in Mobile Gaming

#Glu Mobile: Takeover imminent? Share continues to climb

Glu Mobile shares are trading sharply higher Wednesday on what appears to be speculation that the mobile gaming company could be a takeover target.

Last Friday, the stock spiked 21% after Needham analyst Sean McGowan picked up coverage of the mobile gaming company with a Strong Buy rating, asserting that the stock, then trading at USD 4, could double to USD 8. ““We believe GLUU’s smart phone growth has been hidden in recent years by the decline of its feature phone revenue, but its new model is based on owned-IP, which is far more profitable,” he wrote. “As the global installed base of smart phones and tablets grows and GLUU’s low-margin feature phone revenues burn off, we expect significant gains in profitability.”  The stock sagged Monday and Tuesday as investors took some profits. But GLUU is revving up again this morning, perhaps in part due to a Seeking Alpha piece posted yesterday by an investor named Chris Katje which asserts that the company is “now the biggest acquisition target in the gaming market.”

Meanwhile, Northland Capital Markets analyst Darren Aftahi this morning repeated his Outperform rating and $7 target on the stock, which he notes is trading at a huge valuation discount to Zynga by most measures. He also notes that the company now has 9 of the top 100 games for the iPad market in China – and that China has now eclipsed the U.S. as the world’s largest market for free apps for the iPa

Glu Mobile’s management is interestingly leaving the door open for speculations. While not commenting officially, CEO Niccolo de Masi stated in an email: ” As a public company, Glu’s policy is to not comment on takeover speculation. Our management team and board are fully aligned with our shareholders and would recommend an offer for the company at the right premium.”

Even Bloomberg is writing about speculations today that “Glu Mobile could be the next target in the USD 7 billion mobile gaming industry after deals for OMGPOP, Playdom Inc., PopCap Games and Playfish Inc. in the last three years, said Canaccord Financial Inc. While Glu Mobile has slumped 61 percent since its 2007 initial public offering, the company is projected to post its first profit by 2014 as it transitions to so-called freemium games that are downloaded at no cost and then charge for extra features. The company may lure interest from Zynga, Electronic Arts Inc. or DeNA Co. and fetch more than $6 a share, said Roth Capital Partners LLC, a 34 percent premium.

 “They happen to be in the right space at the right time,” Daniel Niles, senior portfolio manager at AlphaOne Capital Partners LLC, which owns shares of Glu Mobile and Zynga, said in an interview from San Francisco. “If you’re looking at this and saying ‘I know I need to get into the freemium business, and I’d like exposure to the fastest growing pieces of that — which are the guys that produce stuff for cell phones and tablets,’ this is a logical candidate that’s also not that expensive.”

Adam Isserlis, a spokesman for San Francisco-based Zynga, and John Reseburg, a spokesman for Redwood City, California- based Electronic Arts, declined to comment on whether the companies are considering bids for Glu Mobile. Sibel Sunar, a spokeswoman for Tokyo-based DeNA in Los Angeles, didn’t return phone calls or e-mails requesting comment.

Founded in 2001, Glu Mobile began generating the majority of revenue from smartphone games last year and forecasts that the category will make up as much as 88 percent of 2012 sales. In 2010 the company shifted to the freemium model, which allows users to download games for free and then makes money from micro-transactions for virtual goods and in-game advertising.  Glu Mobile, which bought developers Griptonite Inc. and Blammo Games Inc. last year, offers social mobile games from “Deer Hunter Challenge” to “Stardom: The A-List” and also partners with Activision Blizzard Inc. (ATVI) and News Corp.’s Fox on games such as “Guitar Hero: Warriors of Rock Mobile” and “Family Guy: Uncensored.”

The global mobile game market reached about $7 billion in revenue in 2010, according to Technavio, a market research firm in Elmhurst, Illinois. The U.S. portion of the mobile gaming industry expanded 29 percent in the fourth quarter of 2011 from a year earlier, becoming the fastest-growing category of gaming purchases, based on data from NPD Group Inc., a Port Washington, New York-based market research firm. In the same period, 81 percent of mobile game applications were downloaded at no charge, according to NPD. “Mobile has become larger, so the market potential has expanded dramatically,” Michael Mahoney, senior managing director at Falcon Point Capital LLC in San Francisco, said in a phone interview. “Fundamentally, two things are very valuable: a distribution platform and some ability to produce hits. Not many companies have that.”

Glu Mobile said its freemium games for smartphones and tablet computers are up against offerings from public companies such as Zynga, DeNA, Gree Inc. and Tencent Holdings Ltd. Glu Mobile said it also competes for consumer spending with premium mobile games from Activision, Electronic Arts, Gameloft SA (GFT) and Take-Two Interactive Software Inc. (TTWO), according to its annual regulatory filing.  Glu Mobile’s revenue is projected to reach $123 million in 2013, based on analysts’ estimates compiled by Bloomberg, 86 percent higher than in 2011. That’s a steeper increase than every company Glu Mobile lists as a competitor except for Tokyo- based Gree, the data show. However, it is a notch below the expected revenue growth for G5 Entertainment, our top-pick.

