GLUU In a previous article "Glu Mobile's Acquis

GLUU

In a previous article " Glu Mobile's Acquisition Price Could Surpass $10 ," I wrote about the changing fundamentals and seasonality behind Glu's share price rising to $5 by June (NASDAQ: GLUU ). Today, I want to take a look at what's been going on in the company, and will present the case for why I think investors could be in for a huge surprise in May.

Glu's Monetization Challenge

Glu's struggle with monetization has been no secret. The company's current monetization figures sit at about .7% of Monthly Active Users (MAU) paying, and $0.067 in Average Revenue Per Daily Active User (ARPDAU). Those figures are below standards, as 1-1.5% is the industry average. Even so, because of the large number of games and downloads the company gets, it was able to bring in $20.8 million in revenue for the 4th quarter.

Niccolo Demasi, Glu's CEO, understands this challenge better than anyone. This is why Matthew Richetti was hired in October of last year. Matthew was VP of Mobile at Kabam, and was in charge of Kingdoms of Camelot, one of the most successful games on mobile in terms of monetization. Richetti also hired his own team of people this quarter, specifically to assist in improving monetization of Glu's games.

When Glu brought on Richetti, it delayed its planned Q4 releases so that he could review them, to gauge and improve monetization. This frightened investors as not only would those games not be producing revenue for the quarter, but there was a likelihood that the games could be scrapped completely. This would have caused Glu to take a hit to the bottom line in addition to the lost revenue. All of the time, money, and resources spent developing those games would have been for nothing.

We can now see that this was not the case, with the 7 freemium games Glu released in the 1st quarter of 2013. Sure, revenue may have been delayed, but if monetization metrics improve, then it was a smart move on their part.

Previous Earnings

Glu has been able to beat analyst estimates, and its own guidance for each of the last 12 quarters. Furthermore, it was not only able to beat estimates; but the average surprise percentage was 79% over the last 3 years! I was especially impressed with Glu's ability to exceed estimates yet again in the 4th quarter of 2012, even after delaying the majority of its planned titles.

Here is a look at Glu's earnings results over the last 3 years:

Quarter	Actual Earnings	Estimate	$ Surprise
Q1'10	-.03	-.10	+.08
Q2'10	-.02	-.08	+.07
Q3'10	-.02	-.08	+.07
Q4'10	-.02	-.08	+.07
Q1'11	-.02	-.07	+.05
Q2'11	-.01	-.04	+.03
Q3'11	-.02	-.12	+.10
Q4'11	-.02	-.09	+.08
Q1'12	-.01	-.08	+.07
Q2'12	0	-.04	+.04
Q3'12	-.03	-.06	+.03
Q4'12	-.05	-.07	+.02
AVERAGE	-.02	-.076	+.06

Given its track record, the release of the 7 new games, improved monetization, and the release of its real money gambling game in the UK, Q1 is most certainly going to be lucky #13 for Glu.

Q4 Revenue Breakdown

Taking a look at Glu's previous revenues gives us a good guideline to project future revenues. Specifically, I will use Q4 revenues for the baseline of this discussion, as it was a particularly dismal quarter for Glu. Glu's Q4 operating figures are as follows:

Feature phone Revenue	$2.4 Million
Smartphone Revenue	$18.5 Million
Total Revenue	$20.8 Million
Gross Margin	$18.7 Million
Gross Margin %	90%
Operating Expense	$21.2 Million
Operating Loss	($2.5 Million)

Smartphone revenues are the main driver of Glu's total revenues. So in order to project revenues for Q1, we need to see how the $18.5M was earned during the quarter.

Glu only released 4 games during the quarter. By looking at the release date and income the games generated, we are able to estimate the average revenue per day its games bring in.

