Given Rovio has just increased its annual sales 55 per cent and net profit by 94 per cent, you’d think the mobile games maker’s stock would be riding high following its September 2017 IPO.
Instead, the company was the worst performing game stock of 2017 and that dynamic has continued into 2018.
Rovio was also the worst performing game stock of Q1 2018.
In total it’s down 59 per cent since it floated.
So how can we reconcile these two seemingly contradictory pieces of information?
Or, in other words, answer the question: what went wrong at Rovio?
Crash and burn
As can be seen from the trajectory of its stock, two discrete events have driven Rovio’s share price lower.
The first, smaller shock, was prior to announcing its Q3 financials in mid-November when its share price dropped 20 per cent.
The second was prior to announcing its full year financials in mid February when the share price dropped a substantial 53 per cent.
Of course, it’s not uncommon to see stock volatility, both up and down, around earning announcements as that’s when investors get to see how a company is performing.
Equally, it’s not uncommon to see large volatility for newly floated companies because its management has no long-term track record and investors don’t have a long-term history with the company either.
For Rovio to join Zynga and King as prime examples of now not to float a game company is a surprise.
Yet for Rovio to join Zynga and King as prime examples of now not to float a games company is a surprise, especially given the conservative approach it took to its floatation.
Looking at these two events in detail, Rovio’s Q3 announcement was the first warning sign.
Year-on-year sales were up 41 per cent, but compared to a very strong Q2 period which was boosted by one-off revenue from the successful The Angry Bird Movie, EBITDA (a measure of profit) was down 29 per cent.
And taking interest, taxes etcetera into account, Rovio actually made a small loss for the period.
That really wasn’t something investors were expecting, so a 20 per cent hit in the company’s share price was a logical outcome.
What was concerning, however, was this situation wasn’t a total surprise.
In part, it was the direct result of Rovio’s decision to boost user acquisition spending on its mobile games. UA spending was €22 million in Q3, or over 30 per cent of game revenue. In contrast, it had been just over 10 per cent 12 months prior.
Yet as Rovio CEO Kati Levoranta pointed out, user acquisition spending should be seen as an investment in future sales, although in accounting terms it’s booked as an immediate cost.
Clearly investors didn’t get the memo. So clearly Rovio should have spent more time explaining the situation, especially given the majority of those investors were large institutions and not small retailer traders.
Not a pretty sight
But if November was the warning, it went unheeded and February was a bloodbath.
Again, the headline figures appeared fine. Full year sales were up to €295 million and net profits to €20 million.
Indeed, the problem wasn’t really with 2017’s figures but the disconnect with Rovio’s guidance for 2018 compared with what investors expected - effectively what Rovio had suggested during its IPO pitch.
First off, Rovio stated it expected its games division to grow “faster than market growth in Western markets”. During 2017, this metric was met successfully with games revenue up 56 per cent, but that’s not going to be repeated in 2018 if overall sales are static. During 2017, 83 per cent of Rovio’s overall sales came from its games.
And more significantly for investors, Rovio’s second aim was that its games group’s operating profit margin would be 30 per cent. In 2017, it was 18 percent and it’s hard to see how that will do anything up drop if overall sales are static.
Given that situation, in market terms, the 53 per cent decline in the company’s share price was - again - justified.
So how could Rovio have avoided this situation?
The first option would have been to be conservative during its IPO pitch. Of course, that would have been tricky as who would invest in a company predicting static future sales?
In that sense, Rovio’s subsequent stock trajectory was to a large degree set by its decision to IPO in the first place rather than take other rumoured options such as being acquired privately.
Rovio’s stock trajectory was set by its decision to IPO.
Once the decision to IPO had been set, however, Rovio should have focused on hitting that operating profit margin. It is now finally doing this, but by quickly shutting down the more experimental parts of its games operations such as its London office, when announcing its 2018 guidance, it merely caused internal problems.
This resulted in Wilhelm Taht, its experienced head of games, leaving the company with immediate effect.
Similarly, the amount of money Rovio is now spending on UA appears to have been a problem, at least, in terms of communication with investors. This is odd given that Rovio’s UA spending has been around 30 per cent of sales since Q1 2017.
This level of spending is not particularly high in terms of industry standards. Yet when CEO Kati Levoranta talks about UA spending, it’s almost as if it’s a factor over which Rovio has no control.
Similarly problematic is the amount of cash Rovio is injecting into its experimental mobile games streaming platform Hatch.
Certainly an interesting idea, it has widespread support with over 250 games, including premium titles such as Monument Valley, signed up to be available to play through the advertising-funded free service.
And presumably the metrics through the lengthy beta program are good, which is why Rovio is looking to add to the €5 million it invested in 2017 with at least another €10 million during 2018.
But if this is the case, it’s surprising Rovio hasn’t been more enthusiastic and open to investors about the business case for something it clearly hopes - or hopefully expects - to be a sizable and profitable business in future years.
And it’s these sort of communication issues that have also led to the company’s head of communications and investor relations Rauno Heinonen leaving.
So where does Rovio go from here?
The only good news is there can’t be much more bad news to come. Rovio’s games business is solid and if it performs better than Rovio thinks in 2018, the share price will rise.
In the medium-term, however, it’s not clear where Rovio’s next big hit comes from. Angry Birds 2 will likely be its number one game for a number of years, but other 2017 releases Battle Bay, Agry Birds Evolution and Angry Birds Match aren’t performing well.
It’s also not clear Rovio still has a strong games creation culture.
Beyond the loss of Wilhelm Taht, a lot of other experienced games developers have left Rovio in recent years, and - as for all mobile games companies - it isn’t getting any easier to come up with a hit, especially one that will move the needle on the €300 million annual business Rovio now is.
Perhaps Hatch will provide that spark the company needs. But when it comes to making mobile games, the smart money seems to suggest Rovio’s future valuation is going to be based on what it’s always been - the developer of Angry Birds.