On May 11, 2017, Netmarble Games had an IPO on the Korea KOSPI stock exchange.
Due to an enthusiastic demand by Korean, International, and Sovereign funds, the company was able to price the IPO at the high end range of 157,000 Korean won (KRW) / share, or approximately $138 USD / share based on an exchange rate of .00088 KRW / USD.
Within the first hour of trading, individual retail investors pushed the price up to 171,500 KRW. The stock closed the day at 162,000 KRW, making the funds, the underwriters, the company and its Chairman Bang Jun-hyuk very happy.
Three days before trading began analyst Moon Ji-hyun with the Korean brokerage house of Mirae Asset Daewoo predicted that the company would exceed expectations for YoY revenue and profit doubling. She gave the stock a price target of 200,000 KRW, or a 27% increase from the IPO price.
Most other financial analysts and business reporters wrote positively about the company and its IPO.
We alone differed. (Disclosure: we have never held a position in the stock and do not intend to initiate one at anytime. We have not received any remuneration for our articles on Netmarble.)
Three weeks before the IPO, on April 18, 2017 we analysed the offering and concluded that IPO was “priced for perfection” meaning that the expectation of $1+ Billion USD in annual revenue from its newly released game Lineage 2: Revolution (L2R) was already built into the IPO price.
Below is a spreadsheet that summarized our prior analysis:
During the first two weeks post-IPO, three “imperfections” cropped up and the stock fell 9.6% from its IPO price to close at 142,000 KRW on Friday, May 26, 2017.
First, on the first day of trading on May 12th, a report surfaced that the Korean gaming authorities would not let minors play L2R until the company reduced the use of gambling (“gatcha”) mechanisms.
Second, three days later on May 15th it was reported that NCSoft, a rival Korean game company that created and owned the Lineage IP, planned a June 2017 release of a new game based on the same IP as Netmarble’s L2R. The fear was that NCSoft’s new game would draw users away from Netmarble’ s L2R.
Finally, a week later on May 17th, the stock suffered a one day slide of 7.8% from 157,000 KRW to 142,000 KRW despite booking a 111% and 172% YoY increases in sales and profit, respectively, as revealed in its 1Q17 earnings report.
The negative reaction by the stock market to these seemingly stellar financials is exactly what we predicted a month ago when we said that Netmarble’s IPO was priced for perfection at 157,000 KRW.
The market has confirmed our conclusion that Netmarble must book YoY revenue increases that EXCEED 111% if the stock is to move significantly past the IPO price.
Below we will present updated app store data confirming our prior prediction that the annualized revenue run rate (ARR) of Lineage 2: Revolution has fallen significantly since its late December 2016 release.
While still an impressive hit, L2R’s revenue in Korea for 2017 will not be $1+ Billion, but more like $600 MIllion.
We predict that the release of Netmarble’s 2Q17 financials, which should happen around August 17th, will confirm a less than doubling of YoY revenue. We predict that market will react negatively to that reality-check and the stock should be settle in around 105,000 KRW or 33% below the IPO price.
In the meantime, expect business reporters and financial analysts to continue to issue positive forward looking statements regarding the release of L2R in Japan and China, TV spots featuring Korean teen idols promoting L2R, new game releases in Korea, and hints of acquisitions in the USA and Europe.
Expect a number of one day pops in the stock following such announcements followed by a continued downward drift.
For example, on Monday May 29th, the stock popped 3.5% late in the session based on a favorable report by Lee Min-a, an analyst with KTB Investments and Securities. She downplayed the possible negative effects of the ban on playing L2R by minors and the NCSoft’s impending release of a game with similar IP.
The analyst reiterated a “buy” recommendation with a price target of 157,000 KRW, exactly the same as what funds paid for the IPO. To our way of thinking, this would be troubling to IPO investors.
This price target implies that the underwriters allowed the IPO to be price so high that brokerage analysts now admit that they see NO UPSIDE POTENTIAL for early investors for the remainder of 2017.
We suggest that you ignore all forward-looking statements coming from business writers and brokerage house financial analysts. Instead we recommend you follow real revenue trends in L2R and other Netmarble games that are freely available from such analytics companies as App Annie.
Also check around the 27th of each month to see if L2R is still among SuperData’s Top 10 global revenue ranking companies. The month that L2R falls out of the SuperData’s Top 10 will be strong confirmation of our negative prediction that the stock is headed toward 105,000 KRW.
App Store Evidence of Fading Revenue for Lineage 2: Revolution
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 with the exception of two days in late May.
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 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%, the implied 2017 forecast for L2R is 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 #40 by late May 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. In April, it moved up slightly to #9 (See below).
L2R is no longer $2+ Million USD ARR game of January 2017 nor the $1+ Million USD ARR game of February 2017. More likely, its March and April ARR is in the range $600 Milion USD.
Valuing Netmarble Based on Realistic Expectations for L2R
At the IPO price of 157,000 KRW or $138 USD, the company was valued at $11.7 Billion USD.
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. (see below)
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 is 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 L2R’s 2017 revenue is $600 Million instead of $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.
We predict that the release of Netmarble’s 2Q17 financials, which should happen around August 17th, will confirm a less than doubling of YoY revenue. We predict that market will react negatively to that reality-check and the stock should settle in around 105,000 KRW or 33% below the IPO price.