Gravity Co. LTD (GRVY)

Overview: 

Gravity is a company that creates and markets computer games. The most successful one is Ragnarok. The sequel, Ragnarok II (RO2), has been in the works for quite some time. With the company trading around a conservative liquidation value (cash+ST investments minus total liabilities) of $1.15/ADR (6.948M shares, 4 ADRs to 1 regular share) it could be an enticing buy or a value trap.

Investor Fatigue:

Just about nobody really wants to own a stock. The goal is to buy a company and sell it shortly thereafter. This universal renting of companies causes people and investors to lose patience and interest quickly. Some people are more patient than others. Value investors  tend to be more patient. For example, GRVY has been written up on the Value Investors Club four times total.   

"GRVY continues to trade well under net cash ($2.2 per share) with modestly profitable operations and a significant catalyst on the near-term horizon: launch of Ragnarok Online 2 (RO2) this summer. Company IR has now confirmed to me twice - including today - that RO2 will launch this summer (though there is some risk of further delays)."

That was in 2010. 

"But the catalyst for the stock, the release of the Ragnarok 2 (R2) multi-player online game, is now only months away."

That was in 2007. 

The statement "only months away" was true. RO2 was only about 60 months away from launch in Korea. If the analyst who wrote the article still holds shares, let me know. I'll buy you a beer for being so patient.

I'll do everyone a favor and not claim that RO2 is a catalyst. The continued deterioration of sentiment, poor management a few years back, and limited information means that GRVY often trades below cash. 

I like pessimism though. It creates something to launch off of. Five years of waiting creates a lot of pessimism, below liquidation value pessimism.

Are things really that bad?

Like I stated earlier, I have no idea when RO2 will be released across all countries. I think there have been some interesting developments though over the past 6 months. 

Q3 2012 BUSINESS UPDATES

Ragnarok Online II to be launched in two more markets in the first half of 2013

Gravity is planning to release Ragnarok Online II in North America and the Philippines in the first half of 2013 after its launch in Singapore and Malaysia in December 2012.

Steal Fighter to be launched in Korea in the first quarter of 2013

Gravity will launch Steal Fighter, an action real-time strategy role playing game, in Korea in the first quarter of 2013. Gravity entered into a license agreement with L-Time Games Co., Ltd., the developer of Steal Fighter, to publish the game in Korea in April 2012 and conducted closed beta testing in September 2012. The Company intends to launch the game in the overseas markets after its launch in Korea.

Ragnarok Online – Uprising: Valkyrie to be launched in China and Taiwan

Ragnarok Online – Uprising: Valkyrie, a mobile massively multiplayer online role playing game, will be released in China and Taiwan by the end of 2012. Gravity has entered into license agreements with local licensees in each market and the game will be available on iOS and Android platform. Ragnarok Online – Uprising: Valkyrie hits more than 600,000 cumulative downloads in Korea since its launch in May 2012.

Q2 2012 BUSINESS UPDATES 

Ragnarok Online to be launched in Singapore and Malaysia in the fourth quarter of 2012

Singapore and Malaysia are expected to be the first overseas markets where Ragnarok Online is to be released. 

The Company and AsiaSoft Online Pte. Ltd., the licensee of Ragnarok Online II in Singapore and Malaysia, have agreed to commercially offer the game in these markets in the fourth quarter of 2012.
 

Mr. Hyun Chul Park, CEO of Gravity said, “The performance of Ragnarok Online in Korea is below our expectations. However, I believe that we have overcome most of the technical problems in the early stages and that we are ready to release the game in the overseas markets where the game is eagerly anticipated.”
 

The service language of Ragnarok Online in Singapore and Malaysia will be English. The Company is also planning to launch the English version of the game in some other markets in the near future after localizing the content to tailor the game to local cultural preferences of each market.

Gravity strengthening its presence in the mobile game industry

Gravity has been enhancing its mobile game lineup by releasing more smartphone games with up-to-date technology, based on its flagship title Ragnarok Online. In particular, Ragnarok Online – Uprising: Valkyrie, a mobile massively multiplayer online role playing game for iOS and Android released in Korea is surging in popularity with more than 430,000 cumulative downloads in less than three months since its launch in May 2012. Ragnarok Online – Uprising: Valkyrie is a cross-platform game which allows users to play the game on one server regardless of their operating system.
 

The Company intends to release Ragnarok Online - Uprising: Valkyrie in other markets, such as China and Taiwan, in 2012 and more other smartphone games will be available later in 2012."

Okay, so in Q2 they said that RO2 would be launched with AsiaSoft in Singapore and Malaysia by Q4 2012. 

In Q3 they updated that the launch would take place in December in Singapore and Malaysia. 

Well on December 7, 2012 AsiaSoft is unveiling their next blockbuster free-to-play MMORPG. Looking through all AsiaSoft's nine other MMORPG titles it seems likely that release next week is Ragnarok II.  Maybe not though, we'll see.

I've seen some good reviews for ROII, and there are forums dedicated to when an English version of the mobile Ragnarok will be available. Whether or not this is indicative of future success is unknown to me.

