Thinking Points

  • Gree (TSE: 3632) is a social games company which started out by offering browser-based social games, then expanded into mobile games and smartphone games.
  • In its short existence since 2004, the company has already gone through several transitions in order to survive, with its current business mainly driven by smartphone based social games.
  • More recently, the company started investing in media and live virtual entertainment, but this is yet to account for a meaningful amount of business.
  • At 495 yen per share, Gree is trading at 73.2% of NCAV with a market capitalization of 113,036 million yen ($1.05 billion USD).
  • Although Gree is still profitable, the health of its operating business is uncertain at best, and investors are advised to stay away from investing in the company at this point.

Introduction

Gree (TSE: 3632) is a social networking service primarily driven by social games. At the same time, the company operates a media, live entertainment, investment, and advertising business. Gree operates as a single segment as the bulk of revenues are generated by in-game purchases on freemium games. However, the company does breakdown revenue by paid billings (in-app purchases, etc) and other (advertising, media, licensing, virtual reality, etc):

Source: Kenkyo Investing, based on company data

Gree originally started as a social networking service for feature phones, then started to focus more on freemium games for feature phones. Later when smartphones became more common, the company transitioned to social games for smartphones. More recently, Gree has been focused on virtual reality content creation.

The business & environment

Gree was founded in 2004 when Rakuten (TSE: 4755) employee Yoshikazu Tanaka built a social networking service (SNS) for PC users as a hobby outside of work. In fact, the idea behind Gree was first presented as a potential Rakuten project. Upon rejection, Yoshikazu decided to build his idea on his own time.

Interestingly, Gree wasn’t the first SNS in Japan. Mixi (TSE: 2121) already dominated the scene, particularly as a SNS for PC users. Gree was, however, among the earliest platforms for phones when it released Gree Mobile in 2005. 

Still, Gree didn’t hire its first employee until 2005, leaving the phone-based SNS space up for grabs by competitors. Companies like Mixi and Hatena (TSE: 3930) already had more established development teams while Gree was just starting to figure out how to structure its new and small organization.

In 2006, Gree partnered with KDDI (TSE: 9433), one of the largest mobile carriers (operating under the au brand) in Japan. This was a major milestone for Gree as it was struggling to generate profits. In its early days, the company’s main source of revenues were Amazon affiliate sales, Google’s Adsense, and other advertising service.

The partnership with KDDI provided Gree with 36.4 million yen ($3.4 million USD) in additional capital and access to au’s entire mobile customer base through EZ GREE, au’s now official SNS. Even then, Mixi still dominated the scene with more than 10 times the number of users compared to Gree.

This is when Yoshikazu started paying closer attention to other companies that adapted for survival, namely Apple and Nintendo (TSE: 7974). The case for Nintendo was particularly interesting at the time. While Sony (TSE: 6758) was pushing top-of-the-line computing power and graphics to the console gaming scene, Nintendo was busy working on the Nintendo DS, a handheld gaming unit more focused on its interactions with the player than high-end graphics.

Armed with confidence that, however basic, a market for gaming on feature phones exist, Gree transitioned into freemium games for feature phones. The company essentially worked to build out the equivalent of a browser game portal for feature phones and monetize through advertisements.

Around the same time Gree was working on its feature phone gaming site, DeNA (TSE: 2432) launched Mobage Town, which was similar in concept. Facing fierce competition from DeNA, which had 4 times the number of users compared to Gree in 2007, the company increasingly focused on social games.

More specifically, the company started developing in-game structures that tickle the player’s speculative spirit. One example is the “Gacha”, or loot box, which awards players with virtual items in exchange for money. These virtual items often have varying degrees of rarity, with more powerful items typically being rare, and helping the player progress through a game.

While Gree’s social game monetization yielded major profits, it created social problems. Leading up to 2012, Gree often used the word “free” when promoting its social games, then charged players for gatchas and in-game items. Diamond JP, one of the major news publishers in Japan, noted an industry expert’s comment that the company is supported by the top few percent of players that spend over 100,000 yen ($930 USD) each month. In 2012, Japan’s Consumer Affairs Agency saw this as a problem, warning that its advertisement misrepresents the company’s offerings.