Title	Launch Date	Revenue	Days Avail
Death Dome	Oct 11, 2012	$0.4 Million	82
Contract Killer 2	Oct 24, 2012	$2.7 Million	69
CK Zombies 2	Nov 28, 2012	$0.5 Million	34
Dragon Slayer	Nov 20, 2012	$0.25 Million	42
Total		$3.85 Million	227
	Average Revenue/Day		$16,960

From these figures, we can determine that Glu had a 50/50 success rate on its games with Contract Killer 2 being the only real winner. We can also determine that even at this low success rate, Glu makes about $16,166 per day on each game it releases during the quarter.

So let's take a look at Glu's title releases during the first quarter and the days those games have been available to generate revenue.

Title	Launch Date	Days Available
Dragon Storm	Feb 6th	54
Stardom Hollywood	Feb 14th	46
Gun Bros 2	Feb 20th	40
Small City	Feb 28th	32
Samurai vs Zombies 2	March 6th	26
Heroes of Destiny	March 13th	19
Frontline Commando D-Day	March 27th	5
	Total	222

Now, in Glu's 4th quarter, it had a 50% success rate in the titles it released. Glu's games in Q1 have been performing much better than expected as noted by analyst Darren Aftahi of Northland Capital Markets. He upgraded Glu to an Outperform on March 17th and raised his price target to $4.50 (after downgrading it on Feb 4th before Q4 earnings were released on Feb 5th).

Aftahi stated "Based on the games Glu Mobile has released this quarter, the company "has substantially improved its hit rate for new games, and there is evidence Glu Mobile is seeing better-than-expected sales from games for smartphones."

While it is safe to assume Glu's game performance and revenues will be better this quarter over the last, I will still use the lower Q4 number of $16,960 in my projection of Q1 earnings to further substantiate my findings.

Glu's estimated smartphone revenue from new games can then be calculated by taking the total number of days available (222) and multiplying it by the average revenue per day ($16,960) to give us the total expected smartphone revenue from new games in Q1.

222 x $16,966 = $3,765,120 in Projected Smartphone Revenue

Now that we know the smartphone revenue from the new games, we can calculate Glu's total smartphone revenue. Glu's new games tend to contribute about 20% of total smartphone revenues, as seen in Q4. The majority of Glu's quarterly smartphone revenue actually comes from previously released titles, as Glu continues to update the games and they continue to bring in money. This means that the $3.7 million in projected smartphone revenue only makes up 20% of total quarterly smartphone revenue. To account for the remaining 80%, we multiply the projected revenue by 5 (20% x 5 = 100%) in order to get to the total smartphone revenue number.

$3,765,120 x 5 = $18,825,600 in Total Smartphone Revenue

When Glu gave guidance for Q1 revenues, it guided for $16M on the low side and $17M on the high side. Since these projections are based on the numbers of the poor performing Q4 games, the revenue should actually be much higher. This will again put Glu substantially above the High End of guidance.

Here is a look at Glu's guidance for Q1, per the Q4 earnings call:

($ in Millions, except EPS)	Q1'13 Low Guidance	Q1'13 High Guidance
Feature phone Rev	$1 M	$1.5 M
Smartphone Rev	$16 M	$17 M
Total Revenue	$17 M	$18.5 M
Gross Margin (%)	89%	90%
Operating Expense	$20.5 M	$20.7 M
Operating Income / (Loss)	$(5.4) M	$(4.1) M
Depreciating Addback	$0.8 M	$0.8 M
Adjusted EBITDA	$(4.6) M	$(3.3) M
Net Income / (Loss)	$(5.6) M	$(4.3) M

My Projections for Q1

In my estimated projections, I have taken the smartphone revenue number calculated above, and used the average of the high and low guidance for all other numbers. Taking the $18.8M in estimated smartphone revenue, and adding the 1.3M in feature phone revenue, puts total revenue at $20.1M. After factoring in Glu's 90% gross margin, and deducting operating expenses, Glu's operating loss becomes $2.5M.

