NQ Mobile (NQ) is a leading global SaaS provider of mobile security, mobile productivity services and mobile games. NQ reported another 'beat and raise' quarter on its recent 2Q13 report. NQ's strength is evident across the board. 2Q13 revenue of $41.4 million was UP 107% year-over-year, non-GAAP operating margin was 33.0% (up 310 bps Q/Q), Days Sales Outstanding (DSOs) declined by over 8%, FL Mobile (mobile games) revenue was UP 194% Q/Q (wow!!), gross margin for the NationSky (enterprise) business increased 1,400 bps to 33.9% and the company raised 2013 revenue guidance to $185 - $188 million (up from $179 - $184 million). In sum, NQ is growing faster and increasing leverage in its business. I updated my NQ financial model to reflect the incremental information from the recent 2Q13 earnings call. You may notice that my 2014 estimates are higher than the current sell side 2014 consensus numbers. After recent discussions with the sell side analysts, it is quite evident most have not updated their 2014 estimates. In other words, expect 2014 NQ estimates from the sell side to increase.
Every current and prospective NQ shareholder must listen to the audio replay of NQ's 2Q13 earnings conference call that took place on August 12, 2013. You can hear NQ management's conviction and confidence come across loud and clear. The call was densely packed with numerous informational nuggets. I would like to highlight a few and add some additional color….
NQ's Healthy Hyper Growth
NQ's 2Q13 revenue of $41.4 million was more revenue than NQ generated in all of 2011 ($40.7 million). Pause for a moment and think about that. NQ annual growth rates have been astounding. NQ grew revenue 206% Y/Y in 2010, 166% in 2011, 126% in 2012 and is likely to grow 105% in 2013. Four consecutive years of over 100% annual revenue growth is truly an impressive accomplishment. There are very few (if any) companies that have generated this kind of explosive revenue growth coupled with robust 33% non-GAAP operating margins. Any company can grow extremely fast by sacrificing margin. The truly impressive part of NQ is that the company is simultaneously executing on hyper growth while recently increasing operating margins! Perhaps readers can point out a few other public companies with similar growth and margin metrics in the comments section, but I feel confident that if companies with similar metrics exist, they are not trading at just 10x 2014E P/E (ex-cash and ST investments).
Increasing Monetization of Active Users
NQ reported 138.3 million active users as of the end of 2Q13. Before 2Q13, NQ primarily relied on a freemium business model to monetize its consumer security and mobile game business. NQ would offer a free level of service/functionality of its products and upsell the user to the paid version, which provides improved features and functionality. In 2Q13 NQ intensified its focus on monetizing non-paying active users an additional way. NQ began to offer these non-paying users a way to obtain the premium level of NQ's products by performing various actions that would generate advertising and promotional revenue for NQ from 3rd parties. Examples include downloading certain apps, various forms of advertising and referral fees.
(click to enlarge)Advertising revenue was $5.5 million for 2Q13, up 149% Y/Y and 66% Q/Q. At over 13% of 2Q13 revenue, advertising revenue generated by NQ's 138.3 million users is now a material part of the NQ story. You can clearly see the increasing revenue per active user above, where active users grew 10.9% Q/Q and consumer net revenue grew 23.7% Q/Q. NQ defines any revenue generating consumer as a premium customer. Co-CEO Omar Khan said as of April 2013 NQ had just thousands of non-cash paying premium customers and that by the end of June 2013 NQ had millions of non-cash premium customers. Let's take a closer look at the reported premium user metrics. From the earnings call, "As we report our premium user accounts on an average monthly basis, it is incredibly exciting to say that we saw an average of more than 2 million of these revenue-generating user accounts average during the three months of the second quarter." So, if there were just thousands of non-cash paying premium customers in April and the average was over 2 million during the quarter, simple math leads to the conclusion that NQ exited 2Q13 with over 4 million non-cash paying premium customers.
FL Mobile: Mobile Gaming Driving Explosive Growth
FL Mobile generated $7.5 million in 2Q13 (up 194% Q/Q!!) and is poised to generate over $10 million in 3Q13. From the conference call, "In the first half of the year FL Mobile has operated 13 games in the top 100, including current popular games such as Gods and Dragons, Journey to the West - Mythical Edition, Legend of Kings, and the FL Extreme Edition of Tencent's QQYujian. Also we have had four games break into the top 10 in the first half of the year." Why is NQ so good at selecting and developing hit games? NQ developed proprietary analytical software to objectively predict values for the key mobile game value drivers, including, but not limited to game play engagement metrics, retention (next day, 7 day, 30 day, etc.), viral strength, monetization metrics (ARPU, APRU/DAU), etc. The analytics software generates a quantifiable score for each game analyzed. This software provides FL Mobile with a sustainable competitive advantage in mobile game selection. The other key takeaway is FL Mobile is not just an app store. Rather, it is a vibrant community of over 16 million highly engaged like-minded active users (up 17% Q/Q) with Daily Active Users up to 98,595 (up 43% Q/Q). Just like the Yelp community leads to better informed purchase decisions by reading user-generated reviews, the FL Mobile gaming community creates a virtuous cycle by enabling mobile gamers to better find games that meet their gaming preferences.
