On the face of it, Nazara Technologies has it all. An experienced founder, strong backers from Rakesh Jhunjhunwala to Plutus Wealth, and a market that’s got everyone excited. But behind the glitz and the glamour, the company’s fundamentals are shaky. 

Nazara Technologies hasn’t posted a profit in two years, its return on equity is consistently decreasing, it does not generate any free cash. Moreover, its customer lifetime value is dropping and customer acquisition cost is rising. That hasn’t stopped the investors’ frenzy. Within the first few hours of bidding, Nazara Technologies’ initial public offering (IPO) was fully subscribed. But let’s dive a little deeper into the first listed gaming player in the Indian market and see if the gaming frenzy can make up for losses?

A one-stop gaming house

Nazara Technologies is a diversified gaming and sports media company operating in India, the Middle East, Africa, and North America. It was founded in 1999 by Nitish Mittersain when he was in college. The company’s offerings consist of mobile games (like World Cricket Championship, CarromClash), early learning applications for children (Kiddopia), eSports (Nodwin), fantasy, and trivia games (Halaplay and Quami), and sports media (Sportskeeda). It occupies a market leader position in the eSports market with an 80% market share.

Nazara Technologies has been expanding to foreign markets through its subsidiaries and acquisitions. Through its acquisition of Kiddopia, Nazara was able to expand into the North American market, which made up 41.6% of its revenues for the six months ended September 2020, up from 12.2% of revenue for FY20. This growth was because children took to e-learning in the wake of the Covid-19 pandemic and lockdowns.

It operates in the Middle Eastern market through its Dubai-based wholly-owned subsidiary - Nazara Technologies FZ, and in Africa through Nazara Technologies Mauritius. These subsidiaries made up 16% and 18% of its FY20 revenues. The rest of the revenue was brought in by its three biggest acquisitions - Paper Boat, Nodwin Gaming, and Halaplay. The strong growth in gamified early learning and eSports is why Paper Boat and Nodwin Gaming are increasingly contributing to Nazara Technologies’ revenue.

Big bull holds on to his stake in Nazara

Nazara’s promoters are the father-son duo of Vikash Mittersain and Nitish Mittersain and Mitter Infotech LLP, an entity controlled by the Mittersain family. Prior to the IPO, the promoters held a 22.8% stake in the company. 

The gaming company has a wide array of institutional investors, both domestic and international. Superstar investor Rakesh Jhunjhunwala holds a 10.8% stake, which he purchased in 2018 for Rs 180 crore. Financial services company IIFL holds a 20% stake through four special opportunities funds. Other investors include German esports company Turtle Entertainment, Good Game Investments, Azimuth Investments, and Plutus Wealth.  

The issue is worth Rs 582 crore, and is a complete offer for sale (OFS). The OFS will see the promoters and institutional investors sell 52.9 lakh shares at a price band of Rs 1,100-1,101 per share.

As part of the OFS, the promoter Mitter Infotech will sell 6.9 lakh shares, and the institutional investors will sell 46 lakh shares. The institutional investors that will decrease their stake via the OFS are - IIFL, Seedfund, Good Game Investment, Azimuth Investments, and Porush Jain (the founder of Sportskeeda, which Nazara Technologies acquired in 2019). 

The promoter stake will drop to 20.6% after the IPO. Plutus Wealth and Rakesh Jhunjhunwala will continue to hold a 17.9% and 10.8% stake in the company Post the issue, at the upper end of the price band, Nazara Technologies will be worth Rs 3,300 crore.

Nazara Technologies’ earnings have not been positive since FY18. The firm is priced at 6.7 times its H1FY21 book value. It has no listed peers in the domestic market. However, listed personal computer (PC) gaming companies like Nintendo and Activision Blizzard are priced at 4.2 and 4.8 times their respective trailing 12-month book values. 

Strong top-line growth but losses abound

Nazara Technologies’ FY20 revenue was Rs 247.5 crore, a 46% jump on a YoY basis. This jump was because of the massive growth in revenue from the eSports division (34% of FY20 revenue) which grew by 71% YoY. Between FY18 to FY19, revenue declined by 1.4% to Rs 170 crore.

