The Apple App Store Ecosystem and Glu Mobile – Part 2

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March 10, 2010 | SIN Picks | | Author Asif

Note: This blog entry was originally published as a Special Reports update on 3/10/2010 and is now open to everyone.

Glu Mobile (GLUU) $0.98

Guitar Hero 5 Mobile by GluWith 38 games currently in the Apple app store, San Mateo, California based Glu Mobile is smack in the middle of the nearly $3 billion Apple app store ecosystem discussed in the first part of this two part article. Founded in 2001, Glu was once a successful start-up, focused on producing and publishing games for mid-range handsets that were the prevailing, dominant phone of the time. The years 2000-2001 were when cell phone usage became a widespread trend and Glu had precociously jumped on the idea that gaming would take off on this technology. Glu not only publishes original game titles but also has partnerships with SINLetter portfolio pick Activision (ATVI) and other companies like Sony (SNE), Microsoft (MSFT) and Popcap Games. For example Activision’s Guitar Hero 5 is published as Guitar Hero 5 Mobile for Blackberry, Android, Microsoft and Palm based phones by Glu. The company was brought public in early 2007 at a price of $11.50 per share with Goldman Sachs as the lead underwriter. With offices in 11 countries, Glu  has been losing money every year since 2005 and the $84 million it raised in the March 2007 IPO has dwindled to just $10.5 million in cash as of December 31, 2009.

Unfortunately, Glu has been struggling to keep up with mobile gaming trends as they have shifted to phones like the iPhone and this is reflected in the stock price, which is just under a buck as I write this article. In an attempt to reformulate their approach to gaming, Glu posted a press release on July 8, 2009 informing investors and the public that their CEO for the past six years, Greg Ballard would be leaving Glu in “pursuit of other activities.” It was only two months ago, on January 04, 2010, that Glu publicly announced their newly appointed CEO Niccolo de Masi, a man with a strong background in various mobile gaming sectors, including London Stock Exchange listed MonsterMob and Hands-On Mobile, the latter of which is one of Glu’s main competitors.

It is interesting to note that Niccolo quietly replaced David White as the CEO of Hands-On Mobile near the end of 2009, also in an attempt to recoup the company’s struggling finances for a future, heavier focus on the Facebook and iPhone gaming world. Curiously enough, Hands-On Mobile just lost one of its priced mobile licences – Activision’s Guitar Hero – to rival Glu Mobile during the summer of 2009, right before Niccolo was appointed CEO, and before Niccolo left and joined Glu. Seems like Niccolo knows something we don’t – or, at least, he carries a certain faith in these smaller companies, particularly when he’s given a non-qualified stock option to purchase 1,250,000 shares of Glu’s common stock at a strike price of $1.21.

In a recent interview with PocketGamer Glu’s new CEO announced “We’re in the middle of the storm at the moment, but over a three to five year period we expect the market to grow multiple times and see our revenues in the hundreds of millions of dollars. I’m very optimistic.” Digging under the hood, Mr. De Masi has his work cut out for him considering the fact that Glu has seen sequential revenue drop in every quarter of 2009. Full year 2009 revenue also dropped to $79.3 million when compared to $89.8 million in 2008. Q1 2010 revenue is expected to be $15 to $15.5 million when compared to Q1 2009 revenue of $20.77 million. The mid-point of Q1 2010 guidance represents a drop of 26.59% in revenue. Given that the company’s only has $10.5 million of cash on its balance sheet as of December 31, 2009 and $16.4 million in short-term debt, Glu does not have a  very long runway to get its strategy right and there is a distinct possibility that existing shareholders may face dilution if the company raises additional capital.

So why did I decide to explore the market size of the Apple (AAPL) app store ecosystem and Glu in such detail? There are some glimmers of hope for this microcap stock, which the market appears to have priced for bankruptcy. I have broken down both the bull and bear case for Glu below. A number of email exchanges with a San Francisco based institutional investor who reached out to me after reading part 1 of this article, helped crystallize some of these arguments.

The Bull Case:

1. There appears to be a huge disconnect between private market valuations of mobile gaming companies and public companies like Glu. As mentioned in part 1 of this article, San Francisco based mobile gaming start-up ngmoco managed to raise $40 million in three rounds since launching in 2008. The post-money valuation numbers are not public but it could easily be in the hundreds of millions of dollars. In contrast Glu’s market cap as of Tuesday’s close is just $29.72 million despite operating in the exact same space as companies like ngmoco.

2. The company should be given credit for bringing down its operational and development expenses in 2009 when compared to 2008. The net loss of $6.88 million in Q4 2009 is significantly lower than a loss of $37.22 million in Q4 2008, even after you take out the $22.88 million goodwill impairment charge from the Q4 2008 results.

3. The new CEO’s interests are aligned with those of shareholders as his options have a strike price of $1.21, while the stock is currently trading at 98 cents.

4. One of the VC backers of Glu, Hany Nada, acquired over 400,000 shares on the open market at a price of $1.04 less than 7 months ago.

5. Having tried out Glu games like Super K.O. Boxing 2, which received a glowing review from Jackie on AppStruck, I can personally attest to the superior graphics and mostly bug free game play of Glu games. Glu currently has 38 apps in the iTunes app store, out of which 17 are free or lite versions of paid apps.

6. The company is porting its titles to other platforms such as the release of Family Guy on the Blackberry and Glyder 2 on Palm. Glu stands to gain not only from the red hot growth of the Apple app store ecosystem but also from the increasing adoption of other smart phone platforms (Android, Palm, etc) by consumers.

