop 61 are VA administrators and PBMs.  These gatekeepers receive rebates from drug manufacturers in return for insuring limited competition from other patented brand drugs that are “therapeutic equivalents.”  

For example, there is fierce competition today among manufacturers of patented, but substitutable, combo drug therapies used to treat the Hepatitis C virus.  This includes pills from AbbieVie (Viekira Pak and Technivie),  Merck (Zepatier). and the more expensive, but more effective, treatments from Gilead Sciences (Solvadi and Harvoni).

Indeed, Harvoni is one of the most expensive drug therapies in the world with the list price of each pill at $1,125 and a total list price of $84,000 for a 12 week cure.

Plan administrators are able to slice off an estimated 30% to 60% of the list price in form of rebates in cases where there is competition among a few patented, but substitutable, brand drugs.

Indeed, over the past few years, a vicious cycle has emerged: drug  manufacturers raise list prices 15%, PBMs raise rebates demands 10%. Next year there is 20% increase in list prices coupled with a 15% raise in rebate demands, etc.   It is not clear who initiates and who responds here.  The villains might not be CEOs of drug companies like smirk-faced Martin Shkreli, but rebate-hungry CEOs of pharmacy benefit managers.

Prop 61 is about what version of Tony Soprano you want as a bargaining agent.

The vehicle for limiting competition is a list of drugs covered by the plan called a formulary.  The VA formulary is severely limited in terms of total drugs, but there are no copay tiers.  This highly restrictive formulary allows the VA to collect the largest rebates and the lowest net drug prices of any plan in the United States.

The PBM formulary lists many more drugs overall, but exerts secondary power over demand via copayment tiers, step therapy, and prior authorization.

Make no mistake.  Drug rebates are not volume-related price discounts.   If this were the case, then Medicare Part D drug plans with total enrollment of 70 Million enrollees would get higher rebates than the VA drug plan with 9 Million total enrollees.

The VA has a transparent business model.  VA employees earn a salary and only seek rebates in order to lower government costs.  But, unfortunately, the federal government historically has underfunded the VA.  Over the years, VA thinking has become narrowly focused on costs at the expense of quality of care for Veterans.  

A YES vote on Prop 61 is a vote for an honest, but a narrow-minded Tony Soprano seeking rebates for rebates sake,  with not enough weight given to consumer choice and quality of care.

A NO vote is for a secretive Tony Soprano pocketing rebates on the sly, but willing to pay higher prices for newer, more effective prescription drugs.  

We have no strong conviction either way.  

A YES vote is not good for Vets in the short run.  It will link California plans to VA prices and provide a disincentive for drug manufacturers to give big discounts to the VA.  But, ironically, a YES vote might be good for the Vets in the long run as it will call attention to the narrow-mindedness of VA administrators and force them to cover higher cost drugs that deliver better quality of care for Vets.

Our concern with Prop 61 is that it is tries to fix a problem by legislating outcomes rather than by legislating practices.  A YES vote legislates an outcome without any limits placed on the practices used to achieve mandated results. A NO vote preserves the status quo of PBMs as managers of state government employee drug plans.

We would have preferred that Proposition 61 mandate changes in the business model of any PBM that manages a state employee drug benefit plan.  This would include mandating a transparent fee-for-service business model with 100% pass-through of rebates  and no opaque “spread-margins”  earned on the resale of mail order generics.  

It would also mandate that enrollees have the option of obtaining 90-day prescriptions at local pharmacies as well as PBM-owned mail order operations.  Finally,  it would include outside review of PBM formulary choices.

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Lawrence W. Abrams, Ph.D. has written over 20 papers on pharmacy benefit managers freely available at www.nu-retail.com  He lives in N. Monterey County, California and can be contacted at labrams9@gmail.com

 


Kabam: What Causes A Unicorn To Stop Skating To Where The Puck Is Going

The growth in the numbers of technology startups valued over $1 Billion, so-called unicorns, has abruptly stopped and even reversed.

In the last several months, a number of unicorns have seen their valuations marked down by mutual funds. This has been accompanied by a number of titillating articles about frivolous spending — Dropbox’s Chrome Panda sculpture — and debauchery — Zenefits’ sex in the stairwells — claimed to be endemic to high flying unicorns.

