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The CEO of any company controls the fundamental performance of their firm — revenues, costs, and hence, profitability. We work to grow our firms with a balance of upside and downside risk that we hope is optimal for our investor base’s risk-return profile. Much less in a CEO’s control, however, is what public market investors are willing to pay to own a piece of the firm’s equity.
Current public-company sentiment and in turn valuations are volatile and cyclical — particularly in the macro-environment we find ourselves. King, Zynga, and Glu have all experienced some investor skepticism thus far.
As Glu did navigating from feature-phone to smartphone revenues, Zynga is undergoing a platform transition from Web to mobile. Now that its mobile revenues are approximately the same size as its web revenues, I believe that it will be able to more easily deliver overall top-line growth. King’s top-line, by comparison, is dominated by the enormous success of one engine. To the extent that renewed top-line vigor occurs for both companies, an upward re-rating of their equity should be expected.
Public market investors typically understand that the overall macro-environment in which mobile gaming operates is a strong one:
- Rising smartphone penetration worldwide
- A growing middle class in emerging markets
- Increasing time spent by consumers on mobile devices
- An expanding share of disposable income going to gaming
They often, however, find two elements of mobile gaming companies’ business models difficult to fully value:
- The predictability of new title launch performance
- The longevity of existing titles
Due to uncertainty over “when the next hit is” and “the catalog,” public mobile gaming companies do not currently enjoy valuations on par with a range of other, often far less profitable — but more predictable — technology companies. I am highly optimistic this will change over the coming years due to a combination of:
- Elongating operating history
- Portfolio diversification
- Market share gains
I anticipate that King will indeed prove that it can sustain impressive profitability in 2015 and beyond. With an enormous active user base, I believe that its longevity and ultimate growth potential is presently underestimated by public market investors.
Content creation industries are always barbell-shaped
Modern book publishers, record labels, and film studios have been operating for nearer 100 than 10 years in their current organizational forms. Consolidation in each of these sectors created giants and minnows — “majors and indies.”
Consolidation was driven by the opportunity to save on SG&A costs, scale balance sheets, and to diversify content portfolios. A broader set of bets on new content is, on average, more predictable. A deeper catalog on average creates a bigger annuity income stream. More scale means that the risks of a new investment not paying off are more readily absorbable. Scale also creates barriers to entry when content is stored and transported physically — as owning and managing inventory is a logistical exercise in its own right. Scale also creates the opportunity to bundle content together and leverage package pricing.
The digital revolution is in fact about:
- A changing format
- Elimination of physical inventory
- Changing distribution mechanisms
Scale also matters in gaming
Gaming, on the other hand, is a much younger content creation segment. It is nearer to 10 years old than 100. It has progressed from physical distribution enjoyed primarily in the living room, to most of its daily consumers interacting with digitally distributed content on their mobile device. The business model has evolved from “pay upfront regardless of whether you know you will like it” to “pay if you wish to progress faster in this title that you know you enjoy.”
I believe that free-to-play is the more efficient business model because it enables consumers to decide how they wish to trade off their time versus disposable income. We as developers use data to constantly optimize average underlying metrics such as retention, conversion, and lifetime value of paying users. Unlike other content creation sectors, the majority of our life cycle costs for a successful title typically occurs post-launch — through software updates and digital marketing spend. Our overall project risk can be calibrated on an ongoing basis by monthly, weekly, and even daily revenue trends.
No longer needing to buy and store a physical good has reduced the friction and barriers for consumers to enjoy a game. It has as such driven an explosion in the breadth and depth of choices. Instead of (at peak) hundreds of console games to choose from, they now have hundreds of thousands of mobile games to sample. More choice has led to more precise matching between what a player is looking for and what they find. As channels and choices have increased, the overall video content sector has grown its annual revenue significantly.
Free-to-play is the business model of choice. Pricing cannot go any lower — it is effectively on sale every day. Content is already unbundled — you download the precise game you want and only that. Distribution power never existed for mobile gaming content creators. At first it resided with mobile telecoms operators in the feature-phone era. Now it is with mega-platforms who keep 30 percent of revenues for providing billing, distribution, and hosting services. In short, mobile gaming is an industry built around endpoints.
While the mega-platforms have been established and are here to stay, I believe it is still early for the mobile gaming industry. Approximately two dozen public companies around the world have significant portion of their business in mobile gaming content creation: King, Zynga, Glu, and EA listed in the U.S.; Colopl, DeNa, Gree, Nexon, Klab, DreCom, Mixi, and Gung-Ho in Japan; Gamevil, Kakao, Com2Us in Korea; Tencent, KongZhong, Perfect World, Giant, NetDragon, Boyaa, Forgame, OurPalm, and ZQGames in China. Upcoming potential IPOs include Line in Korea, Kabam in the U.S., and Gumi in Japan.
Our industry has yet to create even one global multigenre free-to-play mobile giant. The advantages of scale for mobile gaming players include the same ones enjoyed by traditional content creators other than those tied to physical distribution. Being at “the top of the barbell” creates value through opportunities to:
- Rationalize SG&A costs
- Scale balance sheets
- Diversify content portfolios
- Increase the size of the catalog
I believe that as soon as the first global player is created with strength in all of the major gaming markets — U.S., China, Japan, Korea — there will be an acceleration of consolidation pressure to create the second and third. Ultimately, I believe that there will be a handful of ‘majors’ in the mobile gaming space — with diversified product portfolios and catalogs.
At Glu we are keenly aware of the need to increase the predictability of our product pipeline of new launches, as well as the depth of our catalogue annuity. Over the five years of my tenure, we have operated with a constancy of purpose to build world-class prowess in multiple genres, with IP and engines working with synergy to make our revenue streams more predictable.
Our priorities for each project Glu undertakes are always centered on identifying and nurturing upside while simultaneously working to minimize downside probability and magnitude Be it a new title in an existing studio, organic studio expansion, an acqui-hire, or outright acquisition, we are always looking for potentially outsized reward situations with disproportionately small amounts of downside. Consistently accumulating advantages for the past 19 quarters has allowed us to grow non-GAAP revenues from $66.9m in 2010 to $241.8m in 2014.
Niccolo de Masi is the CEO of Glu Mobile. This article represents the views of de Masi and not necessarily the views of Glu or its directors, officers, and employees.
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