($ in Millions, except EPS)	Q1'13 Median Guidance	My Q1'13 Guidance
Feature phone Rev	$1.3 M	$1.3 M
Smartphone Rev	$16.5 M	$18.8 M
Total Revenue	$17 M	$20.1 M
Gross Margin (%)	89.5%	90%
Operating Expense	$20.6 M	$20.6 M
Operating Income / (Loss)	$(4.75) M	$(2.5) M
Depreciating Addback	$0.8 M	$0.8 M
Adjusted EBITDA	$(3.95) M	$(1.7) M
Net Income / (Loss)	$(4.95) M	$(2.7) M
Basic Shares	66.2 M	66.2 M
Loss Per Share	(.07)	(.04)

Based on only this, you can see how Glu should have a blowout 1st quarter, beating analyst estimates by at least .03/share. These projections however only take into account Glu's smartphone game performance based on a 50% success rate. While Glu's smartphone games are currently its core business, and things are going quite well on those fronts, those games are not Glu's only source of revenue.

There are several other sources that will provide an additional boost to Glu's revenue this quarter.

New Platforms

Glu has increasingly been releasing titles for Mac, and just announced its first title for Microsoft on April 1st. It costs Glu Mobile very little in development cost to adapt an existing successful game to a new platform. This will mean additional revenue to Glu's bottom line at even higher profit margins. As new platforms emerge and gain traction, Glu will be launching titles on those as well. We should start to see Glu breaking out PC/Mac revenues from smartphone revenues soon. It is also safe to say that we will see a slew of Glu's existing titles making their way to the Windows 8, and other platforms in the near future.

Glu's titles are performing particularly well on Mac amid less competition and its ability to create high quality, engaging games. In the 1st quarter, it had as many as 9 titles in the top charts. Deer Hunter, A-list, Frontline Commando, Contract Killer 2, and Eternity Warriors 2 performed exceptionally well by holding spots in the top 50.

Glu's stats on the Mac app store as of April 3rd:

Glu Mobile had 4 Games featured on the games home page

Top 200 Grossing Games : Glu held spots #37, #42, #44, #57, #104, #110, & #171

Top 100 Free Games : Glu held spots #7, #12, #16, #17, #38, #62, #66, #68, #84, and #92

Glu's games perform well already. When they get monetization ironed out, revenues will really take off.

Online Gambling

Neither I, Glu, nor analysts have accounted for any gambling revenues in Q1 guidance. Glu's first gambling slot (based on the Samurai vs Zombies defense IP) went live on March 12th and is a revenue share program with Probability PLC in the UK. Probability took to social media saying:

"Samurai vs Zombies Slots is live and people are loving it. First fruits of our collaboration with Glu Mobile."

Though it has only been live for 20 days, monetization on real money gambling is much higher than on freemium games. Any revenue earned will be a plus for Glu this quarter, and will give vital information to Glu and investors on what type of revenue to expect from the venture going forward.

Glu also invested in Bee Cave games early in the quarter. Its first game, BlackJack Casino, has been in beta testing on Facebook (NASDAQ: FB ) and the mobile versions are set to launch sometime in April or May. Though it is likely that no revenues have been realized yet, this still remains an opportunity to keep on the back burner, and Glu should start seeing some revenue from it in the 2nd quarter.

Zynga (NASDAQ: ZNGA ) also launched its real money gaming in the UK on April 3rd, a move that pushed its shares higher 17% during the trading day. These kind of moves show investors' enthusiasm in the space, and when Glu and Zynga roll out more games to more countries, the stocks should appreciate accordingly.

Improved Monetization

The 7 new games Glu released this quarter have been performing well, and include Richetti's monetization enhancements. The added social integration is also a likely contributor to the success of these titles. Glu is also now utilizing Playhaven to improve monetization and gain a better understanding of when and where people are making purchases, to improve its effectiveness. It is important to note that at .7% monetization, a .1% improvement would move revenues by 14%. This would move smartphone revenue from $18.8 million to $21.5 million. This minor improvement alone would move Glu to profitability in the 1st quarter.

