MYPS - Playstudios: Gaming Growth Can Improve Margins

2023-05-31 03:40:10 ET

Summary

• Playstudios is expected to see mobile gaming growth improve after a slowdown due to overspending during the Covid-19 period, with revenue growth forecast at 15% in FY23 and 5% in FY24.
• The company's margins are expected to improve significantly, with adjusted EBITDA-M predicted to reach 16.4% by FY25, suggesting the company is currently undervalued.
• Key risks to the investment thesis include spiraling S&A spending if revenue growth doesn't meet expectations and potential legislation to protect underage consumers from gambling games.

Investment thesis

Our current investment thesis is:

• We expect mobile gaming growth to improve, as the recent slowdown was driven by overspending during the Covid-19 period.
• Mobile gaming is extremely attractive due to its sticky customer base, scope for monetization through in-app purchases, and the rise of social gambling apps. playAWARDs has the ability to create outsized returns.
• Margins are currently poor but rapid improvement is possible purely if growth returns to 5-10%.

Company description

PLAYSTUDIOS, Inc. ( MYPS ) develops and publishes free-to-play casual games for mobile and social platforms in the United States, North America, and internationally.

Share price

MYPS stock price experienced a monumental decline in recent years, as weakening financial results have contributed to investor sentiment switching.

Financial analysis

Presented above is Playstudios' financial performance for the last decade.

Revenue

Playstudios has grown its revenue at an impressive CAGR of 11%, reflecting a strong period of returns. This is arguably a story of two halves, however, the period leading to Covid-19 and after.

Prior to the pandemic, the mobile gaming industry experienced a rapid rise (the reasons for which we will explore later). Playstudios benefited greatly from this, exploiting consumer habits to grow. Following this, we saw a lull, or mini bear market for mobile gaming, as consumers sought social activities following an extended period locked inside.

The mobile gaming market hit $147B in 2022, according to IDC, and is forecast to grow in mid-single digits to low double-digits in the coming years according to a Stifel analyst. This reflects a resurgence of the market following the brief difficulties. We concur with this view as our following analysis will illustrate.

The increasing penetration of smartphones and the growing popularity of mobile gaming have transformed the gaming industry. Improving mobile computing power and smart marketing has contributed to a rapid rise in casual gaming. Consumers, many of whom have little to no interest in gaming, are increasingly playing mobile games as part of a commute, or in short bursts during idle times.

Many of these games are "free-to-play", giving the perception of no cost to the consumer. The value for the creates come in the way of in-app purchases, which are conveniently placed to allow access to further content. The use of virtual currency and in-game purchases has become prevalent in the online gaming industry. This is a fantastic model from a financial perspective, as these games give consumers a taste of what is being offered, then force them to purchase if they want to truly enjoy the game.

The benefit of mobile gaming is that it benefits from continuous updates, new content releases, and live operations. This keeps the casual fan engaged, where many would easily move on or find themselves bored. This is an advantage over the traditional gaming industry and is likely a driving factor behind the continued success of mobile gaming.

Mobile games use aggressive tactics to keep consumers addicted. They gamify everything possible and tap into human behaviors in order to keep individuals playing. The best example of this is providing rewards for logging in each day. This keeps consumers returning, even if there is no intention to play.

Playstudios has taken this a step further, developing playAWARDS. This is a partner program that rewards partners for marketing their products. This further acts to drive traffic toward Playstudios' games and keep interest high. This is a highly successful tactic utilized by many gaming businesses but is less prevalent in mobile games.

Social casino gaming has gained traction in recent years, driven by the desire for social interaction and access of such games to the younger audience. Further, many adults have an interest in such games but have lacked the conduit to do so. This expansion has been rapid and is an area of outperformance in mobile gaming. Playstudios has a suite of social casino games driving its growth.

There is a concern with regulation here as many of these games are inadvertently targeted at children, creating the risk that addiction is being developed in formative years. This links back to the "gamification" of consumer behaviors. These games create a virtual currency, which creates a perceived difference from real money.

Influencer marketing has become a powerful tool for promoting products and engaging with target audiences. Many of these individuals are streamers or YouTubers, having a large audience of younger consumers, who are the target market for such games. Playstudios should continue its marketing through this avenue as we believe the return on investment is higher than other options.

Economic considerations

Economic conditions have the potential to cause short-term headwinds, as consumers cut back on unnecessary spending. This is because inflationary pressures are contributing to a decline in real incomes, as a greater portion of income is committed to living costs.

Margin

Playstudios' margins have declined in recent years, with an EBITDA-M of 3% and a NIM of 2%.

GPM has improved despite this, reflecting the benefits of scale and the lack of material marginal delivery costs.

The decline in EBITDA-M/NIM is due to increased S&A and R&D spending in recent years. Management has experienced heightened customer acquisition costs, partially due to the difficulties in the industry.

Further, in part due to the slowdown, Playstudios has likely lifted R&D spending as a means of increasing the number of games and content on the existing ones. This has the potential to improve returns in the coming years.

From an objective viewpoint, however, Playstudios' margins are not good. The key is to achieve a significant improvement as otherwise, the business only faces becoming less unattractive.

Balance sheet

Playstudios is conservatively financed, with little debt used and a comfortable level of cash. The company is FCF positive, reducing any concern of solvency/liquidity issues. This will allow the business to continue its investment in driving new customers and new games.

Due to the slim margins, no material distributions are currently offered to investors.

Outlook

Presented above is Wall Street's consensus view on the coming 5 years.

Revenue growth is expected to return, with c.15% forecast in FY23 and a further 5% in FY24. This reflects a change in sentiment around mobile gaming, with analysts expecting a rapid improvement. We concur with this view as the slowdown looked based on a covid-related peak which would lead to an inevitable slowdown following.

Importantly, margin improvement is expected and at an impressive level. Adj. EBITDA-M is expected to roughly double by FY24. We have less conviction about where margins will land but directionally expect a noticeable uplift. The reason margins can increase by such an impressive amount is due to the low marginal cost to supply. One extra gamer comes with very little cost, but the potential for returns is high, even if they only make 1 purchase.

Valuation

Playstudios is currently trading at 1.5x NTM Revenue and 9x NTM EBITDA. This implies the coming is trading at a slight discount to its average.

We expect growth to return to 5-10%, however, valuing the company is difficult due to the lack of visibility on medium-term margin improvement. We have modeled our expected revenue growth, alongside gradual GPM improvement, followed by incremental opex gains. Based on this, we believe EBITDA-M can reach 16.4% by FY25.

This suggests the company is undervalued, as a business with an EBITDA-M of >10% should not be trading below at least 15x NTM EBITDA.

Key risks with our thesis

The risks to our current thesis are:

• S&A spending spirals if revenue growth is not in line with expectations, contributing to greater costs incurred in order to maintain revenue.
• Legislation introduced in key markets to protect underage consumers playing gambling games.

Final thoughts

Playstudios is seemingly oversold following a brief period of slowing growth. The company has a wide variety of games and is investing heavily in driving traffic to its content. The industry is highly attractive and has the potential to quickly propel the company to an improved position.

Our expectation is that improved growth will alleviate cost pressures, allowing margins to quickly improve. Based on the company's current valuation, we see strong upside.

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