Don't Be Fooled by Glu Mobile's Recent Rise

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Glu Mobile (NASDAQ: GLUU) has regained investor confidence after a tough start to the year as Wall Street seems to have taken note of the company's rapid top-line growth. The stock is up roughly 19% since the Feb. 9 drop that followed its quarterly earnings report on Feb. 8. The mobile gaming specialist has been aggressively pursuing revenue growth by striking big-name partnerships and setting up a strong portfolio of games, but this has come at a cost to margins.

Can Glu get its act together and become a solid long-term pick? I don't think so. Here's why.

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What's working for Glu

Glu Mobile's business is growing rapidly. Its top line shot up 73% year over year during the fourth quarter that ended in December, driven by a 44% increase in bookings, which is the amount spent by users within games on virtual items. What's more, Glu's 2017 bookings increased 50% to $320 million, with 63% of these bookings coming from just three titles -- Design Home, Tap Sports Baseball, and Covet Fashion.

Glu categorizes these three franchises as its growth-centric titles, and it plans to keep milking them to boost sales. For instance, it recently launched MLB Tap Sports Baseball 2018 in the iOS and Android stores. This is Glu's second-most popular game, as it accounted for 13% of total bookings, which is why the company keeps adding interesting features, such as allowing users to predict real game results and win prizes. It is also promising console-level graphics and actual baseball strategies.

So, Glu is trying to enhance user engagement, which is the right thing to do. Last quarter, the company's average bookings per monthly active user increased close to 80% year over year, and its focus on delivering additional updates to make its leading titles more relevant and interesting should help it boost this metric further.

Moreover, Glu has been striking partnerships with big names. In February, Glu announced that it is collaborating with Disney for the development of a mobile game that will be based on stories and include characters from the Disney and Pixar franchises.

Now, Disney is the world's 13th-most "powerful" brand according to Forbes, and Glu can use this partnership to its advantage by getting access to a ready base of fans. The mobile gaming market is estimated to grow almost 41% to $65 billion by 2020.

Investors seem to be betting on Glu Mobile to sustain its impressive growth, but there's one thing that could throw a spanner in the works.

Glu isn't focused on bottom-line growth

Glu has achieved massive revenue growth at the expense of its margins as it has been spending a lot of money to get users. In the fourth quarter of 2016, Glu's marketing expenses were $11.3 million, or 20% of its total bookings. The company's marketing expenses as a percentage of total bookings increased to 26% in the fourth quarter of 2017, to $21.8 million.

So, Glu's marketing outlay almost doubled, and this led to a 33% jump in operating expenses. Not surprisingly, Glu's net loss increased to $39.6 million last quarter as compared to $17.2 million in the prior-year period.

Now, mobile gaming is a very competitive industry, so a lot of investment is needed to keep fickle gamers hooked on a title. This strategy worked for Glu in driving its top line, but the flip side is that any slowdown in the marketing push could hamper its growth, and that seems likely to happen this year.

Glu Mobile expects $330 million in bookings this year, which is an increase of just 3% over last year. Additionally, its marketing expenses are expected to drop around 13%, which clearly shows that when marketing spending drops, bookings drop.

Glu has converted 90% of its annual bookings into revenue over the past two years, and an identical performance in 2018 will put its top line at an estimated $297 million. This means that Glu's terrific revenue growth could come to an end this year, and this can be blamed on the drop in marketing spend.

Also concerning is the fact that Glu is a small company with limited assets. The company had a cash balance of just $64 million last year as compared to $102 million in the year-ago period. In fact, Glu's cash position has been on a steady decline over the past few years as seen below:

Glu has taken advantage of mobile gaming growth with the help of its aggressive investments. But the company's thin cash position means that it cannot keep investing forever and fight against more resourceful video gaming giants, so investors should be wary.

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Harsh Chauhan has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.