The Secret GRVY Recipe to Produce 50% YTD

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Jae Jun

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The Secret GRVY Recipe

ADR – Small Korean online game development company

Stock price below $5. “Was” trading below NCAV.
Dirt cheap fundamemtals for a profitable company
No chance for activism because of 51% owner

7+ years of delays for game release
Catalyst of impending game release

Mix the ingredients together and you get a value investor’s dream dish in the name of Gravity Co (GRVY).

There is no need for me to go over everything again because I’ve written about GRVY numerous times. Several other value investors have also written detailed analysis of the company which I’ve linked to at the bottom of the page.

Right now, I just want to get straight into an updated valuation because YTD, GRVY has shot up 50% with increasing volume and it is a good time to review the probabilities of downside vs upside.

GRVY’s Impending Game Release is a Huge Catalyst

I am still very bullish on the company and the original thesis is still intact. GRVY is set to release the sequel to their blockbuster game after 7 long years of delays, redevelopment and more delays.

Waiting has been difficult because GRVY has a talent for announcing a release date and then delaying the date a month or so before the deadline.

But the company is finally entering their Open Beta test phase on Feb 22, which is a big step from Closed Beta testing and towards commercial launch set for March 2012.

It is one small step for GRVY, but one giant leap for shareholders.

7 years of disappointment and being ignored by Mr Market is about to end.

GRVY offers Downside Protection

First thing to consider is the downside. In the previous post where I detailed the market expectations of GRVY, I went through the NNWC, NCAV and tangible book value numbers to show the downside.

For a company that is

profitable and FCF positive
has very little debt
has plenty of liquid assets and cash

and has high margins

then the least it should be trading at is book value.

With the 50% jump since the beginning of the year, GRVY is now just above tangible book value.

Q4 results is not yet available to dig into, but based on Q3 results

NNWC value is $1.50
NCAV value is $1.78

Tangible book value is $1.99
Book value is $3.42
Current price is $2.15

GRVY offers Upside Potential

The current price still reflects a business that is selling for close to tangible book value.

At the current price, you are getting the portfolio of games, future of RO2 as well as additional revenue streams from licensing to other countries and growing mobile gaming revenue for free.

So what is the upside? Here are a few possible scenarios to consider.

Book value scenario: Suppose the market accepts the fact that the game acquisition prices are fair. Then the stock price should be at least book value instead of tangible book value.

That makes 1x BV = $3.42 a very reasonable target price. There is still 59% upside from today’s price of $2.15 to reach $3.42.

Zynga (ZNGA) is 11.5x BV

Glu Mobile (GLUU) is 4.4x BV
Majesco Entertainment (COOL) is 4.5x BV
A company like KONG that is bleeding money is 0.7x BV

If you take time to go through more competitors, you will see that profitable gaming companies tend to trade at about 4x BV.

As the other gaming revenues continue bring in additional revenue and RO2 starts commercial business, there is no reason why GRVY can’t be valued at a paltry 1x or even 1.5x BV.

At 1.5x BV, GRVY would be worth $5.13 which is 140% from today’s price.

EBIT Multiple Scenario: If GRVY has another profitable fourth quarter, my estimate for full year EBIT is $9m.

Based on my rule of thumb, a company like GRVY should be trading at 10x EBIT. On a per share basis, it is worth$3.30, but this value is based on the current EBIT ignoring future revenue increases.

Earnings Multiple Scenario: I’m estimating that fiscal year EPS will be approx $0.30 to $0.32. Again, this is based on pre RO2 revenue. Slap a multiple of 10x EPS and the target price comes to $3.00 to $3.20.

Valuation Scenarios

Conservative value: $3.00
Normal value: $5.00
Aggressive value: $7.00

Not saying that I am going to hold until $7 or even $5 because it all depends on how well the company markets and launches RO2 as well as expanding revenue from its other games.

But considering the bigger picture, the easy conclusion is that GRVY is still cheap at $2.15.

GRVY is still finger licking good.

Disclosure

Long GRVY at time of writing