“I Got Games” Needs a New Game

In the World of mobile games, creating big winners is what counts. Without another game with 50M+ downloads in the next couple years, there could be more water below the current 58% decline in I Got Games’ share price.

I Got Games (OTCMKTS:IGGGF) is an international mobile games producer with market leading strategy & roleplaying games like “Lords Mobile” and “Castle Clash”.

IGG has shown incredible growth over the last three years. 2015 revenue of $202M grew to $748M in 2018, an effective year-on-year growth rate of 55%. With performance like this, and over 34% insider ownership, it’s easy to see why IGG could be a great investment.

However, on closer inspection, things are not looking as rosy as they once were. As well analysed by Robert Leonard in three articles on Seeking Alpha here, IGG looked like a potential deep value pick. Robert’s “most likely” scenario valued IGG at $2.42 per share in April 2019, assuming revenues grow conservatively at just 1/5th of the current growth rate. However, a 15% annualised growth rate for the next 5 years may be optimistic, with IGG revenue down 9% for the first half of 2019 year-on-year.

This article takes a deep dive into the drivers of what makes a mobile games company like IGG successful, in attempt to uncover IGG’s future growth rate and an estimate for its fair value.

I Got Games’ Successes

Launched as a mobile games developer in 2012, I Got Games’ huge growth over the last 5 years has been driven by two key successes; the “Lords Mobile” and “Castle Clash” games. These two games have over 200M and 50M GooglePlay downloads respectively. Despite having built 58 apps, these two games alone drove 92% of IGG’s revenue in 2019.

How does IGG generate revenue? IGG games are free to use, but purchases can be made in game. It’s a classic case of the network affect. The more downloads of each game, the more Monthly Active Users (MAU), the stronger the ecosystem and demand for in game purchases.

This also illustrates that IGG’s mobile games revenue is driven by “the big Winners”. Based on GooglePlay app install stats, IGG has created 7 games with 10M+ downloads since 2012. Yet 10M downloads doesn’t mean much in this space. In 2019, all 56 apps with less than 50M downloads generate just 8% of IGG’s total revenue. What IGG needs to maintain and grow its revenue base in the long-term is more 50M+ downloaded apps. Let’s call these games “Winners”.

Assuming IGG can maintain this historical rate of producing Winners, a new 50M+ downloaded app should be released roughly once every 4 years (2 apps / 9 years). Arguably IGG’s increased cash pile, and successes to date, could give it the muscle to draw on the best developers and potentially increase either the success of individual Winners (downloads & therefore revenue), or the “Winners rate” per year (frequency at which 50M+ downloaded apps are released).

IGG “Winners” — Apps by Downloads
(Source: AppBrain)

The Concern

However, no new games have been created in 2017, 2018 or 2019 with more than just 10M downloads (remember, these are not even Winner apps and don’t generate meaningful revenue). Both IGG flagship games and are now declining from their peak. Lords Mobile revenue is down -9% year-on-year for the current period and Castle Clash is down -23%. Given the age of these games, this trend suggests these two key drivers of IGG revenue are in decline.

Representing 80% of revenues, every percentage decline in Lords Mobile MAU results in an almost 1-for-1 hit on IGG top line. If the rate of decline approaches that of the more elderly Castle Clash’s -23% decline in 2019, it’s easy to see how things could quickly take a turn for the worse for IGG.

IGG Revenues
(Source: 2019 Interim Report)

It is possible that further marketing efforts, app expansions and sequels could see the revival of one or both of the flagship games, but the more likely scenario is that is that users base continue to erode with time.

In a similar vein, the promising “StreamCraft” streaming service release by IGG two years ago has so far failed to grow into a Winner. With just 5M downloads and a rating of just 4 stars, the current iteration isn’t adding much value to the IGG top line.

Another concerning trend is the 15% year-on-year decline in IGG’s biggest market, Asia. Asia represents 43% of IGG sales. This decline was somewhat offset by growth in other international regions.