Bloomberg writes: ” While Glu Mobile is the second-most expensive among its global competitors at 3.9 times sales in the last 12 months, its price-to-sales multiple drops to 2.3 relative to 2013 revenue, based on yesterday’s closing price, data compiled by Bloomberg show. That’s less than the group average of 2.9 times 2013 sales and Zynga’s ratio of 5.6.”  “Considering the growth rates, it’s not that expensive,” Adam Krejcik, an analyst at Roth Capital in Newport Beach, California, said in a phone interview. “Especially if you compare it to the likes of Zynga.”  “There’s no reason for Glu Mobile to trade at a discount to Zynga and historic takeover multiples in the industry of 6 times to 7 times revenue“, Michael Graham, a New York-based analyst at Canaccord, said in a phone interview.

Zynga, the biggest maker of social games, said last week it acquired New York-based OMGPOP, whose “Draw Something” game has 27.8 million monthly users on Facebook Inc., according to the website AppData. OMGPOP also introduced a mobile version last month that’s the most popular program in Cupertino, California-based Apple Inc.’s App Store. Zynga is trying to reduce its reliance on Menlo Park, California-based Facebook, which accounts for more than 90 percent of its sales.   OMGPOP was the latest in a wave of mobile and social gaming takeovers in the last two years. Electronic Arts in 2009 bought Playfish, with games such as “Pet Society” that are played on Facebook, and last year acquired PopCap, the publisher of “Plants vs. Zombies” and other games for cell phones and social networking websites. Walt Disney Co. (DIS) purchased social-game maker Playdom in 2010 and last year took an accounting charge related to the deal and posted an operating loss in its interactive unit.

Glu Mobile introduced 20 new titles last year, eight of which the company considered “successful,” CEO de Masi said on a Feb. 7 earnings conference call. The company has about 85 iPhone apps and 39 iPad apps available in the App Store.  “If a company has one hit game, it’s not a guarantee it will continue to produce hits,” Justin Smith, founder of social-games researcher Inside Network in Palo Alto, California, said in a phone interview, referring to success broadly in the gaming industry. “There are definitely no guarantees. If you are a large developer able to cross-promote your titles, that gives you a big advantage.”  While Glu Mobile is losing money, the company would still be a good takeover candidate because a buyer could reduce expenses by firing some of its approximately 575 employees, said Tom Taulli, who analyzes acquisitions and public offerings for the Los Angeles-based website IPOPlaybook.com. The games publisher may report its first annual profit of $7.7 million in 2014, based on analysts’ estimates compiled by Bloomberg.

“There are not as many companies left,” Taulli said in a phone interview. “The sector has gone through a consolidation over the years.”  Larger gaming companies such as Electronic Arts (EA), valued at $5.6 billion, and Zynga, which has a $9.5 billion market capitalization after its December IPO, could be interested in Glu Mobile to further expand in mobile games, according to Taulli, Falcon Point’s Mahoney and Roth Capital’s Krejcik. Zynga, with $1.9 billion in cash and short-term investments, has made more than 20 acquisitions since 2008. Electronic Arts has holdings of $1.8 billion in cash and short-term investments.  “The big buyers are going to be EA and Zynga,” Taulli said. “It’s going to be their way to stay at the top of the charts. As you get bigger, it gets harder to innovate.”

International gaming companies like DeNA, an operator of social gaming and shopping websites worth 333.3 billion yen ($4 billion), are “looking for a foothold in the U.S. mobile market,” said Graham of Canaccord. “Those are companies that are already slowly getting involved in the U.S. by releasing games here. They could potentially look for an acquisition to accelerate their entry.”  While Taulli estimates Glu Mobile could get as much as a 15 percent premium in a takeover, or about $5.14 a share based on yesterday’s closing price, Mahoney projects a price tag of $6 to $7 a share. Niles of AlphaOne said the company will be able to reach as much as $8 a share on its own in the next 12 months and may sell for more than $10 in one to two years as it reaches profitability.  Glu Mobile is “still a relatively smaller company in a very fast-growing segment,” said Roth’s Krejcik. “The acquisition by Zynga, it shows that they’re going to be aggressive in terms of trying to make moves in the space and that there’s still a lot of interest.

It will be a matter of time until we’ll see the first interested buyer knocking on G5 Entertainment’s door. Management says it does not want to sell at this point but everything has its price. Clearly at today’s valuation, G5 Entertainment stands out as extremely cheap. Peer-group valuation and M&A transaction valuations in the sector would justify a price of 4-5 times today’s levels.

Nordic Investor

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