How do you solve a problem like Korea? Double Down Interactive $DDI

A rocky start post IPO, but their troubles could be behind them

“Again, I’ve always said that if you look at ten companies you’ll find one that’s interesting. If you look at 20, you’ll find, two; if you look at 100, you’ll find ten. The person that turns over the most rocks wins the game. That’s the issue. If you look at ten companies that are doing poorly, you’ll probably find nine companies that there is not much hope for. But maybe in one of them, one of their competitors has gone out of business, or the plant that caused them a lot of problems has been closed, or they got rid of the division that was losing money. You’ll find one out of ten where something concrete has happened and the stock hasn’t caught up with it. If you look at 20, you’ll find two.” - Peter Lynch

This week there are a lot of businesses that fall outside of my core competencies. I’m always looking to expand my competence, but that is a slow process, with mistakes to be made along the way. There is a constant struggle between investing where one has an edge due to their experience, and the search for uncorrelated returns by finding unrelated sectors or industries. Today I am jumping into mobile gaming, as I slowly try to pick apart the components of the sum of the parts analysis for B. Riley Financial (RILY).

RILY, when they underwrite an IPO, occasionally use house money to buy a stake in companies they like, and one of these was Double Down Interactive (DDI). A former US mobile gaming company acquired by a British gaming technology company, sold to a South Korean mobile gaming company, doing a New York IPO in 2021 at the peak of the zero interest rate covid stimulus bubble.

By gaming I don’t mean Tetris, I mean slot machines. The rise of the smart phone app has led to a dramatic cultural shift in the popularity of gambling. It makes me yearn for those years when phones were still wired to the wall. Even in those years we always put a lottery ticket in my grandmother’s Christmas stocking, because gambling is fun if you don’t make it a habit. But now, when I asked my undergraduate students how many of them participate in sports gambling, more than half raised their hands. DDI’s average customer spends over $200 a month buying more tokens to play a slot machine game on their phone, even with no ability to withdraw winnings. Games of chance are just that enticing.

The world of mobile gaming is thought of like a giant funnel, advertising dollars are spent, and some percentage of people who see your ads download your game. Of those that download your game, some percentage of those play and use up the free allotment of initial chips. Of those that use up their initial free chips, some percentage of those buy chips and generate revenue for the company. For DDI, the player conversion rate is up from 5.2% in 2019 to 6% for 2023.

What I find amazing about this business, and what I find equally demoralizing for the pursuit of human flourishing, is just how sticky these customers have been for DDI. They are still bringing in an approximately unchanged amount of revenue from their 2010 to 2014 customer cohort. You can see from the graph below, an increase in customer spend per cohort due to Covid, with a subsequent decline post Covid, but if you compare 2018 revenue per cohort with 2023, the number of people who beat this game is quite small.

DDI has organic and inorganic growth, they either spend on marketing, or acquire new business lines. The most recent acquisition of a Malta based company, SUPRNATION, has given them access to the European gambling market. So far they are active in the UK, Sweden, and Estonia, with the opportunity to expand to the rest of the $25 billion European gaming market through their Malta acquisition.

As these old Protestant laws against vices are repealed, there are growing pains. Even Tommy Chong spent nine months in jail. In 2018, DDI was sued in the state of Washington over violations of gambling laws, Benson vs Doubledown. Even though the app doesn’t allow you to withdraw money from the system, tokens are bought just to play the game, DDI settled out of court and agreed to pay a whopping $145 million. In the same lawsuit, the former owner of DDI and current license partner, International Game Technology (IGT) agreed to pay $269 million.

This has put an enormous strain on DDI’s cashflows, and precluded a lot of growth spending during 2022 and 2023, but they are already on the other side of this mess. Their recent financial performance, however, is the perfect setup for a human being to outperform quantitative strategies. The effect on cashflow was temporary and resolved, we know this, but multivariate regressions do not. Looking at the cashflows below, the regressions see the darkened bars, but a human being can see the full potential of the business and what their 2024 performance will likely be.

Looking past the Covid bump and decline, revenue is up about 3% per year since 2019. Operating cash flow, excluding money put toward the lawsuit settlement, is up 11.4% per year since 2019. And most importantly, the lawsuit settlement is already behind them. Full year 2024 should show somewhere in the neighborhood of $120 million of operating cash flow, compared to 2023’s $20.8 million.

With the recent acquisition of SUPRNATION, and the ability to reinvest in the business again, growth could even accelerate from here. Imagine the swing in valuation that will occur when quantitative strategies price DDI at full and growing cash flows. Gaming companies trade at a very trendy price to earnings ratios of between 10 and 50 or so. Playtika (PLTK) sits at a PE of 13, and IGT at a PE of 22, but it’s hard to find other comps for a profitable mobile gaming company. Most of a similar market capitalization are not profitable. Even at a price to earnings ratio of 10, market capitalization would be $1.2 billion, up from today’s $599 million. That would be about a 2x when the market wakes up to this already resolved situation. I don’t know what milestone it takes for the quantitative strategies to bite, is it trailing twelve month data? Is it full year 2024 data? Does it need full year 2025 to compare with 2024? I don’t know the answer to that, I don’t program the models that drive 60% of active fund flows, but it could be sooner rather than later.

DDI US has a parent company, DoubleU games which is 40.7% owned by its founder, Ga-rham Kim, so I would expect that DDI is relatively safe from non-accretive dilution. The CEO of DDI, In Keuk Kim, has a strong background in mergers and & acquisitions, so I suspect there will be more inorganic growth going forward. And the sticky nature of the customer and healthy balance sheet probably protect it from bankruptcy risk as well.

That leaves the risk of obsolescence, which as a generalist, I am unequipped to answer at the moment. Competitors could come up with mobile gaming apps that are so much more fun that DDI could lose market share. There could be other jurisdictions where hungry lawyers are bundling class action lawsuits. Size positions accordingly, but the potential to grow faster and reach higher multiples is quite strong. I know after the runup in small cap stocks over the last few weeks, anchoring bias makes it difficult to buy things that are off the lows. I wish I was smart enough to find DDI when it was at $7 a share instead of $12. The autumn is typically a rough time in the stock market, if you want to be a trader and put this on your watchlist, there might be another chance to buy DDI under $10 a share. But, the underlying problem is already solved, and every quarter should show accelerating growth. I wouldn’t wait until a dip to start a position, but I also wouldn’t fully size a position at this price.