Not only is revenue down, but operating margin (EBIT/Revenue) has also reduced from 31% to 23% in the current half yearly period. The lowest margin in 4 years. This is likely a classic example of value investing “reversion to the mean”. When growth and margins are high in an industry (eg. mobile gaming) competition is attracted, resulting in margin compression.

IGG haven’t released a 50M+ download Winner in over 3 years. To quote IGG’s 2019 Interim Report, much of the above is exacerbated by

“intense competition”.

Future Prospects

In the free app world, where revenue is made from in game purchases, it’s big Winners with high downloads and Monthly Active Users (MAU) that count. That’s why R&D and new, innovative games are crucial (note above commentary on operating margin compression).

In the first 9 months of 2019, IGG have released 12 new games versus just 3 from 2018. R&D spend for the first half of 2019 is up 48% year-on-year and the spend now represents 12% revenues. Happily, the bulk of IGG’s reduced margins noted above are a result of this near 50% increase in R&D spend. A good investment in IGG’s future.

IGG are focusing more on new game development in 2019
(Source: AppBrain)

Among these new launches in 2019 was “Brave Conquest” in June. Brave Conquest has performed reasonably well so far with over 500,000 downloads in its first three months and a 4.3-star rating. Nonetheless, these figures are still a way from being a 50M+ downloaded Winner.

To date IGG games have predominantly focused on a very similar “historically” themed games; where lords, kingdoms, castles and conquests come together in a strategy or role-play format. There is nothing wrong with specialising in this space, but the more games that IGG creates with this theme, the harder it is for any individual new Winner game to stand out in the crowd. Each new release becomes progressively lost in a sea of similar non-Winner (average) apps. Consumers could even start to see each new launch as “just another Lords Mobile copy” resulting in choice paralysis. All very undesirable for IGGs top line. So, it was good to read the following in the 2019 Interim Report:

“A diverse line-up of new titles, including a space war strategy game, are currently in final fine-tuning phase and are expected to make their debut in the second half of 2019.”

With $270M cash on the balance sheet (about a third of IGG’s current market cap) and no debt, IGG does have the muscle to invest in building quality games. According to the Interim Report, some of this cash may be put to work in the future:

“The Group will continue to seek potential merger and acquisition opportunities that could create synergies, accelerate growth and provide breakthroughs in its business.”

One fantastic asset that IGG does have is motivation. IGG executives have over 400 million reasons (shares) to be motivated, they own over 34% of the company stock.

Valuing IGG

To estimate a fair value for IGG, three different revenue scenarios are considered:

1. Worst Case: IGG’s two leading apps continue to decline and no new 50M+ Winners are created.
2. Base Case: IGG’s two leading apps continue to decline and one new Winner is created every 4 years, in line with historic Winner release rates and revenues.
3. Best Case: IGG’s cash is deployed and R&D pays off. A Winner of similar magnitude to “Lords Mobile” is created once every two years.

A 10-year Discounted Cash Flow (DCF) analysis is performed with the following assumptions consistent across all three cases:

• Discount rate: 10% (relatively high given interest rates)
• Tax rate: 25% (slightly higher than actuals over the last 4 years)
• Operating Margin: 20% (lower than the 27% average over the last 4 years)
• Terminal Growth Rate: 2% (less than half global GDP rate)

Worst Case Scenario

For this case, revenues are estimated to continue in line with the current 2019 interim report, that is:

• Lords Mobile Revenue: decreases by -10% p.a. for the next 2 years, then -25% p.a. for the following 8 years
• Castle Clash: continue to decline at 25% p.a for 10 years
• Others: continue to grow at 15%p.a. for the next 10 years

This scenario is effectively saying that IGG no longer produces any Winners and basically becomes a conglomerate of “average” games. The revenue would decline somewhat chaotic over the next 5 years (and so would the share price), before returning to low growth by year 10:

• The effective Years 1–5 CAGR: -14% p.a.
• The effective Years 5–10 CAGR: -3.5% p.a.
• Year 10 revenue: $285M (38% of 2018 revenue)

Fair value of IGG Stock in Worst Case Scenario: $0.63 (-7% on current price)

Base Case Scenario

Revenue projections are as per the “Worst Case” scenario above, but with one new Winner generating revenues in line with IGG’s worst Winner, Castle Clash. This case effectively assumes Lords Mobile was an outlier. Castle Clash has generated the following revenues.

