DoubleDown Interactive Stock: a cigar butt company (NASDAQ: DDI)
Interactive DoubleDown (NASDAQ:DDI) is a small game company with growing margins, strong cash flow, and deep negative net debt, but valued at a significant discount to book value. For a long time a sword hung over the company in the form of a lawsuit that could deprive DDI of a significant part of its assets. It seems that this risk factor has been overcome. And although by the time stocks reacted with a 12% rise, DoubleDown remains a deep value case. The use of cash accumulated on the balance sheet can reveal the value of the company. It is expected that the cash will be used for mergers and acquisitions transactions, which will allow DDI to obtain a new engine of growth, diversify its income and improve its profitability thanks to the synergistic effect. A high insider ownership share and low free float can limit the downside of the stock and lead to a crunch in the event of excessive demand. Given that the closest pair is trading at P/FCF 7.56, the upside potential we see is around 45%. We value stocks as a To buy.
DoubleDown Interactive develops games of chance for mobile devices and in WEB format. Currently, the company’s portfolio includes four games, three of which are casino games and one is a zombie apocalypse RPG. Spinning Space is slated for release this quarter, along with multiple game releases next year. The developer derives its revenue from in-game user purchases primarily in the United States (87.5% of revenue). The share of WEB games in revenues is 27.1% and that of mobile games 72.9%. DoubleDown Casino’s flagship game generates 96.6% of DDI’s revenue.
A real case of value
In a 1989 letter to Berkshire Hathaway shareholders, Warren Buffett wrote that a cigar butt found on the street that is only a puff away may not offer much smoke, but “buying cheap” will make that puff profit. By a cigar butt, the Oracle of Omaha meant stocks of companies whose market capitalization was less than the net asset value of the company. One such company is DoubleDown Interactive.
With a current capitalization of $533.2 million, the company’s book value is $843.1 million, of which net current assets are $215.2 million or 25.5%. It should be noted that the balance of Total Cash & ST Investments is $284.4 million, which is two-thirds of DDI’s market capitalization. DoubleDown also looks as cheap as its peers.
|DoubleDown||Playtika (PLTK)||Churchill Downs (CHDN)||EA (EA)||Activision (ATVI)|
DDI’s valuation appears irrational since the company is trading at a significant discount to liquidation value, consistent with companies burning shareholder value. DoubleDown, in turn, consistently increases marginality and generates strong cash flow. According to the results of the last reporting period, cash flow from operations and free cash flow exceeded $100 million.
In the pursuit of value, it is important not to fall into a trap. DoubleDown does not look like a value trap because a) the company increases its marginality; b) DDI generates strong cash flow; c) the company has a strong balance sheet and a strongly negative net debt.
In the second quarter, DDI posted a loss of $34.1 million due to the establishment of a legal provision of $71.5 million. The company’s adjusted net income is $37.4 million.
Liquid assets can become a potential driver of value disclosure. The probability of redemptions is unlikely since the company has a low free float. However, management regularly talks about strategic acquisition plans.
“We are targeting – to grow our business through strategic M&A opportunities, although of course we cannot give any assurance as to the timing of a potential transaction” – In Keuk Kim, CEO.
The potential acquisitions will allow the company to obtain a new growth driver, diversify its revenues and improve its profitability thanks to the synergistic effect. Additionally, a reduction in the balance sheet will lead to an increase in ROA and ROE due to an increase in asset turnover. Thus, the rational use of cash can become a driver of stock revaluation.
Property structure as fall protection
Almost all shares are held by affiliates, insiders and employees. The company’s major shareholder is B. Riley Financial with a share of approximately 8.3%. B. Riley acted as DDI’s underwriter in 2021. Korean parent company DoubleU Games has a 67% stake. About 5% is free floating. Such a low float can limit the fall in stocks and lead to a tightening in the event of excessive demand. However, a low free float also limits liquidity and creates a risk of high volatility for investors.
The main risk factor is behind
For a long time, the biggest risk factor for DDI investors has been litigation. A group of people led by Adrienne Benson filed a lawsuit against DDI and IGT for illegal activities in Washington State. Prosecutors put the total damage at more than $2 billion. DoubleDown management approved the upper limit of the settlement of the case at $201.5 million. IGT also awarded $150 million for legal costs, but in its statement asking to dismiss the plaintiffs’ motion, shared that it had made significant progress in negotiations with the plaintiffs.
On August 29, DoubleDown and IGT announced a lawsuit settlement. In total, the companies will pay $415 million, of which $269.75 million will be provided by IGT, and the remaining $145.25 million will pay DDI. DoubleDown needs to allocate an additional $73.75 million in payment for the Benson case, and that will most likely happen in the next quarter. After the release, stocks reacted with a 12% increase, which is insignificant given that the company lost its main risk factor.
DoubleDown is a classic example of Buffett’s cigar butt: the company posts positive margins, generates strong cash flow, trades at a significant discount to equity and a fair share of total cash and short investments. term has accumulated in its balance sheet, which is expected to be directed to M&A transactions. While the downside potential is limited by a low free float, acquisitions will give the company a new engine of growth, allow it to diversify its income and improve its profitability, which can lead to a revaluation of the shares. Given that the key risk factor appears to have been exceeded, we are bullish on the DDI.