DoubleDown: A Profitable Powerhouse With A Cash Cushion - A Buy Recommendation

seekingalpha05-02

DoubleDown Interactive is a leading developer of social casino games with a strong financial position and substantial cash reserve.DDI has a focus on high-return marketing expenses, positioning it for...

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FilippoBacci Introduction DoubleDown Interactive (NASDAQ:DDI), a leading developer of social casino games, presents a compelling investment opportunity. This industry leader has a strong financial position, with healthy profitability and a substantial cash reserve. DDI's focus on high-return marketing expenses positions it for continued financial success, even in a maturing industry. Despite facing competition and potential regulatory hurdles, DDI's undervalued stock price and strategic growth initiatives make it a promising buy for investors seeking stability and value. Business Overview DoubleDown Interactive (DDI) is a leading developer and publisher of digital games for mobile and web-based platforms. It focuses on casual gaming experiences and has a strong presence in the social casino segment. Its flagship game, DoubleDown Casino, was one of the top social casino titles by gross revenue in 2023. DDI boasts a deep content library through internal development and partnerships with industry giants IGT and its parent company DoubleU Games (DUG). Moreover, in October 2023, DDI acquired SuprNation, a European iGaming operator, to expand into the real-money iGaming market. Industry Overview Social casino games are free-to-play mobile and website games in which players receive credits to play table games, slot machines, puzzles, etc. Therefore, players don’t bet real money; instead, they play with the credits the games give them and the credits they get by purchasing. Thus, social casino games monetize their users through in-app purchasing, in-app advertising, and, to a lesser extent, paid apps.   Statista x Adjoe Real-money casinos and social casinos differ in three areas: first, on social casinos, players don’t bet real money; second, social casino games are founded in a social network that allows players to enjoy playing with different people; third, social casino games may have algorithms that are not based on random odds so that the experience and satisfaction of players can be maximized. According to Statista, the social casino gaming industry experienced solid growth from 2014, valued at roughly $3 billion, to 2023, with an estimated market revenue of approximately $7 billion. In this sense, Adjoe estimates the 2023 market to be over $10 billion and projects a CAGR of 11.8% until 2027, while advertising revenue increases faster than in-app purchases revenue.   Adjoe Other industry forecasts estimate an annual growth of between 6.23% and 8.8%. Thus, the social casino gaming industry is a growing industry that is entering a mature phase, as growth is slightly slowing down if we compare future growth with growth experienced in the last decade (over 11.11% annually, according to Statista). Furthermore, keeping an installment rate similar to the rate experienced from 2012 to 2020 is hard.   University of York Moreover, the US is the most critical market for social casino companies as it represents more than half of the global industry.   Adjoe I think the industry has two critical factors: scale and network effects. Comparing the evolution of the most popular social casino games shows how much these two factors matter, as these popular games have been the same since 2017. Even when the industry has grown fast, barriers to entry (other than the two factors) are low, and many companies have tried to develop new games. For instance, DDI has created over 49 new titles, DUG (DDI parent company) has produced over 400 titles, and there are online guides on making your social gaming casino. The most popular games in 2017 were DoubleDown Casino, Slotomania, Zynga Poker, and myVegas Slots. Meanwhile, the most popular games in 2023 were:   Adjoe Hence, two out of the five most popular games in 2017 continue to be on the list in 2023; however, together with Slotomania, Zynga Poker is one of the few apps with more than 50 million downloads, so even if it doesn’t appear in the 2023 list, it’s by far one of the most popular apps. In this regard, DDI states (in its 20F report) that games are becoming older as it’s more economically appealing to keep developing a successful game than to create a new one and gather new players. New developments in-game include new social aspects that increase player engagement, driving higher and more stable monetization. Thus, based on this, I think network effects play a critical role in the success of a new game, as players won’t be attracted to a social game that few people play. Moreover, scale is crucial for game developers as a more extensive scale allows big companies to develop more games, increasing the probability of creating a successful game that may become popular and attract more players, which raises a network effect barrier. Consequently, being a large company in this industry increases the probability of success. In contrast, small companies are in a disadvantaged position as they depend on a few games, increasing the risk of failure. Due to these factors, acquisitions have become common as companies seek scale to unlock its benefits. For instance, Playtika (PLTK) has acquired InnPlay Studios, Youda Games, JustPlay, Reworks, etc; Take-Two Interactive (TTWO) has acquired Nordeus, Popcore, and Zynga; and DDI has acquired SuprNation. Lastly, after a boom due to COVID-19, the industry has experienced adverse conditions as downloads decreased in 2022, and most companies' revenue growth remained flat or even negative. Consequently, Playtika, DDI, and Take-Two shares plummeted in the last few years. Moreover, another trend in the industry is that companies are diversifying as regulations are expected to become a burden. For instance, Playtika and Zynga (acquired by Takes-Two) revenue from casino-themed has decreased as a percentage of total sales. Financial Performance DDI hasn’t grown as fast as its competitors, Playtika and Takes-Two. However, unlike these competitors, DDI hasn’t spent too much on acquisitions. For instance, since 2018, the company has only invested almost $29 million in acquisitions, or approximately 12.26% of current EV. Meanwhile, Playtika has acquired different companies since 2018 for approximately $1,240 million, or almost 30% of its current EV, and Takes-Two invested $12.7 billion in the acquisition of Zinga, or 48.53% of its current EV. These acquisitions allowed these companies to keep growing in a challenging business environment after 202. However, DDI revenue growth turned negative in 2022 but slightly recovered in FY2023. Furthermore, in 4Q23, the company reported positive revenue growth, which, alongside a growing industry and a better macroeconomic situation, may signal a turnaround as free-to-play casino revenue was up 8% QoQ and 3% YoY.   