G5 Entertainment

 


Short name: G5EN
ISIN code: SE0001824004
E-mail: investors@g5e.se

The company:

G5 Entertainment is specialised on app development and publishing with intial focus on casual and time-management games for the Iphone, Ipad and Mac. Since June 2011, G5 Entertainment is also active on the Android market and in November 2011, the company also entered the Amazon App Store when the Kindle Fire was released. In 2012, the Barnes & Noble’s Nook platform was added to the portfolio. G5 Entertainment was founded in 2001 and started as mobile game development studio. Soon, G5 advanced to become one of the leading studios in its field, developing games based on popular licenses for Electronic Arts, Disney, THQ, Konami and others. Since 2006, the company is listed in Sweden.

The major transformation came in 2009, when G5 Entertainment decided to focus on the development and publishing of downloadable games of iOS, PC and portable game consoles. G5 Entertainment’s portfolio includes popular casual games like Supermarket Mania, Virtual City, Stand O’Food and Mahjongg Artifacts and many more. G5 Entertainment also develops games based on third party licenses and publishes games developed by third party developers – in both cases on revenue share terms. With its “Talisman”-technology, G5 can convert games between different platforms at a low cost and in a short time.

The market:

The global app market is growing strongly both for Apple’s Iphone and Ipad but also Android. First of all this is caused by an ever growing base of devices.
According to computerworld.com, Apple’s iOS still has a commanding lead in the tablet market, with Android being the only other OS that registers a market share in the double digits. In the smartphone arena, there are other significant competitors such as BlackBerry and Windows. However, BlackBerry’s market share is dropping according to recent statistics.

According to Gartner, the iPad held a 83.9% share in the global tablet market in 2010, with Android tables being far behind at 14.2%. However, going forward Gartner expects the market share difference to narrow considerably over the next few years, with iOS holding around 50% by 2015 and Android growing to 40% during the same period.

When it comes to the smartphone market, several analysts expect the iPhone to slip worldwide in the coming years as both Android and Windows Phone are expected to gain traction.
What’s most important in our opinion is that both iOS and Android are experiencing very rapid growth. Gartner forecasts media-tablet shipments to soar from 17 million units in 2010 to 70 million in 2011 and 294 million by 2015. Worldwide smartphone shipments are expected to more than triple from 2010 to 2015, also according to Gartner. Android growth is forecast to jump from 67 million units shipped to 539 million as its market share more than doubles. Apple’s global market share is also expected to rise but more modestly, from 47 million to 190 million units shipped. By 2020, there will be over 10 billion mobile connected devices on the planet, while the market of apps for these devices will reach USD 25 billion in 2015, compared with USD 6.8 billion in 2010. The growth is worldwide, with US leading the market since 2009, while Europe and Asia are quickly catching up.

The case:

G5 Entertainment is still small but it is growing impressively and sits on a net cash position. In 2010 sales reached SEK 22.75m and EBIT of SEK 9m, implying a very strong EBIT margin of some 41%. In 2012, G5’s revenue had already grown to SEK 81m, implying growth of 74% compared with 2011 levels. G5 is profitable too and reported an 2012 EPS of SEK 2.77, up 56% versus 2011 levels.

By the end of 2012, G5 had a portfolio of more than 300 apps on the different platforms. Many of its games have received prestigious awards from e.g. bestappever-awards, pocketgamer, etc.  The games published 2 years ago are still generating substantial income, without adding any additional costs, thereby supporting margins nicely. In February 2009, G5 Entertainment released its first iPhone game “Supermarket Mania, which became a success on the App Store. In March-May 2009, there was a substantial peak of sales for the game, and then revenue settled on a stable off-peak level. In 2011, Supermarket Mania for iPhone generates the same level of monthly sales as in 2009 after the peak. Other products show similar patterns. G5 Entertainment capitalizes development costs during the development of new products and depreciates the cost evenly over 2-year period following the release of the game. As of Q2 2011, 100% of the revenue generated by Supermarket Mania for iPhone contributed directly to profit, as it is no longer to be offset by depreciation of the development costs – talk about margin booster.

Many of G5 Entertainment games have been top ranked around the world, but unlike one-hit wonders like “Angry Bird” – maker Rovio, G5 is not depending on a few single games. Nevertheless, it is encouraging to see that games like “Jack of All Tribes” have reached number 1 rankings in important markets like Germany.  Since 2012, the company is more and more focusing on free-to-play games and has so far three successful titles on the iOS market, with Virtual City Playground being continuously ranked very high in global top grossing charts ever since its launch in 2011. More recently, “Secret Society” has become the single best grossing title for G5 with consistent top grossing positions around #50 in the important US iPad market.

You can follow the rankings of G5 Entertainment’s games in our regular ranking checks or on: www.appannie.com

G5 plans multiple regular updates during 2013 for its free-2-play games. Interestingly, as part of the updates, the management plans to roll out social features. The group is also working on a number of new free-to-play games to be released during 2013 and 2014.

As the market of smartphones and tables goes from strength to strength, the management aims to eventually achieve revenue of SEK 300m with operating result of SEK 100m, while keeping the growth at historic 2010-2012 levels. This implies that the revenue target could be hit as early as 2014.

