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Doubling down my position in Gravity Ltd. (GRVY)

December 17, 2013

Gravity Ltd. has had its difficulties over the past couple of years. I originally took a position in Gravity in 2010, built it over 2011 and sold out in February/March of 2012 when the ADSs hit a high of almost $3.50. Since then, the promise of Ragnarok II, which sent the shares to its 1Q 2012 high, has not played out. The relaunched game has only been moderately successful and no other games developed by the company have proved able to replace the original Ragnarok income stream. After the Ragnarok relaunch, the ADSs traded down significantly, falling some 50% from their high by year-end 2012 when it became clear that the Ragnarok sequel wouldn’t have the same success as the original game. When the ADS price dipped below the level of per-ADS balance sheet cash I repurchased one quarter of my original position. In hindsight I was not patient enough, and this entry point proved too high; ADSs have since traded down further as operations have continued to show mediocre results and more recently have become cash flow negative.

With ADSs down some 30% this year I decided to take another look. The company still has significant cash and short-term investments of about $46 million as of the end of Q3, or about $1.68 per share. At the current price of $.93 this means the ADSs are trading at a 45% discount to per-share cash! Wow! almost a $.50 dollar even if we consider that the other assets they own have no value whatsoever. To me, even with operations recently turning cash flow negative, there appears to be a decent margin of safety at this price. The question is can management turn the operations around? Or more precisely, is there a reason why management might be incented to turn operations around. Remember this is an entity controlled by a Japanese company, i.e. an environment where shareholder returns are not necessarily the primary interest of management. The recent downtrend in the ADS price may reflect a shareholder belief that operations will never turn around and the recent lows looks to me to reflect investor capitulation. This smells like a good opportunity! Perhaps December tax loss selling has provided a nice buying opportunity? Of course, management may simply continue its shareholder unfriendly ways and run the company into the ground. But with Gravity’s  rather large cash buffer I think it prudent to wager that things may not be as bad as they appear. We’ll just have to have a bit of patience.

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