Gaming Q&A:Online Play Natural Extension for Social Networks

Editor: Please explain your business and why should investors care about What you think about gaming?

Dewey : Playing online with thousands of other people is a natural extension of the online social phenomenon that we are witnessing with Facebook, Zynga, Twitter, etc. MMO games offers users not only an entertaining, immersive experience, but also a place to socialize and share with existing and new friends – it is an intersection between gaming and online social networks. Aeria Games is the biggest publisher of micro-transaction client-based MMO games in the Western market, with more than 15 million unique visitors in the last 30 days. We currently operate 12 client based MMOs and 5 web based games and in process of launching two more client based games and 5 web based games. A few reasons why investors should care about us – first of all, we have been profitable with fast improving EBIT margins. Second, we have a one of the most diversified portfolio of MMO games, from fantasy MMORPGs, casual and social MMORPGs, action MMO games, first-person shooters, to browser games. Third, we are one of the few publishers with local presence in all key Western markets and have games in English, German, French, Turkish, Spanish, Portuguese, Polish and will soon launch services in Italian and Russian.

Editor: What is the revenue break-up between in-house games and third-party games; and what is the revenue break-up between the U.S., Europe, and elsewhere?

DS: We have been publishing all third-party games, mostly licensed from Korea, Japan, Taiwan and Germany. Recently, we have begun a number of internal development and co-development projects. These will not be launched until later this year and early next year. 60% of our revenue is from North America; 35% Europe; and 5% Latin America. We have started our Latin American office only 2 months ago, and have seen rapid growth. For 2011, we expect 45% of revenue to come from North America, 35% from Europe and 20% from Latin America.

ED: What is your target audience in the Western market? Is it mostly people from Asian ethnicity, or is it a fairly good mix between different ethnicities that are playing this game?
LH: About 30% of our users are from North America, with most of the rest coming from Europe and Latin America, and players from Asian ethnicity do represent a higher proportion than their percentage in the population in North America, but that is more likely due to their familiarity with online games and the revenue model.

ED: Can you explain how do you make money – virtual goods, advertising, what could be the mix between these different revenue streams currently and how do you see it trending over a longer term?

DS: Our business model is almost exclusively a micro-transaction based business model. So far, we have not focused on advertising revenue or revenues from offers. Revenue from offers may grow as a percentage of revenue over time, as we include browser games and more casual MMOGs in our portfolio. We expect in-game virtual goods will continue to be the bulk of our revenue.

ED: Given the tough economy, is it getting easier for you to license a game and get better terms?

DS: License terms are more governed by competitors in the space, rather than the macro-economic situation. We have seen a variety of competitors - those who have not grown in the last few years and those who have done well and they mainly come from Europe. The former group is less relevant in the competitive licensing landscape. Therefore, license fees have generally been stable or even decreasing as compared to 2009. There is surely a strong competition for top games but we feel the supply of games is still plentiful, especially with the entry of much-improved Chinese developers.

ED: Free-to-play MMO has not taken off in the U.S. as much as it did in Asia. What are your thoughts? Do you have any plans for the subscription based games?

DS: In Asia, the market has been around for almost 10 years; in the US, the market was unknown until recently. It is only recently when the market saw the successes on micro-transaction with the social gaming companies. Those who have played social or casual games will move to more in-depth client games, which will expand the audience base.
The micro-transaction model does have higher risks for high-cost projects compared to a subscription or box sale model. Many players may opt to experiment with a hybrid model for triple-A games. We are open to such a scenario.

ED: Can you give us some sense about the size of the addressable market?

DS: According to a report by DFC, the market for client games in English is expected to grow to $2 billion by 2015 up from $466 million in 2010. We are present not only in English but other fast-growing markets such as Europe, including Eastern Europe, and Latin America.

ED: How do you acquire customers?

DS: It depends on territories, but mostly it is online. More than 50% of our users come virally. For territories where Internet cafes are the main source of Internet access, such as Turkey and many Latin American countries, offline distribution is a big part. As the client becomes bigger with better quality games, we will also use more offline distribution channels.

ED: How is the cost of acquisition trending over the last couple years? Specifically, have you seen acquisition cost rising because of a strong growth in Facebook games?

DS: The acquisition cost has increased over time. Although there is some overlap with Facebook games, I think the channels used are generally different. For us, the increased acquisition cost is largely due to more competition in MMOGs, both from browser and client games. We calculate the maximum cost per player based on the LTV of users of that particular game and the desired marketing ROI. With real time data for our metrics, we can adjust marketing campaigns to maximize returns.

ED: Can you also share some of the metrics - ACU, PCU, DAU, attrition, conversion rates, ARPU, typical lifespan of users?

DS: PCU for our games is approximately to 90,000, but that is not the most accurate metrics to analyze game performance. For us, Daily Active User (DAU) is a better measurement. Our peak DAU is approximately 300,000. Our ARPPU is consistently around $90, though there is a wide variation between games. For each game, we use the revenue per DAU metrics, which better shows our monetization and buyer conversion ability. The average lifespan of a user is around 6 months; but the hardcore users, who make up the majority of our revenue, can stay for over 2 years. Our players also move from one game to the next on our portal, increasing lifespan.

