Tuesday, July 26, 2005

Infinium Labs - Fact or Fiction?

After a 6-month hiatus (and 95% stock decline), Infinium Labs (IFLB:OTC) is back in the news. According to sources close to the company, a final round of funding is being closed before finally launching the Phantom console in early 2006. Most observers remain skeptical.

The Idea

The exciting questions investors grappled with last year sounded something like, "Will the Phantom ever catch on? How many games will be available? And what kind of hardware will be employed?" After delaying the launch of the Phantom console late last year, this excitement has turned to paranoia. Followers now question whether Infinium will ever gain the necessary capitol to launch the Phantom service. Conspiracy Theorists will tell you that the Phantom console was never meant to launch in the first place.

For those new to the company, Infinium Labs basically employs the NetFlix model for PC gaming. Their Phantom Gaming Service aims to be the industry's first end-to-end, on-demand game distribution service accessible through their broadband receiver. Infinium Labs will offer subscribers a vast library of titles, from the top new games to old standards. This service will be available with purchase of the Phantom console and a recurring monthly fee.

The idea is beautiful: Gamers will no longer have to put up the hefty $50 purchase price for the latest titles, but rather rent these games for as long as they please. More importantly, the Phantom will be compatible with all platforms meaning users will not be confined to a certain set of titles designed for one specific console such as the case with XBOX, Game Cube or PlayStation.

The Hurdles

It remains to be seen, though, whether Infinium has the means to bring this great idea to market in a profitable manner. The Phantom was originally slated to go live on November 18, 2004. But in addition to the delay, a number of other events have crushed the stock to mere pennies.

-After creating quite a buzz at the 2004 E3 conference, Infinium Labs was nowhere to be found this year. Critics found it extremely puzzling for an upcoming product to skip the industry's most important conference considering it is the perfect venue to gain potential users & investors. President Kevin Bachus indicated that a booth was too expensive.

-The following press release regarding the employment status of President Kevin Bachus on April 18, 2005 baffled analysts:
"Contrary to published reports, I have not left Infinium Labs. I have not accepted another job. I am still in the same role, working with the same great team and still 100 percent committed to our mission to launch the Phantom Game Service later this year."
Instead of reassuring investors, the news instead furthered their paranoia as most followers had no idea this was even an issue. The stock continued its descent as a launch seemed even more unlikely with the apparent executive instability.

-In an April 20th filing with the SEC, President Kevin Bachus stated, “there’s a high likelihood that sufficient capital will not be available for the launch of the Phantom.” When questioned later, Bachus indicated that this sort of situation is typical for "pre-revenue public companies" and that he remained confident that they would find the necessary funding for launch.

-On July 19th, Michael Pickens and another man were arrested and charged with securities fraud for allegedly manipulating thinly traded stocks through a "pump and dump" scheme orchestrated via blast faxes. Infinium Labs does have a monetary link to Mr. Pickens and CEO Timothy Roberts executed a curious insider sale in the mid-$1s days after this took place. Infinium Labs has not been charged with any wrongdoing.

-As of today (July 26th), the balance sheet shows only $4,000 in cash (not a typo) and still no word of funding. In addition, insiders continue to sell.

But the main reason for the 95% decline? CEO Timothy Roberts & the shady reputation he has created for Infinium Labs. Never has such a more promising company been destroyed so suddenly be executive mismanagement. It appears that until Infinium Labs rids itself of Mr. Roberts, shareholders will have to sit patiently while Roberts and the chosen few enjoy the good life at $250,000 per year plus amazing benefits at a near-bankrupt company. Below are the details of Mr. Roberts’ equity package that he has created for himself:

On December 13, 2004 (stock price $0.25) Roberts committed to a convertible security at a 25% discount with a maximum price of $.10. If the stock traded below $.10, he would then get it at 75% of the current price to assure him a minimum profit on the deal of 33%. The $0.10 maximum represents a discount of 60%.

On December 23, 2004 (stock price $0.80) Roberts went back to the well and cut a deal for another million in cash with a similar 25% discount and a maximum price of $.10. But this time around IFLB was trading around $.80 on its way to $1.60! In layman's terms, Mr. Roberts bought shares for $.10 when the market was at $.80 and climbing. With this kind of shareholder dilution, anyone can see why IFLB stands at $0.08 today.

