Valuations in the gaming sector have gone down in many places

Translation: Original comment published in Finnish on 9/18/2023 at 7:06 am EEST.

We looked at the current valuation levels of listed gaming companies and their growth and profitability forecasts for the coming years. The companies are divided into three groups: 1) Mobile games companies, 2) Console and PC games companies, and 3) Multi-platform games companies, a group of gaming giants. We also briefly review interesting companies in the sector. In general, valuations of games companies have seen a strong downward correction in recent years after a sharp rise in demand following the COVID pandemic (2020-2021). Of course, this has also been influenced by the significantly higher required rates of return resulting from the rise in interest rates. The long-term growth outlook for the sector remains good, with growth in the number of players and the amount of money spent per player on games as key drivers. Given these drivers, the current moderate valuation levels may offer interesting opportunities for stock picking in the sector.

Mobile games company valuations down in the dumps

The median EV/Sales multiples for mobiles game companies for 2023-2024 are around 1.1-1.0x and the corresponding EV/EBITDA multiples are 6.5x and 5.2x. The multiples are low in absolute terms and have been under pressure in recent years from 1) the digesting phase following the peak in demand brought on by the COVID pandemic, 2) the challenges to targeted user acquisition brought on by Apple's IDFA changes, and 3) the impact of the weakened economic outlook and consumer confidence on player spending and advertising revenues in mobile games. Competition in the mobile games industry is also extremely fierce and companies often have to invest a significant part of their revenue in user acquisition and marketing, which puts a strain on their profitability. Overall, the valuations of mobile games companies seem low at the moment and earnings expectations are at a good level if analysts' forecasts for the coming years are on the right ballpark. Low valuations can also further increase consolidation in the market, a recent example being Sega's bid for Rovio (transaction valuation around 11x EBITDA).

G5 Entertainment: Founded 20 years ago, the company is a mobile game developer specializing in games for women over 35. The company has an extensive portfolio of casual games and employs over 900 people. In 2022, the company's revenue was SEK 1,400 million (+6%) and this year ‘s development is forecast to be slightly negative (-4%) with improving profitability (EBIT: 11%). For this year, the company is priced at 0.9x EV/S and 4x EV/EBITDA. In particular, the low earnings-based valuation indicates that investors are currently doubtful about the sustainability of the company's earnings level and that the games under development are not expected to materially boost the company's solid growth prospects.

Stillfront: The company has been shaped by a series of M&A and today has more than 20 studios and around 1,500 employees. The broad game portfolio consists of casual games (40% of revenue), strategy games (33%) and simulation, action and role-playing games (27%). In 2022, the company's revenue was SEK 7,058 million (+29%) and this year is expected to be stable (+2%) with good profitability (EBIT: 21%). Good profitability is also reflected in the company's EV/S multiple (2023e 1.8x), but the earnings-based valuation is low (2023e EV/EBITDA 5x). In our view, the sluggish near-term organic growth outlook is weighing on multiples, while there is still work left to digest acquisitions made at high valuations in the bull market of previous years.

Modern Times Group (MTG): MTG only became a pure-play mobile gaming company last year, when it sold its e-sports company ESL Gaming to Saudi Arabia's Savvy Gaming Group for a whopping $1 billion. MTG's game portfolio, which is spread over several genres (incl. strategy, simulation, word games and driving games), generated a revenue of SEK 5,537 million last year. MTG is also expected to show a stable revenue development this year (+2%) and a good level of profitability (EBIT 16%). MTG is currently priced at 1.1x EV/S and 4.5x EV/EBITDA, which seem very low. The weak short-term growth outlook is also reflected in MTG's valuation, and the market does not seem to place significant weight on the company's longer-term organic and inorganic growth opportunities enabled by its strong balance sheet.

Fragbite Group: Fragbite is a games company whose business is built around e-sports, mobile games and web3 games. Growth is sought both organically and through acquisitions. The company's revenue in 2022 was SEK 254 million and the company employs more than 80 people. This year, Fragbite is still in the investment phase, and its revenue is expected to remain stable and profitability to be at a rather modest level (EBIT: 5%). The company also has the potential to do much better if the growth opportunities in the various businesses start to materialize in the coming years. In this context, the valuation of the stock (2024e EV/S 0.9x, EV/EBITDA 8x) does not look particularly demanding.

High price paid for quality in console and PC games companies

There is a strong divergence in the valuations of console and PC games companies, partly explained by differences in the quality of the companies and their growth prospects. Partly due to the timing of major game releases, there is also considerable year-on-year fluctuation in the multiples, so a direct comparison of the multiples is not always particularly meaningful. The median EV/EBIT multiples for 2023-2024 are 4.1x and 4.7x and the corresponding EV/EBIT multiples are 10x and 9.5x. The companies that deserve the highest valuation are those (e.g. Paradox and CD Projekt) that have succeeded in developing high-quality game brands for their game portfolios, with the ability to develop sequels and a variety of add-on content. This is usually reflected in strong earnings growth expectations loaded onto equities. With numerous game releases this year, console and PC game companies are expected to grow at a median rate of 20% this year. Companies are also on average very profitable, and the median EBIT margin is expected to be above 30% in the coming years, although there are large differences between companies.

