Category Archives: Video games

a short reprise of the Zynga (ZNGA) IPO

February 24, 2014 By in Current Market Thoughts, Entertainment, Industry Analysis, internet, Technology, Video games, Wireless Tags: , , , , , , , , , Leave a comment

King Digital Entertainment, PLC  is the maker of the fabulously successful mobile-centered game Candy Crush Saga.  The firm has filed a form F-1 in preparation for an IPO.  King (proposed ticker: KING) intends to raise around $500 million.

Not surprisingly, the KING offering has reawakened bad memories of the 2011 IPO of ZNGA, which was led by Morgan Stanley and Goldman (no shock, either, that neither of those firms has a role in the KING IPO).

I haven’t yet read the KING offering document.  It’s possible that I won’t.  But I still thought it might be useful to look back at the characteristics of ZNGA that, in my view, made that stock an unattractive investment from the start.

1.  Virtually all the traffic coming to ZGA’s games was generated by Facebook.  This made it difficult to tell whether ZNGA’s games were successful because they were great games, or because they were being featured on FB.  If the latter–which subsequently proved to be the case–FB held the economic power in their partnership.  Any lessening of FB’s marketing efforts would quickly translate into a reduction in ZNGA’s profits.  A big weakness of ZNGA, not a plus.

2.  A reasonable way of assessing social games is to measure:

–the time needed to reach the peak number of players,

–the number of peak users, and

–the rate at which the number of users fades from the peak.

Even prior to the IPO, ZNGA offerings launched after its signature game, Farmville, were peaking faster than Farmville, and at lower numbers of users than Farmville.  In addition, they were as fading from the peak more quickly.  In other words, none of them had anything near the oomph of Farmville. This was all bad news.

3.  The actions of  the lead underwriters, both before and after the ZNGA IPO were quite odd, in my view.

For one thing, according to the New York Times, Morgan Stanley mutual funds bought  $75 million worth of pre-IPO shares of ZNGA in February 2011 at $14 a share.  Some have suggested that this was done to help persuade ZNGA to choose Morgan Stanley as a lead underwriter.

For another, the underwriters released the top management of ZNGA, as well as some venture capital investors, from IPO share “lockup” agreements that prevented their sale of stock prior to May 29, 2012.   Instead, a sale of 49,4 million shares at $12 each raised close to $600 million in early April for these high-profile holders.  By the original lockup expiration, the stock was trading at little more than half that level.

My overall impression is that the underwriters (incorrectly) thought that the heyday of tech investing was over.  This would imply that they and the companies they were moving to initial public offerings had only a short time to cash in before the rest of the world figured this out.  As a corollary, the traditional rules of trust and fair play between underwriter and professional portfolio manager/wealth management client no longer held–because there would be no follow-on business that once-burned clients would shy away from.

relevance for KING?

Again, I should mention that I haven’t yet analyzed KING.  Candy Crush Saga may well prove a fleeting fad and KING a one-trick pony.  On the other hand, the underwriters are different this time.   And I don’t sense the same IPO-before-it’s-too-late urgency that was in the air in 2011.

cable TV cord-cutting is here to stay

August 1, 2011 By in Current Market Thoughts, Entertainment, Industry Analysis, internet, Stock ideas, Technology, Video games, Wireless Tags: , , , , Leave a comment

That’s according to media consultant, SNL Kagan.

SNL Kagan is the firm that first called widespread attention to the phenomenon that significant numbers of subscribers to multi-channel entertainment service providers, like cable TV or satellite, are cancelling their service.  People are watching increasingly their favorite programs over the internet through services like Hulu.  And they’re using Netflix as a substitute for on-demand movie watching.

During the middle two quarters of last year, cable et al. in the US actually showed declines in subscriber numbers for the first time ever.  The fact that subscribership has since rallied back into the plus column has some observers concluding that internet-based “over the top” content distribution will remain a fringe phenomenon.  SNL Kagan disagrees.

The consultant points out that:

–while traditional cable/satellite is growing, its expansion is less than the rate of new household formation.  This means the older services are gradually losing market share;

–the number of OTT households will likely rise by 80% this year to 4.5 million, or about 4% of the market;

–for at least the next several years, the consultant expects OTT households to expand by a steady 2 million annually.  This means they’ll number 12 million or so by 2015, and represent 10% of the market.

Netflixing and Huluing are different

Neilson observes that, although they may be the same people, individuals behave quite differently while Netflixing from when they’re Huluing.

