Q&A: Glu Mobile CEO De Masi on Acquisitions, Third-Quarter Forecast

After Glu Mobile’s earnings call on Tuesday, we talked with the company’s chief executive Niccolo de Masi the following day about the two recent acquisitions it made and how he expects the mobile gaming landscape to change on Android and iOS in the third quarter.

This interview happened before we knew the company had restructured and laid off several executives. (This apparently happened the same day we interviewed De Masi and the company later only provided a canned statement on the matter).

Still, some of this information may be helpful in understanding how the company thinks about its revenue prospects this fall. And yes, we do cover Glu a lot here, but that’s because it’s one of the very few publicly-traded mobile gaming companies around. So its earnings can be a way of benchmarking how other privately-held companies with similar revenue models like Pocket Gems and Storm8 are doing.

Glu’s smartphone revenue rose 58 percent year-over-year to $9.42 million in the quarter ending in June. During that time, it saw 999,000 in-app purchases, up from 755,000 in the first quarter. The average revenue per in-app purchase was $4.07, up from $2.31 the previous quarter, because of higher price points for virtual goods.

Q: Why do you expect net losses to rise to between $7.4 and $8.2 million this quarter?

A: If you want to dive in — in a nutshell, the reasons why we’re taking losses is because we’ve taken on approximately 200 new employees. They won’t be generating new revenue until 2012. So it’s really about investment in R&D, plus our feature phone business declines every quarter.

Also, there’s a loss in CPI advertising or a significant degradation which means there are two hills for us to climb. To keep us flat, we have to keep growing smartphone revenues.

Q: You also said that it looked like alternatives were replacing 25 to 50 percent of CPI revenue, down from the 50 to 75 percent you said you expected in May. Why is that the case?

A: We talked about this yesterday. When we get good inventory — that’s premium, high-CPM video advertising –we’re able to replace 75 percent of offer wall revenue. When we don’t have high-quality CPM inventory, we get a number lower than that.

The lower replacement is happening because we are burning through all of the high-quality inventory very quickly. On the Pandora earnings call, they mentioned this too. There’s not that many high-quality high CPM ads, so the bigger players are burning through it.

We hope that the overall video industry is going to learn more about mobile generally and that brands are going to spend more. Two years ago, there was really very little video advertising for mobile. I’m still a long-term bull for advertising in general, however.

Q: What seems to be most effective for replacing CPI in terms of user acquisition?

A: We’re always trying new techniques and channels. I haven’t found anything that’s effective as CPI either for making money or for acquiring users. We’re more diversified now though and we’re continuing to be on the look out.

Q: Are there any new providers that are really working for you right now? 

A: We’re working with all the same people — Tapjoy and Flurry and so on. We’re staying close to the companies that have been able to deliver in the past.

Q: How is in-app billing working out on Android after a quarter since launch?

A: What’s helping Android a lot is carrier billing. More and more carriers are signing up and that’s their biggest mechanism for reducing friction. I think they’ve made great strides. Look at where Android was nine months ago.

In the long-run, we see Android overtaking iOS for overall market size. So the exciting thing for Glu on that front is that we have a great Android relationship. We’ve been on the platform since the start. We had some of the first games out there and started to follow along with all of their new initiatives. As Android takes off, developers will have to deal with language and storefront fragmentation. There will be Amazon and the carrier stores. We have an advantage because we’re global, we have 600 employees and we know how to handle that fragmentation efficiently.

Q: Many of the companies that have developed expertise in freemium gaming on the Facebook platform have started to become more visible on the top-grossing iOS charts. How is that additional competition affecting Glu?

A: We haven’t noticed much of a threat from Zynga. They have two to three extensions of Facebook games and Words With Friends. We’ve been competing with them favorably with them for the past year.

In general, we’ve seen a shift in demographics among smartphone consumers. I’ve seen more resource management games as a proportion of the top 100 grossing titles. That’s probably because smartphones are starting to be adopted by majority users instead of innovators and early adopters. You’re starting to see the Facebook non-gamer demographic to get smartphones and so you’ll see more simple resource management games.

At the same time, gameplay is becoming more sophisticated on Facebook. Zynga recently put out Emperors & Allies, which has much deeper gameplay than Farmville did in 2008 and 2009. Glu has been at the forefront of games with deeper play.

We think that’s where gameplay will be going. We know what the trends are going to be. I expect that momentum behind higher production values will throw the balance of growth in Glu’s favor.

With every industry, there’s a handful of scale players and companies that can’t necessarily compete at that level. Glu is a scaled business. It is and always has been that way. As the market matures, we’ll have companies like EA, Gameloft, Glu and then there will probably be one to two other companies that like Storm8 that factor in.

Q: What about HTML5? How much experimentation are you pursuing with that?

A: Moore’s law is in operation on the hardware side to much a more predictable extent than it is with bandwidth. Look at where hardware processing has gone. Today we’re talking about dual-core processors and soon we’ll be talking about quad-core processors. It’s going take a much longer time for 4G to reach full market penetration.

So it’s going to be hard not to be long on the client-centric download model that Apple, Google and Microsoft are educating and inculcating consumers on. If you’re seeing hardware processing power double or triple and bandwidth isn’t doing the same, you’ll see gaming companies favor native apps that are more playable. Not only is it a great macro trend, Apple is training people to download clients like on the PC.

Q: Does that mean you’re relatively bearish on Facebook’s rumored mobile HTML5 platform project?

A: I think HTML5 is going to continue to be more and more interesting every year.

But let’s take an example. I’m a subscriber to the FT and I still use their native client instead of downloading their HTML5 app. The HTML5 app requires a lot of bandwidth and accessibility of Wifi to make it work quickly.

That’s the thing. If you can’t make a news application work as well on HTML5, you can imagine how a game is going to perform. My prediction is that you’ll see simpler resource management games work on HTML5 and not anything more complicated than that. And then higher-performance games will have to be native.

Q: With the emergence of more top-grossing casual games this quarter, are you shifting your mix away from half action-adventure games, half-casual? Or are you keeping it the same?

A: Half-half is about right. All of our big successes have been action-adventure. With the Blammo games acquisition, we’ll have more casual DNA.

Q: Why do you think your casual games haven’t been as high up on the grossing charts as those of your competitors?

A: Bug Village has done pretty well. On Android, it’s been top 10 to 20 grossing. Since Bug Village, we haven’t had a lot of successes. I think there’s a lot more competition in casual. We’ve also seen a shift toward people responding to sub-20MB apps because you can download them on Wifi. We’re looking at getting our client size down. Bug Village is about 60. It’s been a bit of a barrier.

We’re going to be addressing that. Glu has had a lot of action-adventure DNA, but not as much casual. We’re a learning machine though. We’re going to be getting better and these acquisitions are going to help us.

Q: How is the GPartners program going?

A: We’re definitely still scouting. Blammo was discovered through the partners program so it’s been very helpful for us in seeking out potential employees. We’re finding it’s hard to find good developers that have any freemium expertise. We are being careful and we’re making sure that we strike relationships that are comfortable for both parties in the long-term.