Let's Begin with the KING IPO
With yet another gaming app company-King Digital Entertainment (NYSE:KING) of Candy Crush Saga fame-filing for an IPO today, it's time to take a good look at the mobile gaming niche. If you want to see a sector that makes no sense, look no further than mobile gaming. It is often said these days that investing in the conventional markets in general is like rolling the dice on Fed policy, but that notwithstanding, some of these stocks behave so erratically and out of phase with any intuitively sensical metric that investing in them really does seem to be nothing more than a crap shoot. As appropriate as that may be for a gaming company, it is not exactly the bedrock of sound portfolio planning. Those interested in taking a stake in KING or other mobile gaming stocks should not expect anything less than a Vegas thrill.
In this article I will point to a few fitting examples, explain why there is such randomness in these stocks, and then turn it around a bit to make the case for what I believe to be the key for stability in the gaming app industry. That is, gaming apps with objective service value, closing off with the newcomer to this space, Glassesoff (OTCQB:GLSO).
Two stocks with virtually incomprehensible price movements are gaming companies Electronic Arts and Activision. That is not to say that the companies are failures. It is more complicated than simply sticking an F on their report cards. Let's start with EA. It's been trading since 1990, beginning its long history with now classic gaming consoles like the Super Nintendo, what some of us remember by its acronym SNES. I still remember the classic opening tag line to so many SNES games 20 years ago. "EA Sports - It's in the game." Classic. A company decades old cannot be considered a total failure, but consider this: retained earnings since inception are actually negative $338M. Despite all the equity raised and the 30x stock gains since its IPO way back then, the company is net negative, and the stock is now at post Great Recession highs. Make sense?
It gets weirder though. EA price movement since 2011 is baffling. From the end of Q1 2011 to end of Q1 2013, yearly earnings rose from a $276M loss to a $98M gain. One would expect the stock price to sort of reflect a company going from a huge loss to a modest gain over those two years, but it went nowhere. In fact, as it was pulling out of that net loss in 2012, the stock was at historic 10 year lows. The cherry on top is that, with EA now finally clawing back to post 2008 highs, the company is reporting large consecutive quarterly losses of over half a billion dollars.
And what about Activision? The company had a huge earnings bump of 160% year over year by the end of 2011, and yet its stock price went nowhere that year and was actually down in 2012. But since then ATVI has been great. Why? In 2013, earnings were up only 6% year over year. But the stock is up almost 100% since then. And over the long term, ATVI is up "only" 23x since IPO in comparison to EA's 30x, and it has retained earnings of over $2.5B. So why in the world has a gaming company that has lost money on net balance had 7x more capital gains than a gaming company that has made over $2.5B? Cue Twilight Zone music.
King could end up fitting into either of these categories: A company at a net loss like EA with a 30x gain over the next 20 years whose stock rises when earnings shrink and falls when earnings skyrocket. Or it could end up like Activision, a company that actually makes money on net balance but whose stock only moves up when earnings are flat and moves down when earnings skyrocket. Or King of Candy Crush could end up like Zynga (NASDAQ:ZNGA) of Farmville and just spin its wheels and go nowhere. Maybe there's a game app for that too.
I believe King will end up just like Zynga or worse, as King is allowing its Candy Crush success to go to its head. Both EA and Activision have deep roots in the gaming sector that don't just involve mobile apps and they won't burn out so easily. But as for King, according to the Reuters article linked above, Candy Crush makes up an estimated 78% of its annual revenue of $1.9M, the company is expecting "a multibillion dollar valuation" for its IPO, its ticker will be KING, and it has actually made a move to trademark the word "candy". This reminds me of when Zynga got drunk on its own initial success and acquired OMGPOP for $200M, which turned out to be a big OMGFLOP. Will King's growth strategy involve simply suing anyone who uses the word "candy" in a marketing campaign and collecting royalties?
The Fad Factor and No Entry Barrier
How can these strange stock movements be explained? "Game Theory", pun intended, or more accurately, the Butterfly Effect, chaos theory, and lack of barrier to entry. Stocks tend to move similarly to how their underlying goods and services move. Therefore, gaming stocks tend to move much like the games themselves - randomly and for seemingly little reason. One day somebody has a great time flinging an angry bird into a wall and passes it on to a friend, and all of the sudden the company makes millions and there is Angry Bird merchandise in every toy store on the planet.
Is Angry Birds really all that fun and amazing? Has Farmville or Candy Crush really changed the face of the universe or enhanced our standard of living? No, these things are fads. They come and go. They are powerful, sweeping, yet unpredictable, and have no underlying objective service value aside from a subjective entertainment experience that could change at any time when people get bored. Just as there is no way to predict if one game will take the world by storm and another will fall on deaf ears, there is no way to predict which gaming stock to buy, which to sell, how much and when by any meaningful metric.