–Netflixers, as you’d suspect, primarily watch movies using the service.  A small majority view content on their TV screens, with a game console as their preferred connection device.  42% watch the movies directly on their computers.

–Huluers, as you’d also figure, watch almost nothing but TV shows.  They view their content almost exclusively on their computers, however, although sometimes they’ll hook the computer up to a TV screen.

One constant for both services:   almost no one uses Google TV or Apple TV.  More people watch on cellphones or tablets than on either.

my thoughts

Let’s assume that Huluing and Netflixing give us a peek into the future.  What are we seeing?

–a world where cable TV companies are valuable because they deliver internet access to customers, not entertainment content directly to a TV. Their rivals will principally be the wireless companies that are building their own mobile internet networks.

–a world where TV sets no longer play a prominent role.  Maybe you’ll have one in the house to watch sports events (the only kind of entertainment where people are willing to pay for picture quality), maybe not.  Viewing gets done on computers or tablets.

–a world where the low-end PC disappears.  Tablets are one successor, as the market already realizes.  Traditional PCs, laptop or desktop, with larger, better resolution screens and good audio may be another.   APPL is moving in this direction by eliminating the MacBook from its lineup and offering customers only the MacBook Air and the MacBook Pro as choices.  (This seems to me to open the door to Chromebooks in the education market, but time will tell.)

Implications for INTC are, at worst, mixed and maybe pretty favorable.  It may sell fewer chips, but its product mix will shift to higher value-added products.  Cloud computing becomes much more important.  And the performance bar is raised for ARMH’s much-discussed entry into the PC market.

there are hard-core digital gamers, lots of them

June 28, 2011 By in Industry Analysis, Stock ideas, Technology, Video games Tags: , , , , , , , 2 Comments

shrink-wrapped software–yesterday’s story

In the heyday of shrink-wrapped video game software, the dominant companies, like Nintendo, Electronic Arts and Activision, had three key advantages other than engaging original content. None were well understood by Wall Street.  They were:

–these firms owned/controlled the strongest distribution networks

–like other entertainment forms, fans restocked their inventories with titles in the newest format.  So they enjoyed a big surge in sales growth every four or five years as a new generation of game devices was introduced, and

–perhaps the key competitive advantage, the industry spawned a group of intense users of their products, maybe 300,000 strong in the US and an equal number abroad.  These hard-core gamers could be counted on to buy almost any well-crafted game.

hard-core users

How important was this group?  If you figure that the wholesale price of a shrink-wrapped game would be $40, and that it would be a hit only in the US or only abroad, then you could be very confident of generating revenue from a good game of about $12 million from the hard-core group.  Until the past few years, when game development costs spiraled up over $20 million, that meant that a well-made game would be highly profitable even if no casual gamers bought it.

social gaming

Enter simple games, cheap to develop and delivered either through social networking sites or through cellphones.  My assumption, and that of Wall Street, I think, has been that these gamer players are by and large casual fans who dabble but don’t get very involved in game play.  Maybe it’s just that the games are relatively simple and don’t require the lightning reflexes most hard-core shrink-wrapped gamers display that fosters this belief.

It turns out, however, that that’s not so, at least according to a recent survey by market researcher NPD.  In fact, there is a large group of hard-core mobile and social networking gamers.  These gamers bear more than a passing resemblance to their hard-core console gaming counterparts.  For example:

–avid console gamers spend 18 hours a week (yes, that’s right) playing; their digital counterparts spend 16 hours

–hard-core console players buy 5.4 games a quarter; digital gamers buy 5.9.

One big difference between the two groups is size.   There are presently about twice as many obsessed console gamers as there are mobile/digital ones.

A second is dollar purchasing volume, although the disparity may not be quite as high as it seems at first.  At $50 each, hard-core console gamers spend just under $1100 a year on games.  Their mobile/digital counterparts lay out only a tenth of that.  But console gamers’ net outlay can be far lower than the gross, depending on how many of their games they resell, either privately or through video game stores.

investment implications

The real question on the table, if you think there’s a chance (as I do) that social gaming will develop along the very lucrative lines of console gaming, is how to make money from the idea that digital/mobile gamers aren’t as “casual” as they may seem.  Using the shrink-wrapped game industry as a model, I think one should look for companies that:

–control distribution

–can charge by the device for use, and

–are able to attract large numbers of hard-core gamers who provide a steady stream of recurring revenue–whether by buying game downloads, microtransactions or advertising.

