Not As Bad As It Sounds

JAMDAT had their first quarterly conference call with the release of their first earnings results. The call sounded awful. If you have been following the stock, you know the result: JMDT fell 30% in a couple hours.

The temptation is to look for an apocalyptic reason for such a thudding fall. But if you read the transcript of the call, you might be left wondering “Dude, where’s my eschaton?” It doesn’t read nearly as bad as it sounds.

What did JAMDAT do wrong? Gross margins slipped, surprising analysts. And, to make a bad day worse, they insisted they could still hit a lofty 25% pretax to an audience that was already peeved and skeptical.

There are reasons the transcript reads better than the call sounds:

• The call sounded hurried.

• The presenters did not connect the facts. Easy to see on paper, but in a conference call, they should have slowed down and made the connections explicit.

For example, analysts asked about the decline in gross margins: Two responses, among which it is easy to see the relationship when reading the transcript, provide a good reason for this to happen: First, and most directly, JAMDAT’s brand licensing costs are going up. Second, and this was left unconnected to the first, 20% of JAMDAT’s products produce 80% of revenue. Guess which have a license burden.

JAMDAT would do well to continue to license more brands while building their own. Building a brand costs tens of millions of dollars, and JAMDAT is still too small to do as, for example, Intel did in buying instant brand recognition. JAMDAT won’t be a fully developed brand for another two years. In a business with no end user marketing, identifiable brands are the only form of marketing other than joint promotion with the MNOs.

If JAMDAT’s products really follow the 80/20 rule, the revenue ratio is about 10X, after tossing out outliers. Is 10X more revenue worth losing 10 points of gross margin? You bet, especially when JAMDAT is following the game-industry recipe of brand-building to get out from under the need for licensed brands.

That accounts for most of the damage, but there were other points where a stronger response could have been made: Subscription revenue, for example. The numbers make it look as if subscription revenue remains constant at about 30% of total revenues. Management was asked about that, and about plans to grow that number. This is important because mobile games have to get to a business model centered around acquiring and keeping subscription customers.

Understanding this number really requires looking under the hood:

• Verizon probably accounts for nearly all of JAMDAT’s subscription revenue.

• JAMDAT added numerous new channels, none of which are nearly as well-developed in subscription revenue as Verizon (and the Qualcomm BREW m-commerce system). Many have no subscription revenue at all, and untried m-commerce mechanisms for subscription charging.

• JAMDAT still relies on subscription purchases of single player games. Multiplayer games are still a small part of JAMDAT’s business.

• Verizon’s strong growth kept JAMDAT’s subscription revenues up.

• A key ratio was left out: The fraction of subscription customers. Subscribers account for half of all transactions – an impressive number! They account for 30% of revenue, because each monthly subscription transaction is less than half the amount of a one-time purchase. Now let’s say a subscriber is worth 5X a one-time purchaser (a DCF value of $15 versus $5 net for a purchase). This means the 7% of customers on subscriptions provide 30% of revenue!

All this can be inferred from the channels’ share of revenue and some knowledge about how well subscription revenue works in the BREW m-commerce system, but outsiders were left wondering. CEO Mitch Laskey did point out that many new products are subscription-only. It would have been better to have a more fact-filled road map: Plans for increasing the number of subscription products, and projections for the development of subscription revenue in other important channels, like Sprint, that now have reasonable support for monthly recurring charges in their m-commerce systems.

JAMDAT recently recruited a new head of studio technology. They must have some plans to bring technology development, including multiplayer, into a coherent strategy to grow recurring revenue. Maybe we will hear more about that on the next call.

Where will JMDT go from here? In a business where 90% of revenue growth is yet to come, it all hangs on the perception of JMDT relative to a peer group. But what peer group? The early-IPO penny stocks that have a fraction of JAMDAT’s revenue? Gameloft? On top of which, if 90% of all revenue growth is yet to come, something like 97% of subscription revenue, which will be the core of a mature market, remains undeveloped, and will likely only fully emerge after global channels are opened and original content starts to take off. It is relatively safe to say that JMDT’s orbit is still well inside the radius of a fully developed mobile entertainment market, and still shows continued good execution of a plan firmly grounded in the game industry.