Glu Mobile (NASDAQ:GLUU) is one of the only global pure-plays on social-mobile video games for smartphones, tablets, and Facebook. It is also the #1 video game publisher on Google (NASDAQ:GOOG) Android for 2011. Market cap is roughly $240M (net cash is 17% of market cap) and average daily volume is more than 2M shares per day. GLUU has been a frequent subject of debate on Seeking Alpha but some of the prior comments miss the bigger point. The Zynga (NASDAQ:ZNGA) IPO has increased the attention on PC social games but in the next 3+ years, I believe mobile social will be proven to be a bigger addressable market than PC social (the active installed base of mobile devices is at least 3-4x the size of the active installed base of PCs with far lower penetration rates of smartphones/tablets).
In addition, the mobile opportunity is far less penetrated than social is today. Already today, 23% of worldwide social network users play social games. This number will inch higher in the years ahead but the low hanging fruit is largely gone. On the other hand, mobile penetration is still in the low single digits. More importantly, Google's Android installed base is now bigger than Apple's (NASDAQ:AAPL) iOS and is growing at a faster rate. While Apple was the first mover in allowing developers to reach a global audience via the iTunes app store, the Android opportunity is now a bigger, and largely untapped addressable market. The Amazon (NASDAQ:AMZN) Kindle Fire is on track to sell more than 4M units this quarter alone and along with new models, could easily take more than 20% of the available tablet market share in 2012. Amazon largely hides Android from the everyday consumer, but the platform and current apps are 100% Android.
Android Top 100 Grossing Apps (as of 12/6/11):
#5 Zynga Poker
#7 Glu Mobile Blood and Glory
#17 Glu Mobile Blood and Glory Not Rated Version
#23 Glu Mobile Big Time Gangsta
#31 Glu Mobile Contract Killer
#34 Glu Mobile Contract Killer Zombies
#42 Glu Mobile Contract Killer Zombies Not Rated Version
#62 Glu Mobile Bug Village
#95 Glu Mobile Gun Bros
#96 Glu Mobile Eternity Warriors
As you can see from the table above, Glu Mobile makes more money on Android that Zynga does.
So what does this mean for the stock?
First, the M&A angle... In a prior post on Seeking Alpha, a contributor discussing GLUU stated "the going M&A rate for mobile game developers with material revenue is 3-5x revenue." This statement is completely incorrect. If you look at comparable transactions including DeNA-ngmoco and most recently Electronic Arts (ERTS)-PopCap, acquisitions in the space for companies with scale have averaged 10x next-gen revenue (Electronic Arts' purchase price of PopCap must be adjusted to include the massive earn-outs). Even if you cut the multiple in half simply to be conservative, 5x CY12 EV/next-gen revenue for GLUU would equate to $6.00 per share. Note that this analysis values the legacy feature phone business at zero. If one were to apply the same take-out multiple as comparable transactions such as ngmoco and PopCap, 10x equates to $12-13 per GLUU share. It is also helpful to think about GLUU relative to private company valuations in the space. Just ask yourself this question, what valuation would a venture firm place on a company with #1 market share on Android, with a defensible niche in hard-core games (far more differentiated than casual titles), at the front-end of a multi-year Android adoption and monetization cycle? Perhaps this is why Glu's shareholder list still includes New Enterprise Associates (NEA) and other prominent VCs. Note that on December 8th Google announced on its Android developers blog that Android app downloads have reached 10 billion and are now growing by an incremental 1 billion every month.
That same prior post also argues that Zynga is not acquisitive and would not do a deal as large as GLUU. This also is incorrect. It was widely reported that Zynga was the #2 bidder versus Electronic Arts in the $1.3 billion PopCap sale process. More recently, the New York Times has reported that Zynga bid $2.25 billion for Rovio, owner of the Angry Birds franchise.
Zynga is about to be valued at more than $10 billion (post the IPO) and will be armed with both cash and stock to use as currency for M&A. Zynga is incredibly strong at casual titles but has a significant product hole in the hard core genre. They made an attempt to buy PopCap for more than $1 BN and lost to Electronic Arts. Now they lost a bid for Rovio. Is it really so far-fetched that they would consider acquiring GLUU? This market is evolving rapidly, network effects matter, and there simply aren't many quality assets that add developer talent, global carrier relationships, and scale.
But where does this stock go in the absence of M&A?
Based on consensus estimates for revenue of 128M in CY13 and a 12-13% operating margin (well below the company's long-term target for 20-25%), GLUU could easily earn $0.20 per share in EPS for CY13 (FCF per share should be similar). Applying a 30x multiple (well below the consensus estimate for 50%+ revenue growth rate for CY13) also implies a price target of $6.00. If GLUU were to reach its 25% operating margin target sooner than expected, EPS would be more than $0.40. Coincidentally, that same 30x multiple applied to $0.40 in EPS would equate to $12 per GLUU share, roughly the same valuation as in the M&A scenario based on CY12 estimates (even without assuming any revenue synergies in a market where network effects are proven to matter). This is worth noting as in an M&A transaction, an acquirer would be able to generate 20-25% operating margins simply by eliminating GLUU's G&A expense, which runs at roughly 15% of revenue.
In conclusion, while the Zynga IPO is likely to attract the most attention this month, this is but one step in the longer-term trajectory of GLUU as Android continues to gain share, Android monetization enjoys a step function higher, and GLUU's growing studio talent releases a record number of high quality, freemium social/mobile games. This should be $5.00-6.00 stock even in the absence of an acquisition.