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G5 Entertainment: Ahead of Q3 2011 report

On November 15th, it is time for G5 Entertainment to report its Q3 2011 result. As usual, management has already given the market a heads-up with its mid-quarter update statement on October 4th. Therefore, I think we should not be too concerned about the actual Q3 figures. G5’s mid-quarter updates are usually quite accurate and I see no reason why this should be any different this quarter. Consequently, revenue for the period January to September 2011 is likely to be SEK 31.2m while EBIT and EPS are expected to end up around SEK 11m and 1.26 respectively. This forecast corresponds to 112% revenue growth and 88% EBIT growth compared with the same period one year ago.

Also regarding the current guidances regarding full-year 2011 and 2012, I would not expect any major changes. For FY 2011, G5 Entertainment currently guides for revenues of SEK 47m, an EBIT of SEK 16.5m and an EPS of SEK 1.90. For FY 2012, G5 Entertainment’s goal is to reach revenues of SEK 87m, an EBIT of 30m and an EPS of SEK 3.20.

We think it is important to highlight that G5 Entertainment is in an expansion phase. The company tries to exploit the opportunities that the rapidly growing smartphone and tablet markets are offering. This effort is naturally linked to an increased need for investments. This was seen for example in Q2 2011, when cash flow was around a negative SEK 1.2m as G5 boosted its internal development capacity and invested in additional projects and IP rights acquisitions (the Android market was entered in Q2 2011, as an example). Total cash reserves at the end of Q2 2011 amounted to almost SEK 7m so the company has plenty of reserves and as a shareholder I really want to see that they put this money to work and not keep it in the bank account. Neither would I want to see any dividends any time soon. G5 Entertainment is a fast growing company in a fast growing industry. To start distributing cash back to shareholders would be the same as acknowledging that they do not know how to expand any further. I am pretty sure they know quite well!

G5 Entertainment’s management aims to “maintain the balance between having sufficient cash reserves and actively investing for higher growth” going forward. I can easily live with a few more quarters of negative cash flow if it is due to an increased expansion rate.  A good measure for this are the capitalized development costs for their games. G5 Entertainment activates these costs during the quarter they occur, i.e. when the game is developed. The more games developed, the higher the capitalized development costs will be.  The capitalized development costs for the game are then evenly depreciated over 2 years following the day of the commercial release of the game. We know from examples like Supermarket Mania, that the games sell much longer than only 2 years which leads to a nice earnings booster once the game is fully depreciated.

We at Nordic Investor believe that the focus in the report will be on general comments regarding the development of the busines such as download activity on the different platforms, number of developer partnerships etc. Judging from recent download-statistics (check out www.g5info.se for a daily updated overview) G5’s Android business is developing particularly well so we would not be surprised by bullish comments from managment regarding this matter.

If G5 Entertainment was to deliver on its guidance, the share looks extremely cheap. Apparently, insiders think so too as they have increased their holdings in recent weeks.

I am long G5 Entertainment and you should be too.

Nordic Investor

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