Top 3 undervalued Israeli tech stocks. Playtika: Mobile game developer with 54% upside potential

Playtika positions itself as one of the leading mobile game developers. The company's offerings cover some of the most popular genres, including adventure and online gambling games. Playtika operates on a freemium model, allowing its users to download and play games for free. The company makes revenue primarily through selling in-game items and services to gamers. The most popular Playtika games — Slotomania, WSOP Poker, and the Board Kings casual strategy — were downloaded more than 20.2 million times in 2022.

Most downloaded Playtika games; source: Statista

During the height of the pandemic, video games were a popular leisure activity. However, as countries emerged from lockdowns, game developers faced high base effects: In the previous two years, their operational metrics reached unprecedented high levels that proved hard to maintain. Thus, the number of active Playtika users has been steadily declining since the beginning of this year. However, unlike many competitors, Playtika has deep expertise in user monetization. The company actively improves the gaming experience by analyzing individual gameplay to match user preferences. As a result, average revenue per player and payer conversion are growing steadily.

Playtika’s key performance indicators; source: Company Presentation

Besides, the decline in the company's total users is mainly observed in the casual games segment. The online casino segment is still growing, accounting for 56.8% of the company's total revenue at the end of the last reporting period. The shift towards gaming could be strategic for Playtika as the market is experiencing impressive growth rates driven by aggressive legalization in the US, rising internet penetration rates worldwide, and technological advancements to increase player engagement.

It is worth noting that Playtika is also actively increasing its direct to consumer (DTC) sales: The company's own platform accounts for 25.7% of its total revenue, while third-party platforms provide 74.3%. The rise of direct sales is an important growth driver as it provides the firm with higher margins and allows for cross-selling strategies, increasing the efficiency of its customer acquisition costs.

Revenue structure by types of games and sales channels; source: Company Presentation

Playtika's development strategy is largely focused on M&A deals. The company has a solid history of acquisitions at attractive prices and subsequent improvements aimed at growing shareholder value. Over the past 10 years, Playtika has successfully acquired several mobile games and studios, including JustPlay (2022), Reworks (2021), Seriously (2019), Supertreat (2019), Wooga (2018), Jelly Button (2017), House of Fun (2014), World Series of Poker (2013) and Bingo Blitz (2012). It is worth noting that two of the three Playtika's most downloaded games, WSOP Poker and Board Kings, were acquired from other developers.

Playtika made two major acquisitions in the last quarter alone. In early August, the company agreed to purchase Youda Games from Azerion studio for an initial cash consideration of €81.3 million (~$87.4 million) plus a payment based on the performance of the acquired business, limited to a maximum amount of €150 million (~$161.2 million). At the end of September, Playtika closed its acquisition of Israeli studio Innplay Labs for an initial consideration of $80 million plus a performance-based payment, with a maximum amount of $300 million.

Both transactions could become important growth drivers for the company. The acquisition of Innplay will allow it to enter the Luck Battle gaming market with the promising Animals & Coins franchise, while Youda Games will strengthen Playtika's position in the gambling market with the Governor of Poker franchise.

Financial performance

Over the past five years, Playtika has grown at an average annual rate of 9.6%. The company's trailing 12 months (TTM) financial performance can be summarized as follows:

• Revenue amounted to $2.58 billion, down 1.4% from the end of 2022. The decrease is due to negative dynamics in the third-party platforms’ sales.
• Gross profit decreased from $1.88 billion to $1.84 billion. Gross margin fell slightly, from 71.87% to 71.44%.
• Operating profit increased from $471 million to $551 million due to a significant reduction in administrative, R&D and marketing expenses. Operating margin increased from 18.02% to 21.38%.
• Net income amounted to $340 million versus $290 million at the end of the year. Net margin increased from 11.08% to 13.20%.

Dynamics of the company's financial results; source: compiled by the author

Company margin dynamics; source: compiled by the author

• TTM cash from operations was $480 million versus $494 million for the year. The decrease is due to the net working capital increase.
• Free cash flow increased from $425 million to $432 million, driven by capital expenditure reduction.

Company cash flow; Source: compiled by the author

Playtika has a healthy balance:

• Total debt is $2.42 billion, while cash and short-term investments account for $957 million.
• Net debt is $1.46 billion, which is only twice the TTM EBITDA (Net Debt/EBITDA — 2.01x).

Although the company's revenue decreased in the last reporting period, we expect the figure to stabilize shortly. Playtika management provided its 2023 guidance, expecting revenue to amount between $2.57 billion and $2.62 billion, implying a change of -1.7% to 0.2%. Adjusted EBITDA is forecast at $805 million to $830 million, suggesting a 0% to 3% year-on-year growth.

Management's 2023 guidance; source: Company Presentation

Playtika is likely to beat its guidance as accounts receivable, representing the company's right to receive payments collected by platform providers, rose from $141.1 million to $159.8 million in the most recent quarter.

Stock valuation

Although Playtika is one of the few game developers with positive earnings, the company is trading at a significant discount to the industry average based on the following multiples: EV/Sales — 1.81x, EV/EBITDA — 6.19x, FWD EV/EBITDA — 5.70x, P/Cash flow — 6.88x, P/E — 10.40x, FWD P/E — 10.06x.

Comparable valuation; source: compiled by the author

The minimum price target set by D.A. Davidson is $11 per share, while TD Cowen estimates PLTR at $25 per share. According to the Wall Street consensus estimate, the stock’s fair market value is $13.4 per share, implying a 54% upside potential.

Price targets of investment banks; source: compiled by the author

Key risks

• A sustained decline in the number of active users is a major risk for Playtika and its shareholders. Given that the revenue per user growth potential is limited, the company's financial performance may come under pressure over time.
• Playtika's long-term development strategy involves M&A deals. While strategic acquisitions on attractive terms benefit shareholders, businesses are often acquired at a control premium, which poses risks to the company's asset turnover and overall profitability.
• Playtika operates in a highly cyclical industry. There is a possibility that slowing economic growth and deteriorating consumer sentiment will hurt the firm's operations. In this case, the PLTK stock may remain under pressure.
• As the company's head office is located in Israel, country risk is likely to be a key factor that has a discounting effect on the company's valuation. If geopolitical tensions continue, the PLTK stock could remain under pressure for an extended time.

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