The Secret Recipe:
- ADR – Small Korean online game development company
- Stock price below $5. “Was” trading below NCAV.
- Dirt cheap fundamentals for a profitable company
- No chance for activism because of 51% owner
- 7+ years of delays for game release
- Catalyst of impending game release
Mix the ingredients together and you get a value investor’s dream dish in the name of Gravity Co (GRVY).
There is no need for me to go over everything again because I’ve written about GRVY numerous times. Several other value investors have also written detailed analysis of the company, see here, here and here.
Right now, I just want to get straight into an updated valuation because YTD, GRVY has shot up 50% with increasing volume and it is a good time to review the probabilities of downside vs upside.
GRVY’s Impending Game Release is a Huge Catalyst
I am still very bullish on the company and the original thesis is still intact. GRVY is set to release the sequel to their blockbuster game after 7 long years of delays, redevelopment and more delays.
Waiting has been difficult because GRVY has a talent for announcing a release date and then delaying the date a month or so before the deadline.
But the company is finally entering their Open Beta test phase on Feb 22, which is a big step from Closed Beta testing and towards commercial launch set for March 2012.
It is one small step for GRVY, but one giant leap for shareholders.
7 years of disappointment and being ignored by Mr Market is about to end.
GRVY offers Downside Protection
For a company that is;
- profitable and FCF positive
- has very little debt
- has plenty of liquid assets and cash
- and has high margins
then the least it should be trading at is book value. With the 50% jump since the beginning of the year, GRVY is now just above tangible book value.
Q4 results are not yet available to dig into, but based on Q3 results,
- NNWC value is $1.50
- NCAV value is $1.78
- Tangible book value is $1.99
- Book value is $3.42
- Current price is $2.15
GRVY offers Upside Potential
The current price still reflects a business that is selling for close to tangible book value.
At the current price, you are getting the portfolio of games, future of RO2 as well as additional revenue streams from licensing to other countries and growing mobile gaming revenue for free.
So what is the upside? Here are a few possible scenarios to consider.
Book value scenario: Suppose the market accepts the fact that the game acquisition prices are fair. Then the stock price should be at least book value instead of tangible book value.
That makes 1x BV = $3.42 a very reasonable target price. There is still 59% upside from today’s price of $2.15 to reach $3.42.
- Zynga (ZNGA) is 11.5x BV
- Glu Mobile (GLUU) is 4.4x BV
- Majesco Entertainment (COOL) is 4.5x BV
- A company like KongZhong (KONG) that is bleeding money is 0.7x BV
If you take time to go through more competitors, you will see that profitable gaming companies tend to trade at about 4x BV. As the other gaming revenues continue bringing in additional revenue and RO2 starts commercial business, there is no reason why GRVY can’t be valued at a paltry 1x or even 1.5x BV.
At 1.5x BV, GRVY would be worth $5.13 which is 140% from today’s price.
EBIT Multiple Scenario: If GRVY has another profitable fourth quarter, my estimate for full year EBIT is $9m.
Based on my rule of thumb, a company like GRVY should be trading at 10x EBIT. On a per share basis, it is worth$3.30, but this value is based on the current EBIT ignoring future revenue increases.
Earnings Multiple Scenario: I’m estimating that fiscal year EPS will be approx $0.30 to $0.32. Again, this is based on pre RO2 revenue. Slap on a multiple of 10x EPS and the target price comes to $3.00 to $3.20.
- Conservative value: $3.00
- Normal value: $5.00
- Aggressive value: $7.00
Not saying that I am going to hold until $7 or even $5 because it all depends on how well the company markets and launches RO2 as well as expanding revenue from its other games. But considering the bigger picture, the easy conclusion is that GRVY is still cheap at $2.15. GRVY is still finger licking good.
Disclosure: Long GRVY at time of writing