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Gravity Inc (GRVY: 1.82 0.00%) has recently dropped below $2 again but the recently released 2009 annual report shows improvement in the business which should in fact only add to the intrinsic value, so ignoring the price and volatility, let’s take a look at the business.

If you’re catching up on Gravity, the company develops MMORPG (Massively multiplayer online role-playing games). GRVY developed and released Ragnarok Online in 2001 which I will just refer to as RO. Other titles include Emil Chronicle Online and other minor games.

For more details and background info, there is a healthy and intelligent discussion in the GRVY discussion board.

Gravity has been a part of the Old School Portfolio since the end of 2009. It is a young position, but has plenty of potential.

Another Delay

Earlier in the quarter, GRVY revealed yet another delay to the release of RO2. This time, RO2 is expected to be released during Q4 of 2010.

The company isn’t covered by any analyst so the news didn’t send the stock rocketing down, but the fact is that RO2 has been in beta testing since May 2007 and there have been multiple delays. It will be more than 3 years since beta testing when the game finally launches.

The schedule for the launch of Ragnarok Online II, a sequel to Ragnarok Online and massively multiplayer online role playing game (“MMORPG”), has been delayed to the fourth quarter of 2010. Ragnarok Online II was originally scheduled to launch in the first half of 2010; However, Gravity has decided to postpone the schedule to the fourth quarter of 2010 in order to make the game better. The Company is planning to start commercial service of Ragnarok Online II in Korea in the fourth quarter of 2010 followed later by the other territories where Gravity has already entered into license and distribution agreements. The Company has been conducting open beta testing of Ragnarok Online II since May 2007 and continues to upgrade and develop the game in response to market feedback received during the testing phase. “The launch of Ragnarok Online II has been delayed on a number of occasions but we don’t want to launch it before it is ready and want to ensure that it meets the expectations of our players as well as those of our own.” commented Mr. Toshiro Ohno, the President and CEO of Gravity. “We will continue to refine Ragnarok Online II and look forward to providing our users with a high-quality experience.”

This is the main reason why GRVY is trading at ridiculous levels. The market is impatient and it wants to see results now. Mr Market won’t stick around to see how things will progress.

However, I do like some certain statements in this press release.

GRVY plans to start commercial service in Korea in Q4 of 2010 and the fact that they have already entered into license and distribution agreements in other territories, i.e. other countries, is huge.

It means that the agreements must have been met and I’m sure GRVY does not want any further nagging, messy lawsuits related to license and distribution agreements.

Another confirmation derived from the statement is that future revenues are set. Expect to see royalties and licensing fees in the future. The numbers won’t materialize until 2011 but future revenues have already been signed for.

I don’t like delays and just like anybody else, I hope to see results quickly, but patience is the key here. Some call GRVY a value trap and I don’t blame them. But ignore stock fluctuations for a second and look at the value + potential value and the opportunity is striking.

Dependency on Ragnarok Online

The company clearly knows that the dependence on RO as its main revenue source is risky and I was pleased to see that they are trying to address this. The 2009 annual report includes a new short paragraph outlining additions to their business strategy.

Having strong global network and success from Ragnarok OnlineTM, the Company is expanding its business areas from online game development and publishing to cultural contents industry based on various platforms, such as animation, game character merchandising, development of console games and IPTV games.

Since designers work to produce game animations, it’s pretty clear that they can apply those skills to produce animation and other forms of art. I’m no artist but I have used and seen many design tools and know that the same software is applied for many gaming and visual animations.

Asset Valuation

Using a conversion rate of KRW 1,163.65 to US$1.00 as stated in the document, I get the following NCAV and NNWC numbers.

Running it through my stock valuation tools [click to enlarge]:

But GRVY has a lot of long-term available-for-sale securities on its balance sheet. About $4.1m was impaired but the remaining is still as good as cash. The total amount of these investments comes out to be about $9.39m which will increase the NNWC from $1.58 to $1.92.

At $1.92, the current price is 5% below NNWC. Ignore NCAV in the second image because long-term available-for-sale securities is under long term assets, not current assets.

Now, looking at the numbers above and at the points below, does GRVY look like a company that is about to declare bankruptcy?

  • Revenues increased 4.7% compared to 2008
  • Royalties and licensing fees increased 13.6%. This will only continue to increase when RO2 is launched
  • Korean RO subscriptions decreased 36%
  • Reduced expenses and SG&A in hard times
  • Company is profitable at the top and bottom line
  • Gaming margins are fantastic
  • Consistent revenue business model
  • Has been collecting receivables consistently, which again emphasizes the profitable business model
  • Received a huge advance of $1.6m compared to $60k in 2008. Most likely from the license agreements.

These are just a few points gathered as I read the report but there is no possible way that GRVY is going bankrupt anytime soon.

Disclosure: I own GRVY at the time of writing.

Source: Patience Is Key for Gravity Investors