tinyBuild: Building Something Big
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As MicroCapClub founder Ian Cassel likes to say: “All great companies started as small companies. Find them first.” I am yet to find a small, often referred to as microcap, company that I am more confident will become great, and subsequently big, than tinyBuild. Currently valued at under $100M tinyBuild is a developer and publisher of video games across various categories and platforms. Led by CEO and ~38% shareholder Alex Nichiporchik, the company seems to be making the right moves in every aspect of the business, and yet trades at a stunningly cheap valuation - a true anomaly (yes, I know I wasted that title).
The video game industry is very broad, to say the least. From mobile to PC, MMOs to puzzles, the video game industry is both a mile wide and a mile deep. While different categories within the industry have different growth and economic profiles, at a high level it is important to understand that the industry has an extremely long runway for growth. By most estimates, the video game industry is set to grow at a high-single digits compound annual growth rate (CAGR) as far as the eye can see. Besides its expanding breadth and growth, the key to understanding the industry is that there is only one true moat: intellectual property (IP). Whether it be AppLovin, Keywords Studios, or another company eager to capitalize on the trend, just about everything in the industry can be outsourced, from development, to distribution, to advertising, and everything in between. Now back to IP. As great as having an IP moat is, creating truly exceptional IP from nothing is a shot in the dark, and buying it is quite expensive. Even when a company can create this type of IP, it is often hit-based and fleeting, causing the business’ performance to have peaks and valleys. This makes it rather hard to maintain continuous and sustainable success in an increasingly competitive industry as more and more companies enter the space in order to try to capture its growth.
At a very high level, tinyBuild is a developer and publisher of video games. In the video game world, this means that they are vertically integrated, taking games from simply an idea all the way through to its launch, and even further from there. That said, tinyBuild is so much more than a traditional video game developer and publisher. Whether it’s their multimedia approach, famous orange merch, or DevGAMM conference, tinyBuild continues to take steps that separate it from its perceived peers as it builds towards something much bigger.
What They Do Right
As we discussed before, outside of IP there are no real moats in the video game industry as any and all services can be easily outsourced. Still, there are many things a company can do right in order to ensure success, and tinyBuild seems to be hitting the nail on the head with each one of them, as we’ll dig into. Before we get into these factors, I want readers to pay attention to one thing: not once am I going to mention any individual games of franchises. While tinyBuild does have some exceptional IP, specifically the Hello Neighbor franchise, there is no single game, franchise, or piece of IP that controls the destiny of the company. Instead, it is a confluence of factors pushing the company in the right direction, that when put together create what Charlie Munger would call a “Lollapalooza Effect.”
Like we discussed before, tinyBuild is vertically integrated, meaning that they both develop and publish the video games they are involved with. This is important as it allows the company to have a lot of control throughout the process, while simultaneously allowing them to develop deeper relationships with their developers.
High Percentage of Own-IP
In its 2017 fiscal year (FY) tinyBuild’s sales were less than 50% from its own-IP. As of FY 2022 this number stands at more than 77% and seems to only be going in one direction. By owning the IP tinyBuild is able to control its storylines and strategic directions without outside influence. This shows itself in various ways which we’ll touch on later on.
Focus on Franchises
One of the benefits of owning most of your IP is that you can leverage it in different ways, including franchises. Focusing on franchises allows tinyBuild to create a virtuous positive feedback loop. By creating new content based on previously popular IP, fans can instantly recognize and resonate with this content, which over time leads to more recognition and so on. This also decreases the brain drain of development teams, as they don’t need to continuously come up with brand new worlds and ideas.
High Percentage of Sales From Back Catalog
As of FY 2022, 80% of tinyBuild’s revenue came from its back catalog. This is important for two reasons. The first is that these sales are very high margin, as they come with little to no incremental costs. The second is that this reduces the reliance on the need to rush out or pay high prices for new games in order to generate revenue, allowing the company to make the right funding decisions for long-term success.
Emphasis on GaaS/In-Game Purchases/Monetizable Events
Part of the reason tinyBuild derives so much of its revenue from its back catalog is its focus on in-game purchases. Think Fortnite. Fortnite is a free game and yet makes billions of dollars. Though it's anecdotal, my younger cousin always asks for Fortnite’s in-game currency for his birthday and holidays, making a free game extremely lucrative. As we just mentioned, adding new features that encourage this type of monetization comes with an immensely high margin. Over time tinyBuild plans to focus progressively more and more on these types of games.
tinyBuild offers its games across all platforms. The company is agnostic as to where it reaches its consumers. Rather, the focus is on engaging with as many consumers as possible on whatever platform those consumers prefer.
This is a particularly unique point. tinyBuild has more than 10,000 verified influencers, and 1.6M social media followers (almost as much as its two largest peers combined). When the company first starts to roll out the beta version of a game (a rough draft, think the unedited version of a movie) it gives it to these influencers to live-stream to their fans. This comes with three important benefits. The first being it instantly increases the recognizability and “hype” of the game. The second and third go hand-in-hand. By putting out the rough draft version of the game to its future consumers, tinyBuild is able to listen to the suggestions made by these potential consumers. This simultaneously increases engagement and serves as research and development (R&D) to ensure the game will take well with consumers at launch.
