Mobile Game Developers Enjoy Win Streak, but Analysts Are Skeptical

08.05.2013 16:34

Mobile Game Developers Enjoy Win Streak, but Analysts Are Skeptical

Profits are up, investors are keen and acquisitions are plentiful, but experts say the good times have to end some time

Liu Ran and Zheng Fei

(Beijing) – The country’s mobile game industry is sizzling hot with cash from investors apparently undaunted by analysts’ warnings that the business is volatile and may be overvalued. Rarely can a startup company in any other industry make a profit in its first year, an investment banker said. In the mobile game sector, however, this is common. He said one company he recently visited was set up in 2011. It turned in a profit that year, and in the next its earnings hit 40 million yuan.Another investment banker, with CITIC Securities, said that this year there would be more than 10 mobile game developers with a monthly turnover of at least 10 million yuan. By a conservative estimate, they can make at least 60 million yuan a year, he said.

Investors on the secondary market have sensed the great growth potential of these companies, leading to a surge in the share prices of a number of public mobile game developers.

In the first seven months of the year, every one of the top six mobile game developers listed in Shanghai or Shenzhen has seen their share prices at least double.

The share price of the leader, Beijing Ourpalm Co. Ltd., which debuted on Shenzhen’s ChiNext board in May last year, has risen by almost 300 percent this year.

Deep-pocketed institutional investors are in the game as well. Huayi Brothers Media Group Co., the only listed filmmaker in China, said on July 24 it would buy 50.88 percent of Guangzhou Yinhan Technology Co. Ltd. for 672 million yuan.

Based on the estimate of Huayi’s financial consultant for the acquisition, China Securities Co. Ltd., Yinhan’s net profits were 637,000 yuan in 2011 and 6.4 million yuan last year.

This meant the price-to-earnings ratio of Yinhan, using the 2012 profit for calculation, is higher than 206, a senior analyst said. By contrast, the ratio implied by a transaction four months ago, in which Tencent acquired 15 percent of Yinhan for 19 million yuan, was only 19.9. The surge in valuation surpasses most people’s expectations.

Measured by Yinhan’s profitability this year, however, the ratio may return to normal. In the first six months, the company has made 53 million yuan in net profit. It expects to more than double the amount by the end of year.

If it hits the target, the price-to-earnings ratio implied by Huayi’s deal will fall to about 12, Chen Caimao, Guoxin Securities’ analyst, said.

Acquisitions Abound

There are certainly pitfalls, however. More than 80 percent of Yinhan’s revenue in the first half of the year came from one game.

“But the life cycle of mobile games is short, mostly in the range of six to 12 months,” an investor familiar with mobile technologies said. “So, Yinhan’s performance in the latter half of this year, let alone next year, will face a lot of uncertainties.”

Liu Zhi, an analyst at HwaBao Securities, said game developers and movie producers have one weakness in common: their boom or bust relies too heavily on the performance of a single product. One blockbuster does not guarantee future success.

Huayi has written what it sees as a failsafe mechanism into its contract with Yinhan: in case the software developer fails to deliver on profit promises, it must compensate Huayi with extra equity shares and cash. Nevertheless, a source close to Huayi said it was not expecting to use the mechanism in the future because it believes that Yinhan’s profitability will be satisfactory.

The filmmaker is also the second-largest shareholder of Ourpalm. It sold 5.1 million shares of its holdings in Ourpalm for 285 million yuan in May, but still owns 12.6 percent of the company. Ourpalm spent 810 million yuan in March to take over online game developer Dovo Technology Inc. and is reportedly mulling acquiring Beijing-based mobile game developer PlayCrab for up to 2 billion yuan.

The trading of Ourpalm’s stock has been suspended since July 17 after the company said it is working on a “major event.” Trading has not resumed by the time this article was published. The company declined to confirm it was trying to buy PlayCrab.

Since April, at least six companies have announced moves to either acquire a mobile game company or set up one of their own.

A Place to Put Money

Meanwhile, the size of the mobile game market is expanding fast. Sales last year totaled 5.4 billion yuan, says Analysys International, which provides information on the industry. This year, it exceeded 5 billion yuan by the end of June.

The rapid growth rate helped mobile game developers’ share prices soar, but many analysts said the exuberance may not last.

Liu Jin, a founding partner of Lotus Capital, a venture investment company, said investors have expressed a great amount of interest in mobile game developers because the industry is one of the few bright spots in a chronically weak A-share market. Also, many developed unrealistic expectations for the industry’s growth. He described the expectations as irrational and said growth will not continue forever.

Wang Yuying, an angel investor focused on the Internet industry, said the valuations of domestic mobile game developers have far exceeded those of similar Chinese companies listed in the United States. Over time, he said, they are bound to fall a bit.

Even if there are some companies that are genuinely worth the high price, it is hard to tell them apart from others under current circumstances, a fund manager familiar with the industry said. That is because almost every listed mobile game developer has been highly sought after by investors who have nowhere else to put their money.

In other words, he said, a share price alone does not offer any clue to the real competitiveness of a company.

And expanding through acquisitions can be perilous, a securities broker said. Ourpalm, for example, had so far been successful playing the game, but there is no guarantee that it will always succeed.

The company has been trying to expand businesses vertically along the industry chain by deepening cooperation with other game developers and enhancing its distributing channels. But it is still heavily reliant on China Mobile, the country’s largest telecom operator.

The dependence makes it all the more important that the company chooses its next target wisely because once the performance of the acquired firm fails to meet expectations, the impact on the acquirer will be huge, the broker said.

About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (, the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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