CFA Institute Research Challenge Hosted by CFA Society of Poland Kozminski University

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CFA Institute Research Challenge hosted by CFA Society of Poland Kozminski University

Kozminski University – Student Research

This report is published for educational purposes only by students competing in the CFA Institute Research Challenge CD Projekt SA (CDR) Date: 2015/02/10 Current price (15/02/10): PLN 16.20 Recommendation: BUY (29.5% upside) Ticker: CDR:PW (Bloomberg) USD/PLN (15/02/10): 3.71 Target price: PLN 20.99 (USD5.65)

Table 1: Composition of Target Price CDR – a risky pick and an upcoming success story… Valuation method Weights PPS Target (DCF) 0.75x 19.63 CD PROJEKT S.A. (CDR) is a highly risky security that already promises high returns in Target (Multiples) 0.25x 25.04 the short to medium term. We therefore issue a strong BUY recommendation with a Target price 20.99 target price of PLN 20.99 (USD5.65), an upside of 29.5% to the current share price of PLN 16.20 (USD4.36, as of closed markets on 2015/02/10). Due to a very promising Market price 15/02/10 16.20 upcoming project cycle with two major AAA titles in the 2015/16 pipeline, The Witcher III Upside 29.54% and Cyberpunk 2077, CDR will profit from an essential sales boost at stable to increasing margins, resulting in strong cash flows without incurring debt. Interesting will be future Source: Team estimates management decisions, including potential dividend payments, expansion projects and Table 2: Market Profile of CDR acquisitions to strengthen CDR’s international footprint. Market profile 52-week price range (PLN) 12.96-18.38 Strong outlook together with numerous upside potentials… 2014 dividend yield 0.00% Other than during CDR’s last release cycle, the Witcher brand is globally established Shares outstanding (in '000) 94,950 based on a strong customer base with buying power while the Cyberpunk brand is Market capitalization (PLN mm) 1,534.39 established in the U.S. since the late 1980’s. Also a debut for CDR is the release across Shares held by mgmt 35.8% all major platforms (PC, PS4, XBOX One), thus paving the entrance into the much more Free float 44.2% lucrative console market. The footprint was further strengthened by the sale of the ROE 2015E 49.2% majority in CDR’s subsidiary CDP.pl in Q4-14, divesting the pure distribution business ROE 2016E 36.0% with low entry barriers and a rather grim outlook due to increasing digital sales. Main P/BV (2015/02/10) 9.4x upside potential is incorporated in future sales of two to three AAA titles in 2018/19, P/E 2015E 10.6x higher margins in the long term due to digital distribution, a successful GOG Galaxy, tax P/E 2016E 9.2x savings from intercompany transactions, materializing revenues from selling rights to the EV/EBIT 2015E 9.7x Witcher engine as well as financial upsides such as optimization of the capital structure. EV/EBIT 2016E 9.1x

Source: Team estimates, Bloomberg Cash-intense balance sheet without leverage…

Graph 1: KPIs over Time The waiting period of more than three years will finally be over in Q2-15, with CDR’s prime title The Witcher III producing a substantial cash flow that will further strengthen 480,000 CDR’s already extraordinarily cash-intense and debt-free balance sheet. No signs point 380,000 towards utilization of the numerous approved credit lines. On the contrary, CDR will be 280,000 flexible enough to finance (organic/M&A) growth internally with remaining means for 180,000 potential (first time) dividend payments. On the medium term, we see massive 80,000 optimization potential in CDR’s capital structure on the way to a four- to five-games

(20,000) pipeline.

2012A 2013A 2014E 2015E 2016E 2017E 2018E 2019E 2020E Potential hurdles to overcome… Sales EBIT Net profit The highly volatile business model of game development bears huge risk in itself, Source: Team estimates especially in the Mid Cap stage with a limited pipeline of releases. The more important is

Graph 2: Monte Carlo Simulation the quality of the upcoming titles, currently leading the rankings of most-anticipated titles in 2015. If the two upcoming blockbusters should be unsuccessful, CDR would tumble from a rising star to mediocrity with high volatility and no dividends – a highly unfavorable scenario in which the stock would most probably react in the higher double-digit range. However, game footage, beta tests and fan reviews point the other direction – rather an imitation of success stories such as Elder Scrolls 4/5 (Bethesda Softworks LLC) or Diablo III (Activision Blizzard, ATVI:NASDAQ GS). We therefore do not only forecast risk to be adequate in contrast to expected return but rather that upside risk beats downside risk by far – also due to the promising management team. Source: Team estimates

