In recent weeks, the Glu Mobile (GLUU) Deer Hunter 2014 (DH14) mobile game has been all over the news. A PR that Glu issued on September 25th claimed that the game has broken multiple all-time records for the company. Impressive as it is, I think Glu have one more cherry to put on top of the DH14 news. I'm talking about skill-based gambling.
With the recent buzz around the upcoming launch of legal online gambling in the state of New Jersey, I think that the street is underestimating the real growth engine that can propel Glu to become a profitable, growing company.
Setting the Record Straight
I think there is a lot of confusion out there about Glu's online gambling future business. In the past year and a half Glu announced 2 interesting yet different partnerships.
1. The partnership with Probability plc.
2. The partnership with Skillz.
The Probability plc agreement is aimed at the online chance-based gambling market. That means poker, slots, bingo etc. Currently both companies have launched 2 slot games in the UK, and are planning to launch full casino suites that will offer blackjack, roulette and bingo. With the UK being a very competitive online gambling market, Glu is pretty late to that party. Glu CEO Niccolo De Masi commented about this partnership in a Q1-13 earnings call.
"We look forward to further launches later in the later, as we deepen the operating relationship between Glu and Probability. Though expected to have a modest topline impact in 2013, with New Jersey and Nevada now both poised to allow interactive gaming, we see a robust long-term opportunity in the mobile real-money gambling sector."
After a month, during Glu's analyst day Di Masi said the following:
"Let's be honest, no one goes to Nevada to gamble on their phone. They go for a different experience. so you gamble on your phone when you're at home. So to make money in real money gambling, you've got to have New York, Texas, California, these kinds of states have to kind of get knocked over. And I think those are some of the harder ones to actually liberalize because of the different interest that are in there. So our bet in the next two years is going to be on the skill-based cash side."
So, I think it is clear that Glu's online gambling business won't have a substantial effect at least in the next two years or so.
Now, the Skillz partnership is a whole different story. Skillz is a very young company founded in March 2012, which provides a platform for skill-based real cash tournaments. Game developers can implement the Skillz platform in their own games and enable players to enter tournaments in which they will compete against other players for a cash prize. Think of playing DH14, paying $1 to enter a tournament against 100 other players. The player that demonstrates the best skills, in this case fast and accurate hunting, wins the pot. Of course, Glu get their share from the pot just as a casino gets its share from every hand played on a poker table. Currently Glu offer the real cash skill-based tournament feature only on their old Deer Hunter Reloaded game on the Amazon (AMZN) app store. Skill-based cash tournaments are legal in 37 states in the US, and currently the Skillz platform is legal to use only in the US and only in those states. They actually verify your location via GPS before you can play.
Skill-based Gambling: Opportunity Valuation
Intuitively, the opportunity of skill-based gambling sounds very good, but an intelligent investor will have to conduct thorough research to verify his "hunches". I tried to do exactly that and I hope you'll find my insight valuable.
First, we need a base case for comparison. A perfect base case would be another game financial result and metrics before and after the Skillz platform was embedded into it. Unfortunately, Skillz is a private company and doesn't have to release this information. Skillz did make a case study available for download on their website and we can start there. In this case study (3D cave runner) Skillz claim that the inclusion of their platform in this game increased the percentage of paying users to 19%, increased ARPU (average revenue per user) by a factor of 11, the gameplay was 4 times longer, and caused 256% better retention. These are truly amazing figures but we have to take into account that Glu users come from all over the world, and there is a possibility that this is an exaggeration from Skillz.
According to Glu's latest quarterly report, 40.5% of revenue came from the US. Only 37 states in the US allow skill-based gaming (every state except: AZ, AK, CT, DE, FL, IA, LA, MD, MT, SC, SD and TN) so I calculated the number of people eligible to play those games, and their share of the US general population. About 240.5M out of the 313.9M, or 76.6% of the general population live in states where they are eligible to play. Multiplying 40.5% by 76.6% gives us about 31%. That means that 31% of Glu users are eligible to play those skill-based games.
The next step is to understand what the inclusion of the Skillz platform in a new game can do to the revenues it generates. I think the ARPU or ARPDAU (average revenue per daily user) is the relevant metric for this matter. I cut the x11 Skillz ARPU growth factor to x8 just to be conservative as Skillz could easily have over stated that number for their own marketing reasons. To get to an adjusted ARPU growth factor that takes in account the fact that just 31% of Glu users are eligible to enter those real cash tournaments, the following calculation is needed :
We reach the conclusion that the skill-based gaming platform, when embedded into a game, can increase the revenue it generates by a factor of about 3.17. That is remarkable considering that this number doesn't reflect other monetization improvements that Glu is taking with GluOn, or the extra users real cash tournaments can attract. The bottom line is that Glu can increase revenues by about 200% for new games that will utilize Skillz platform.
I think that the adoption of the Skillz platform could make the company profitable quickly. I think that while the market tries to understand where Glu can fit in the new US online gambling market it overlooks the substantial opportunity Glu has with the Skillz platform. With 24 games (a dozen 1st party titles and a dozen 3rd party titled) planned for 2013, and the recent success the company experienced with DH14, with projections for game revenues for Q4 as high as $20M, I think Glu can show sustainable profits in 2014. Glu reports after the market closes on October 30th. After the DH14 numbers are official we can start thinking about forecasts for 2014 revenues and profits. If things develop like I believe they will, Glu Mobile should be worth a lot more than the current $209M market cap. Looking forward to your thoughts.