The company’s revenue was initially dependent on subscriptions from users playing mobile games. This segment made up 89% of revenue in FY18. By H1FY21, its share dropped to 21%. The revenue drivers since FY19 were gamified learning and eSports (making up 39% and 31% of H1FY21 revenue). Nazara Technologies’ gamified learning only began in FY19 thanks to its acquisition of Paper Boat.

The company’s three main expenses are content licensing, commissions paid to telecom companies, and advertising. These expenses were Rs 190 crore in FY20, growing by 150% on a YoY basis. In FY20, these expenses made up 73% of the total, up from 67% in the previous year. Advertising alone was Rs 133 crore, a 3.8x growth from the previous year, making up 46% of total FY20 expenses. 

In H1FY21, the company continued to spend aggressively on advertising (Rs 119 crore) to increase its customer base in the early learning and esports segments. This resulted in its subscribers increasing to 3 lakh in September 2020, from 1.8 lakh subscribers in March 2020, a 65% growth. Nazara Technologies’ customer lifetime value (LTV) has been consistently dropping. In September 2020 it was $7 (Rs 508) down from $48 (Rs 3,480) in September 2018. During this time its customer acquisition cost (CAC) rose from $26.8 (Rs 1,940) to $31.3 (Rs 2,200). This expansion in CAC with the higher advertising spends resulted in a net loss in FY20 and H1FY21.

Nazara Technologies’ expenditure in these three areas - content licensing, commissions, and advertising, brought down its earnings before interest, tax, depreciation, and amortization (EBITDA) to Rs 9.1 crore in FY20, a 72.7% drop YoY. For the six months ended September 2020, EBITDA was Rs 12.7 crore. EBITDA margins were 4% in FY20, down from 19% in FY19. 

Nazara Technologies has not been profitable for two years. In FY18, the company last reported a net profit of Rs 6.7 crore. In FY20, it reported a net loss of Rs 26.6 crore. This was because Nazara Technologies was introducing its gamified early-learning platform for which it incurred a high amount of advertising expenses. For the six months ended September 2020, the net loss was Rs 10.1 crore.

Here’s how the company’s return on equity (RoE) was since FY18. It has no listed peers in the domestic market.

No free cash flow because of high capex

Nazara Technologies’ cash generated from operating activities in FY20 was Rs 5 crore, a significant decline of 89% YoY. For the six months ended September 2020, the company had negative operating cash flows of Rs 5 crore as well.

Nazara Technologies’ capex in FY20 was Rs 241 crore. This was 38 times what it spent in the previous year. However, 94% of the capex (Rs 229 crore) was intangible assets out of which Rs 124 crore was capex to build its brand image. The company has used its funds to make acquisitions to enter different businesses.

The company had made a slew of acquisitions between FY 19-20. In 2019, the company acquired a majority 51% stake in Paper Boat Apps, the developer of the e-learning game Kiddopia, for Rs 83 crore. Nazara Technologies also acquired a majority stake in Halaplay Technologies, a fantasy gaming platform, in 2020 for Rs 32 crore. For the six months ended September 2020, capex was Rs 16.1 crore.

A positive for the company is the low debt and strong cash position. Since FY18, the company has been debt-free. In FY20, cash and cash equivalents were Rs 72.1 crore, a jump of 35.3% on a YoY basis. 

Bold bet in a rapidly growing market

The domestic gaming market in India was worth Rs 10,500 crore in 2020. It is expected to grow at a compound annual growth rate (CAGR) of 32.6% to reach Rs 25,000 crore by 2023. The mobile gaming market comprises 77% of the domestic gaming market and will grow at a CAGR of nearly 40% between FY 20-23. Since Nazara Technologies is a mobile-first gaming company and occupies a market leader position in the domestic gaming market, much of this growth is likely to accrue to it. 

With the growing penetration of mobile phones all across the country coupled with India’s cheap mobile internet tariffs, gaming is set to take off. Nazara Technologies has a strong foothold in a market that’s going to grow at a 40% CAGR. This coupled with its diverse gaming offerings from e-learning to eSports, well-spread geographical reach, and strong domestic and foreign investor backing makes Nazara Technologies a bold but potentially worthy bet for high-risk taking investors.