Saturday, March 31, 2012

Glu Mobile Can Make It On Its Own

A couple of weeks ago, I took a position in handheld gaming developer Glu Mobile (GLUU) at $4/share. Two items of note caused it to heat up in a hurry, and it closed at $4.85 today. The first item that contributed to the liftoff is a recent initiation of coverage by Needham & Company with an $8 price target. The second catalyst is the speculation that Glu Mobile may be an acquisition candidate by a larger organization. Both Bloomberg and Seeking Alpha contributor Chris Katje posted articles the last few days on this subject that got the stock off the launchpad.

My take is that this small cap company can make it on its own, and, in the long run, I'll be better off if it doesn't get absorbed by one of the more established players in the gaming sector like Electronic Arts (EA), or, Activision Blizzard (ATVI). I believe I may have hit pay dirt by purchasing the stock at a reduced level, and, it has the potential to make me significant money. Hear me out and see if you agree.

If you aren't familiar with Glu Mobile, they are one of the few pure-plays in the nascent mobile video game industry. They specialize in psychotronic titles such as Contract Killer Zombies, Blood & Gore, Frontline Commander and Big Time Gangsta. All of these games are made specifically for smartphones and tablets. Although they've been an established organization for ten years developing games for the PC and platforms like the XBOX (MSFT), they've recently changed their business model to concentrate primarily on mobile devices. In fact, 75% of revenues were derived from the handheld universe in their latest quarter.

One thing I like about Glu Mobile is that they are an international organization with development studios on four continents, according to the latest 10-K. These studios, based in San Francisco, California; Kirkland, Washington; Toronto, Canada; Sao Paulo, Brazil; Moscow, Russia; and Beijing, China, have the ability to design games to suit the needs of each region. In addition, with acquisition of rival Griptonite last year, they will now be positioned in India in the second quarter of 2012 without paying material additional consideration.

With a total of 1.75 billion smartphones projected to be activated worldwide by 2016, Glu's international exposure gives them home-court advantage in the major population centers. Another thing I really like about the company is that not only do their applications run on all of the major handheld operating systems like Android (GOOG), iOS (AAPL), Microsoft's Windows Phone and Research in Motion's (RIMM) Blackberry, but they have the potential to be utilized on large screen HDTV's in the home in the next few years.

CEO Niccolo de Masi discusses this in the Q4 conference call: " The good news for Glu is that we already invest in big canvas sizes and high resolution art for all of our Q4 2011 titles onwards. So games like Blood & Glory and Frontline Commando, it would also not only hypothetically work well if Apple introduced something for a living room, but it would work well if taken in places like the Mac store which has even bigger screens than tablets. So, we are thinking of course about long-term futures...".

Glu's new business model is a freemium one. If you aren't familiar with this concept, you probably aren't alone because it's fairly new. The 10-K says: Freemium games are, "downloadable without an initial charge, but which enable a variety of additional content features to be accessed for a fee or otherwise monetized through various advertising and offer techniques.".

"A recent survey by Park Associates found that while only 5 to 10 percent of the player base of social and free-to-play games regularly pays out of pocket, those who do pay are generous. The average Facebook gamer who spends money on games spends about $29 per month, according to the report. And those who pay for virtual goods and upgrades in free-to-play games average about $21 per month. And that adds up quickly when your player base is in the millions.", reports Chris Morris in USA Today.

In December 2011, Glu had approximately 2.9 million daily active users and 31.4 million monthly active users of their games on Apple's App Store, the Google Play Store and other platforms such as Facebook, Amazon's Appstore and Google Chrome. As of December 31, 2011, they had 176.1 million cumulative installs of their games on these platforms, including 44.7 million installs during the fourth quarter of 2011. Although it's a small universe, it will only get bigger.

Before we crunch the numbers, let's quickly take a look at recent research by Superdata:

  • Mobile gaming will represent a $7.5 billion worldwide market by 2015E, tripling from $2.7 billion today.
  • Asia currently the largest market for mobile gaming, with revenues forecasted to total $3.2 billion by 2015E.
  • Freemium accounts for 55% of all mobile game revenues, compared to 6% ad revenue.
Financial facts that stood out to me from the last conference call are that they finished 2011 debt free with a net cash balance of $32 million, and, they expect to break even on an adjusted EBITIDA basis once their new product cycle from their acquisitions is fully active in Q4 2012. Glu Mobile is also the number one seller of gaming apps on the Android platform. Android was the top smartphone operating system in 2011 with 48% market share, compared to Apple's iOS with 19%.

When we examine the econometrics supplied by Yahoo Finance, we see that Glu is slated to lose money this fiscal year which ends in December. However, for 2013, they are projected to earn $.18/share according to average analysts consensus. This would give us a forward P/E Ratio of 27. Sales look even better. Glu is slated to take in $87 million this year, and, $123 million in 2013. A growth of 43%. If they create a blockbuster title like Rovio's Angry Birds, then these figures will be much higher. When you take into consideration they are expected to grow earnings at 30% on a compound annual growth basis for the next 5 years, the stock doesn't look too pricey, especially if estimates prove to be conservative.

Although Glu shares could fetch a premium if they are absorbed by a larger rival, I believe it would be short sighted by the board of directors to approve such a move. I am very impressed by CEO Niccolo de Masi and think he has done a great job with the turn around strategy. My money is on him and his team. I didn't invest in Glu for a quick 50% gain (which I will proably get if they are bought out), I invested in the comapny because I think they can generate a healthy profit for not only my portfolio, but for the company in the next five years.