GRVY - Gravity Co.: Ragnarok Game Model Is Successful

2023-04-19 05:18:57 ET

Summary

• The mobile video game industry is growing rapidly, and the company is positioned well there.
• I think the company found a formula to keep generating revenue for a long time, and I believe Ragnarok IP games are not oversaturating the game stores.
• The company has a very strong balance sheet. A bit too strong because of the hoarding of cash.
• A simple DCF model suggests there's a lot of upside.

Investment Thesis

In this article, I will look at Gravity Co. Ltd ( GRVY ) and its potential to reward its shareholders in the short to medium run. Preliminary results showed high revenue growth y-o-y, coupled with a very strong balance sheet and a steady user base on its very popular mobile game Ragnarok Online, and its many iterations on the market, the company is poised to perform well even in a downturn of global economies. Furthermore, the company is generating cash flow at very high levels and retaining it which can then be returned to shareholders if the management desires in the future or keep expanding its Ragnarok franchise offerings to compound into perpetuity.

Outlook

The company is in the most dominant video game platform in the world; the mobile game industry, especially in Asian countries where mobile gaming is predominant. Mobile gaming took in over $92B in revenues in 2022. The other 3 platforms: console, PC games, and browser PC games were $92B combined, so the mobile gaming industry is a juggernaut.

The free-to-play (F2P) model has been proven very successful in bringing much more revenue than its counterpart pay-to-play which is seen much more in the console/PC environments, although there are many F2P games on those also which are very popular, like Warzone 2 and Apex Legends still having high numbers of players daily and bringing in record revenues.

GRVY is positioned well in my opinion because it is operating in the regions that have the largest population of mobile gaming users in the world and seeing that the F2P is very low risk for users, they will download the new thing because you don’t have to pay for it and at least try it out.

Statista hasn’t published the numbers for 2022 yet, or at least I couldn’t find them, but I would venture a guess that Asian countries are still leading the herd by a long mile.

Ragnarok IP Oversaturated?

Many people reason that the company is milking its one IP dry, by releasing and expanding the universe of Ragnarok constantly. The first time I encountered Ragnarok is, back in 2007-08 when I was a wee lad in Ireland, where I saw a few of my Filipino classmates going nuts in the computer class playing this colorful game non-stop. I was very surprised to see that after all of these years, the original Ragnarok Online is still going strong with a steady player base according to this website .

Just to name a few of the successful games the company has recently released that show the company is doing just fine in not overmilking the cash cow that Ragnarok IP is.

Ragnarok X: Next Generation has been received relatively well, with over 10+m downloads on the Play Store alone.

Ragnarok M: Eternal Love boasts 5+m downloads on the Play Store.

The most recent launch of Ragnarok Origin has been the top downloaded video game in the Apple App Store since it was launched on the 6 ^th of April ’23 in countries like Thailand, Indonesia, The Philippines, Malaysia, and Singapore.

Every time the company releases a new iteration of the game, whether that is an MMORPG, RPG, or another genre in the Ragnarok Universe, it becomes a top downloaded game for a while.

In the latest Q4 report, the company is committed to growing IP further and they have plans on expanding the offerings to more regions in the future.

We can see from the above image, that there are a couple of non-Ragnarok IPs, like NBA and WITH, so maybe this is the beginning of them diversifying their game lineup a little bit, which looks like these offerings are like region tests to see if they would be profitable in the future.

In my opinion, Ragnarok games will turn out to be like the popular game Clash of Clans and many other very similar iterations on the app stores. There are always people playing these games even to this day especially if the image of the game is a person screaming like in Clash of Clans or Clash of Lords.

I think they found a business model that seems to be working for them which is to keep partnering up with different publishers and developing many different games in the Ragnarok Universe. This way the company will keep receiving revenue as long as it is going to be around, and as I said, there is very little risk for people to try them out because the games are F2P and if the games are good enough, they might purchase something, as long as the in-app purchases aren't very aggressive. I have no problem spending some money on cosmetics if I like the game/character in the game as long as it is not a pay-to-win item.

So, to sum up, I don’t think the market is oversaturated with Ragnarok IP and if the company continues to release high-quality games like the ones mentioned, it will keep chugging along forever in my opinion.

Financials

The company's cash position is ridiculous in my opinion. It is sitting at around $250m as of the end of FY2022, half of the company’s market cap. The company also has no debt and the cash flow it's been generating has been very impressive. This is where many investors dislike the company because the management isn't doing much with the cash, except hoarding it. Investors would like to see some sort of distribution to the shareholders, in a form of a dividend or share buyback or something that would add value, but the company, majority controlled by GungHo Online Entertainment, isn't doing anything with it. I'm wondering if there is some sort of big plan to acquire some smaller companies/IPs in the future with the pile of cash that it's sitting on.

Staying on the liquidity side of things, the company has, according to my model and the financial statements I got off Quickfs.net, a current ratio of 4.00 right now. Meaning it can pay off its short-term obligations 4 times over. It’s a bit much, which proves that the company is hoarding cash and not doing anything worthwhile with it.

ROA and ROE have been trending down since 2018, meaning the company is not as profitable and efficient as it was back then, but still has very good returns. The company needs to turn the trend around or at least keep these numbers steady going forward.

The company has been losing its competitive advantage and its moat in the last couple of years. ROIC has been coming down from the pandemic highs when everyone was locked up at home and did nothing but browse/play on the internet. Nevertheless, ROIC is still much higher than what many other companies I look at have, suggesting it is still doing very well. It could do even better if the cash it has in the books was put to work on some projects that would bring positive NPV, which in turn would bring higher ROIC.

Overall, the company’s balance sheet structure is very solid. I don’t think it would have any problems in weathering a downturn in global economies with such a high cash pile and zero leverage position.

Valuation

For the valuation, I wanted to approach this in a simple manner. The DCF model will assume revenue decreases in ’23 and ’24 of 5% in each period to account for some sort of a downturn, then after that, it jumps to a 15% increase and linearly decrease it to 5% growth by '32, giving me 7% average growth over the next decade. Under this base scenario, the company's revenues will grow by 93%, which is not bad but over the last decade, the company saw almost a 700% increase in revenues. I think I'm still being rather conservative.

For the optimistic case, every period in the model is 200bps better than in the base case, and vice versa for the conservative case.

For the margins, since I assumed revenue declines in the short run, margins will contract by around 150bps for those periods also and then linearly come back to where they were at the end of ’22.

As for margin of safety, the company’s balance sheet suggests the company is quite safe and so it warrants what is my lowest margin of safety I like to give to companies: 25%.

With that said, the company’s intrinsic value is $105.75 which suggests there is an 88% upside to the current valuation.

Closing Remarks

I missed the ride of the pandemic when the share price skyrocketed. I believe at these levels there isn’t much risk in owning the stock, it is down quite substantially from its highs in January ’21. The company is trading at a relatively low P/E ratio and is generating free cash flow like there's no tomorrow. I just wished that the company would do something with that excess cash, or at least would let the investors know if there are any plans to acquire some company or buy back shares. My bet here would be a bet on the company's change of heart in the future about how to reward shareholders, but the company’s financial health is also what interests me in starting a position here.

I'll wait a couple of months to see how global economies develop, which I know will see some volatility in stocks for sure and provide us with a better entry point for the long run.

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