in Mobile Gaming

G5 Entertainment: Encouraging outlook and valuation

G5 Entertainment’s Q1 2011 result offered few surprises and was in-line with the company’s guidance. Furthermore, the company decided to leave its FY 2011 guidance unchanged, including revenue of SEK 45m, EBIT of SEK 16m and EPS of SEK 1.9. However, in its outlook statement G5 Entertainment states that: “…the probability of raising the forecast in the following months increased, as the group has prepared a strong line-up of new game releases for the rest of the year. The management will update the forecast for the full year after the end of Q2 – in the beginning of July”

G5 Entertainment has contracts with more than 15 of the leading casual game development studios from around the world and is working on bringing their games to the market. “Romance of Rome” is one of these examples which was published by G5 for iPhone and iPad under license from Awem Studios and the iPad version of the game became Top 10 Grossing Game in 32 countries, including USA and major EUR countries. Looking at Awem Studios portfolio of casual games for the PC, there seems plenty of additional Top-10 potential left for the iOS markets. Simultaneously, G5 Entertainment is working on a number of original proprietary games for release during 2011. Starting May, G5 is going to be releasing new games regularly, on average one per week further emphasizing its ambition to release 80 games during 2011 (compared to 27 games during 2010).

Rightly so, the G5 Entertainment share jumped some 10% during the week and is now trading around SEK 23 , implying a PER of 12x 2011 EPS guidance of SEK 1.90.  At an implied EPS growth of 90% compared to 2010, G5 Entertainments share is trading at a PEG of 0.13…

Personally, I think the market should be willing to pay PE-ratios of >30 for a fast and profitable growth story like G5 Entertainment but the company is still too small and unknown to get this kind of valuation (fundamentally, it is more than justified). An example from the academic world further illustrates my point: By modifying the Gordon growth model, one can get a formula for what a justified PER for a given investment should be:

PER= (1-g/ROE)/(WACC-g)*100

Applying this method and VERY conservative assumptions, I get a justified PER of 17x for G5 Entertainment.

My assumptions: ROE of 55%, a WACC of 10,25 and a growth rate of 5%..

Again, I do believe these assumptions are too conservative but even with these cautious estimates, the justified PER is more than 40% above the current valuation.

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