A First Look at Applovin

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Hi everyone. No major update from us this week, so let’s jump straight in. Here’s your weekly roundup and analysis of what’s happening in the video game industry…

#1: Takeaways from AppLovin’s S-1

The long awaited AppLovin IPO is finally seeing the light of day. The company filed its S-1 this past week, and it was a pleasure to read. Founded in 2011, AppLovin’s mission is to “grow the mobile app ecosystem by enabling the success of mobile developers”. It does so by providing a suite of Core Technologies and Software that drive both app growth and revenues for its Business customers through an elegant six step process:

App Graph collects ad interaction data across all apps working with AppLovin.
AXON uses that data in its ML algorithms to match app users to relevant ad content.
AppDiscovery curates that ad content by matching advertiser demand with publisher supply.
MAX powers those matches by running real-time competitive auctions for in-app ad slots.
Compass analyses those auctions to deliver ROI insights through an analytics tool.
Mobile developers are enabled by the above technologies and insights to not only drive more installs to their apps, but also continuously optimize the ad revenue generated per new install acquired and therefore drive towards a positive ROI equation.

Since AppLovin knew they’d build out the above reality for the vast market of third-party mobile developers, it probably was a no-brainer internal decision to apply the above process to their own portfolio of games, too. And that is exactly what they did in 2018 through AppLovin Apps - a portfolio of AppLovin owned and partnered on games that’s being built out through a mix of in-house development, third-party publishing, and strategic mobile game studio acquisitions to drive both its Consumer and Business revenue streams. This clever vertical integration results in a healthy business flywheel where AppLovin uses its unified marketing, monetization, and analytics technology stack to drive user growth and revenues across the entire AppLovin Apps portfolio.

On the face of it, this flywheel might feel like AppLovin’s created major conflicts of interest with its 1,400 Business customers. But in my (Manyu, here) eyes, AppLovin is in the midst of a well thought out business model evolution, which is not only being executed on well, but also unlocks the company’s next stage of long-term growth. The reason why can be deduced from the following numbers, where -

Business Revenue is generated from advertisers spending on Software and Apps. Software revenues, which is mostly from AppDiscovery, is generated from advertisers utilising various AppLovin’s core technologies and softwares. Apps revenues come from advertisers that purchase ad inventory on AppLovin’s diverse portfolio of owned and partnered on games.
Consumer Revenue is generated through IAP purchases made by users on AppLovin Apps.

Clearly, revenues continue to grow swiftly, even though 2020’s +46% YoY growth rate was lower than 2019’s +106% YoY growth. And notably, EBIDTA has taken a hit over the last three years (although still impressive and translates into strong cash flows) with 2020 ending at 28%, which is mainly driven by increases in cost-of-goods-sold (COGS) and sales & marketing (S&M) expenses. So, why have both of these expenses been increasing? This is primarily because AppLovin is slowly transitioning its revenue mix over to first-party Consumer Revenues versus third-party Business Revenues. In other words, AppLovin’s focus is shifting to its own AppLovin Apps rather than its Core Technology and Software Business customers.

To illustrate this, AppLovin’s 2020 Business Revenues grew +$115M YoY, and ~92% of this was driven by advertisers purchasing ad inventory from AppLovin’s diverse portfolio of apps. And this Business Revenue from Apps made up for 71% of 2020’s overall Business Revenue. Only ~8% of 2020’s Business Revenue growth was driven by Business Revenue from Software. Simply said, there is more revenue upside for AppLovin by selling ad placements within a highly downloaded and top grossing first-party app portfolio. No wonder their first step towards AppLovin Apps in 2018 was to set up Lion Studios as a third-party publishing unit for primarily ad monetised games, and further backing it up with strategic investments into ad monetisation reliant mobile game studios such as PeopleFun and MagicAnt in the very same year.

Further, 2020’s Consumer Revenue increased by +$342M YoY, primarily due to a +41% increase in the volume of in-app purchases, as well as a +32% increase in price per in-app purchase. Apps acquired during 2020 generated ~57% of the increase, while apps that were part of AppLovin’s portfolio prior to the beginning of 2020 and newly developed apps accounted for the remainder. The increase in IAP-driven revenues naturally results in higher platform fees that need to be paid out, which contributed to ~36% of the COGS increase, while most of the remainder was driven by an increase in amortization of acquired-technology due to increased acquisition activity. And as we all know, this level revenue growth requires heavy user acquisition investments, which is why S&M continues to be significant cost sink that will most likely turn out to be ROI-positive in the long-run given the top grossing apps these investments are being made in.