The Million-Dollar Question

Can Infinium Labs survive all these hurdles, receive capitol, and launch a profitable Phantom console? Infinium Labs has eaten through hundreds of millions of dollars & diluted millions of shares with nothing to show for. The good news for current and potential shareholders is that IFLB is priced to fail. In other words, every piece of bad news is already priced into the stock with the market valuing the company at only $13 million! If you have some extra money lying around, this appears to be a good entry point as the risk/reward is very favorable. Any news of funding and/or launch should push it past $0.30. But with all the shareholder dilution during the last year, it will be tough to see anything north of $0.50 until the console hits the shelves. Once it does, all signs indicate that it will receive plenty of looks from potential consumers. Just last month the Phantom was ranked in "Top Gear: The Top 25 of 2005" in Maxim magazine. Plus all the conspiracy theories will be proven wrong.

But time is of the essence. President Kevin Bachus frequently refers to Sirius as a similar "pre-revenue" business model that has succeeded by building a customer base over time. But Sirius never had problems finding capitol. And in an industry with competitors like Nintendo, Sony, and Microsoft, the window of opportunity is closing.

Friday, July 22, 2005

The Future of the Grand Theft Auto Franchise

Shares of Take-Two Interactive (TTWO) shed more than 5% yesterday after racy scenes in its popular Grand Theft Auto: San Andreas game led the Entertainment Software Rating Board to change the title's rating from Mature to Adults Only. As a result, Take-Two will stop producing the game, recall any copies from retailers who no longer wish to sell the current version, and ship a new version later this year that blocks access to the infamous sex scenes.

The ESRB found that players can download a file off the Internet -- the so-called hot coffee mod -- to view sex scenes on the disk. Thus, the board assigned the game its uncoveted adults-only rating. According to the ESRB's official definition, the AO rating means that the game "should only be played by persons 18 years and older and may include prolonged scenes of intense violence and/or graphic sexual content and nudity." On the other hand, the M for Mature rating has “content that may be suitable for persons ages 17 and older.” Sounds pretty similar, right? But the AO and M ratings are different in one big way: Most major chain stores will not carry AO-rated games. By contrast, M-rated games aren't even separated from games bearing the T for Teen and E for Everyone ratings.

Major video-game retailers wasted no time responding on Thursday. Citing company policies that prohibit the sale of "adult only" rated titles, Wal-Mart (WMT), Best Buy (BBY), Circuit City (CC) and GameStop (GME) all said they would pull San Andreas from their store shelves.

Consequently, Take-Two predicts earnings will come in 30 cents to 40 cents lower than expected and projects a $50 million shortfall as the company braces for the massive returns. For fiscal 2005, the company is looking to earn between $1.05 and $1.12 a share, while analysts were expecting $1.44. But investors differ on the longer-term meaning for the company.

Are these recent “missteps” actually a good thing for Take-Two? There’s no doubt the company has received plenty of free press over the last few week; albeit negative. But current GTA gamers should remain unaffected by the recent negative press. In fact, the Grand Theft Auto should rise to an even higher cult status with all the buzz surrounding the company. While this crimping of distribution could hit sales, the company might actually benefit from the publicity, reducing the hurt. I believe that the ‘Adults Only' rating, particularly for people over the age of 17, may actually increase sales for future installments. With Grand Theft Auto: Liberty City Stories due out later this year, we could get the answer sooner than later. The game has been expected to be a big part of Take-Two's revenue and earnings this year.

Who was responsible for this modification? Last week, Take-Two denied that this came from any internal employees suggesting that the modification was created by outsiders. Although Take-Two executives seemingly had no knowledge of the hidden content, the source was most likely the work of a naughty programmer (remember the old Disney cartoons when bored animators included explicit messages?).

At what cost is NetFlix growing?

I'm in the mood for math. I want to illustrate some principles of how Netflix's current potential profitability is being spent to induce growth. I'm going to focus principally on the marketing component of cost.

Marketing for Q1 was 23% of revenue. For the year, it will be about 20%. 2005 Net earnings is estimated for -10M, producing a net profit margin of -1.5%.

Now, what if Netflix decided to convert all growth to profit?

This introduces what I call the 'replacement rate' which is the nominal number of new subs required each quarter to achieve a net growth rate of 0%.

At 3M subs and 5% churn this figure is 530K subs per quarter. This is a direct result of the Netflix churn calculation applied in reverse.

Now, what is marketing as a percentage of revenue if this were the number of gross adds per quarter?

Presuming a 40$ SAC (to be revisited):
Marketing Cost: 40$ * 530K = 21.2M$
Revenue: 3M * 18$ * 3 months = 162M$
Marketing as percent of revenue: 13.1%

We have now squeezed out 6.9% in net profit points. But it gets better for 2 reasons:
a) Slower growth implies a more rapid aging of subscriber base, which has been shown to reduce churn.
b) At a 40$ SAC Netflix actually achieves much more then the replacement rate, so it must reduce the SAC in order to reduce growth.

