Update Equity Research 18 December 2019 Toadman Interactive Sector: Gaming A fairy tale transformation FAIR VALUE RANGE BEAR BASE BULL Redeye initiates coverage of Toadman Interactive, a one-stop-shop for the entire gaming value chain. Our positive stance reflects management’s untypical focus on cash flow 16.0 26.0 34.0 generation alongside game development, enabling it to fund a pipeline of new releases and TOAD.ST VERSUS OMXS30FAIR increasing the likelihood of blockbuster commercial successes. VALUE RANGE TOAD.ST VERSUS OMXS30 Many shots at goal OMXS 30 Toadman Interactive Toadman differs from the usual volatile gaming model, which depends heavily on how 25 individual releases perform. It is able to put stable cash flow from work-for-hire/financed TOA20 D.ST VERSUS OMXS30 REDEYE RATING projects, as well as its marketing consultancy (Petrol) and publishing business (Sold Out), 15 to work in game development projects that could produce significant returns. This 10 structure increases its ‘shots at goal’ and lowers individual title risk usefully, and also 5 increases the likelihood of a commercial success. REDEYE RATING TOA0 D.ST VERSUS OMXS30 Active M&A agenda 04-feb 05-maj 03-aug 01-nov The company has a bond framework of SEK 500m, of which SEK 220m has been utilized. It REDEYE RATING is clear that we will see more acquisitions, most likely to fill gaps in the value-chain where TOAD.ST VERSUS OMXS30FAIR REDEYE RATING Toadman is not present today or dig deeper in the “legs” they currently have operations in. VALUE RANGE By expanding in the value-chain, we also find that the strength of Toadman will increase. 4 3 Entrepreneurial lead owner operator 2 TOA D.ST VERSUS OMXS30FAIR The company’s ownership structure is a clear positive for external shareholders. As VALUEPeople RANGE Business Financials management, the board and other key employees own about 58% of the capital, Toadman ’s leadership is highly incentivized to maximize returns. We genuinely prefer what REDEYE RATING we call “Owner Operators”, namely a management team that owns a substantial stake of REDEYE RATING the company. “Skin in the game” is a key part of Toadman’s acquisition strategy. TOA D.ST VERSUS OMXS30 KEY STATS C ompany transformation justifies revaluation People Business Financials Ticker TOAD.ST We believe the market is yet to fully grasp the transformation Toadman has undergone, TOAMarketD.ST VERSUS OMXS30 Nasdaq which, in our view, leads to an attractive valuation of the company. Our Base-case, based REDEYE RATING Share Price (SEK ) 19.4 on a DCF, amounts to 26 SEK per share, about 35% above market levels. We find robust Market Cap (MSEK) 607 support for our Base-case from both fair valuation multiples and a SOTP (Sum-Of-The- REDEYE RATING People Business Financials Parts). Our valuation range amounts to 16-34 SEK per share, which implies that we see a REDEYENet Debt RATING 19E (MSEK ) 172 limited downside in the stock thanks to the stability of Toadman’s cash flow generating TOA FreeD.ST Float VERSUS OMXS30 42 % capabilities but still significant potential. Avg. daily volume (‘000) 1 00 TOAD.ST VERSUS OMXS30 KEY FINANCIALS (SEK) 2017 2018 2019E 2020E 2021E 2022E People Business Financials Net sales 11 73 160 552 703 723 REDEYEANALYSTS RATING EBITDA 1 6 31 79 129 127 Kristoffer Lindström REDEYE RATING EBITA 1 6 30 76 118 114 [email protected] RATING EPS (adj.) 2017 2018 2019E 2020E 2021E 2022E EPS (adj.) 0.0 0.3 -0.5 -1.0 0.3 0.4 Tomas Otterbeck A fairy tale transformation EV/Sales 0.0 2.1 5.4 1.6 1.2 1.2 People Business Financials [email protected] EV/EBITDARedeye initiate coverage0.0 of Toadman24.4 Interactive,27.3 a one-stop10.9 shop for6.7 the entire6 gaming.8 EV/EBITvalueA chain. Our positive0.0 stance reflects27.1 management29.0 ’s 11.3untypical focus7.3 on cash21.6 flow P/Egenerati on alongside game0.0 development43.0 , enablingn.m. it to fundn.m. a pipeline76.2 of new release51.4 s and REDEYE RATING increasing the likelihood of blockbuster commercial successes. REDEYEPeople RATING Business Financials Many shots at goal REDEYE RATING ToadmanImportant differs information: from the Allusual information volatile regarding gaming limitation model, of liability which and potential depends conflicts heavily of interest on canhow be found at theTOA endD.ST of the VERSUS report OMXS30 individual releaseRedeye,s perform Mäster. SamuelsgatanIt is able to 42, put 10tr, stable Box 7141, cash 103 87 flow Stockholm. from Tel.work +46- 8for-545-hire/financed 013 30, E-post: info@redeye. se projects, as well as its marketing consultancy (Petrol) and publishing business (Sold Out), to work in game development projects that could produce significant returns. This People Business Financials structure increases its ‘shots at goal’ and lowers individual title risk usefully, and also REDEYE RATING REDEYE Equity Research Toadman Interactive 