Ideally, this would seem to mean finding social network companies that have their own game subsidiaries.  As far as I’m aware, the only publicly traded ones exist in Japan.  The worry about companies like DeNA and Gree (I own both) is whether they will be able to exporting their very successful domestic market model to the rest of the world.  All the Japanese firms are trying, and aiming either at China or the US.  But it’s too early to tell.

 

MSFT’s 3Q11: signs of Windows weakness

May 2, 2011 By in earnings conference calls, growth vs value, Industry Analysis, internet, Stock ideas, Technology, Video games Tags: , , , , , , , , , , , , Leave a comment

the results

After the close of the market in New York on Thursday April 28th, MSFT reported its 3Q11 (MSFT’s fiscal year ends in June) results.  The company earned $.56 per share for the three months (+24% year on year), on revenue of $16.4 billion (+13%).  A non-recurring tax benefit raised the final per share tally by $.05, to $.61.  This compares with the Wall Street consensus estimate of $.56.

MSFT shares dropped by 3% in Friday trading, in a flat market for IT.  INTC, the second member of the “Wintel alliance,” whose shares tend to  trade more or less in line with those of MSFT, rose, in contrast, by 1.5%.

the details

picky points (symptoms of analyst’s disease)

–MSFT continues to show impressive control of operating expenses.  Despite this, operating income for the quarter was up by only 10.3% year on year.  That’s less than the rate of increase in revenue–not what you’d expect from a software company.

–The company spent $10.3 billion, or a tad less than 60% of net income, over the first nine months of fiscal 2011 buying back its own stock.  That’s far above the $2.2 billion in new issuance (presumably from exercise of employee stock options) over the same period.  Outstanding shares are down by about 4% year on year–meaning around 4% of the advance in per share income comes, not from an increase in the bottom line, but from shrinkage of the denominator used in the calculation.

more important things

MSFT has five divisions, two big ones, one medium-sized and two that you can safely ignore if you just want a general picture of where growth is likely to come from.  In size order, giving the percent of operating income each represented in fiscal 2011 to date, and year on year growth for 3Q11, the divisions are:

Business (meaning MS Office and related productivity tools)      43.5% of operating earnings, 24.5% year on year growth in 3Q

Windows (the PC operating system)          38.7% of operating earnings, 10% year on year decline

Server and Tools          20% of operating income, 11.7% year on year growth

Entertainment + Devices (X-Box, cellphones…)          5.4% of operating income, 50% year on year growth

Online Services          -7.6% of operating income (a loss of $1.8 billion), a 10.% increase in the year on year loss.

the numbers need a bit of tweaking

Windows 7  launched in late October 2009.  So year-ago sales were flattered by the rush to buy the new product (and ditch Vista).  Office 2010 debuted in June 2010.  Anyone who bought Office 2007 in the runup to launch of the new version got a free upgrade.  Revenue was booked when the upgrade was redeemed, not when the sale was made–meaning that revenues in the Business segment during the year-ago quarter were unusually weak.

MSFT thinks the true rate of the Business segment revenue growth was 13%, not the 20% reported.  Conversely, it believes the decline in the PC market it saw in 3Q11 was 1%-3%, less than the 4.5% drop in sales it posted.

MSFT’s take on the PC market…

According to the company, netbook sales were down 40% year on year, business PCs were up 9% and consumer PCs were down 8%.  MSFT thinks that emerging markets represent “nearly half” of global PC shipments.

…vs. INTC’s

In simple terms, INTC (see my latest post on the company) is saying that the lion’s share of PC growth is coming in the emerging world, where consultants like Gartner or IDS, who are projecting lackluster growth in the PC market this year, have limited ability to collect data.  The two consultants are mistakenly extrapolating the present weakness in the US and Europe to include the developing world.  As a result their unit sales projections are too low.  INTC, which does over half its business in developing countries, says it has a much better look at demand through its warehouse and sales staffs–and business is better than the consultants think.

In a nutshell, MSFT sees the same picture the consultants do.

my thoughts

I don’t think netbooks are an important factor.  If they comprised 5% of the total PC market a year ago and that’s been cut in half, the resulting unit volume decline is 2.5%.  But they use low-cost Atom processors and Windows 7 Starter, which does little more than start the machine.  So they’re not a commensurate revenue loss.  Also,  to some degree buyers have switched to low-end laptops, which carry higher revenue and profits for both MSFT and INTC.

