Against the backdrop of one of the strangest days in the market with the Dow Jones dropping nearly 1,000 points in late afternoon trading, gaming giant Activision Blizzard announced strong first quarter results. During the conference call following the release of their results the company revealed some interesting details about its pipeline for the rest of the year. I got a chance to live tweet most of the conference call but in case you missed the call, I decided to post this blog entry with some key highlights from the call just like I did last quarter with the post Thoughts on Activision Blizzard’s Q4 Results.
Overall I continue to remain happy with the execution of this company and continue holding on to my long position in the stock.
On an unrelated note, the May investment newsletter has been delayed and should be out on Monday, May 10th.
The Blizzard division of Activision Blizzard (ATVI) generated $1.2 billion in annual revenue last year without releasing a single new game in 2009. Blizzard still gets some of its revenue from legacy games like the original Starcraft that was released more than a decade ago in 1998. In fact Starcraft managed to crack the list of top 10 PC games as recently as May 2009 according to the top game industry research firm NPD Group. Starcraft has been spotted in the top 20 multiple times since the announcement of Starcraft 2 in 2007. The beta version of Starcraft 2 featured in the video below was released last month and the game is expected to ship sometime in the first half of 2010.
A majority of Blizzard’s revenue however comes from its hugely popular MMORPG World of Warcraft (WoW) that had 11.5 million subscribers as of last month and has helped Blizzard generate above average operating margins when compared to Activision as a whole. Operating margins for the Blizzard division in 2009 were over 46%. Given how important World of Warcraft numbers are to Activision, I decided to dig into the subscriber numbers and specifically look at the growth opportunity from China as I have received a couple of questions about this from SINLetter subscribers.
As you can see from the chart below, World of Warcraft experienced exponential growth from its launch in November 2004 through 2008. Only Second Life by San Francisco based Linden Labs, which unlike WoW is free to play, managed to surpass WoW’s subscription numbers. Keen followers of the Massively Multiplayer Online Gaming space noted that the 11.5 million subscribers that Activision Blizzard reported at the end of 2009 were the exact same number of subscribers reported at the end of 2008.
With WoW restored in China as of September 19, 2009 following regulatory hurdles, are subscription numbers going to start growing again or has WoW peaked until the next expansion pack Cataclysm comes along? The bigger question to ask is how many of the 11.5 million subscribers are from China and how much revenue do they generate for Activision Blizzard.
If all 11.5 million subscribers were paying $15/month or $180 annually to play WoW, Blizzard’s revenue from just this one online source would be,
$15 X 12 months X 11.5 million subscribers = $2.07 billion.
Even after averaging the monthly fee down to roughly $14 after taking into account that some subscribers pick the cheaper $13.99 plan by paying for three months at a time or the $12.99 plan by paying for 6 months upfront, the expected revenue drops to,
$14 X 12 months X 11.5 million subscribers = $1.93 billion.
This is significantly higher than the $1.2 billion in revenue the entire Blizzard division reported for 2009. So it stands to reason that a large number of these 11.5 million subscribers are Chinese subscribers that don’t shell out roughly $14/month like their North American and European counterparts do. Based on what I have read from various sources, it is possible that between 4 to 6 millions subscribers are from China and they pay 6 cents per hour to play the game. Assuming 5.5 million subscribers and adopting a conservative estimate of 10 hours played per month, annual Chinese revenue works out to,
10 hours X $0.06 X 12 months X 5.5 million subscribers = 39.6 million
Chinese revenue is probably even smaller after Activision splits the proceeds with its Chinese partner Netease.com (NTES). The rest of the non-Chinese 6 million subscribers generate approximately $1 billion in revenue, putting the total WoW subscription revenue at $1.04 billion. Taking the sales of legacy titles like Diablo, Starcraft, etc., into account, we get very close to the $1.2 billion in annual revenue Blizzard reported for 2009.
There is a good chance that given the addictive nature of the game, Chinese players spend more than 10 hours/month playing the game and that the release of expansion packs (some of the old ones have not yet been approved in China) might drive additional revenue. But even if you were to double both the hours and the number of subscribers, revenue would top out at $158.4 million before Netease takes its cut.
