Thinking Points

  • DeNA (TSE: 2432) is a company with Silicon Valley-like characteristics, primarily engaged in game development.
  • At first glance, DeNA appears cheap at an 8x adjusted EV/EBIT, but the company’s core browser-based feature-phone targeted gaming platform “Mobage” is in terminal decline.
  • The company’s Nintendo partnership plays a key role in replacing the Mobage business with new smartphone app-related revenues.

DeNA (TSE: 2432) started out as an online auction site, but is now most famous for its mobile game portal “Mobage”, which provides browser-based mobile games geared for feature phone users. Additionally, the company develops  smartphone apps/games, operates e-commerce sites (travel, auction, etc), manages professional sports teams (mainly Yokohama Baystars [baseball]), and is engaged in a wide variety of new businesses (like self-driving tech).

In the US, DeNA is probably better known as Nintendo’s mobile game partner (since 2015), particularly after developing the backend of megahit Super Mario Run.

Source: Super Mario Run

Since its IPO in 2005, ROE has fluctuated wildly. The lowest point was in 2016 (~7%) and the highest in 2011 (~55%). That said, the company has consistently turned a profit and generated free cash flow.

New business catches fire… in a bad way

DeNA has Silicon Valley-like characteristics. Combine this with being Nintendo’s one and only mobile game partner and you would think the company trades at a lofty multiple. However, DeNA currently trades at a 5.2x EV/EBIT (8x adjusted).

The reason for this seems to extend back to 2016, when the company recorded its lowest ROE. DeNA had setup “curation sites” as part of its new business venture in late 2014. Curation sites are basically topic-specific websites where topic-related content is gathered from all over the internet and posted in one place. Often times, these sites operate in gray areas – paraphrasing/rewriting third party content with no references, copying/reuse of images, etc.

In total, DeNA had started about 10 of these curation sites, all with different topics. Welq, a healthcare-focused curation site, was a hit. Then in late 2016, someone on Twitter (Japanese link) pointed out that Welq ranked #1 for the search term “死にたい”, or “I want to die”. This linked to a Welq article which stated that people who want to die have a high desire for approval. In order to gain approval, a self analysis would help. Career tests are useful for self analysis. Then an affiliate link to a career test was posted. Each time a Welq reader took the linked career test, DeNA got paid.

Clearly, there was a major lapse in judgment here. This caught fire on the internet, which also uncovered a series of problems around plagiarized content. DeNA ended up shutting down all of its curation sites in December of 2016. DeNA was not the only one guilty either. The problem existed across the industry. Competitors like Yahoo Japan (TSE: 4689) and Cyber Agent (TSE: 4751) started taking down questionable articles from their curation sites before it became a major problem.

In any case, the curation mess resulted in a write off of 3.9 billion yen ($37 million USD). For the fiscal 2016 period, the curation business accounted for 3.66 billion yen ($3.5 million USD) in sales and 2.88 billion yen ($2.7 million USD) in operating losses.

As a reference, DeNA generated 143.8 billion yen ($1,356 million USD) in revenue and 23.2 billion yen ($219 million USD) in operating income for fiscal 2016.

Source: Google

Not an excuse, but an explanation

In 2011, founder Tomoko Namba had stepped down as DeNA’s CEO. Her husband was fighting cancer. She was still a part of the management team, but on a part time basis, spending most of her time caring for her husband. Two years later in 2013, her husband’s health had improved and she was back on board full-time.

When problems with the curation business came into the limelight in late October of 2016, Tomoko was facing a personal crisis: Her husband’s cancer had returned. In late November, she started spending nights at the hospital. On December 5th, her husband passed away. Two days later, she was in front of cameras, apologizing about the missteps in the curation business.

Source: Business Journal (Japanese)

In the press conference, Tomoko spoke about searching for the term “cancer” on Welq after the site caught media attention. She candidly mentioned that she was shocked to find out Welq started handling such sensitive medical topics.

While inexcusable, the situation is understandable. DeNA damaged its reputation considerably through this experience. However, in cases like these, intentions matter.

Back in 2007, when DeNA’s mobile game portal Mobage was on the rise, social problems were emerging. Adults were using Mobage and other similar social network sites in order to get in touch with minors. DeNA was the first key player in the industry to take steps to prevent these issues. In December 2007, the company  set up “age zoning” and “patrol” systems. With the age zoning system, minor user profiles are only able to receive messages from fellow minor users, and users are only able to search profiles of other users within a two year age gap. With the patrol system, DeNA employees monitored flagged posts around the clock. Given this history, it is difficult to think that the same DeNA had intentions to harm its users and third party content creators through its curation business.

With that said, DeNA’s browser-based Mobage platform has been on a steady decline since smartphones started replacing feature phones. Mobage has been DeNA’s core business and the company has been unable to build a “replacement” core business so far. It is not far fetched to say the management team is under pressure to build the next core business segment, and probably hoped the curation business would be the next big thing. After all, they had build 10 different curation sites in a few short years.

A little more about Tomoko

Taking the topic back to the founder, Tomoko Namba has an interesting background. For one, Tomoko is a woman. Then add a Harvard MBA and a McKinsey & Co background. And then add that she was the third female McKinsey & Co partner in Japan.