Unlike stories of fallen unicorns, this article is about a company that “officially” is still on all unicorn lists. It is about the mobile game company Kabam, elevated to unicorn status by its last funding round in August 2014 of $120 Million by the Chinese platform company Alibaba.

Kabam 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 results have been a disastrous string of five failures and one success.

Kabam Timeline of Hits and Misses

Kabam Timeline of Hits and Misses

 

 

 

 

 

 

 

 

What caused this unicorn to stumble?

There is an inspiring YouTube video of a Keynote address given by Kabam co-founder Holly Liu at a Women 2.0 Conference in 2014.

She talks about key moments in the early history of Kabam when the founders decided to “Go Big” in her words. By this, she meant building products based on a vision of where a market was going rather where the market was at. Today, we use a hockey metaphor of “skating to where the puck is going” not “skating to where it is”

Kabam’s Downfall: “Skating to Where the Puck Is” after 2013

Specifically, for the Kabam founders it was deciding in 2007 to port their games to Facebook via its newly created API in a year when the dominant access to games was through the PC browser.

Then again, at the height of game company success on Facebook in 2010, Kabam founders were anticipating Facebook’s closure of its game API and made the visionary decision to develop only for the mobile phone.

Silicon Valley VCs have a bias toward supporting founders opinions over professional managers when startups periodically face existential choices.

This is because founders have vision (“skate to where the puck is going”) and want to build long-lasting companies. They have a Facebook “move fast and break things” mindset that is risky, but can result in outsized payouts in the end.

Whereas professional managers prefer risk-averse choices (“skate to where the puck is” ) that look to be the fastest path to cashing out via a buyout or an IPO.

Kabam stopped making visionary choices in 2013. What had happened was the emergence of a “talk the talk” culture championed by hired professional managers that favored strategies geared toward short-term revenue goals followed by an IPO.

In 2013, Kabam’s revenue grew 100% that year, fueled in part by the explosion of mobile phone purchases. Kabam had 3 hit games with greater than $100 Million in annualized revenue.

CEO Kevin Chou talked to the press about timetables for an IPO. He even announced publicly early April of 2014 that revenue was forecasted to grow 80+% or more and be in the range of $550 — $650 Million.

The safe bet to achieving these short term goals was to release as many games with $100 M in annualized revenue as possible. And that is what Kabam did, with disastrous results.

Visionary game founders in 2013 would have seen that only a company with multiple chart-topping $1 Billion games could ever have a chance at an IPO.

They would have known that another mobile game company Machine Zone (now MZ) was doing the visionary thing by building a ultra-low latency many-to-many game platform based on Erlang and investing in dedicated servers with field programmable gate arrays.

Visionary founders at Kabam would have stopped doing more of the same, and would have started building a new platform. They would have shut off all talk of IPO, stopped giving the press explicit financial numbers and revenue forecasts, and told investors that revenue would plummet in 2014.

In our opinion, the source of Kabam short-sighted culture was non-engineering managers brought in run Kabam’s operations. COO Kent Wakeford, a lawyer and former AOL executive, has been the face of Kabam to the press in matters of deals. To his credit, he consistently deflected any questions dealing with IPO specifics.

The real source of Kabam’s culture of “talk the talk” was former SVP of Corporate Communications Steve Swasey. The idea for making annual explicit financial disclosures can directly be traced Swasey.

The height of Kabam’s arrogance occurred in December 2013 when Kabam announced that it bought the naming rights for the Cal-Berkeley’s football field for $18 Million paid over 15 years. This idea had to be initiated by Steve Swasey. But, to be fair, this symbol of arriveste had to be approved by Kabam’s Board of Directors and founders.

One can understand the desire of Kabam’s co-founders — all three UC-Berkeley grads — to give back to their alma mater. But, founders should wait years after their IPO to give cash for University buildings. For example, buildings on the the Bay Area campus of Stanford and Berkeley include no less than Gates, Allen, Moore, Varian, Hewlett, Packard, and Wozniak.

In our opinion, we do not think Kabam can recover. It is running out of cash. The IPO window is permanently closed to mobile game companies after the Zynga and King Digital IPO debacles. Kabam’s only hope for more funds is Alibaba, its prime investor to date.

The naming of the football field at UC-Berkeley in December 2013 looks to be Kabam’s symbolic “Kiss of Death.”

Former SVP of Corporate Communications Steve Swasey at Cal Football Field Naming