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Jason Sarasin
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My name is Jason Sarasin and work in the public accounting field. I have been reading and researching on value investing for ten years now but didn't start investing until 2008.
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  • Is a $5 stock selling for under $2?
    I have had an investment in Gravity Co., LTD. (NASDAQ:GRVY) for a year now, and it currently is selling for the same price it was at when I purchased it. The stock is under $2 but I believe its worth over $5 and here are my reasons.
     
    Background
     
    Gravity Co. is basically in the online gaming industry. They are based out of South Korea but have sales in numerous countries. In 2008 Gungho Online Entertainment, Inc. purchased over 50% of the company and is currently running Gravity Co.
     
    Ragnarok Online and Ragnarok Online 2 – Legend of the Second
     
    Gravity’s main game is Ragnarok Online, which is a massive multiplayer online role-playing game (MMORPG) that was released in 2002. Ragnarok Online is one of the most successful MMORPG games in the world. It still has a huge following in various countries including the United States. I advise interested investors to Google “Ragnarok Online”, and you will see what I am talking about.
     
    Ragnarok Online 2 – Legend of the Second is the big catalyst here. It really has been in the works since at the latest 2007. But in late 2009 new management started from scratch and completely changed it. This new version has gone through two beta tests and has received positive feedback. From what I see, gamers are really excited in America for this game. One can’t imagine what the excitement is like in Asia where the game is even more popular. Management has set a release for this game in the second quarter of 2011 which we are currently in now.
     
    Other games:
     
    One of the main reason Gravity Co. has not received the attention it is warranted, is that the majority of it sales are from Ragnarok Online. Under Gung-ho Online Entertainment, Inc. Gravity Co. has really turned the corner and started developing new games. The following are a list of games I know of that either have been released, updated, or are in development. Please notice the majority of releases and updates have occurred in 2010 or 2011.
     
    • Requiem – 5% of total revenue and revenues continue to rise. Big update released in 2011
    • ROSE Online – 1% of revenues and New World was released in 2010
    • Emil Chronicle Online – Over 1% of revenues
    • Estar (tentative title) – In development
    • Canaan – Recently went through beta testing. Not sure if released yet
    • NeoCyon – Various mobile games are released through this subsidiary. Revenues are increasing and multiple news reports have come out of new mobile games. The 2009 revenues were $7 million and according to the unconsolidated report might be up 30%.
    • HAVE Online – Entered into publishing agreement with online game developer to publish game in Korea and Japan. Expected release was third quarter 2010.
    • Dragon Saga – Purchased over 50% from Barunson Interactive for around $10 million. This game was launched in late 2010 with excellent reviews. Hopefully, we will see a nice increase in revenues for the first quarter of 2011 due to this game.
    • War of Gods – Entered into publishing agreement with another company to publish in Korea in late 2010.
    • Weapons of Gods – Entered into publishing agreement with another company to publish in Korea. Expected release is third quarter of 2011.
     
    Warpportal.com
     
    Recently Gravity Co. has started the following website:
     
     
    Basically, you can go to this website and they allow access to a majority of their games right there. Please go and check it out. It looks like they have other games that I haven’t heard anything about.
     
    Financial Reports
     
    Before I discuss the numbers behind Gravity Co, I would like to help interested investor understand what Gravity Co. reports for financial information. Since it’s a foreign company I would not use any of the information from websites like Morningstar.com, etrade and the like. I advise only to go to sec.com/edgar and look at their official filings. Gravity Co. reports an annual report called a 20-F. This can be confusing because they also report unconsolidated reports which do not reflect the correct numbers from their subsidiaries. To add to this confusion, in 2010 they reported a so called consolidated report which only consolidated its purchase with Barunson Interactive. It is important to understand that this Barunson consolidated report does not include consolidated numbers from its other subsidiaries, only Barunson. My analysis in this article is based off of the 2009 20-F, but you will see that I note what is likely to be reported on the 2010 20-F once it comes out.
     
    Balance Sheet
     
    I flat out love Gravity’s balance sheet for two reasons. First, is the obvious cash position and basically no liabilities. As an accountant you rarely see a balance sheet this strong outside of investment companies. The second reason is what this tells me about management. I think the balance sheet is a great way to assess a management’s ability. Gravity’s ability to develop a strong balance sheet to go forward is impressive.
     
    On a valuation stand point I like to add the cash and short-term investments less total liabilities to my FCF valuation. The 2009’s per share amount is $1.70. But I think we need to consider the 2010’s 50% Barunson Interactive purchase price of $10 million. Even though accounting rules should put 50% of any cash on Barunson’s books on Gravity’s balance sheet, I still want to be conservative. So let’s reduce cash by the 10 million and say cash less liabilities is $1.34 per share.
     
