Since 1996, I have tripled my money every three years or so, on average. In 2009, I started sharing my Wall Street expertise with Main Street investors. That led to the creation of my popular "Poised To Triple" series on Seeking Alpha, along with the founding of PTT Research.
On Tuesday morning, B. Riley downgraded GLUU Neutral on the basis of valuation and the possibility that the U.S. release of Eternity Warriors 3 might be delayed. In this article, I will discuss why both reasons are shortsighted and threaten to leave B. Riley (and investors) behind as the GLUU train leaves the station.
First of all, B. Riley had/has a $4.25 price target on GLUU. To downgrade the stock simply because it is getting close to one's target price seems ill-conceived. If for no other reason, downgrading a stock so close to year-end is a sure-fire way to anger institutional clients. It impacts their bonuses at a time when many are away for the holidays.
Of course, if the stock should be downgraded, the move is justified. However, a price target should at least be achieved before a downgrade is even considered. More importantly, strong stock performance should spur a fundamental review to ensure that the stock's momentum isn't based on a fundamental shift in the company's fortunes (which I believe to be the case for GLUU).
Specifically, Glu has completed a total renovation of one of its major historical strategic weaknesses (monetization). Of equal importance, the company has converted that historical weakness into a major strategic competitive advantage (strength).
Comparing the positive weight of this change to the negative weight of a possible game delay is like putting an elephant on one side of a see-saw and a mouse on the other.
Speaking of the possible delay of EW3, it is my long-held belief that selling a gaming stock on the basis of a game delay is almost always shortsighted -- a quick trade. This is due to my equally long-held belief that game releases are merely tactical reasons to own a gaming stock. While it's true that gaming stocks rise and fall with the success of individual blockbusters, the true lasting value of a gaming company is in its strategic (or core) strengths and weaknesses.
Individual events with no lasting impact should generally be ignored. The only exception is if it's a sign that the company has a permanently-impaired ability to develop games in a timely fashion.
That is not the case here.
For GLUU, recent delays have served to increase the revenue profiles for the titles in question. Thus, I believe that delays can be expected to be the norm for GLUU going forward. The reason is that management astutely recognizes the ROI associated with delaying a game to enhance its long-term monetization/value.
For proof of this, I submit the following fact -- Eternity Warriors 3 has already been released… in Canada, in early November. Thus, a logical person should conclude that a U.S. delay is intentional on the part of GLUU management.
Further, the only logical reason for this is to forego X revenues today for much more than X revenues tomorrow. Considering what their monetization platform has enabled to date (a roughly 50% uplift in the typical game's revenue generation), such decisions are no-brainers. They should be applauded, not penalized.
In summary, I believe that GLUU's new monetization capabilities will drive at least 50% more revenue on a per-game basis than it could generate in the past. This is a tectonic shift. Not only does it significantly enhance the company's revenue growth profile, it instantly transforms it from one that struggled with -20% operating margins in 2012 to one that can feasibly operate with +20% operating margins.
Monetization Analysis (FY2012)
Cost of Revenue
Selling General and Administrative
Total Operating Expenses
Operating Income or Loss
For the stock, the implications of this cannot be understated. Despite delivering poor operating margins in 2012, GLUU grew its revenues by 46%. For the next several years, the mobile gaming market is expected to grow at a rate of 35% annually. Simultaneously, GLUU has solidified itself as one of the leaders in this consolidating market.
In consolidating markets, leaders tend to grow faster than the market rate, not slower. Yet, Wall Street only expects 19% growth for GLUU in 2014.
So, which of these figures seem off?
Clearly, 19% makes no sense. The reason for such a low estimate is easy to explain -- Wall Street's estimates are guided by GLUU management (which has a history of conservatism with Wall Street).
If the market grows at 35%, a leader like GLUU should deliver growth well in excess of 19%. Something closer to the market rate of 35% is more likely. Further, a return to 46% growth should be viewed as feasible (and this doesn't address GLUU's opportunity to grow even faster by acquiring talented-but-monetization-challenged game development houses).
For the sake of this discussion, I'll split the difference, truncate, and use a 30% growth estimate.
20% operating margins generate a fully-taxed EPS margin of 12%. By my calculation, a company with GLUU's profile, generating 30% revenue growth and 12% EPS margins, should be valued at 3.6x forward revenues + the value of its excess net tangible assets.
For GLUU, 3.6x forward revenues = $440 million (using Wall Street's estimates, which are low in my opinion). Considering its shifting profitability profile, GLUU's tax assets should be counted among its tangible assets, giving it $70 million in total net tangible assets.
$440 million + $70 million = $510 million = $6.50 per share. If we account for the impact of 30% growth on revenues (which we should), the current valuation goes to $7.11.
This is what I believe GLUU is worth today.
One year from now, I believe the company will be 30% larger, with more assets, leading to a valuation of close to $10, which is why I introduced the company as being poised to triple when it was $3.20 per share.
This is my base-case scenario. However, I believe that the company is quite capable of exceeding the market growth rate organically. It could even return to its 2012 growth rate of 46%. Inorganically, it could begin acquiring talented development shops that don't have GLUU's scale or monetization capabilities, in which case GLUU's growth could accelerate to a number in excess of 50%. Throw in the possibility of a real blockbuster (I don't believe Deer Hunter 2014 should be considered one) and we have several ways that GLUU's valuation could go parabolic.
As I've stated before, leading video game companies (like Activision Blizzard Inc. (ATVI) and Electronic Arts Inc. (EA)) often achieve $10-20 billion valuations. Secondary players (like Zynga (ZNGA) and THQ Inc.) often achieve $2-4 billion valuations. GLUU's valuation is currently $300 million, giving it very real shot at becoming a 10-bagger ($3 billion) and an outside chance at becoming a 50-bagger ($15 billion). Remember, all companies start with a $0 valuation. ATVI and EA were no exception and THQI was a 240-bagger before its collapse.
Thus, we have a company that is reasonably worth over $7 per share that should soon be worth more than $10. We also have a company that has a chance of eventually reaching $40 or even $200 per share. In my circles, we call that a "home run with a free explosive call option" - a winning investment with the potential to be a game-changing investment, without a commensurate level of risk.
As I've said to dozens of investors in recent weeks, the GLUU story isn't about Deer Hunter, Eternity Warriors 3, or any other game in their arsenal. It's about the monetization platform. Period. If that stops working, then we have a problem. Based on the platform's accelerating success, I don't see that happening.
I've seen this scenario play out many times with my picks to triple. In almost every case, share-price pullbacks driven by misguided analyst downgrades prove to be opportunities to buy, not sell.
In other words, shares of GLUU remain poised to triple.