Ragnarok Revenue Tail

Even without the release of RO2, the company is doing alright. They are similar to land line providers: dying, but very slowly. On page 8 of their most recent 20-F, the company claims that users for ROI peaked in the first quarter of 2005. They also supply a lot of information about their users. From an ARPU (Average Revenue Per User) basis, RO makes Farmville look pathetic. 


While ARPU has declined from $744 in 2009 to $313 in 2011, total Average Current Users (ACU) have increased. The largest user increases occurred in Taiwan/Hong Kong, while Japan has declined ~9-14% per year. This isn't good because the average Ragnarok user is worth about 18X more in Japan than in Taiwan. Even so, it's not as if Ragnarok revenues fell off a cliff.

Japan is very important to the long term success of GRVY and the Ragnarok franchise. In the short term Malaysia and Singapore are not that important, at least using backwards numbers. A successful launch could inspire confidence though. 

Perhaps the game is released and it does OK and they release to North America in 2013. If that happens, awesome. We've got a company that should produce positive cash flow. If not, well at least we have a lot of cash and a bunch of user who are still playing the game.

Is it Worth an Investment? 

I believe it is. The key here is that the player base is sticky and a conservative liquidation value has stayed (basically) the same (it was $1.20/ADR in 2010) for the past several years. It seems unlikely that a permanent impairment of capital could take place. 

The company as a whole has been able to expand beyond Ragnarok. Ragnarok was 88% of sales in 2005 and at the end of 2011 only made up 66% of sales. The company saw overall sales increase by 7% for the same period.

It could very well be a value trap and opportunity cost is real. Right now though a company that is trading for its liquidation value, still generating cash (admittedly from an attriting business) and someday may deliver on it's promises seems like a safe bet. I believe this is an asset play for now. If RO2 (or other games) get released more accurate valuations/exit price can be determined. As always, do your own research and come to your own conclusions. Long GRVY.

EVI EnviroStar

This will be a brief post as the story is simple and the investment has largely played out.

I've followed EVI for a couple of quarters but never purchased shares. They had a decent(profitable) business, large insider ownership, and good asset protection. I shoulda, woulda, and coulda bought when the company was trading below $1.30/share, but I didn't. Instead I waited for them to offer a special dividend of $0.60/share(not on purpose). Here's my thought process, all figures are from their respective 10Q.

As of 9/30/2012 there were 7.033M shares outstanding.  They had $10.397M of cash on the books with customer deposits of $4.997M. Net cash therefore is $5.4M or $0.76/share. They will pay out $0.60/share, or $4.2M as a special dividend in December.

Right now they have a tangible book value of $8.387M, paying out the dividend will reduce that to $4.16M, most of it will be working capital. 

So what's a fair value?

They have a four year average of generating $0.58M of free cash flow (net income plus D&A plus non-cash items minus CapEx). Slap a 10X multiple (arbitrary choice) on that and the operating business is worth between $5-$6M, or $0.71-$0.85/share. Sprinkle in BV of $0.59/share ($4.16M of post-dividend BV) and you get a post-dividend value of $1.30-$1.44/share.

With EVI currently at  $1.95, the post dividend share price should be $1.35, meaning we're in fairly valued territory now.

Is there more upside?

Potentially, yes. Backlog has increased to "historic levels" this quarter and I would be willing to bet owner-operators like the Steiner family could allocate capital efficiently. If the price of the shares pops again, I will likely be a seller. Should we hit my initial buy prices in the low $1.60's I would be willing to buy more.

This could be interesting to revisit post-dividend in case the market over-corrects to the downside. Long EVI

ADES Update

Charlie Munger has said that if an investor can't stomach a 50% loss they shouldn't be investing. I'm about half-way there with ADES and Munger's pain threshold. I thought now would be a good time to review the investment and determine future actions. In the efforts of full disclosure, funds I manage are long ADES. I have not backed the truck up though.

What's happened?

Well not much and that is the problem/reason. I think investors were expected a quick acceleration of profits. People are not seeing results and are clearly frustrated. I must admit that I thought things would be moving along faster as well.

Michael Durham highlighted this frustration in the Q3 call:

"But just the optics if you don't look beyond initial quarter what you see is that $3 a ton expense that leads to significant loss this year even though that is creating a $7.57 per ton cash benefit in the future. That doesn't show on this quarter. So if you look at an investor who is only looking at the headline they're going to miss that. So, I think until we get additional monetizations and you see that slip from the big expense to the big segment income and then an earnings the investment community is not going to understand the story."

The key point of frustration came with the company announced results this past quarter and once again it lost money. They failed to monetize two of their plants and several other plants are taking longer than expected. This was seen as a strike against management, and rightfully so. Management has promised to deliver for several quarters now.

The story is still confusing and management is losing credibility. If you listen to the Q3 conference call it's clear that several of the analysts asking questions are confused. And not just about simple things, but about the entire structure of ADES and Clean Coal Solutions(CCS).

Is Mr. Market right?

