Glu Mobile (GLUU) is one of the world's leading vendors of video games for mobile devices. Back in July, I told investors that GLUU had the opportunity to capitalize on this mega-trend. However, after bursting onto the scene during mobile gaming's novelty phase, GLUU and its larger competitor Zynga (ZNGA) suffered as hundreds of competitors flooded the market with games. Nobody could turn a profit.
Because of this, I did not make GLUU an official Poised to Triple portfolio pick at the time. The company needed to do something about its future profitability first.
After several quarters of R&D investment, I now believe they have.
The first thing they did was to hire Chris Akhavan. Akhavan is a mobile advertising rock star who worked for the highly-successful company, Tapjoy. With Akhavan on board, they set out to increase the amount of money they could generate from each game. They cut out middle men and formed direct relationships with dozens of top advertisers.
If you want all of the details, there's an article by Brandon Osborne on Seeking Alpha that I endorse. For the sake of this article, I'm going to keep it simple. Basically, they spent several months and millions of dollars to create a set of processes and technologies to improve their per-game revenue and profits. I'll discuss the results of these efforts in a moment.
While they did this, it's clear to me that GLUU management delayed the release of several new games. This hurt their sales and profitability for a while, but the move made perfect sense. After all, if you had something that you could hold for 6 months and sell for a 40% higher price, why wouldn't you? GLUU understood this concept, but Wall Street didn't like the idea. A few months after my original article, the stock hit a 6-month low of $2.10. This happened despite the fact that GLUU continued to top its EPS estimates while it worked through its growing pains.
As it turns out, GLUU was right.
When GLUU finally completed and tested its new capabilities, they found that it increased the long-term value of one of their games by 41%. It was a good sign of things to come. The tests were followed by the release of Deer Hunter, which quickly became the industry's #1 selling mobile game. On October 30, the company announced earnings and guidance that beat and raised Wall Street expectations.
For the stock, it was a buy the rumor / sell the news event. After ripping up to $4.14 per share, the stock pulled all the way back to $2.98. Short interest has increased, indicating a belief that Deer Hunter was a one-hit wonder. In the video game market (which I have covered since the early 90s), this is usually the right move … but not this time.
I didn't buy GLUU for its Q3 earnings. I bought it because every game GLUU makes from now on should benefit greatly from the investment they made. All the games they delayed will come out and benefit. The company will also benefit from games made by other companies, as GLUU forms partnerships to leverage its money-making techniques. The company will generate revenue in many new ways … and for a long time to come.
Before long, I believe that investors will come to realize that Deer Hunter isn't just a winner - it's the first of many winners to come. The difference is substantial. The stock is only ~25% higher than it was when I wrote my original piece. In my opinion, 25% doesn't begin to reflect what this change is going to do for GLUU's future. In fact, I believe the number should be at least 200%.
That's right - a triple.
With its new-found ability to generate revenue, it will be much easier for GLUU to profit from its games than most any other game maker, in Q4 and beyond.
GLUU will also be able to make better games and still be profitable. This will accelerate the demise of its competitors. I believe that most of them will go out of business. When they do, things will get even better for companies like ZNGA and of course, GLUU. With less competition, they will make more profit in a market that will be bigger than the traditional video game market (because GLUU's games will work on far more devices than any game maker from the past).
In the console market, leading game makers attract market valuations of $20 billion. Over time, I believe ZNGA and GLUU can emerge as the gaming giants for mobile operating systems. Remember, the number of devices running mobile operating systems dwarfs the console market. It is much larger, beginning with 1.5 billion smartphones, tablets, and TVs (not to mention the millions of glasses, watches, automotive displays, etc that will proliferate in the years to come).
Thus, GLUU has an outside chance of eventually becoming as big as Electronic Arts (EA) or even Activision (ATVI). Both of those companies topped out at $20 billion. At present, GLUU's market cap is just over $200 million, so tripling could just be the beginning. It's conceivable that GLUU could triple, triple again, and then triple again.
Things like this are always hard to believe before it happens, but big companies always start as small companies. In fact, my very first triple was a video game company named THQ (back in 1995). After nearly going out of business in the mid-90s, THQ made Brian Farrell its new CEO.
Soon afterward, I interviewed Mr. Farrell (I was an analyst at IDC at the time). I was very impressed. At that point in my career, I had never met an executive as smart as Farrell running a company as small as THQ. I bought the stock immediately. In the years that followed, THQ flourished.
Back in 1995, THQ was about six times smaller than GLUU is today (less than $20 million in revenue). By 2007, they were ten times bigger than GLUU (over $1 billion in revenue). From its low in 1995 to its high in 2007, THQ's market value rose from less than $5 million to over $2.4 billion.
That's a triple followed by a triple followed by a triple followed by a triple followed by a triple … and then a double as a cherry on top.
I think it's safe to say that nobody saw it coming. Keep that in mind.
Also keep in mind that GLUU has a head start over where THQ was in 1995. 2014 estimates call for $122 million in revenue, representing 19% growth. However, the market is forecasted to grow by about 30% for the next several years. Given GLUU's strategic enhancements, I believe the company should gain market share, not lose it. That means that they should grow faster than the market rate of 30%.
40% growth would equate to about $140 million in revenue. Given a PEG ratio of 1, GLUU would sport a market cap of about $580 million … just 20% shy of a triple from current levels.
This growth scenario is not hard to envision. For the past five years, GLUU's growth has been hampered by a dying feature phone business. Excluding that business, GLUU nearly doubled its revenue last year. More importantly, the feature phone business is now contributing less than 15% of its revenue. In other words, that business now has minimal ability to restrain GLUU's progress going forward.
Oh … and there's one more thing. It appears that GLUU will eventually enter the online gambling market. With legislation potentially working in favor of this, the opportunity is enormous and not at all reflected in GLUU's valuation. Also, investors should understand that this isn't just limited to traditional gambling games, like Blackjack. Rather, GLUU could be well-positioned to charge players to enter prize-tournaments on its existing games, like Deer Hunter.
Of course, execution will be critical. Not only must GLUU re-accelerate its growth path, it must also rely on consumers to continue adopting mobile games. With new consoles coming from Microsoft and Sony, gamers might be distracted away from mobile games. However, I think it's more likely that the new console cycle will raise consumers' appetite for games. This will benefit virtually every good video game company, including GLUU.
For the time being, there are still many disbelievers. About 25% of GLUU's float remains short as of October 31, demonstrating very negative investor sentiment. I can understand why. If you judge GLUU based on its past, it's easy to assume that Deer Hunter is just a lucky win.
But this is how shorts get killed.
With continued momentum, I believe that shares of GLUU will rise markedly. If I'm right, short-covering will ensue, giving bullish investors a built-in catalyst for higher share prices.
In conclusion, I applaud GLUU's progress. When I wrote my July report, I wasn't convinced they were poised to triple, but now I am. Accordingly, GLUU is officially being adding to my Core Portfolio -- Indeed, I believe that shares of Glu Mobile are poised to triple.