Macs are a factor, but not the key one, in my opinion.  Macs are growing much faster than the overall PC industry.  They use INTC chips but the AAPL operating system.  However, although Macs represent over 10% of the PCs sold in the US, they’re less than 4% of the world’s unit purchases.  Yes, they’ve been gaining half a point to a point of market share per year, but that probably means less than a 1% unit volume increase for INTC.

The MSFT management didn’t respond to an analyst’s question about piracy, which, in my experience, is rampant in the Pacific.  My guess is that non-branded “white box” computers with unauthorized copies of Windows software are a big part of the difference between MSFT’s experience and INTC’s.  There’s no way of knowing for sure, though, so MSFT’s judgment not to broach the topic is probably its best tack.

One other interesting MSFT management comment about INTC:  The MSFT CFO suggested that maybe the biggest reason for INTC’s good results was its ability to raise prices.  Although he didn’t say this, what seemed to me to be implied is that INTC can raise prices in a way MSFT can’t.  In other words, through constant innovation in chip size, speed, power consumption, INTC has a better value proposition for customers than MSFT does.  I think that’s right, but it’s funny to hear it from the lips of MSFT.

the stock

MSFT is guiding to a 4Q11 about in line with results from 3Q11.  This would bring full-year results to about $2.60 a share.  I think we’ve already seen the crest of the current product cycle with the launches of Windows 7 and Office 2010.  So fiscal 2012 will likely show eps growth at a much slower pace than the likely 24% gain this year.  Let’s pencil in 12%.

If so, the stock is trading at about 9X forward earnings, has net cash of around $4.50 a share, generates free cash flow and yields about 2.5%.  That looks cheap to me.  It’s hard to figure where the upside is going to come from, though.  Certainly, there are isolated interesting products, but I’m not sure there’s anything big or dramatic enough to move the needle for a giant like MSFT and engage investors’ imaginations. So value-oriented investors, the prime potential buyers of MSFT, may well worry that the stock will remain the “value trap” it has been for the last decade.




Activision’s 4Q10: a reprise of 4Q09

February 11, 2011 By in Current Market Thoughts, earnings conference calls, Entertainment, Industry Analysis, internet, Stock ideas, Technology, Video games Tags: , , , , , , , Leave a comment

the results

Activision reported fourth quarter and full year 2010 results after the market closed in New York on Wednesday. On a non-GAAP (Generally Accepted Accounting Principles) basis, the firm earned $.53 a share–in line with Wall Street analysts’ expectations–vs. $51 in the year ago quarter.  For the full year, GAAP earnings per share were $.34 vs $.09 in 2009.  On a non-GAAP basis, eps were $.79 vs. $.69.

On a GAAP  basis, however, ATVI reported an operating loss in the vicinity of $400 million for the closing three months of the year–the second time in a row they’ve accomplished this “feat.”

The company issued initial (non-GAAP) guidance for 2011 of $.70 per share in earnings, or about an 11% year on year decline (more on this below), which was lower than analysts’ preliminary guesses of a flat earnings year.  (Some are also saying that ATVI is guiding to earnings of $.07 a share for the March quarter, which would be below analysts’ estimates of $.10.  I don’t think that’s right, though, since the $.07 includes $.02-$.-3 of restructuring charges.  In other words, ATVI guidance is for earnings of $.10 per share for March.)

ATVI also announced that its board of directors had authorized a 10% increase in the dividend to $.165 per share and a $1.5 billion share buyback.

The shares were down about 7% in the aftermarket.   As I’m writing this, in the early afternoon of February 10th, ATVI shares are down about 10% on very heavy volume.

the details

1.  Bobby Kotick has developed feet of clay.  The CEO of ATVI has had a well-deserved reputation for quickly focusing his firm on new trends and deftly cutting his exposure to the old without taking big losses.  No more.  For the second year in a row, ATVI is taking a gigantic writeoff related to the Activision side of the business.

Elements of the writeoff are scattered around in different accounting categories, however, including some costs that will only be recognized in 2011, so I find it difficult to figure out exactly how big the current damage is.  $400 million + is the best I can do.  Unlike last year, when management blithely ignored the loss completely in the conference call, there were at least a few passing references to it Wednesday night.

What’s happening?  ATVI’s financials suggest that, ex Call of Duty, the Activision side of the house continues to be deeply in loss. That got the former Activision-side top brass fired a year or so ago.   After posting a large deficit ex CoD again in 2010, new management has decided to:

–stop making new versions of Guitar Hero and concentrate on digital downloads to the title’s waning fan base,

–shut down True Crime,

–not launch a new Tony Hawk game this year (no more, ever?).

