We are uncertain what the future will be like for mobile-game makers. We don’t know a lot about this industry yet or the risks of mobile development in the long-run. For example, the recent IPO of King Digital (KING) was a little confusing because the company had virtually no track record and its primary product is a single (but very popular) game for mobile phones and tablets. Clearly, the mobile gaming space can be extremely profitable in the short-run, but success seems hard to predict.
One of our biggest concerns with companies like KING or Zynga (ZNGA) is that their success seems as much luck as skill, which can be seen in the fact that most of their revenue comes from one or two products. What if Farmville hadn’t been as big of a hit or Candy Crush Saga had flopped? These companies wouldn’t have existed as public entities without those hits. They don’t own the platform or distribution channels, so why would investors be interested in this new sector at all?
However, what if a company in this sector had the experience to not only know how to take advantage of a hit mobile game or application, but they had the ability to reliably manufacture those hits? That would be the holy grail of mobile development. It’s a stretch to assume that any company can do it, but it might be worth the risk since these companies can double or triple in value on the back of a single hit.
Glu Mobile (GLUU) has increased in value by almost 40% over the last month on upgrades and the success of a game featuring Kim Kardashian. The game has previously tipped into the top three highest-grossing apps on iTunes and is still at number five as of this writing. Some analysts estimate that GLUU could earn $200 million from this game alone. We like GLUU as a very speculative opportunity both for their recent success as well as how they got that game to succeed.
From a fundamental perspective, there are significant differences between GLUU and its peers that we think will enable its success in the near term.
GLUU has a less concentrated portfolio of games. Despite the runaway success of Kim Kardashian’s game, the company disclosed that less than 30% of their revenue comes from their top franchise. By contrast, almost 70% of KING’s revenue comes from their top franchise, which represents a very concentrated risk.
The company is better positioned to develop games and revenue strategies based on “engines” than their peers. This means they can develop and deploy games, updates and other apps more quickly than their peers. This is how the Kim Kardashian game was developed and deployed.
Through acquisitions, GLUU has intellectual property that gives them an advantage over their peers.
However, there are some disadvantages as well. The company has struggled to be profitable over the last few years as it worked its way out of the financial crisis. It is smaller than most of its peers and has had to raise capital through new offerings in order to complete its acquisitions. That means the pressure is on to deliver results, and short traders have continued to be fairly interested in the stock.
Following the big gains over the last month, the stock has started to consolidate in a pennant pattern. Earnings will be released after the market closes today, July 30, so a pause shouldn’t be a surprise. The options are fairly inflated as investors prepare for the report, so we don’t recommend entries until earnings are released. This is a simple technical pattern, but breakouts in favor of the previous trend have been productive on GLUU in the past.
GLUU Mobile: Chart Courtesy of eSignal
To be clear, we don’t think GLUU is a long-term hold at this point. The industry is too new and uncertain for this stock to be an appropriate component of a conservative portfolio. However, there are likely to be some short-term opportunities for profits. An entry after earnings may be an ideal opportunity for a long call position.
There is currently a big premium in the stock’s options because there is a high likelihood for a big move one way or the other. In that situation, option sellers demand more for options they are writing because they are taking more risk. Following the announcement, the stock is likely to gap one direction or the other and should experience a collapse in implied volatility and premium. That collapse could make the options undervalued as long traders sell quickly to take profits or stop losses.
Historically, the initial move on GLUU has continued in the short-term following an announcement gap. We don’t like the idea of a short or bearish position considering the success they have seen so far this month, but a gap higher is likely to continue in the near term as investors jump in behind that momentum. Because of the short time-horizon, we think buying an at-the-money call on a bullish breakout makes sense as larger investors move into the stock and drive the price higher in August.
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