The small town girl from Niigata prefecture, however, didn’t always have an elite, woman-in-power background. In a Dream Gate interview (Japanese), she described how her father was the indisputable head of the household. His word was the family’s command. Her childhood conversations with her father frequently consisted of “yes sir” and “understood”. At one point in high school, she was even worried whether her father would allow her to attend college.

After her first rebellion, combined with some convincing from her mother and high school teacher, Tomoko’s father agreed to allow Tomoko to attend college in Tokyo. Even after moving out to Tokyo, however, Tomoko felt like her father was watching her. She found out about her university’s study-abroad program. The student with the best grades can attend classes at Bryn Mawr College (Pennsylvania, USA) on scholarship for a whole year. Figuring that her father would not have eyes on her in the US (he did not speak a lick of English), she kept her grades up and eventually studied in the US.

Since moving to the US, she wrote to her father every week. Strangely, the conversations went beyond “yes sir” and “understood”. At the end of her one year in the US, her and her father went on a vacation together in Hawaii.

Today, Tomoko serves as DeNA’s chairman. With the curation operation gone, DeNA is still in search for its next core business, and smartphone games are becoming increasingly important.

Where Nintendo stands in DeNA’s game segment

As mentioned earlier, DeNA generated 143.8 billion yen ($1,356 million USD) in revenue and 23.2 billion yen ($219 million USD) in operating income for fiscal 2016.

The company operates through four segments:

  • Games
  • E-commerce
  • Sports
  • New business

As is often the case, the new business segment tends to record losses.

Source: Fiscal 2016 filings

Adjusting out corporate expenses and losses from new business, the Game segment makes up 90% of DeNA’s gross profit for fiscal 2016.

The following chart is the game segment’s quarterly user spend as reported in Q3 fiscal 2017, not to be confused with quarterly segment sales:

Source: Q3 2017 Report

DeNA does not break out Nintendo-related game revenues. Fortunately, I came across an interesting analysis from a Japanese blogger, which cross-referenced previous press conferences (partnership announcement), Nintendo’s financials, and industry standard IP licensing fees, then provided an estimate on how much Nintendo-related revenues flowed into DeNA.

First, he pointed out that, apart from IP licensing fees, revenues will be split according to responsibilities. For the most part, revenues will be split 50/50. This was mentioned in a joint press conference.

Second, he created an estimation of how the revenues will be distributed.

    • Google/Apple’s cut (30%)
    • IP licensing fee (10%)
    • Front-end development (30%)
    • Back-end development – DeNA’s cut (30%)

I was not familiar with industry standard IP licensing fees, so I did some reading. According to Araipat (Japanese), character IP licensing generally ranges between 4 and 6%. Considering Mario is probably the most valuable IP in video game history, 10% seems appropriate.

Nintendo breaks out smart device and IP related revenues in its reports.

Source: Compilation of Nintendo Filings

As with most Japanese companies, Nintendo’s fiscal year ends at the end of March. Super Mario Run came out in Q3 2016. My figures above and the blogger’s figures differ. I’ve also incorporated some of the latest quarterly figures.

In any case, the blogger subtracts Q2 revenues from Q3 revenues and figures that the difference is due to mega-hit Super Mario Run. In my calculation, this comes to 5,516 million yen ($52 million USD).

The only other IP revenue source I can think of is Niantic’s Pokemon Go. Barring some major update being released, it is probably reasonable to subtract 1,000 M to 2,000 M yen per quarter from Nintendo’s IP revenues (gross), then multiply that figure by 0.3 to get DeNA’s share of Nintendo-related revenues (net).

So far, for fiscal 2017, DeNA’s share of estimated Nintendo revenues adds up to 6,930 million yen ($65 million USD) in the first three quarters.

Nintendo-related DeNA game segment revenues started off at 4.9% of total segment revenues in Q3 2016, spiked at 9.9% in Q4 2016, and has worked its way to 8.4% in Q3 2017. It is important to keep in mind that Nintendo-related DeNA revenues are reported on a net-basis. DeNA’s internally developed apps are reported on a gross basis.

With Mario Kart Tour slated for a 2018 release, it will be interesting to see how much new revenues will come in. It will also be interesting to see what sort of “tail” we can expect from a Nintendo core Mario IP title like Super Mario Run.

The bottom line

DeNA’s core browser-based feature phone game portal Mobage is likely in terminal decline. Additionally, the up and coming curation business is no longer a thing.

Judging by user spending, DeNA has been able to build its smartphone game business into one that compares to Mobage prior to major Nintendo-related title releases (2016 Q3, Super Mario Run).

Source: Fiscal 2016 Report

The game segment’s challenge over the coming few years is whether it can profitably grow the smartphone game business enough to offset declines in Mobage. It appears Nintendo-related game releases has helped considerably.

Based on the two user spending charts above, I estimate smartphone games currently account for about 70% of game segment revenues. When comparing the first three quarters of 2016 with that of 2017, Mobage user spending declined about 27%. Meanwhile, Smartphone spending increased 37%. In total, user spending increased 6%. With a continued Nintendo partnership, DeNA should be able to effectively replace all of current Mobage revenues with Smartphone revenues over the next 2 or 3 years. This would likely happen sooner with core Nintendo IP title releases – like Mario, Kirby, Donkey Kong, Zelda, etc.

Kenkyo Investing
Kenkyo Investing

Kenkyo Investing applies a value investing approach to Japanese equities, providing insights that are often unavailable to non-Japanese speakers.