7. The recent partnership with Activision should not only help Glu capitalize on well known franchises like Guitar Hero but also position it well for an acquisition.

8. When compared to peers, the stock trades at an incredibly cheap 0.37 times sales and has an EV/Revenue ratio of 0.45.

The Bear Case:

1. Despite an established presence in the mobile gaming market, Glu did not have the foresight to act swiftly when the Apple app store was launched. This lack of strategic thinking has foreshadowed Glu’s results over the last few years and the market is rightfully skeptical of a turnaround at this juncture. Even with twin tail winds of a red hot app store and smart phone adoption, revenue declined in 2009.

2. The company has yet to fully explore the use of business models like in app purchases that have been highly successful for companies like Zynga through their social media games like Farmville and Fishville.

3. The Apple app store has over 160,000 apps vying for attention and it is difficult for Glu to keep its games in the spotlight long enough to earn a good return on investment. I did not find a single Glu game amongst the top 50 paid or free games on the app store tonight. I have in the past seen a number of their games in the top 50 rankings but Glu needs to develop the staying power of apps like Doodle Jump and Pocket God. Doodle Jump was developed by two brothers out of New York and recently broke through 3 million downloads. Pocket God has built a cult following by releasing fresh updates almost every week.

4. Glu’s balance sheet is not very strong (current ratio 0.93) and the company could face liquidity concerns when the short-term debt comes due. The $10 million in cash and a revolving credit facility should however give the company some breathing room.

An investment in Glu at this point is like buying a call option that might expire worthless or generate very good returns. It is also a vote of confidence in the new CEO and his ability to either turn the company around or prime it for an acquisition. Given that his interests are aligned with ours, the open market purchase by a VC, the low valuation, the strong stable of games that are being ported to other platforms and the recent deal with Activision, I am willing to start a position in Glu for my personal portfolio. The size of the position might be a little smaller than my standard position size of 5% so that the portfolio is not adversely impacted should the investment not work out. I am also going to purchase 3,000 shares of Glu for the SINLetter Special Reports Portfolio.




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Comments

  1. Dave
    April 1st, 2010

    Asif,

    Recently GLUU came out with their 10-K. Based on your research and thought process, could you shed some light on their situation?

    Thanks,
    Dave

  2. Asif
    April 2nd, 2010

    Sure Dave. Will post my comments about it this weekend.

  3. Asif
    April 5th, 2010

    Dave, a few things stood out from reviewing their 10-K including the fact that they have already started experimenting with social media games with 2 beta games and one live game on Facebook. They are also following all three revenue models as they apply to the iPhone app store including game purchases, in game microtransactions and advertising.

    The part that stood out the most was that revenue from smartphone platforms grew 248.1% in 2009 as compared to 2008, and grew by 98% in Q4 2009 as compared to Q3 2009 . So there is definitely opportunity there but it is also a highly competitive space unlike their traditional business of games for feature phones through the service provider.

    I get the feeling that to fully implement both their social media strategy and the smartphone strategy (not to mention the iPad now), they may have to raise additional capital. The good thing is that they have been profitable on an operational basis for the last three quarters.

    If possible I will post something more comprehensive on the blog later this week.

  4. [...] to Asif Suria on this one.  His two-part series on Glu Mobile and the Apple App Store (part 2 here) shows why microcap mobile game developer Glu Mobile has a lot of upside.  Glu has 38 games in [...]

  5. george gillespie
    April 11th, 2010

    Asif

    I am really interested in what Gluu has planned for the iPad. i think the future of big gaming dollars is tied up in this device and the other OEM’s that are sure to follow Apple’s lead. Do you have any insight to Gluu’s plans in this area?
    George

  6. Asif
    April 11th, 2010

    George, Glu Mobile released one of the recent games Glyder 2 for the iPad as soon as it came out and priced it at $4.99 when compared to $2.99 for the iPhone version.

    I am assuming they will repackage some of their other games and especially their in-house IP like “Super KO Boxing 2″ and “1000: Find Em All” for the iPad as well.

    I have reached out to their management team and will most likely get a chance to talk to them after the quite period related to Q1 results is over. If I do, I will ask them more about their iPad plans.

  7. robert
    April 12th, 2010

    Hi. Agree with your perspective on the positive and negative case for Glu. On the debit side the balance sheet is even weaker than it looks as the company still has to meet a lumpy deferred acquisition payment of $12m (which pushes up the EV to trailing revenues ratio to more like 0.7x (price $1.30). You can still see the potential though as the quoted mobile gaming co’s like Gamevil, Com2us and Gameloft trade in the 2x to 6x trailing revenue range. If the management can begin to execute, refinancing from exisiting shareholders on those ratios doesn’t seem so scary.One feature I like about the company is that it is still spending on R&D, including the deferred consideration the EV is only just over 2x the $25m they identify as R&D spend in 2009.

  8. Kartick Narayan
    April 24th, 2010

    Hey Asif,
    Congrats on calling this.

    Looks like the last trasaction from Apr 23rd was for 1MM shares @ $1.426. Was this a buy or a sell?

    Kartick

  9. Asif
    April 25th, 2010

    Thanks Kartick. It was a risky play that has worked out well so far. We will have to see if it continues to deliver or not.

    Regarding the transaction on Apr 23rd, someone has to sell for someone else to buy, but given the price movement, it looks like the buyer was motivated.

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