Needless to say, Gree’s business performance started deteriorating shortly after the government’s intervention:

Source: Kenkyo Investing, based on company filings

Although Gree continues to maintain its browser game offering while creating smartphone games, the company’s performance has continued to deteriorate. Since 2016, Gree has put its media business as a focal point. Then in 2018, the company started investing in its new virtual Youtuber business.

Essentially, the media business is a collection of content curation websites. Gree currently operates five key websites, mainly focusing on lifestyle. The virtual Youtuber business is basically the creation of live Youtube videos using avatars. Neither of the focus areas have grown enough to meaningfully contribute to business performance yet.

Gree has not provided any guidance for fiscal 2020, noting that the company’s performance difficult to predict as it varies greatly depending on the release of new games. The company used to provide an annual expected performance range, but in recent years has only provided guidance for the first quarter of each fiscal year until fiscal 2020, when the company provided no guidance.

Shareholders

As of Q4 2019 (ending June 30, 2019), Gree had 242,231,200 shares issued and 12,016,161 shares in treasury, putting outstanding shares at 230,215,039.

Here are the major shareholders:

Source: Kenkyo Investing, based on company data

Founder CEO Yoshikazu Tanaka owns just under a controlling stake. There are 861,100 shares worth of unexercised stock options (0.4% of outstanding shares), 321,400 shares of which are currently exercisable.

Financials & Valuation

  • Gree is a social games company which started out by offering browser-based social games, then expanded into mobile games and smartphone games.
  • In its short existence since 2004, the company has already gone through several transitions in order to survive, with its current business mainly driven by smartphone based social games.
  • More recently, the company started investing in media and live virtual entertainment, but this is yet to account for a meaningful amount of business.
  • At 495 yen per share, Gree is trading at 73.2% of NCAV with a market capitalization of 113,036 million yen ($1.05 billion USD).
  • Although Gree is still profitable, the health of its operating business is uncertain at best, and investors are advised to stay away from investing in the company at this point.

Gree started out as a personal project of a Rakuten employee in 2004. Although Mixi already dominated the SNS scene, Gree was able to grow its user base, particularly after it started focusing on social games.

Despite its short existence, the company has gone through several transitions, fending off Mixi’s SNS presence and competitive pressures from DeNA on social games. When the company introduced gatcha features to its free social games, profits soared.

In 2012, however, Japan’s Consumer Affairs Agency warned Gree that its advertisements were misrepresenting its offerings. Ever since the Consumer Affairs Agency intervened, Gree’s business performance has been on a deteriorating track. 

More recently, the company is attempting to expand its game business overseas while building out its newer media and live virtual entertainment businesses. Neither of the new businesses have gained traction just yet, and the company’s existing social games business drives unpredictable, but generally declining business performance.

At 495 yen per share, Gree trades at 73.2% of NCAV with a market capitalization of 113,036 million yen ($1.05 billion yen). Although Gree has 17,652 million yen ($164 million USD) worth of long-term investment securities on its balance sheet, much of this is in non-public companies, making it difficult to determine how much the securities are actually worth. 

Hence, there aren’t any adjustments to make for Gree’s market valuation. Moreover, while the operating business is still profitable, there is significant uncertainty regarding future performance, especially with the mainstay social game business which has been on a continued decline. Given this, it’s difficult to place a valuation of over 100% NCAV, and prudent investors are best advised to stay away from investing in Gree at this point.

The bottom line

Gree is a social games company which started out by offering browser-based social games, then expanded into mobile games and smartphone games. Today, the company is making efforts to build its newer media and live virtual entertainment businesses. While currently profitable, the health of Gree’s operating business is uncertain at best. Hence, investors are advised to stay away from investing in Gree at this point.


Kenkyo Investing
Kenkyo Investing

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