International Opportunites #4: Gravity Inc.

Video game developer with terrible capital allocation at a bargain price

This piece is an opinion and for information purposes only, and it isn't investment advice. Seek a duly licensed professional for investment advice.'

Housekeeping

Merry Christmas and a happy new year! The last two months were the beginning of the cold season. I lose myself in video games and try to get over the miserable weather. This year was different tho, as I looked at the gaming companies from an investor's perspective.

For the last few years, the market has been in a bull market, and the mindset that price doesn't matter for qualitative best companies is prevalent. As I disagree with that mindset, I instead looked for the cheapest one that isn't a total disaster.

Enter Gravity Inc, a Korean video game developer with a market cap of $489M. It trades significantly below its peers and historical valuation.

Here are a few people which knowledge I relied on to write this article: @EmilMikkelsen20, @ForceMajeureFUT, @SickValue, and @punchcardinvest.

Feel free to contact me on Twitter @InvestRoiss or leave your comment below. I am long Gravity Inc with 5% of my portfolio.

Summary

• Gravity is a Korean company trading at 3.07 EV/EBIT

• The company has $93M in cash and $208M in current assets with a market cap of $498M.

• GungHo Online Entertainment holds 59% of the company, so Gravity will not return money to minority shareholders.

• With no debt and upcoming titles, their future isn't as bleak as many think.

• Margins are improving, creating the highest quarterly income in Q3 2021.

Ragnarok and Business

Ragnarok is the primary IP from Gravity Inc. Ragnarok Online was one of the first MMORPGs that became popular in 2002 in South Korea. MMORPGs are mass multiplayer online role-playing games, with World of Warcraft being the most famous. Ragnarok Online has continually received updates and, despite its age, has around 740.75K subscribers, according to mmo-Population.com. The Ragnarok brand isn't as famous in Europe and the US due to its long grind (spending hours on the same repetitive task for progress) and the bad English translation when Ragnarok Online first came out. Subsequent expansions thus focus on the Asian market.

Like the rest of the gaming market, Gravity moved into mobile games resulting in nearly 70% of Gravity's revenue. Compared to last year, online gaming revenues in Q3 2021 have decreased 42.5%, as they got an incredible push during the pandemic. However, margins and operating profit have increased. Quarterly numbers are varying but revenues have risen the last few years, with 2021 having stronger revenues than 2020 overall.

With $93M in cash and current assets valued at $208M, the company trades at an EV/EBIT 3.07.

Historically the company only traded for less during March 2020 and 2016, when they had more net-working capital than the market cap. While the company has lots of cash, it will never return it to minority shareholders. GungHo Online Entertainment owns 59% of the company and has no plans to divest its shares. With uncertain growth prospects after 2022, it is natural for the company to trade at current levels. 

Current Games and expansions

Gravity tried to reduce the dependency on the Ragnarok franchise and expanded into consoles and indie games. They have released Sadako M, Grandia for the Nintendo Switch, and "NBA Rise to Stardom," a mobile sports game. It launched in Japan in November 2021. So far, the non-Ragnarok games haven't been very successful. 

I have used Sensortower, which visualizes the ranks of Top Free/Top Paid and Top Grossing Apps for Android and iPhone in different countries, to see how successful their various Ragnarok games are. 

Ragnarok X: Next Generation is a success. In Southeast Asia (Philippines, Thailand, Malaysia, and Singapore), the game is in the Top 6 Grossing on Android and iOS. In Vietnam, where Gravity launched the game in September 2021, it is still in the Top 40 for Top Grossing. 

Southeast Asia is among the fastest-growing mobile gaming scene globally. Future releases there look promising. 

Ragnarok Origin launched well in the US and Canada in November 2021, ranking second in free Downloads. However, as expected, the game fell down the ranks quickly. The game should launch in Taiwan, Hong Kong, and Macau in the first half of 2022 and Southeast Asia in the second half of 2022. Ragnarok: The Lost Memories launched in the Philippines, Singapore, and Malaysia on December 13, 2021, but there is no ranking on Sensortower yet. 

With a planned release in 2022, Ragnarok Begins will be a cross-platform game across PC and mobile. Whether it will be a success, I don't know. 

In the future, the company wants to focus more on console games and establish its subsidiary in Hong Kong to expand into China. 

Conclusion

Gravity is not a company that excels in terms of quality. With no proper capital allocation, varying quarterly results and dependency on a single franchise are all points that count against it. However, it is so cheap that I have taken a position. If you have additional comments, please feel free to do so.