IGG “Winner” App Revenues
(Source: IGG Annual Reports)

To date, Castle Clash has generated $646M in revenue, and continues to generate cash for IGG. To simplify, a Winner app in this case is assumed to generate $120M in cash for 3 years, and then decline by -25% p.a. A Winner app is created roughly every 4 years, so the resulting revenue profile is as follows:

• The effective Years 1–5 CAGR: -4%
• The effective Years 5–10 CAGR: -2%
• Year 10 revenue: $536M (72% of current revenue)

Fair value of IGG Stock in Base Case Scenario: $0.89 (+31% on current price)

Best Case Scenario

IGG creates a Winner app of similar magnitude to “Lords Mobile” every two years. With reference to the above table, a Winner app in this case is assumed to generate $350M in cash for 3 years, and then decline by 25%p.a.

• The effective Years 1–5 CAGR: +17%
• The effective Years 5–10 CAGR: +4%
• Year 10 revenue: $2,030M (+270% of current revenue)

Fair value of IGG Stock in Base Case Scenario: $2.30 (+238% on current price)

But can’t IGG do better? What if Lords Mobile was nothing against their next app? Sure, it’s possible. Such an event would result in a drastically higher upside opportunity for IGG shareholders. Nonetheless, looking at IGG’s history, Lords Mobile is an outlier. In an effort to develop a grounded valuation, it is treated that way until IGG can prove otherwise.

IGG Valuations

Another scenario

Given IGG’s size and cash pool, it could potentially also be the target of acquisition in the coming years. Such a scenario would likely be great for shareholders picking up IGG stock at $0.68 and an acquisition valuation may lie somewhere between the Base- and Best-Case scenarios. Nonetheless, to avoid muddying the waters, this scenario has not been considered (just consider it a “cherry on top” if it happens).

A final word of caution. By investing in IGG, you are betting on them continuing to create new Winner apps. Without new Winner apps, IGG will continue on a slow and painful decline.

Conclusion

IGG’s stock has taken a beating over the last year, down 58% since its 2018 peak despite strong revenue growth. Yet IGG’s inability to produce a new Winner game in the last three years may justify this. Today, IGG is predominantly riding on the coattails of its successes in 2013 and 2016 and the current share price reflects that.

Without a new Winner, IGG’s current share price of $0.68 is fairly valued today. Based on the three valuations in this article, the market is currently pricing in a worst-case scenario for IGG’s future.

Nonetheless, the substantial cash pool, increasing investment in R&D and incentivised alignment of management are reasons to remain cautiously optimistic. Provided IGG can generate a “Castle Clash” size Winner game once every four years, the IGG stock represents value for the long-term investor today. Because of this, and as identified in Robert Leonard’s articles, IGG offers an asymmetric risk reward profile. There is a significantly greater upside opportunity than downside risk. That asymmetry is arguably higher today than at any other point in IGG’s history.

Given IGG’s past Winner game release rate, the aspiring IGG investor should bear in mind they will probably have to be very patient with this stock. Every year that goes by without a new Winner landing on IGG’s Income Statement will result in further deterioration of the Worst-Case scenario valuation (by approximately -10% a year). This is the risk inherent in businesses with very concentrated product portfolios. Similarly, every year that goes by without a new winner reduces the historic “winner rate”, and therefore further reduces the valuations in this article.

So, the key questions to ask before considering an investment in IGG are:

• Do you think IGG can create a “Castle Clash” size success in the next 4 years?
• Are you willing to hold on to a stock that could see big swings in price?
• Are you willing to lose 25% of your investment over the next two years, for a 30–240% return potential?

If you can answer “yes” to all above questions, then IGG might be great for you. Good luck!

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CAPRIOLE INVESTMENTS
Quantitative Asset Management
www.Capriole.com
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