An investment in ADES is not going to be based on BV, safety of assets or something typical, which I think makes these issues all the more difficult to weather. Is the sell-off due to frustration and only a temporary hiccup, or is the business permanently impaired?

Based on the 12 plants that I have been able to track down and the numbers I have backed into, it doesn't matter if the company gets their RC facilities up today or in 24 months. A company that has an earnings yield of 25-60% is cheap with even the greatest discount over a two year period. There has been no change in the overall numbers, simply the time it will happen. Sixty million tons of RC coal should be processed and management is hunting for larger plants to process even more. So if they fail at 1/2 their plants they'll still process 30M tons. At $1.60/ton flowing through to ADES the company will still see $48M of EBIT.

This assumes that the entire Emissions Control business does nothing. Which is unlikely, they have >$100M of bids out there and were recently awarded a $14M contract for DSI systems and expect to announce several longer term ACI contracts soon.

Yes, coal is terrible and Obama is the coal Antichrist, but 42% of electricity generated in the US depends on it. Hurricane Sandy taught everyone on the East Coast just how valuable base load power is. It's not going away.

So right now this seems to be a time issue, and if the plants are monetized in the next couple of years it really isn't a big deal. The question is, how do we handicap the likelihood (or lack thereof) of monetization?

I don't have an answer for that question. It's a difficult one to answer but I can rely on some of my research to back my belief that monetization of RC facilities will occur.

We learned that the two plants that were supposed to be monetized by now, are not. These plants are actually costing CCS ~$3/ton in operating expenses. If they monetize them that's $18M of cash going into CCS(Q3 '12 Call). So that's the basic math there, approximately $7/ton difference between self-monetizing plants, and getting an outside monetizer(CCS sees over $3/ton go to them instead of booking a tax credit and a operating losses).

So why didn't Goldman or the other partner become the monetizer? We know that GS was expected to monetize these two plants. How?

"In October 2012, GS determined that it would not pursue leases on two particular RC facilities on which it had paid deposits totaling $4.7 million and concurrently gave notice for the return of the related deposits. "  pg 24 10Q Q3 2012

GS wants their money back, right?

"While, as previously noted, GS has given notice for the return of deposits in the amount of $4.7 million, which we are obligated to return by January 30, 2013, we anticipate that this amount may be offset by deposits for additional RC facilities that we expect to receive from GS in the near future." pg 33 10Q Q3 2012(emphasis added)

GS, a 15% owner in the CCS JV, decided not to pursue two facilities. Facilities which only add up to about 2-3 million tons of coal per year(per ADES management on the Q3 call). We know that CCS is pursuing gulf coast lignite (and pulverized) coal burning facilities that consume up to 8M tons of coal per year. Me thinks that GS is waiting for a bigger and better plant.

Another problem is getting a Private Letter Ruling(PLR). I wanted to figure out how much of a hassle these are so I chatted with a gentleman who has approved numerous Section 29 PLRs and at least five (that I was able to find) Section 45 refined coal PLRs.

"We aren't ruling on who benefits. The only question is does it qualify as refined coal?" -PLR reviewer IRS.

The reviewer wouldn't go into great detail but it literally sounded as simple as this: if the process qualifies as refined coal then the PLR will be granted. This has been done already at multiple plants with Arthur Gallagher/Chem-Mod and CCS.

We know that at least 14 plants have RC facilities built out by Helmkamp. I inquired about a facilities operator job at a PRB coal plant in North Dakota. Although I didn't get the job, I can confirm that there are real people on the phones interviewing people. Several environmental directors of utilities also said it works, they like it, and will keep on using it. These things indicate to me that all the facilities are real, working, and actually staffed.

Bottom Line


This looks like a "shoot first, ask questions later" reaction. Listening to the call I was confused too, mostly from the poor questions. It sounded like people have no idea what ADES does as a company. I was surprised that someone asked what kind of technology M-45 uses.With all that said, I also think management has done a poor job explaining how it all works to the community and tends to tell confusing numbers that you have to really dig into.

Overall, the call led me to believe that there are two inefficiencies here. The first is that people don't understand the technology and the structure of the company. That, in turn, leads to the second inefficiency. When things don't perform as expected (i.e. immediately when management says so) the only answer is to get rid of the "failure." I personally don't believe we have to believe in management to see success in this investment. All the wheels are in motion and the success of the projects are not dependent on management.

I think all signs point to good things, if the monetizations occur. I see no reason why they won't occur. Yes, it's taking longer than expected. That's what happens when investment bankers and utilities get together and play Let's Make a Deal. I believe the delay is ultimately for the better though. I believe that GS did not monetize two plants due to a lack of belief or failure, I believe they wanted to be part of better plants with better operating costs. Over the next quarter or two we will see if my belief is correct.

Of course, I could be missing something as well. It is obvious that management was overly optimistic but if the RC facilities aren't monetized the cash flows will never be realized. I have found no information to indicate that the eventual monetization won't occur. For me, this is about patience and reliance on my multiple sources. Long ADES and hoping for continued volatility.