There were high expectations heading into Apple’s (AAPL) fourth quarter earnings report as investors worried whether or not iPhone sales had, in fact, peaked for the world’s largest company. When the numbers finally hit Tuesday, the concerns were validated.
While the company did beat on earnings ($3.28 versus an expected $3.23 per share) and sold a record number of iPhones (74.8 million missed expectations for 75 million), it disappointed on revenue and showed no signs of life in other areas like the iPad, Apple Watch, etc. Then came the guidance. Revenue is expected to fall for the first time in 13 years by as much as into double digits, and iPhone sales are also expected to come in lighter than the prior year for the quarter.
For bulls, the hope is that as the company’s hardware sales growth slows, the drop-off can be made up by the company’s growing services business (App Store, Apple Pay, Apple Music, etc.) to leverage the over 1 billion installed devices by Apple customers. In a sense ,Tim Cook may be trying to change the conversation on Apple. That’s evidenced by the company’s plans to break out the services financial figures in future earnings reports.
Apple Changing the Conversation to Apps
While those are certainly big shoes to fill, the idea isn’t without merit. Apple is currently head and shoulders above the competition when it comes to monetizing the app market, generating 75% more revenue than its second-closest competitor Google, despite half the number of downloads.
Looking at the current app market landscape, mobile games accounts for 75% of the revenue generated for iOS apps (while Google Play apps are almost totally dominated by games at 90% of revenue). In fact, mobile gaming is expected to become a $45 billion market on its own by 2018, growing 15% a year.
So it is curious that for a market as large and rapidly growing as this, there’s so few pure play options for investors to consider. It doesn’t help that mobile gaming is an incredibly top-heavy market, either.
Of the top-grossing apps in 2015, Supercell led the way by a wide margin with the wildly popular Clash of Clans and Boom Beach. Supercell, however, is owned by Japanese major conglomerate Softbank. King Digital, which produces the Candy Crush games, was acquired by Activision Blizzard (ATVI) for $5.9 billion in November, forming the second-largest gaming company by revenue in the world. Puzzle & Dragons (Gungho), Colopl Rune Story (COLOPL), MonsterStrike (Mixi), and Disney Tsum Tsum (Line) are all owned by companies trading on the Tokyo Stock Exchange.
Of the top 10, only Fantasy Westward Journey’s NetEase (NTES)—which is based in China—trades publicly in the US markets. Machine Zone, which owns the Game of War franchise and behind the onslaught of ads in recent years, would fit the pure play description. Based in Palo Alto, California, the private company is reportedly being valued as high as $6 billion, doubling its valuation from its July 2014 round. Unfortunately for investors, the company does not look to be seeking an IPO anytime soon.
Mobile Gaming for Investors
So where does that leave us?
The three names that are most commonly brought up are Electronic Arts (EA), Glu Mobile (GLU), and Zynga (ZNGA) on the public side, and a handful names on the private side.
Electronic Arts is no pure play when it comes to mobile, but it is making headway on that front. After an extended period of aggressive acquisitions—which was heavily criticized by the gaming community—the company seems to be focused on organically leveraging its formidable portfolio of console game IP to establish its mobile business. Mobile currently makes up about 13% of EA’s overall revenue. But again, the company’s focus isn’t necessarily on growing mobile but more so on digital in-game sales on a variety of gaming platforms.
When it comes to pure play mobile gaming companies, Glu Mobile stands out as one of the few options currently available for investors. Though, that company is not without its warts, either. Glu Mobile enjoyed its time in the sun two years ago with the surprise success of its Kim Kardashian: Hollywood game, sending shares soaring over 80%. They announced that Chinese tech giant Tencent—also the world’s largest gaming company by revenue—bought a 15% stake in the company, as well as a number of celebrity deals that included Britney Spears, Jason Statham, Nicki Minaj and Katy Perry. The success was short-lived, however, as Glu has yet to recreate the success it had with the Kardashian game. In December, the highly anticipated Katy Perry Pop launch sparked a massive selloff after download numbers underwhelmed. Shares are currently back down to pre-Kardashian levels, and the company is sitting on a market cap of around $300 million. The company, which reports earnings next week, did recently announce a $50 million share repurchase plan.
Another name in the gaming industry looking to rebound is Zynga. Known mostly for its’ astronomical success with Farmville several years ago, the company has largely been left for dead by investors. Since it IPO’d in late 2011, shares of Zynga have fallen over 80% from its peak to settle in around the mid $2.00 level at a market cap of about $2.25 billion. The challenges stemmed from the company’s need to transition its business off of Facebook (FB) and into various platforms, primarily mobile. While it hasn’t had a big hit since Farmville, Zynga’s turnaround efforts and focus on “casino” games may be working—albeit quietly. In November, the company announced a $3 million profit for the quarter, along with a $200 million share repurchase. But while the company was able to generate more revenue, it did see the total number of users declined considerably. Zynga is expected report its next earnings in about two weeks.
Private Gaming's High Difficulty Mode
On the private side, there are a number of companies that had explored IPOs a couple years ago but for one reason or another, did not complete the process to go public. Kabam and Rovio were among the biggest mobile gaming companies reported to be mulling IPOs around the same time King Digital went public. Kabam specializes in multi-player online strategy games and sported a valuation as high as $1 billion after Alibaba’s (BABA) $120 million stake in 2014. But the company pulled out of its planned IPO in 2015, citing generally unfavorable conditions and under-performing on its own projections.
Rovio, maker of Angry Birds, might be the epitome of a one-hit wonder in the industry. The company’s valuation was pegged as high as $4.2 billion in 2014, with IPO talks swirling. But Rovio may have spread its iconic franchise too thin, and gotten away from what endeared fans to begin with. It’s effort to refocus on emphasizing its business toward videos and games hit a snag last year as Angry Birds 2 received mixed reviews and failed to catch fire. It does, however, have the Angry Birds movie coming out later this year. So there’s that, but video games are notoriously difficult to translate to film, so the Angry Birds movie is far from a sure thing.
As more focus shifts off revenue generated by iPhone sales and into the revenue generated in the smartphones themselves, investors need to understand how the mobile gaming market is shifting. Companies need to show the ability to create sustainable franchises rather than just ephemeral viral sensations.
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