Here is what Glu's earnings would look like with just a 0.1% improvement in Monetization:

($ in Millions, except EPS)	Q1'13
Feature phone Revenue	$1.3 M
Smartphone Revenue	$21.5 M
Total Revenue	$22.8 M
Gross Margin (%)	90%
Operating Expense	$20.6 M
Operating Income / (Loss)	$0 M
Depreciating Addback	$0.8 M
Adjusted EBITDA	$0.8M

Increased Profit Margin

Glu's move to only original IP games enables it to keep all of the revenue it generates vs. paying out some of that revenue in royalties and license fees. The interesting thing is that instead of buying other companies' IP, Glu is now generating income from its own. The addition of new platforms such as Mac and PC, as well as making games available on more devices/platforms sooner will also lift Glu's revenues and profit margin.

Glu's focus on sequels by creating more compelling games also decreases its development cost and the lifetime value of its games. Glu released 5 sequels during Q1: Small City, A-list: Hollywood, Gun Bros 2, Samurai Vs Zombies Defense 2, and Frontline Commando: D-day. The development of a sequel is a fraction of the cost of building a new game from the ground up. Even though development costs included social integration and cloud servers, this should still enable Glu's profit margin to tick up a percent or two.

Decreased Operating Expenses

Glu's General and Administrative expenses have been flat for some time, but as Glu stated in its Roth Capital Partners presentation, the company is committed to get it even lower than the 14% it saw in 2012. 40% lower in fact… as its long-term plan calls for G&A expenses at 10%. Glu has already begun to make strides in this metric by closing offices and decreasing its headcount by 100 people during the 4th quarter. These actions will decrease expenses and lend to an improved probability of profitability.

Increased Downloads

Glu's hire of Matthew Richetti, and delay of its games in the 4th quarter was not by chance. The 4th quarter tends to be a poor performing quarter for Glu anyway, as people are gearing up for the holiday season and upgrading their cell phones to the latest and greatest smartphones. Glu's revamping during the quarter enabled it to get everything lined up for its best performing quarter at the start of the new year. As millions of people were getting acquainted with their new phones, Glu was able to release game after game after game. Glu's games get about 65 million downloads each quarter. The release of popular sequels such as Gun Bros 2, Stardom: Hollywood and Samurai vs Zombies 2 should drive the number of downloads even higher. The boom of the 1st quarter coinciding with the launch of the 7 monetization improved games should lead to a record quarter of revenue for Glu.

Getting to Break Even

Any and all of these factors will add to revenue and/or decrease expenses during the quarter. As you can see below, when looking at my estimates, Glu only needs an additional $3M in revenue from these other sources to turn profitable on the quarter. I believe that Glu's performance on the Mac App Store alone could push it to profitability, as it has consistently had several titles in the top grossing charts for the entire quarter. The improved hit rate and monetization will also provide a large boost to its Q1 revenues.

Glu's Break Even

($ in Millions, except EPS)	Q1'13 Break Even
Feature phone Revenue	$1.3 M
Smartphone Revenue	$18.8 M
Misc Revenue	$3 M
Total Revenue	$23.1 M
Gross Margin (%)	90%
Operating Expense	$20.6 M
Operating Income / (Loss)	$0.2 M
Depreciating Addback	$0.8 M
Adjusted EBITDA	$1M
Net Income / (Loss)	$0 M
Basic Shares	66.2 M
Loss Per Share	$0

Conclusion

Glu is incredibly undervalued currently. After a 50% run up to the high 3's on the company's move into real money gambling, Glu has given up all of those gains and is back to almost flat on the year. The drop in price the stock has seen has come on a fraction of shares traded, compared to the truly massive volume the shares experienced on the move up. With a 20% short interest, the stock price has been run into the ground, creating an incredible opportunity for long investors. When Glu does post a profit, the 50% pop from the online gambling news will be dwarfed by the gains that will ensue. If you missed out on the run before, I encourage you to take a hard look into this stock. I have a $7.50 price target on Glu, and can see the stock trading above $5 by June.

Additional disclosure: I do not intend to close any positions within the next 72 hours, but may add to my existing holdings.