QuickFS Even if DDI is not growing, it is a highly profitable business that, even in an adverse scenario, has kept growing its operating margin (excluding impairment and contingencies expenses in 2022). DDI has sustained higher operating margins than its competitors since 2020. Hence, even if sales haven’t grown as fast as competitors’ sales, the firm has kept increasing its margins without investing less in R&D; instead, the company has reduced its sales and marketing expenses by 37.02% compared to 2021, while revenue fell only by 14.96%. Moreover, the gross margin increased by 2.8 pp since 2021; therefore, the company prioritized profitability over growth, generating value for shareholders as EPS has kept growing (excluding impairment and contingencies) while Playtika and Takes-Two EPSs have been falling since 2021. The results reflect a successful implementation of management’s strategy of focusing on marketing expenses that increase return on investment rather than just spending to increase topline.   QuickFS and Annual Reports  QuickFS *Excluding contingencies and impairment expenses Furthermore, the company has a net cash of $228.3 million, or 43.92% of its market cap. Meanwhile, Playtika has a net debt (including leasing) of $1,477.6 million, or roughly three times the 2023 free cash flow, so even if its financial position is not vulnerable, DDI has a better financial position as of December 2023. Take-Two has a net debt of $2,603.9 million, or 3.08 times the 2021 free cash flow (as 2023 free cash flow was negative and 2022 free cash flow was a low $99 million). Now, even with a stronger financial position, I don’t understand why having all that cash, instead of redistributing it to shareholders through dividends or stock repurchases. Especially when the management believes the social casino industry is a mature one with few opportunities to keep growing, according to its last earnings call. Risks Competition I think DDI has the scale and network effects to defend its current competitive position successfully; however, the competition has a larger scale and may enjoy more substantial network effects. Moreover, the company competes against many substitutes for entertainment, such as casual games, sports betting, console games, and other leisure activities that compete for customers’ leisure time. Shareholders Returns Management has successfully implemented its strategy of increasing returns by cutting low-ROI marketing expenses. However, the company is not returning the cash generated to shareholders through dividends or share repurchases, even though DDI’s stocks have traded at low multiples since 2023. Reliance on its Flagship Product Most company revenues came from the DoubleDown Casino game. In 2023, DoubleDown Casino accounted for 96.3% of sales and 96.7% in 2022. Furthermore, according to its 20F, the company expects that dependency will continue in the future; therefore, a shift in customers' tastes may be disastrous. In this sense, diversification has yet to be possible, as the company has already developed 49 titles and still depends on only one game for almost all its revenue. Stricter Regulation DDI faces potential regulatory risks due to concerns about social casino games. These concerns include social casino games being a gateway to real-money gambling and targeting vulnerable users. Regulators may impose stricter rules on how DDI designs, develops, distributes, and presents its games, potentially increasing costs and limiting DDI's ability to operate. Valuation For my DCF, I assume revenue growth will be lower than the expected industry growth. So, company sales will grow 6% in the first year (to account for the full integration of SuprNation) and 5% in the following years. The free cash flow margin will be 28%, which is almost 300 bps higher than the 4-year average FCF margin from 2019 to 2022, as the company strategy to focus on high-ROI marketing expense continues to return higher profitability than in the past. Moreover, I expect margin expansions from current levels, so I think a proper multiple for a company lacking growth opportunities, suboptimal competitive advantages, and stiff competition will be a P/FCF of 10. Furthermore, considering the risks of the investment, I think a premium of 12.85% over the risk-free rate (10-year Treasury yield) is ideal to discount future free cash flows.   Author's Elaboration Given these premises, the intrinsic value of DDI ADS (every ADS equals 0.05 shares) is $20.01, which, compared to the current price of $10.49, means that the company is undervalued and offers a wide margin of safety (>30%) to protect investors against downside risk. Consequently, I think DDI is a ‘Buy.’ However, it’s noteworthy that the two main factors increasing the intrinsic value are a multiple expansion and a large cash reserve. Conclusion  DDI is a ‘Buy’ despite facing competition and regulatory risks due to its strong financials, undervalued stock price, and growth potential. DDI boasts high profitability and a healthy cash position, and with a focus on high-ROI marketing expenses, it is well-positioned for continued financial success. While the industry matures, DDI's recent acquisition and cost-cutting measures position it to capitalize on remaining growth opportunities. With a current price significantly below its intrinsic value, DDI offers a compelling opportunity for investors seeking a stable, undervalued company.","kind":null,"is_publish_news":null,"is_publish_highlight":null,"is_publish_live":null,"is_publish_wemedia":null,"editions":null,"symbols":[],"gpt_button":1},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":0,"commentSize":0,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":true,"deviceId":"web-server-community-laohu8-v3","version":"4.22.4","shortVersion":"4.22.4","platform":"web","vendor":"web","appName":"ttm","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/2432856670"}