As AppLovin increasingly fuels its revenue through first-party content, the business risks move closer to that of any large mobile games publisher. The most imminent one is related to Apple’s deprecation of the IDFA, which is underscored by how a majority of revenue driving AppLovin Apps depend on targeted user acquisition and the consequent rise of S&M costs. In AppLovin’s defense and to slightly combat this risk, it’s good to see that no single game contributed more than 16% of 2020’s total revenue and the portfolio is highly diversified across genres, such as word, hypercasual, match-three, 4X strategy, simulation, and card/casino. Further, AppLovin’s acquisition of Adjust will allow AppLovin to reuse Adjust’s technology to measure ROI performance across its entire app portfolio without having to fully own these partnered on apps.

Market Share by App — *Source:* *SensorTower*

Other key business risks are mostly the converse of three specific business growth opportunities:

First - growing revenues from the existing portfolio of AppLovin Apps. Most of this will come down to how well its owned and partner studios continue to execute on the excellent live operations they’ve already been carrying out, and how well AppLovin can multiply that value generated through ROI-efficient user acquisition efforts as the market moves towards a privacy-first context.
Second - utilizing the relationships with its owned and partner studios to build new hit games. This is a key strength for AppLovin, as most of the studios in its portfolio have a strong track record in creating strong long-tail top grossing titles. That said, we’re all aware how hit and miss that effort can actually turn out to be.
Third - pursuing more accretive strategic studio acquisitions and partnerships. Again, AppLovin has a very strong track record here (PeopleFun, Magic Tavern, Belka Games, Machine Zone etc.), but the M&A market is hotter than ever and that’s not making this growth opportunity any easier to achieve.

In conclusion, if I had to speculate about why AppLovin is executing on this business model evolution, my bet would be on a smart management team realizing the importance of changing the game when the original game they were playing had the cards stacked against them. In other words, why take on Facebook’s and Google’s asymmetrically front running ad network business, when AppLovin can utilize a proven technology stack as a strategic advantage to not only grow its total addressable market, but also gain market share over the myriad of competing mobile game publishers. This is simply a very good business and our best wishes are with the team for their first day of trading!

#2: Reflecting on Google Stadia’s Demise

Recent announcements around the struggles and failures of Google Stadia highlight once more that making games is difficult and that a business can’t simply spend its way to producing a successful game. The recent articles in Bloomberg and Wired offer a bit more interesting context to the story behind the challenges and struggles faced by Stadia (not to mention the original head of Amazon Luna already departed). But let’s break it down in simple terms.

Google is of course as good as it gets when it comes to developing new tech products and functionalities. Google, Amazon, but of course also Facebook and Netflix are kind of the gold standard when it comes to thinking about what innovation looks like, or how to build and iterate on digital products. It’s perhaps because of that mindset and the experience of building new and innovative products that Google was particularly bullish. Google thought it was set to disrupt gaming in the same way it disrupted so many industries before. Stadia’s mission statement helps understand the level of ambition here: “Stadia is Google's cloud-based gaming platform that lets you play your favorite hit video games across screens instantly."

Beyond the obvious technical, cost, and general overpromise/underdeliver challenges involved in achieving success, there is the additional challenge of selling a subscription-based service for gamers. It’s fair to assume that most gamers who want to play AAA console games have a console (surprise!) and don’t need or want a streaming solution (at least as the core service). Of course, there is also the question of content. There is a portfolio of older available games out there, but only a small slice of players are actually willing to spend time + money to play them. And when it comes to producing new and exciting content, the models of innovation that work for a tech product (and become deeply entrenched in a tech company’s culture) often clash with the creative process needed to make games.

Time will tell if Google was too ahead of its time. But it seems in this case like it’s more a mismatch on three important levels. First, it’s uncertain there was a big market for a streaming subscription service for AAA games to begin with. Second, making a game is hard, and Google is not a gaming company (nor was the parent company apparently eager to buy big studios outright). The creative process is the most important thing to produce a best-in-class game - and it’s very different from the innovative process aimed at creating new functionalities via technology. Even though we see titans like Microsoft or Tencent find ways to succeed in games at scale, a company can’t buy or manufacture that kind of culture and expertise overnight. And third, cloud gaming is interesting because it unlocks entirely new ways to play and engage, and slapping old school business models onto this new tech essentially misses the point. We’ll see where Stadia goes from here — whether it meanders on, turns into a white label platform, or entirely shuts down — but it’s unlikely to be the torchbearer for cloud gaming’s future. (written by Alex Macmillan)

#3: NetEase’s Path to Glory

According to recent filings, NetEase’s Games revenue reached $8.3B in 2020, an 18% increase from 2019. NetEase is famous the world around, mainly as Blizzard’s key partner in China and also as the constant #2 to Tencent (in terms of revenue). But what else do we know about the gaming giant?