ATVI will also be laying off 500 employees.  This will leave the Activision part of ATVI with Call of Duty, the Bungie team that’s developing a new MMO, and some niche products like Cabelas hunting games, that make money.

2.  Blizzard is doing fine–better than fine, actually.

–Non-GAAP operating income, at $850 million, was up 53% year on year. 

–World of Warcraft has over 12 million subscribers globally.  Blizzard’s new partner, NetEase, is making it easier to get permission from Beijing to introduce new WoW software to China. 

–WoW: Cataclysm sold 4.7 million units during its launch month in December.

–Starcraft II has sold almost 4.5 million units, as well.

–Blizzard has also been talking about a new WoW-like game it is developing, code name: Titan.

3.  Call of Duty is, too.

–Despite pre-launch worries that Call of Duty: Black Ops could never surpass the success of the 2009 entry in the game series, CoD: Modern Warfare 2, the number of players of Black Ops during its first three months is about 50% higher than for MW2.

–First-day downloads of the initial expansion pack for Black Ops (just launched) were 25% higher than for the comparable release for MW2.

4.  ATVI will be announcing a mystery new gaming initiative at Toy Fair today.

5.  New releases for 2011?  Will there be any?

–There’ll certainly be one for Call of Duty. But ATVI is (sensibly) unwilling to project that it will meet the lofty sales standards of Black Ops. Other than that, the current-year cupboard may be pretty bare.

–There’s no word from Blizzard on (the now long-awaited) Diablo III. All we know is it’s not ready for beta testing yet.  A 2011 launch has not been ruled out.

–Heart of the Swarm, the Zerg entry in the Starcraft II series, is certainly a 2012 event (if then).

–The Bungie MMO definitely won’t debut this year.

–On the bright side, there won’t be self-inflicted losses from Guitar Hero et al. But worries the new Blizzard launches could be pushed back into 2012 are the main reason for ATVI’s conservative earnings guidance.

why the big selloff in the stock?

1.  Some investors may be throwing in the towel.  ATVI has been a severe underperformer over the past two years.  Another huge writeoff and prediction of a down earnings year in 2011–especially when most other firms, video game and otherwise are posting surprisingly good results–may have been more than many investors are able to take.  Some professional investors who use mechanical rules for buying and selling, in an attempt to keep emotion out of their decisions, may also have been forced by them to divest.

2.  Has Bobby Kotick lost the magic touch?  I thought the Activision division problems had been fixed last year.  It’s distressing to see that it has required another year of large losses to get management to smell the coffee.  Odder still, ATVI has been much more aware than its rivals about the threat from casual and mobile games.

3.  It’s also possible that ATVI’s juvenile attempt to divert investor attention from the writeoffs by not mentioning them is undermining investor confidence in management’s integrity and competence.

where to from here?

ATVI is a stock I’ve been consistently wrong about, so maybe you should skip this part and make up your own mind without my two cents. 

First of all, the company has about $3 a share in cash on the balance sheet, and no debt.  It is generating cash flow from operations, principally from Blizzard, of about $1.15 a share.  That level of cash generation can probably continue indefinitely.  True, there may not be a new mega-hit like Starcraft II in 2011, but there won’t be Guitar Hero, Tony Hawk or True Crime to pile up offsetting red ink.  And MMOs, a field Blizzard leads, are the future for serious gamers.

Assume a current stock price of $11 and subtract the $3 in cash.  The remaining $8 is equal to about 7x cash flow.  If the current level of cash flow is sustainable–and I think it is–the stock is cheap.  It’s the equivalent of a bond that yields 15%.  If this were a different industry, or if ownership weren’t so concentrated in Vivendi’s hands, a takeover bid would be a good possibility.  I don’t think that’s likely here, though.

The big question is whether there’s anything in ATVI’s future that could make it less cheap than it is today.  A new Bungie MMO, a big increase in the number of WoW subscribers, new online moneymaking opportunities for Starcraft or Call of Duty are all possibilities that come to mind.  Also, in time, and with more forthright communication, management may win back investor trust.  In addition, at some time before the end of summer, focus will turn to 2012, which could be a year with two or three big new releases.

I can easily imagine circumstances–and again I have been as cold as ice with this stock–where ATVI is trading 20% higher than it is today six months from now.  Like almost any value stock, however, the “what” is easier to figure out than the “when.”