I found this stock after researching Gravity Co., which is a subsidiary of Gungho Online Entertainment. Gravity's financial look very similar to those of Gungho but the main issue with Gravity was their lack of creation of shareholder value. Therefore I spent a lot of time researching the shareholder value that Gungho creates.
In this post I will share my findings after doing some research on this company. It's by no way a complete analysis and shouldn't be seen as one; especially considering that this post does not cover everything I found. Therefore the valuation in this post should be taken with a big grain of salt too; I simply made it to give myself a rough range of what the stock should be worth and whether it's worth doing more research on.
Business overview
Gungho Online Entertainment is a Japanese company that develops and publishes video games, focusing on mobile- and free-to-play games. Their revenue comes from the sale of ads, in-game purchases and the sales of games. Gungho is mostly known from two game series; Puzzle & Dragons and Ragnarok, which have been hit games since they were released. The release of the mobile game P&D in 2012 caused a big surge in revenue and earnings, followed by a surge in the stock price. Gungho has created a lot of sequels to these two series but have been releasing a lot of new games as well. A popular, recent example is their Free-To-Play game Ninjala for the Nintendo Switch which has exceeded 8 million downloads.
Asia, and Japan in particular, are by far their main markets. In 2020 more than 60% of revenue came from Japan, with roughly 35% coming from other parts of Asia. The remaining 5% came from North America and other regions.
Financials
There are two main points considering the financials of Gungho. The first one being the history of their revenue and earnings.
As mentioned before, the release of Puzzle & Dragons in 2012 caused a big rise in revenue and earnings. The revenue jumped from 25B yen in 2012 to a peak of 173B yen in 2014 before dropping to 92B yen for both the years 2017 and 2018. Sales have slowly increased since then, to 104B yen in 2021. Earnings has followed a similar path (8B in 2012, 62B in 2014, 16B in 2018 and 22B in 2021).
The second thing to note regarding the financials of this company is their very high amount of cash. In fact, their net cash (i.e. cash – total liabilities) is 99B yen, which makes up for more than 60% of their market cap. This makes for an enterprise value of 63B yen. To quickly put that in perspective; their 2021 EV/FCF is 2.7 (ie a FCF yield of 36,5%) and their 2021 EV/Earnings ratio is 2.57. Now since earnings and FCF have been relatively stable in the last five years, these ratios won't differentiate that much if you were to compare them to 5-year averages.
Strategy and risks
The strategy for Gungho is somewhat straightforward; they want to create new values (which is definitely necessary in the market that they're in), get more exposure in other regions than Asia and work together with other parties as a publisher. What is more noteworthy in my opinion is that they want to maximize existing values; they are creating TV shows, comics and event for series that have proven to be popular.
One possible negative is that these focus points seem to have been more or less the same since 2016. The global expension does not seem to be very succesfull with only 5% of revenue coming from non-Asian parts of the world. You can argue that the maximization of existing values and creation of new values has been okay with their financial results being stable/slowly growing, as a result from users in their most popular games being stable and new games doing decently well.
An undeniable risk in this sector is the novelty and uncertainty of it. Although Gungho has done well in the past, it's hard to predict what revenue and earnings will look like five years from now. Therefore a large margin of safety would be needed to invest in this company.
Shareholder value
Since Gravity Co. neither bought back shares nor paid a dividend I wanted to make sure Gungho, their parent company, does provide shareholder value. Gungho pays a 1.2% dividend and have actually paid double that in 2021. This was a one-time dividend but it's still a sign that they want to improve shareholder value.
More important than their dividen is share-buybacks. In 2021 they bought back about 4,2% of shares. Adding in the 2,4% dividend that has been paid in 2021, Gungho returned 6,6% to shareholders in 2021. The question is whether they will continue to buy back shares and pay a dividend; considering their very large pile of cash, it would certainly be beneificial.
Valuation
As said before, it's hard to predict future earnings for a company like Gungho. For the valuation I made a simple DCF as well as (an even simpler) net-net calculation.
Assuming their Free Cash Flow decreases by 2% for the rest of time and taking their net cash into consideration, fair value today would be 3,813 yen for a 12% annual return. This would mean the stock, currently at 2,550 yen per share, is undervalued by 49%. This means that, if you were to apply a 30% margin of safety, the stock would still be undervalued by about 5%.
The net cash per share is 1,550 yen, which is 65% down from the current price. The stock actually hit this price during Covid so it's not out of the question.
Conclusion
The financials on this company look very good; both the balance sheet and financial ratios are really attractive. However their is a lot of uncertainty in this sector and we are not guaranteed that Gungho will continue to provide shareholder value.
For now, I will look into their competitors and try and find out what their customers think of Gungho as a brand and their games; it's been hard trying to find information on this since most customers are not from Western countries.
I would love to hear what you think!
Leave a Reply