To address the first component, recall that a trial sub churns at 10%, 6-month-old subscriber churns at 5%, and a 12+-month sub churns at 2.5%. It should be fairly evident that the fewer new subs put in the pipe, the lower the average churn will be for the entire sub base given the above fact. Let us for simplicity presume something like a 4.5% churn just so we feel like we have considered this benefit.

Running the numbers on a churn of 4.5% we get a reduction of marketing from 13.1% to 11.6%.

To address the second component, Netflix does not pay 40$ per new member precisely. Some members are former customers that would return without advertising inducement, other members are free word of mouth subs, still others are enchanted by a banner or two but don't go through affiliates.

The expectation in Q2, which is the most difficult quarter for Netflix to add subs, is 750K gross adds at a SAC of 40$. If we presume that 200K subs would join at 0$ in marketing, the SAC of the remaining members is 55$. At replacement rate this is: (200K * 0$ + 330K * 55$) / 530 = 34$. If 200K is accurate, this is an upper bound to the SAC required.

Employing this fact reduces marketing expenditure further by (34/40) or 15%.

We now have a 'replacement rate' marketing expenditure of 10%. Revenue for the year would be 3 * 18 * 12 = ~650M, and net profit is then 8.5% (-1.5% + 10%), and the current profitability is 55M or a current P/E of roughly 21.5.

This would be considered pricey if you are looking at a company with 0 growth, however Netflix chooses to invest in growth because it leads to a higher total in profitability. If you run these figures at 4M subscribers, the P/E drops to 16.

Another perspective... in 9 months they will add 1M subs but will incur an opportunity cost to do so of about 40M$. However, at 4M subs they would be making 18M$ more per year and it is therefore like an investment with a 45% yield. A wise choice.

This analysis focuses only on marketing; there are many other reasons to adjust potential earnings including today's news. The second biggest adjustment to profitability expectations is a change at Blockbuster.

Wednesday, July 20, 2005

Raising the Entry Fee at the World Series of Poker

Is the World Series of Poker getting out of hand? At what point will viewers begin to lose interest?

The 2005 WSOP main event concluded last Friday with Australian poker pro Joseph Hachem taking home the $7.5 million first prize. With a prize pool exceeding $50 million, the WSOP is by far the richest sporting event in the world. But when will these out-of-this-world numbers lose their novelty value?

Since Chris Moneymaker's WSOP victory in 2003, TV ratings have skyrocketed from events such as the World Poker Tour, to celebrity charity events. NBC's ratings for its National Head-us Poker Championship last month, which included many household names & ex-champions, exceeded those of Major League Baseball's All-Star game. But do viewers watch these tournaments for the people involved or for the sheer amount of money at stake? Judging by the recent ratings for celebrity events & the Heads-Up Championship, the answer is name recognition!

This year's WSOP championship included nearly 6000 participants. So it was a forgone conclusion that the seats at final table would be filled with amateurs. Until the WSOP dramatically increases the buyin & cuts down on the amateur entries, the event's popularity will soon plateau. This is already starting to occur as the World Poker Tour continues to gain in popularity.

A popular observation among non-poker fans is that the game is all about luck. You'll eventually need the cards to win. In contrast, poker historians will point to Johnny Chan's consecutive victories in 1987 & 1988 as proof otherwise. But if amateurs continue to dominate the final tables at the WSOP, this thought will continue among casual fans. Who has ever heard of Joseph Hachem or even poker pro Mike Matasow? Yes, the serious poker fans & fellow players will tune in regardless of who makes the final table. But these no-names will not lure in the casual viewers.

Monday, July 18, 2005

Strong Buy of the Month - EYET

Eyetech Pharmaceuticals Inc (EYET)
Current Price= $11.25
12 mo Target=$17.50

"This is a rare chance to invest in a small-cap, high-growth Pharmaceutical company that has a minimum 2-year monopoly in the highly lucrative AMD market."

"With $265 million in cash (>50% of market cap), an expected $450 million from Macugen sales before rival Lucentis launches & the backing of Pharma giant Pfizer, I believe EYET is extremely undervalued at these levels."

Eyetech shed another 10% today after positive Phase III results were released for rival Genentech's (DNA) Lucentis drug. After finishing the day at $11.75, Eyetech now sits well below its IPO offering & more than 75% below its 52 week high of $47.92.