The conclusion I came to after digging into the China factor was that the Activision Blizzard investment thesis cannot rest on expectations of growth from China. The strong pipeline of games from Blizzard for 2010 and the potential of another MMORPG are better reasons to get excited about Activision.
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
With 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.
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.
Note: This blog entry was originally published as a Special Reports update on 2/16/2010 and is now open to everyone. Marcus has risen since this update was originally published and is now trading slightly above book value.
2009 was a record year for the U.S box office with moviegoers spending more than $10 billion ($10.585 billion to be precise) despite the Great Recession. James Cameron’s epic Sci-Fi flick Avatar and 3D technology have given new life to movie theater chains and investors are looking at companies in this sector with renewed interest. It should be noted that Avatar, which was released on December 18, 2009 managed to “only” generated $283.8 million in domestic box office receipts before the end of the year and that the biggest domestic earner of 2009 was actually the sequel to the Transformers movie, Transformers: Revenge of the Fallen, that managed to pull in $402.1 million on the domestic box office and over $800 million worldwide. The lifetime gross domestic receipts for Avatar currently stand at $667.61 million, surpassing Titanic’s $600 million gross to become the biggest selling movie of all time (on an inflation adjusted basis, Gone With the Wind released in 1939 still kicks the wind out of Avatar).
In stark contrast 2009 was a terrible year for the lodging industry. Revenue Per Available Room or RevPAR in industry parlance, a key metric used to determine the financial performance of a property, fell in both 2008 and 2009 with both business and leisure travelers tightening their purse strings. The good news is that RevPAR declines have moderated in recent months and now appear to be stabilizing at a number of companies in the lodging industry including Wyndham Worldwide (WYN), Starwood Hotels (HOT) – love that symbol – and Marriott International (MAR). Both Starwood and Marriott raised their outlooks for 2010 when they reported recently reported 2009 results. Wyndham Worldwide, the parent company of chains like Ramada, Howard Johnson and Wyndham amongst many others tripled its dividend from 4 cents to 12 cents.
These two trends reminded me of Marcus, a company I last wrote about in the October 2007 edition of SINLetter. Marcus owns and operates 668 movie screens in the Midwest. The company also owns 8 upscale hotel properties including the Four Points by Sheraton in downtown Chicago and manages an additional 11 properties. Marcus could in the short-term benefit from the Avatar effect and in the long run benefit from improvement in RevPAR in its lodging division.
In the fiscal second quarter ended November 2009, revenue from theater admissions and concessions was $41.29 million, more than twice the $20.43 million in revenue generated from rooms. However the gross margins in the lodging division are much higher than margins from the theater division. Since Avatar was released in December, the company should see a boost to revenue when it reports results for its fiscal third quarter ending this month. Besides Avatar, the third quarter will also benefit from the $204 million that Sherlock Homes rung up since December, about $150 million in box office receipts from The Twilight Saga: New Moon since the close of the second quarter on November 26, 2009 and a strong showing from The Book of Eli in January.
The four key reasons I like Marcus at this point are,
I will purchase 500 shares of Marcus for the SINLetter Special Reports portfolio and also for my personal portfolio after this post is published. The closing price of the day on 2/16/2010 will be used as the purchase price.
Activision Blizzard (ATVI) released its fourth quarter and full year 2009 results yesterday and instead of writing a blog post about it, I figured I would try to live tweet the earnings conference call through the http://twitter.com/specialsin account and follow up with some key highlights here.
Starcraft 2 Screenshot. More screenshots here.
Overall I was very pleased with the results for Q4 and the fact that Starcraft 2 is so close to being launched. Even with the 70 cents earnings outlook for 2010, I am looking at an adjusted forward P/E of 14.43 for a company with very healthy margins, strong pipeline and a very strong balance sheet. I plan on retaining our long position both in the SINLetter Model Portfolio and in my personal portfolio.
Live tweeting the call was a lot of fun and you can read the tweets in reverse chronological order from the @specialsin account here.