As for barrier to entry, perhaps I am only slightly exaggerating when I say these games can be programmed by any small group of teenage whiz kids in a garage and uploaded to the Apple App Store. If every time a mobile gaming app catches a viral wave we get a new IPO, the NASDAQ is going to be a pretty wild party by the end of the decade.
And yes, it is certainly true that revenue from mobile apps is growing by leaps and bounds, see chart below. No one disputes that. But given the chaotic nature of specific fads, lack of objective service value and the lack of barrier to entry into this industry, it is impossible to make a solid investment conclusion based on the sole fact of an obviously growing market.
Uniting the Viral Power of Gaming Fads with Objective Service Value
Yet, there is something incredibly powerful about the way an app spreads when it's really on fire, the way the whole technological world can be captivated in a matter of weeks by a game. In order to achieve stability in the app world, what is needed is to unite viral potential with objective service value. One great and recent example of this is Waze. Google acquired this Israeli company based on a single app for $966M in July 2013. Unlike Zynga's ill-fated acquisition of OMGPOP for $200M for a few games, Waze actually provides a real service that can be objectively measured outside of an individual consumer's mind. It helps people find the best route to work, contributing greatly to evening out traffic patterns and increasing efficiency on the roads. The need to get around traffic and get places faster is not just some fad. It is something that consumers will always need to do, at least for the foreseeable future. Waze is not exactly a game, but it can be seen as a sort of real life game with users trying to get to their destination faster and avoid traffic jams in real time.
Glassesoff and Vision Improvement Game Apps
And here we come to a new phenomenon in mobile gaming apps: medically relevant games. Here I am referring to another app company called Glassesoff, which has come out with the new concept of an app that can eliminate the need for reading glasses in the estimated 1 billion presbyopes on the planet. Presbyopia may sound like an exotic disease, but it occurs in just about everyone in their 40's and older when they can no longer read without reading glasses.
Before dismissing the idea of an app that claims to "improve vision" though a few visual exercise games, it is critical to understand exactly what Glassesoff is claiming about its app. Specifically, Glassesoff does not claim that the app will actually improve the eye's ability to focus on words at shorter distances, but rather to improve the brain's ability to process and interpret the images that the eye captures.
The difference is crucial and can be demonstrated easily enough. Watch this video of a spinning spiral for 30 seconds, staring at the center. Then look away and you'll notice everything around you is strangely amorphous and wavy for several seconds. This is not because your eye has changed, but rather because your brain did a visual spinning exercise and got accustomed to seeing spinning things. It then proceeds to interpret everything else as spinning for a few seconds.
Same concept here. The Glassesoff app attempts to reprogram the brain, not the eye, through visual exercises. The difference is crucial for another reason, and that is that in the past, companies have made claims of vision improvement through certain exercise programs that claimed to actually improve eye acuity. The most infamous case was the See Clearly Method, which was shut down in 2006. This happened in part because the academic community shunned the See Clearly Method and refused to publish any studies involving it, as it was making impossible physiological claims about the eye itself. This is not the case with the science behind Glassesoff, which is backed up with peer-reviewed academic research from respected journals.
Most notably, a thorough study was conducted at UC Berkeley and published in the journal Nature. The hypothesis, tested on 30 presbyopes, was that if neural signals from a blurred reading image could be boosted or used more efficiently by the brain, it may be possible to overcome or delay the effects of presbyopia. The results, consistent with previous studies as noted by Nature, showed that perceptual learning, or in other words visual games, can improve visual acuity and "in some cases result in performance levels similar to the young control group." Most importantly, the study notes, "Our study is the first to show conclusively that these improvements are not due to improved optical performance of the eye."
The app has only been available in the Apple App Store since December 2013, so this is brand new. The technology is patented with a license from Revitalvision, and the program involves three 12-minute sessions per week for a period of three months, followed by maintenance exercises.
I don't expect Glassesoff to suddenly grow into a sprawling behemoth because of one app. Nevertheless, the potential market is enormous as everyone in their 40's and older has presbyopia, and if it works and word starts spreading, Glassesoff is the perfect combination of mobile gaming with objective service value. It is possible that Glassesoff may have to tweak its business plan to the "freemium" model like Candy Crush or perhaps make the exercises more game-like with levels, points, players and the like, building up the viral potential. But much like Waze caught the attention of Google, some big fish may just take a closer look at Glassesoff if and when it starts to spread.