For context, NetEase Games 2020 revenue of $8.3B is a tad higher than Activision Blizzard’s $8.1B and much higher than EA’s $5.54B. (Of course, no one is catching up to Tencent anytime soon) NetEase’s key games-related revenue generators are the two MMORPG titles Fantasy Westward Journey (PC released in 2001) and Westward Journey Online series. Both PC titles were transplanted to mobile and released in 2015, are anchors NetEase’s gaming revenue, and are Top 10 grossing in China’s iOS platform. This background gives NetEase a very different DNA when compared to Tencent, whose top games like Arena of Valor, Peacekeeper Elite, and Call of Duty Online are esports-focused (and also technically unoriginal titles — Arena of Valor is derived from League of Legends, Peacekeeper Elite from PUBG)

NetEase was founded in 1997 by Lei Ding, is headquartered in Hangzhou, a top tier city an hour away from Shanghai but not known for its gaming industry. Game companies in China are usually clustered in Beijing, Shenzhen, Guangzhou, Chengdu, and Shanghai. Just like its headquarters, NetEase’s strategy and products march to its own drum. While NetEase continues to build on its MMO successess with more MMO titles, the company also set out to diversify in new ways. One of those key success is Onmyoji, a 2016 turn-based strategy game that has grown into a $10B IP. LifeAfter, an open world doomsday survival game, and Identity V, a 1v4 multiplayer horror game, (both launched in 2018) also show NetEase’s versatility and capability in creating new gameplays and IPs that become commercial successes.

The games mentioned here are not an exhaustive list of NetEase’s successes in China by far, as NetEase usually accounts for 10-15 of the top 100 grossing games in China. Its strength in game development and the China market also allowed it to net deals with Blizzard, Mojang, Disney, Warner Bros, and more top tier western companies. However, NetEase’s strength in China has not yet translated well to the west, as their best titles in the US (LifeAfter & Identity V) are in-and-out of US Top 100 Grossing. That said, with co-developed games like Diablo Immortal, Pokemon Quest, Harry Potter: Magic Awakened, and Lord of the Rings: Rise to War in the works — plus leadership’s eye for potential M&A and investments — this could evolve. The company might also increasingly focus on the Japan market, where Knives Out topped the iOS charts on several occasion. Whatever the case, NetEase has strong talent, significant capital, and ambitious goals, so it will be fascinating to see where they go from here. (written by Owen Soh, China Market Entry Consultant)

🎮 In Other News…

Epic Games buys Fall Guys studio Mediatonic. Link
Zynga acquires Diablo co-creator’s Echtra Games in expansion to PC and consoles. Link
GameRefinery Joins The Vungle Family. Link
Sea Limited reported pretty exceptional fourth quarter and full year results. Link
Twin Sisters Score Japan’s Hottest IPO by Making Games for Women. Link
Istanbul’s Dream Games snaps up $50M and launches its first game, the puzzle-based Royal Match. Link
Theorycraft Games secures $37.5M in Series A funding. Link
Nintendo will reportedly unveil 4K OLED Switch this year. Link
TiMi studios hiring for new open world cross-platform title. Link
Virtuix raises $11 million on SeedInvest for Omni One VR treadmill. Link
Arizona bill aims to prevent Apple, Google from blocking third-party payments. Link
Judge orders Valve to provide Apple with sales figures. Link
Motorsport Games acquires racing simulation tech firm Studio397. Link
India’s All-Star Games raises $1.5M to make cricket sports games. Link
Gaming Giant Ubisoft Partners With Ethereum-based NFT Platform Sorare. Link
Valve ends production on rebooted Artifact. Link
PlayStation Store drops movies and TV shows. Link

🖥 Content Worth Consuming

Paving The Way For The Metaverse: Exclusive Interview With The CEO Of Genies About The 3D Avatar Company’s Present And Future. “Genies is not only one of the world’s most innovative avatar technology companies, it is also creating digital identities that can be used across many platforms. Through Genies. celebrities and athletes can use digital identities to memorialize one of their life's defining moments and sell them as digital or virtual goods to their fans who want to share in their biggest life moments.” Link

The Value Chain of the Open Metaverse. “I’ve been a Metaverse bull for a while, and I’m now finally understanding the huge potential of decentralization. My goal today is to translate to a broader audience, and flesh out some of the business models and value chains underlying the future. Let’s get to it.” Link

The real-time evolution of Rival Peak. “As a Massive Interactive Live Event, or MILE, Rival Peak didn’t just evolve from a storytelling standpoint over its 3-month Season 1 run. Genvid’s Live Operations and Services teams helped ensure that the entire Rival Peak experience improved and expanded dramatically as the interactive reality show-cum-adventure game unfolded. New features, functionality, mini-games and more were added to Rival Peak on a nearly daily basis as the dev and support teams tweaked the show and its thirteen simultaneous, 24/7 interactive livestreams to address audience requests and fine-tune the entire experience.” Link

Thanks for reading, and see you next week! As always, if you have feedback let us know here.