    Going Forward: Going forward, the most important thing is that management keeps this strong balance sheet. If you are optimistic like I am, cash flow should stay positive going forward. So the question is what they will do with all their cash. If they keep buying into new games are they going to be successful? Will they buy back more shares? Only time will tell.
     
    Income Statement
     
    The positive on the income statement is the net income they are able to pull from this old Ragnarok Online game. This is mainly due to management’s ability to keep costs down. The not so positive side is that this old game was 74% of the revenues in 2009. This alone will scare most investors away, not to mention 2010 unconsolidated report showing revenues way down from Ragnarok Online. I am ok with this, because if you look at the Barunson consolidate report, once they include the revenues from the subsidiaries not consolidated on this report on the 2010 20-F revenues should be similar to 2009. This is very impressive because the majority of their new games weren’t updated or released until late 2010.
     
    Going Forward: The most important thing to watch on the income statement is revenues. Ragnarok Online revenues are falling, but revenues from other games should be rising. I expect revenues to increase each quarter in 2011. The other thing to watch is how their cost structure will change from all these new games coming out including Ragnarok Online 2.
     
    Cash Flow Statement
     
    Looking at the cash flow statement, the 14 million in cash they received from operations shows a promising future if RO2 is somewhat successful. Remember, the majority of this cash is from an old game with declining revenues. If I subtract capital expenditures and use a conservative multiple of 10, I get an approximate value of $3.96.   Remember Gravity Co. is selling under $2.
     
    Going Forward: I will continue to get my valuation from the cash flow statement and expect cash from operations to increase in 2011. Unfortunately Gravity Co. does not report a cash flow statement on their quarterly reports. So I will have to watch the income statement and cash on the balance sheet carefully each quarter.
     
    I must note that the unconsolidated report does look like the FCF is probably going to be down for 2010. How much I am not sure, but many of the new games did not come out until the end of 2010 and others in 2011. So this is expected with the declining revenues of Ragnarok Online.
     
    Risk of owning a foreign company
     
    Most will ask themselves what is the risk of owning a Korean company. What do I know about the currency risk? What do I know about South Korea’s economy? What if North Korea nukes South Korea? Well, the U.S. is increasing their business with South Korea dramatically. Investors have been investing in South Korea. This is all I need to know, because this should keep the WON strong enough for my investment in Gravity Co. and actually could be a huge catalyst.
     
    Why is it so cheap?
     
    It’s obvious why Gravity Co. is cheap. The majority of its revenue is from one game which is old and declining. RO2 has been in the works for years and there is still no release. Old management was accused of diverting revenues to them, and other litigation issues were charged against old management.
     
    Why I like the delay in RO2 release.
     
    If you have owned this stock you would know its been tough waiting for the release of RO2. Management has delayed the release numerous times. This is fine for me because I compared other similar games and their development timelines. Remember new management started this new version of RO2 in late 2009. So in reality it hasn’t even been two years. The market needs to relax because these games take time. I believe the delays show the strength of new management. They could have easily released a weak game due to the pressures from gamers and investors. But they continue to work on it and make sure they release a successful game. I am fine with this.
     
    Is this value investing?
     
    Now I know many will say this is not true value investing. You are betting on one successful game. I disagree with this because you value a company on FUTURE earnings not past earnings. Gravity Co. has a huge potential in Ragnarok Online. RO2 is going to be very popular with no doubt. These MMOPG games are more like a community of players unlike just a regular video game. Even little success should turn some profit, plus don’t forget the numerous new games recently released or soon to be released and the cash they have to work with.
     
    Valuation
     
    So let’s add the value I get from the balance sheet and cash flow statement together.
     
    $1.34
     3.96
    $5.30
     
    The unconsolidated report looks like the cash on the balance sheet and the cash from operations will be lower. So my above calculation is of course going to go down some but not by much. Still I think the market is too tough on this stock. Even if everything doesn’t turn out like I expect, there are enough things going on where I think they can stay positive in their cash flow. Now if everything turns out like I expect, the $5.30 will be the low point for the valuation of this company.
     
    Catalysts
     
     
    Going forward investors and interested investor need to pay attention to the following:
     
    • Release of RO2 and its success. News could literally come out any day now. But it also could come out days from now. 
    • Every new quarterly report should show us new revenues and income from these new games, especially Dragon Saga.
    • Keep an eye on their cash and short-term investments. What will management do with the excess cash?


    Disclosure: I am long GRVY.
    Tags: GRVY
    May 04 3:09 PM | Link | 2 Comments
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