NationSky - Enterprise Mobility
NationSky became a Tier 1 distributor for Apple in 1Q13 and has been ramping up its NQSky Mobile Device Management business, both of which contributed to the significant increase in the Enterprise Mobility revenue in 2Q13 (up 33% Q/Q). Reports dated August 15, 2013 indicate talks between Apple (AAPL) and China Mobile (CHL) are progressing smoothly. The time is right for a deal between Apple and China Mobile, as China Mobile's transition from its proprietary TD-SCDMA 3G technology to 4G TD-LTE progresses. Apple's iPhone does not work on TD-SCDMA since Apple's current chipsets are incompatible with TD-SCDMA. The new Qualcomm chips in the upcoming iPhone 5C and 5S support 4G TD-LTE. Opening access to China Mobile's 740 million subscribers to the iPhone will be a huge benefit to Apple and Apple's Tier 1 distributors in China, like NationSky.
Consumer Product Roadmap
On the earnings call, NQ said it is expanding its iSMS deployment with MediaTek. First, let's refresh on the background of the relationship between NQ and MediaTek. NQ Mobile acquired a one-third interest in Hesine Technologies ("Hesine"), a wholly owned subsidiary of MediaTek in August 2012. MediaTek is a leading fabless semiconductor company for wireless communications and digital multimedia solutions. Hesine's main product "Hissage" unifies all communication and messaging tools, including push email, webmail, blogging, social networking, instant messaging and others across various radio access technologies, wireless carriers, and geographies. In addition to its push technology and messaging solution, Hesine offers a web suite that bridges Internet and mobile communications, allowing mobile users to conveniently and transparently manage or sync content. Incremental information can be found on the English version of Hissage's website.
MediaTek has been extremely successful in penetrating the smartphone chipset market. MediaTek went from shipping 10 million smartphone chipsets in 2011 to 110 million in 2012, with 200 million projected for 2013. MediaTek's strong smartphone chipset growth is expected to continue in 2014 as well. MediaTek primarily sells to lower and middle tier white label smartphone manufacturers that compete on price. These handset manufacturers do not invest in messaging software development. Instead, the manufacturers embrace MediaTek's software stack, which is embedded in its chipsets. There is usually a 6 month period between the time when chipsets are initially shipped to the handset manufacturers and the time when the smartphones begin to reach the market. Therefore, I expect to see tens of millions of smartphones with MediaTek's chipsets being sold each month with the iSMS unified messaging software with the ramp beginning at the end of 2013. Obviously, having an installed base of tens or hundreds of millions of customers using NQ's and MediaTek's iSMS messaging software provides numerous opportunities for cross selling NQ's other products.
Valuation - NQ's Fair Value
Though NQ Mobile's stock has been a strong performer in 2013, it is still ridiculously cheap. I have refreshed the EV/FCF/G fair value analysis based upon my updated NQ financial model (above). As I mentioned in previous articles, most investors believe a high growth company priced at an EV/FCF/G ratio of 1.0 is an extremely compelling buy. Many high growth companies currently trade closer to an EV/FCF/G ratio of 2.0. NQ is currently trading at an EV/FCF/G ratio of just 0.29! If NQ were to trade up to just a ratio of 1.0 (still viewed as an extremely compelling entry point by most growth and GARP investors), NQ would trade at $52.50 today (up 192% from NQ's August 15th closing price).
NQ's stock is going through a typical consolidation process in the $17-$20 range after its quick upward move from the $8-$10 range. Some of the speculative and fast money investors that bought NQ on the Atlantis announcement recently exited or trimmed their holdings. Numerous growth, growth-at-a-reasonable-price (GARP) and institutional investors (both hedge funds and mutual funds) are currently building positions in NQ. NQ spent August 14th and 15th in Boston (headquarters of many mutual funds). The feedback from the mutual fund meetings was extremely positive. Given that NQ's market cap is now $1 billion and trading liquidity is excellent, several mutual funds are in various stages of due diligence or are beginning to build positions. Mutual funds represent the next class of NQ owners and will likely propel NQ's share price higher in the coming weeks.
I will leave you with a quote from co-CEO Omar Khan from the recent 2Q13 conference call. "On last quarter's earnings call I stated that our business development pipeline was strong. I am pleased to report that the pipeline is even stronger today than it was three months ago." In sum, NQ remains a super-compelling, dirt cheap, pure play mobile company with numerous catalysts ahead.