Getting ready for Nasdaq OMX

In early 2013, G5 announced that the Board of Directors of G5 Entertainment has decided to apply for a listing of the company’s shares on NASDAQ OMX Stockholm in the second half of 2013.  We have argued for quite some time that a listing on the NASDAQ OMX Stockholm will increase opportunities for institutional investors to invest in G5 Entertainment, not the least also foreign investors. We have noticed big interest for the case from countries other than Sweden and those investors will finally be able to buy into this fantastic growth story. Such a listing is also another proof of quality for the company in terms of its operations and information disclosures.

The valuation and fair value:

With a current share price of around SEK 50, G5 Entertainment is valued at a PE-ratio of 15.6x, 9.6x and 5.1x on 2012-2014 earnings respectively. There are not many app developers listed on the stock exchange but two of the more well-known are French Gameloft and American Glu Mobile. They are also developing gaming apps but their profitability is either much weaker compared to G5 Entertainment (in Gameloft’s case) or non-existing (Glu Mobile). Nevertheless, Gameloft is currently valued at a PER of around 25x expected 2012 earnings. It is a bigger company than G5 and followed by several French analysts so estimates are readily available. Since Glu Mobile is still loss making (analysts expect this to continue into 2012) it is not possible to look at a PE-ratio for 2012 or 2013. On estimates for 2014, however, Glu Mobile is trading at around 13 times.

Another listed pure-play mobile gaming company is “Gamevil“, which is traded on the South Korean Stock exchange. Gamevil is expected to have 2012 revenues of around USD 66m and with a debt free balance sheet and an EBIT margin of around 37% it is rather similar to G5 Entertainment. As you can see in the peer group valuation table below, Gamevil is currently traded at a PE-ratio of 25x 2012 earnings and almost 17x 2013 earnings. Applying the same multiples to G5 Entertainment, we would get a fair share price of between SEK 70 (assuming 2012 EPS of 2.80) and SEK 88 (assuming 2013 expected EPS of SEK 5.2).

Here is a valuation table for the sector (first week in January 2013):

Mobile gaming peer valuation

Looking at one of the many recent M&A deals in the app developing market, it becomes again obvious how undervalued the G5 Entertainment share is right now. In July 2012, Electronic Arts announced the acquisition of PopCap Games, a US based developer of casual games for iPhone, iPad, Android and Facebook. The deal is valued at some USD 1.3bn. In 2010, PopCap generated revenues of USD 100m, implying an EV/Sales multiple of 13x trailing sales (assuming PopCap is debt free). Using the same valuation criteria, G5 is trading at a 40% discount and that comparison would not even be fair since G5 Entertainment is grew sales by more than 100% in 2011 while PopCap was looking at “only” 40% growth in 2011.

CEO Suglobov has been clear about his mid-term goal for the company: “The company targets revenues SEK 300m and an EBIT of SEK 100m in a few years. Furthermore, management aims to keep the group’s long-term average revenue growth at 2010/2011 levels going forward”.

Assuming 90% growth p.a. (in-line with recent history) in combination with an assumed 30% EBIT margin, we believe G5 will be able to realize an EPS of SEK 5.21 in 2013. To illustrate our thinking we have made the following sensitivity analysis:

We argue that a company that grows at the pace that G5 is doing and with such a profitability level should be trading at at least 15-20x 12-months forward looking earnings. This would imply a reasonable share price of SEK 75 – 100 based on expected 2013 earnings. As you can see in the graph above, applying a PE-ratio of 15x on the expected EPS level of SEK 5.21 implies a fair share price of SEK 78.

 

If the company can manage to capture the growth opportunities going forward as well as it has done in the past, Mr Suglobov’s goal of revenues of SEK 300m could almost be reached by the end of 2014. What this would mean for the share price is best shown with a back-on-the-envelope calculation:

  • In order to arrive at an implied EPS under the “mid-term scenario” (i.e. revenues of SEK 300m and an EBIT of SEK 100m), we make the following assumptions: a) a financial net of zero, which is conservative since G5 Entertainment has actually a net cash position and b) a tax rate of 15%, i.e. in-line with current levels. This leads us to a net profit of SEK 85m under the “mid-term scenario”, which implies an EPS of SEK 10.6
  • Applying a 12m-forward PE-ratio of 14x would mean that the G5 Entertainment share should trade at close to SEK 150 at the beginning of 2014, i.e. in one year.

We are not suggesting that the G5 share should necessarily trade at SEK 150 today, but the example above shows that such levels are clearly achievable within a reasonable timeframe. Interestingly, at SEK 150 we are still using a PE-ratio of only 14x, which seems hardly fair for a fast growing, profitable company. If the mid-term scenario was to materialize we expect the market to be willing to pay higher multiples by then. A PE-ratio of 20x would imply a fair share price of around SEK 210 by 2014.

We would not be surprised if sooner or later one of the bigger software companies will put a bid for G5 Entertainment if the low valuation continues to persist. M&A activity has been picking up in the app market in recent months and companies like Electronic Arts and Zynga have acquired several smaller developers during recent months.

Nordic Investor holds shares in G5 Entertainment.

Company presentation by CEO Vlad Suglobov, Stockholm, June 2011:

5 Comments

  1. Goofy June 11, 2012 Reply
    • Nordic Investor June 11, 2012 Reply
      • Goofy June 12, 2012
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