Use of Multimedia/Creative Advertising
tinyBuild has recognized that simply being a video game company leaves a lot of opportunity on the table. This has led to the company taking a multimedia approach. In a recent interview Todd McFarlane, creator of the famous comic book series Spawn, described the key pillars of IP cross-monetization as being video games, movies, TV shows, comic books, and toys. tinyBuild uses all of these channels, keeping consumer engagement and mindshare high, while also making money doing it. The company has even incorporated some of these other forms of media into the actual games, uniquely blending the lines between these various mediums.
tinyBuild’s management recognized that the hit-based nature of the video game industry is far from a great business model. Most of the industry players (pun very much intended) rely on a single title or franchise to generate most of their revenue. This leaves these players extremely vulnerable to a change in consumer preferences, which for one reason or another can turn on a dime (ask Bud Light). Because of this tinyBuild has emphasized a portfolio approach, reducing its reliance on its top three games from more than 63% in FY 2017 to just 30.5% today. Over time this number will continue to come down.
In any business capital allocation is key. tinyBuild’s management understands this and makes it a point of emphasis. New game ideas are often floated out on social media, with initial funding dependent on how well it takes with potential consumers. From there projects receive continued funding based on hitting various milestones, making sure that the cash is earned. In FY 2022, the company released three games with budgets over $1M, with their return on investment being 190% - a staggering statistic.
Often in the industry when other players are looking to expand they will buy the IP of another studio. While this seems great on the surface, simply transferring the IP to a new development team often comes with challenges. tinyBuild takes a different approach, which they call “acquihiring.” Rather than just buying the IP, tinyBuild buys the whole development team. This keeps the sense of ownership within the development team and makes sure that their vision is seen out. It also comes with the added benefit of keeping the talent for the long-term so that the team can develop the game into a franchise and/or start a new project(s).
tinyBuild operates with a decentralized structure. As the company’s CEO likes to describe it, tinyBuild has a “supporting team at the top to keep the rain out, and supporting team below to make sure the company has a solid foundation.” From there, the development teams work on their projects as they best see fit. This has the double benefit of encouraging an ownership mentality amongst the development teams and improving company culture by largely eliminating bureaucracy.
This is a key part of the story, which is driven by the large ownership stake of Co-Founder and CEO Alex Nichiporchik. Alex currently owns ~38% of the company (there is a vote at the upcoming AGM which will allow him to buy more - the original IPO documents stopped him from owning more than 40%). This allows the company to take a long-term approach to running the business. Alex is a true luminary of the industry. He has touched every part of the video game ecosystem from being a professional player, to becoming a journalist, game producer, and marketing executive. As described in the FY 2022 Annual Report: “The key is not to make short term decisions that may impact our long term growth potential. Every decision we make needs to get us incrementally closer to the long term goal.” Alex is a prime example of an elite owner-operator, pushing the company towards continued success.
Driven by Alex, the company places a major emphasis on being open minded. As is seen through the decentralized structure, Alex has a disdain for bureaucracy, which can often be the downfall of an otherwise strong company. Instead, tinyBuild’s management team focuses on what they objectively believe to be the best decision for the business. A great anecdotal example of how this is put into action is the following quote from the FY 2022 Annual Report: “Every week the executive team sits down and reviews all options. Every week we approach capital allocation decisions as if it was the first time, with no sacred cows and the determination to uncover new opportunities that have the right ingredients, both in terms of financial upside and strategic fit.”
People and Culture
One of my favorite Warren Buffett quotes is “I try to invest in businesses that are so wonderful that an idiot can run them.” Of course, this is the Holy Grail of investing, but the chances of finding the next Coca-Cola is (probably less than) one in a million. If you can’t rely on an indomitable business model, what is the key to finding a great company? The answer is almost always people and culture, an area in which tinyBuild is hard to match. The company emphasizes this in everything they do. I think there is no better example of this than the company relocating more than 100 people out of Russia and Ukraine last year on the dime of the company. Here is the incredible interview in which Alex describes the story:
This is best summed up (far more gracefully than I ever could) by Alex in the FY 2021 Annual Report: “The only constant here is people. People you want to work with, people you trust – not just with work, but literally with your own life. This is what we built. We built a company where colleagues trust each other with their own lives.”
In my HIFS writeup I started off the valuation section by stating that it “will almost undoubtedly be the shortest valuation section I ever write” - this one may take the cake. tinyBuild is currently trading at less than 4x EV/OCF (which excludes amortization of capitalized development costs). This number grew 61.86% year over year, and converted 100% into free cash flow as the company has no maintenance capital expenditures. Not only was this growth and economic profile not a one-off, they are actually improving. The company has no debt or senior securities so there is no concern on that front. I don’t think I need to explain why the company is undervalued.
Other Items of Note
As a means of getting more exposure to potential consumers, tinyBuild has a deal with Microsoft to put games into its Xbox Game Pass bundle.
Like we touched on very briefly before, tinyBuild owns 49% of DevGAMM, a series of video game developer conferences. These conferences are an important and lucrative way to increase the company’s recognition amongst the developer community, and in developing (pun again intended) relationships that may lead to aquihires.
In line with the capitalist spirit of the company, tinyBuild has an online merchandise store that sells both game-specific merch, as well as their famous bright orange gear.
tinyBuild offers an opportunity to invest in a company of immensely high quality at an immensely low price - a true anomaly. With a top-tier management team running a superb business that is firing on all cylinders, it is hard to see how investing in tinyBuild does not yield spectacular results. I believe this is an extremely rare opportunity to buy a tiny company which is building something very big.