ED: How do you expect monetization trending overtime, especially as you are growing presence in relatively lower GDP/capita countries like Latin America?

DS: Our ARPPU has remained consistent over the last 3 years, despite expansion to newer and lower-GDP territories. Over the longer term, we expect ARPPU to trend lower, but we expect a much higher conversion rate, similar to trends in Asia for online game, resulting in overall growth in total revenue. This is the normal consequence of going mainstream. There will be more users, with better access to payment options and a much larger total buyer base.

ED: What is your Facebook games strategy? Do you have any games on Facebook?

DS: We are developing Facebook games, but they generally will address more our current demographics, rather than the casual demographics of most social games. We will leverage Facebook features to virally disseminate our browser games.

ED: What about mobile – are you doing anything on mobile front?

DS: Mobile may be a part of a comprehensive online strategy in the future. At the moment, we are not dedicating much resource into this space.

ED: What is the growth strategy – more games, more geographies, more distribution channels/platforms; better conversion between playing to paying users or clocking up ARPU?

DS: We have much room to grow in our current territories: the US is still a nascent market; we have yet to launch games in all EU territories; and our Latin operations started only a few months ago. We will continue to grow our current games, to introduce new, higher quality games and new genres of games, and expand further into countries in Europe and Latin America. Strategically, we have expanded into browser games to further enhance our portfolio. From a monetization standpoint, we will focus more on buyer conversion rather than ARPPU, for the current ARPPU is already extremely high.

ED: Can you talk about the competitive landscape? Who are your competitors currently and who do you have poses competitive threat potentially?

DS: I believe our strongest competitors come from Europe, with expertise in browser games, but so far less focus on the client gaming space. Generally speaking, except for 1-2 companies at most, most of the publishers in North America are struggling. In Latin America, we see only 2 established players in Brazil and no major player in the Spanish-speaking countries. In any new market, competitive threats change quickly. All the major players in the traditional gaming market are now focusing on the online market. Add to that the possibility that the social gaming companies will move to more in-depth and content-rich games. These are threats that may occur in the next few years.

ED: What is the reason that larger companies are not aggressive in this market – is it because this market is just not big enough for them?

DS: The larger companies are aggressively eyeing this market. They see the potential but entry into the space takes time and preparations. Operationally, this is a challenging business that can frustrate bigger and slower players. The publishing business is difficult to execute - it is a 24/7 marketing, customer service and gaming service, requires much more know-how, expertise, infrastructure and data analysis than most expect. Large companies will have a challenging time building such a business organically. We have been in the business for 4 years and we are still learning, demonstrating the operationally complex nature of the business.

ED: What is your secret source? What part of your business is difficult for any other company to replicate?

DS: First and foremost, our operations and the ability to be ROI-focused on all projects are our biggest competitive advantages. An example would be our marketing expertise, which relies on daily LTV analysis for each game and each territory, and from there we derive the maximum cost per player per game. For monetization, we monitor spending habits and duration to maximize revenue per daily active users. We have a specific team for data analysis, which provides a weekly report on progress for monetization and customer retention. The team takes the best practices of each office and implements them globally. Each game is a different business unit, requiring a team to address game production, developer communication, customer service, marketing and monetization. Unless processes are in place and improved with experience, it would be quite difficult to scale the operations. With our scalable infrastructure and processes - we have been able to launch more games, in more languages and in less time than any competitors in the client MMOG space. Most companies take months to launch one game – we launch one game in at least one territory every month.

ED: What are the things on your road map for the next 12-18 months that we should be paying attention to?

DS: We have three key initiatives for 2011: (1) continue expanding our presence in North America and Europe by launching new games, (2) invest and expand our footprint in Latin America and (3) enter new but complementary markets, such as browser games and, on a lesser note, social games.

ED: How big is Aeria and how fast are you growing?

DS: We are already the largest publisher of free-to-play client based MMOGs and will continue to build on our lead in North America; in Europe, our goal is to be the top 3 MMOGs publishers within next year; in Latin, we expect to be one of the top publishers by the end of 2011. We are currently at about 190 employees and expected to be 220 employees by the year-end and 350 by next year. We have seen record revenues in the last few months and expect the trend to continue, in all our current territories. Based on current trajectory, we project reaching a revenue run rate of $75-100 million within next year, with EBIT margin of 20%-25%.

ED Over the next couple years, what do you think are the big challenges for Aeria?

DS: Our biggest challenge is hiring and training good people. There are not many people well-versed with the micro-transaction model for client MMOGs. The ability to scale our operations with good personnel is probably the most important factor for success.

ED: Where do you see Aeria three years from now; do you see it as a standalone private company, as a part of a bigger platform or as a public company?

DS: My job is to maximize value for our shareholders, our staff and our players – and we would not turn down any good opportunity to do so. Aeria Games is a very lean and efficient enterprise. We have built the company almost without any external financing. To reach our current revenue, we have used up only $7.5 million and the current growth is funded from operations. If we slightly alter our risk profile and pursue faster growth, we can certainly do so with more capital.