Remedy: With the release of Alan Wake 2 on October 27, Remedy’s investor story is gradually moving into a phase of profitable growth after years of strong investment. In our view, the valuation of the stock (2023e EV/S 7x) already prices Alan Wake 2 for good success, and the other projects in the pipeline are also expected to create value. We find Remedy's investment story very interesting looking to the end of this decade, but the current valuation keeps us in a wait-and-see mood. A recent extensive report on the company is available here.

Starbreeze: The investor story at Starbreeze is also about to get very interesting with the release of Payday 3 on September 21. The stock is also already loaded with expectations for the success of the game and also for the next game projects at the beginning of the production pipeline. However, the recent fall in the share price has improved the risk/reward ratio of the stock, which in our view justifies taking a risk ahead of the release of Payday 3. Our latest update on Starbreeze can be found here.

Paradox: Founded back in the 1990s, the game developer and publisher specializes in strategy games. Strong game brands developed by the company include Crusader Kings, Europa Universalis and Hearts of Iron. The company has 9 game studios with a total of more than 670 employees. Paradox's revenue last year was SEK 1,973 million (+36%) and growth of 31% is forecast for this year. Thanks to strong game brands, the company has very strong profitability with new game releases and add-on content (2023e EBIT: 40%). The quality and strong performance of the company is also reflected in the high valuation multiples of the stock (2023 EV/S 10x and EV/EBIT 25x).

Enad Global 7: EG7 is a company formed through several acquisitions with a portfolio of games that includes several long-lived live-operated games (some F2P). In addition, around 20-30% of the company's revenue comes from services (publishing and marketing). The company employs around 700 people, and its studios are well-known game brands such as EverQuest, H1Z1 and My Singing Monsters. The company's revenue last year was SEK 1,866 million and growth of 19% is forecast for this year. EBIT is also forecast to remain at a good level of 18% in 2023. EG7's earnings-based valuation looks very low (2023e EV/EBIT 4.4x and EV/EBITDA 3.1x). In our view, this is partly due to uncertainty about the company's sustainable earnings performance. Last year's viral hit My Singing Monsters has provided a clear boost to the company's bottom line and the key question now is to what level the game's normalized profit levels will eventually settle down. Based on valuations, the market expects a clear deterioration in earnings for the coming years.

Thunderful Group: In addition to game development and publishing, Thunderful Group also includes a distribution business, where the company has been a distributor of Nintendo products in the Nordic and Baltic countries since 1981. In 2022, around 17% of revenue (3,031 MSEK) came from the games business, although as much as 75% of EBITA (285 MSEK) came from games. Thunderful has also been growing, partly through acquisitions, and currently employs around 500 people. The company is currently investing in several game projects to be released in the coming years, which is partly reflected in stable growth (4%) and sluggish profitability (EBIT: 5%). Thunderful's sales-based valuation (2023e EV/S 0.3x) seems partly too low due to the distribution business. However, earnings-based multiples (EV/EBITDA 3x) are also very low, which we believe reflects the recent slowdown in the growth of the games business, which has increased uncertainty about future developments.

Important company-specific factors reflected in the valuations of multi-platform companies

The group of multi-platform gaming companies brings together the giants of the games industry. Significant differences in valuation multiples between companies can be seen, driven by company-specific factors. Activision Blizzard, a very strong performer, is close to Microsoft's offer price for the company and the valuation (2023e EV/S 6.5x, EV/EBIT 18x) is elevated as a result. The transaction, which has long been in the clutches of the authorities, now seems to be finally going through. Take-Two's high valuation (2023e EV/EBIT 32x) reflects the high expectations for the upcoming GTA 6, which is expected to significantly increase the company's earnings in the medium term. Ubisoft's low valuation (2023e EV/EBITDA 5.5x) reflects the company's short-term profitability challenges. In response, the company has sharpened its strategy around its strongest game brands and is seeking cost savings. Electronic Arts continues to post steady earnings and relative to this, the current valuation (2023e EV/S 4.6x, EV/EBIT 16x) looks fairly neutral.

Embracer: Embracer, which has grown rapidly over the years through numerous acquisitions, today consists of four business areas: PC and Console Games (FY22/23: 36% of revenue), Mobile Games (15%), Entertainment & Services (14%) and Board Games (35%). The company's revenue for the financial year that ended in 3/2023 increased by 121% to SEK 37,655 million, driven by acquisitions. The company employs more than 15,000 people in over 130 game studios. In the current financial year, the company expects to increase its revenue by 16% and has guided its adjusted EBIT to be in the range of SEK 7,000-9,000 million. With the sharp fall in the share price, Embracer's valuation has fallen very low (FY23/24: EV/EBITDA 5x), reflecting eroded investor confidence after the company's challenges surfaced this year. Embracer announced a major restructuring program in June, which effectively marked a turnaround in the company's strategy after a period of strong M&A activity. In the current digesting phase, the company is seeking significant cost savings and efficiencies from its owned game brands and studios. This has already led to the closure of certain studios, while capital is being allocated to new game projects at an ever-tighter pace. Previously, the company's strategy was to give the acquired studios free rein to continue operating as before, but now centralization and mergers are aimed at increasing efficiency. According to market rumors, the company might also be looking to sell its Gearbox publishing studio, known for its Borderlands games, which it acquired for around USD 1.4 billion in 2021. Should Embracer be successful with its turnaround program and its debt load, the stock currently looks cheap given the company's long-term growth potential and the value of its game portfolio, which includes a number of well-known game brands.