At these levels, Eyetech is priced to fail. Rival drug Lucentis is not expected to come to market until 2007 at the earliest. This gives Eyetech more than a 2-year monopoly. At that point, how many doctors will switch to Lucentis? With a market cap of only $500 million, the market is basically saying almost all. This is a rare chance to invest in a small-cap, high-growth Pharmaceutical company that has a minimum 2-year monopoly in the highly lucrative AMD market.

No studies have yet to compare Lucentis versus Macugen. That doesn't stop analysts, however, from making such comparisons from reporting speculation that Lucentis will eclipse Macugen as the principal treatment for AMD. It should also be noted that Lucentis is dosed once every four weeks, while Macugen is dosed once every eight weeks. Which would doctors & their patients prefer? Also, Macugen should be much cheaper to manufacture than Lucentis. This will allow Eyetech to offer price advantages without significantly sacrificing margins.

With $265 million in cash (>50% of market cap), an expected $450 million from Macugen sales before rival Lucentis launches & the backing of Pharma giant Pfizer, I believe EYET is priced to fail at these levels.

Key Statistics:

  • Cash at hand: $265 million (over $6/share)
  • Total debt: $2.35 million (0.017 debt/equity)
  • 2005 Revenue: $175 - $190 million
  • Revenue Growth: 195%
  • % Held by Insiders: 10.08%
  • P/E: 13.03

Recent "Analyst" notes:
CSFB believes that EYET's shares reflect expectations for flawless DNA's Lucentis data that will be presented at the ASRS meeting on Monday, leaving more room for stock upside than downside as only slighest hiccup in data could benefit EYET shares. Firm continues to believe that safety could favor Macugen due to less frequent dosing, an outcome that could temper potential efficacy advantages for Lucentis. Firm assumes roughly equal market share for Macugen and Lucentis with a slight edge for Macugen owing to its 2-year lead time to market, Pfizer marketing strength, fewer injections, potential for combo use with Visudyne, and longer patient experience indicating. With $550 mkt cap, $265 mln in cash, and expected $450 mln from Macugen collaboration before Lucentis even launches, firm believes EYET is undervalued. Maintains Outperform and $30 tgt.

Standard & Poor's Equity Research maintained a "hold" rating for Eyetech Pharmaceuticals after positive Phase III results for Genentech's Lucentis drug. "Lucentis, as well as other drugmakers' experimental treatments, reinforce our view that Eyetech's Macugen is poised to lose market share. Still, we think Macugen sales will be supported by current patients, those unable to tolerate Lucentis, and possibly non-age-related macular degeneration conditions in the future." The research firm also maintained a "strong buy" rating on Genentech.
"Meanwhile, we think Eyetech needs to expand its product portfolio." S&P Equity Research has a $15 price target for the company and views it as a potential takeover candidate.

Eyetech Pharmaceuticals, Inc., a biopharmaceutical company, engages in the development and commercialization of novel therapeutics to treat diseases of the eye. The company’s Macugen is a pegaptanib sodium injection, which is used for the treatment of neovascular age-related macular degeneration. It has collaboration with Pfizer, Inc. to develop Macugen for the treatment of diabetic macular edema and retinal vein occlusion.

2005 World Series of Poker results

In the longest final table in the history of the World Series of Poker (WSOP) Main Event, 39-year-old Australian poker professional Joseph Hachem survived a record field of 5619 players to win the $10000 buy-in 2005 WSOP No Limit Texas Hold'em World Championship Main Event at Binion's Gambling Hall.

The 9-player televised final table, which started at 4:48pm on Friday July 15, ended at 6:44am on Saturday July 16. The 2005 final table eclipsed the previous record set in 1983 by 18 minutes.

A former chiropractor who quit his practice to become a poker professional three and a half years ago, Hachem (pronounced "HAH-shem") won the record $7.5 million first prize and the coveted white gold world championship bracelet after 7 days of play.

The top nine places at the 2005 World Series of Poker were:

Place/Prize Money
1st Joseph Hachem, Melbourne, Australia $7.5 million
2nd Steve Dannenmann, Severn, Md. $4.25 million
3rd John Derick Barch, McKinney, Tx. $2.5 million
4th Aaron Kanter, Elk Grove, Calif. $2.0 million
5th Andrew Black, Dublin, Ireland $1.75 million
6th Scott Lazar, Studio City, Calif. $1.5 million
7th Daniel Bergsdorf, Umea, Sweden $1.3 million
8th Brad Kondracki, Kingston, Pa. $1.15 million
9th Mike Matusow, Las Vegas, Nev. $1.0 million