Yalla bets on hardcore gamers in bid to jumpstart growth

The Middle Eastern social networking and gaming company recently launched its first two games targeting serious players after months of testing, hoping they can become a major new growth driver

Key Takeaways:

• Yalla’s revenue grew 4.1% in the second quarter, while its profit rose by a stronger 38.9% thanks in part to big gains in interest income
• The Middle Eastern social networking and gaming company is hoping to rekindle its earlier strong double-digit growth with its recent launch of two games targeting more serious players

By Doug Young

Bring on the hard-cores!

That’s the battle cry these days at Middle Eastern social networking and gaming company Yalla Group Ltd. (YALA.US), which is betting big on a pivot to hardcore games as it seeks to bring back investors who flocked to the company in its earlier days of strong double- and even triple-digit growth. The company, which has experimented with a metaverse game as well, also hinted at another upcoming initiative aimed at animation lovers with the release of its latest quarterly results released on Monday.

Yalla played up those initiatives as it reported stable revenue growth in the second quarter, continuing a trend for most of the past year. Despite that, it posted strong profit gains for the period, though much of that was due to factors beyond its control as its big cash holdings allowed it to profit from the current high interest rate environment.

Based in Dubai, Yalla started out as a social networking and gaming company with a focus on voice-based chat services, which still make up more than two-thirds of its revenue. But it has discovered that games can be equally lucrative, as users are often more willing to part with their cash for a chance to engage in a bit of fun and competition.

Yalla’s Middle Eastern home remains its main focus to date, and it is the region’s top locally based social networking and gaming company. But it has also expanded into other developing markets, including Turkey and Latin America. It also operates an R&D center in the Chinese city of Hangzhou.

While it has mostly focused on casual games since its founding in 2016, Yalla is betting that more serious gamers will give it the lift it needs to return to its days of headier growth in the first year after its 2020 IPO. The hardcore games initiative has clearly gained attention from the investment community, with the first three analysts on its earnings call all asking related questions.

One of its first two hardcore titles is “Merge Kingdoms,” a simulation game that began beta testing last year and was officially launched in this year’s second quarter. CFO Karen Hu said Yalla recently began promoting the game, and the company was “already seeing better retention and willingness to pay.”

Meantime, Yalla launched the Middle Eastern-themed fantasy game “Age of Legends,” its other title aimed at more serious players, in May in Turkey. The company began expanding the rollout this month to its core Middle Eastern countries in the Persian Gulf region. CEO Yang Tao noted that
Age of Legends” was the most downloaded title in the low-tech game category on Apple’s iOS for both the United Arab Emirates and Saudi Arabia after its launch.

While company officials made no mention of meaningful revenue contribution from either title just yet, they are clearly holding out big hopes for both.

“We will also continue to expand our pipeline of games through both staff development and external distribution collaboration,” said Yang on the earnings call. “We look forward to building our mid-core and hardcore game portfolios and expect this to serve as important growth drivers going forward.”

Diverging trends

Yalla talked up its two hardcore babies as it released second-quarter financials that showed less impressive top-line revenue growth, even though its profits rose sharply. The company is relatively conservative, repeatedly stressing it is focused on quality growth and return on investment (ROI) over growth at any cost. Accordingly, its cash pile is quite large and continues to grow, climbing to $510.5 million by the end of June from $453 million at the end of last year. At the same time, the company has relatively little debt.

Its top-line revenue continued a recent trend of single-digit growth, rising 4.1% year-on-year to $79.2 million in the second quarter.

Revenue from its chat services rose by 4.9% year-on-year to $55.2 million, accounting for about 70% of its total. While the company started out with a focus on voice-based services, it has more recently started to add complementary text-based services with its YallaChat, which launched last year and is now being ramped up with “strong retention rates,” officials said on the call.

The company’s gaming revenue, its other major income source, rose 2.8% year-on-year to $24 million. It continued to add users at a steady clip, with its total and paying user bases up 14.3% and 26.6%, respectively. Notably, nearly 40% of Yalla’s users are now paying customers.

Yalla’s costs and expenses were relatively steady during the quarter, rising slightly to $55.3 million from $55.2 million a year earlier. But the company got a big gift from the U.S. Federal Reserve, whose aggressive interest rate hikes to tame inflation benefited companies like Yalla with big cash savings. Yalla reported $4.6 million in interest income during the quarter – a major jump from just $176,000 in the year-earlier period.

As a result of that cash injection, the company’s net margin rose nearly 9 percentage points to 35.7%, lifting its net income by a sizable 38.9% year-on-year to $28.3 million.

The company forecast it would report third-quarter revenue of $73 million to $80 million, which would represent a decline from the $80.1 million it reported a year earlier. It did not comment on the reasons for that conservative forecast.

Shareholders were generally content with the report, bidding up Yalla’s shares by 1.4% in the two trading days after the announcement. The stock has gained about 50% this year, suggesting that investors believe the company was previously undervalued. At its current price-to-earnings (P/E) ratio of 12, Yalla still trades well below the 39 for Facebook parent Meta (META.US), and is also slightly behind the 13 for Weibo (WB.US; 9898.HK), often called the Twitter of China.

The bottom line is that Yalla is looking for the next big thing, though it’s doing that in its usual measured and careful way. Yang revealed that the two new hardcore games could be just the beginning of Yalla’s efforts to cater to more serious participants in the online world, as he teased another product in development.

“Another update I would love to share with you is about what’s building on the animation social world and about how we build it,” he said on the call. “We plan to fill it in combination with mid-core and hardcore games to boost the gamification of the product.”

All that shows there’s certainly plenty of activity going on in the Yalla workshop. Now, the company just needs to show it can make some money from those efforts.

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