18 December 2019 Investment Thesis Toadman has transformed itself from a small gaming studio focused on work-for-hire to a presence across almost the whole gaming value chain. The company’s acquisitions have taken it from annual EBITA of SEK 7-10m to SEK 70m in 2020 (our forecast). In our view, management is building a highly attractive operation with a clear focus on cash flow generation in combination with game development’s significant return potential. We believe the market is yet to understand the “new” Toadman fully. The lack of understanding of the transformation Toadman has undergone is indicated by the attractive valuation of the company. Stable cash flow gives many shots at goal Gaming is a volatile business where success depends on how well games releases perform. Toadman differs from most listed gaming companies by its stable cash flow from work-for- hire/financed projects, marketing consultancy (Petrol) and publishing (Sold Out). This is then reinvested into game development projects that could produce significant returns. Assessing games’ potential success before launch is almost impossible, but Toadman’s strong financials enable it to manage title risk as its future does not depend on any single title. This structure gives it the ability to take many ‘shots at goal’ and increases the likelihood of a commercial success. Marketing expertise in-house Petrol’s services are highly sought after in gaming with over 50 clients including projects like ‘Call of Duty’, the highest grossing game series on console. This world-class marketing expertise gives Toadman a valuable asset and advantage over many peers that should boost its prospects of successful releases – as well as lowering its marketing costs. Petrol generates annual revenues of SEK 179m with an expected 3-year CAGR of 7% and EBITDA margin of 14-15%. Partnership with leader Leyou Toadman has stable cash flow and revenue thanks mainly to Petrol, but also its consultancy- focused game development revenue model. An example is the major ‘Osiris’ project with China’s Leyou, the owner of ‘Warframe’ - one of the most successful free-to-play shooters of recent years. Toadman has an 20% royalty of gross sales on top of work for hire revenues. If the game is released, Toadman should see significant revenues. Skin in the game 58% of Toadman is owned by management, the board and other key employees, which shows that its leadership is highly incentivized to generate shareholder returns; we find this as undoubtedly positive. We genuinely prefer what we call “Owner Operators”, namely a management team that owns a substantial stake of the company. We regard Robin Flodin, founder and CEO, as crucial for Toadman’s future success. He is the largest shareholder with over 12% of the capital. Fatshark, the renowned Swedish gaming studio, is both an owner and a close partner on work-for-hire deals. See Appendix 1 for Ownership and board. M&A across the value chain Toadman has an active M&A agenda with the aim of expanding across the gaming value chain. The company has used SEK 220m of its SEK 500m bond program. With an underlying pro forma EBITDA of some SEK 50m following the acquisition of Sold Out, there is still significant room to increase leverage. It is clear that we will see more acquisitions to strengthen Toadman, either by filling current gaps or reinforcing current business areas. So far Toadman has conducted five acquisitions, from a list of about 150 prospects. Targets can be divided into three buckets (though they often fit into more than one): 2 dsfdsf REDEYE Equity Research Toadman Interactive 18 December 2019 • Strategic acquisitions – entering new parts of the value chain or strengthening existing areas • Fairly priced quality – companies that management admires seeking a move into the Toadman group • Cheap opportunities – Examples include acquiring Tangentix (GameSessions) for GBP 50k, when GBP 6m had been invested in the platform. Toadman focuses on not overpaying for companies and has historically paid an EV/EBIT multiple of about 6x for their acquisitions. Compared to standard gaming valuations, this is low. Toadman has strengthened its M&A team significantly during 2019. We view the recruitment of COO Christopher Bergstresser as key in this. Value drivers ahead We identify several potential medium-term catalysts for the share: • Increased investor awareness – We believe the market's understanding of the "new" Toadman is low. As time goes by and the company produces stable quarterly updates, we believe that the recognition and valuation of the company will increase. • Osiris announcement – The most imminent catalyst is more information about the Osiris project. Toadman has a 20% royalty of gross sales, but the project’s future is still unclear. If the game is released, it could generate significant revenues and a high return on investment.