Graph 3: CAGR over 3y Cycles Actuals Estimates 48.8%% 43.1%% 45.6%% Key ratios (CDR) 2012A 2013A 2014A 2015E 2016E 2017E 2018E 2019E 2020E 33.1%% 31.3%% Cash ratio 61.4% 88.2% 47.8% 151.7% 279.5% 275.8% 322.3% 445.6% 373.9% 29.8%% Operating margin 17.3% 10.5% (3.2%) 48.5% 49.3% 36.0% 49.3% 46.3% 30.2% Net profit margin 17.1% 10.4% (1.9%) 41.9% 46.2% 40.9% 45.0% 43.0% 31.3% 12.2%% 11.1%% Return on equity 18.6% 8.9% (1.7%) 49.2% 36.0% 12.8% 26.7% 20.5% 8.2%

Total asset turnover 80.9% 65.3% 54.4% 73.2% 56.0% 22.9% 44.0% 37.6% 20.1% Inventory turnover 491.6% 273.6% 154.3% 367.4% 449.4% 134.0% 351.6% 434.7% 166.5% '12-16% '12-20% Long-term debt to assets 0.5% 0.7% 0.5% 1.5% 1.0% 0.7% 0.6% 0.5% 0.4% Sales%CAGR% EBITDA%CAGR% EBT%CAGR% Net%Income%CAGR% Earnings per share (in PLN) 0.30 0.16 (0.03) 1.54 1.78 0.73 2.08 2.02 0.84 Dividend payout ratio 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% Source: Team estimates

CFA Research Challenge CD Projekt SA (CDR) 2015-02-10

Graph 4: CDR Group Overview Business Description CD Projekt SA Group CD PROJEKT S.A. is a Polish developer and distributor of digital entertainment, mainly video games. Headquartered in Warsaw and founded in 1994, CD PROJEKT Capital Group consists of two main companies: CD PROJEKT RED and GOG.com. In 2013 the 1 group had revenues of c. PLN 140m and a net income of approx. PLN 28m. Source: Company information

CD PROJEKT RED operates since 2002 as the game development division for AAA role- Graph 5: Direct Physical playing games (RPG), mainly video games. Offices are located in Warsaw and Krakow Distribution of TWIII with around 270 employees. The biggest projects of CD PROJEKT RED were The Witcher I (Polish: Wiedzmin) and The Witcher II: Assassins of Kings both basing on the series of fantasy short stories by the Polish writer Andrzej Sapkowski. Two upcoming projects are The Witcher III: Wild Hunt, which is planned to be released on May 19th, 2015, and Cyberpunk 2077 with the official launch date to be announced. The release date of The Witcher III was delayed twice by CDR in order to assure the high quality of the game.2

The Witcher I (TWI) and The Witcher II (TWII) together sold more than 8 million copies globally, even though TWI has been only available on PC and TWII additionally on the CDR Headquarter platforms Xbox 360 and Linux. The Witcher III (TWIII) will furthermore be available on the

Source: Company information new Xbox One and PlayStation 4. From the side of the company, no official forecasts regarding the sales number of TWIII or Cyberpunk 2077 exist. Previous to its release, the Graph 6: Shareholder Structure game received more than 170 awards and is heavily anticipated throughout the world (see Graph 8). Graph 5 shows territories, in which physical distribution of TWIII will take place directly by CDR. In addition to these bigger projects, two mid-range games with around 20 hours of gameplay will be released.3

GOG.com (formerly Good Old Games) acts since 2008 as the digital distribution platform of the group and since then became the world’s third biggest player in this market behind market leader Steam. With around 80 employees, it provides games and movies for PC, Mac and Linux worldwide.4 A new project of GOG.com is GOG.com GALAXY which acts as a cross-platform multiplayer meaning two or more people are able to play games together online.5 Its beta version is active since October 2014. A vision of the company is not to use digital rights management (DRM), which is a widely spread anti-piracy tool in the Source: Company information video gaming industry. As the company does not believe in the protection through DRM, GOG.com is the only platform so far providing DRM-free video games online resulting in a Graph 7: CDR Stock Movements unique selling proposition for GOG.com.6 compared to WIG20 and S&P500

Until 26 November 2014, a third company was part of the group named CDP.pl. It was the oldest one operating since 1994 and accounting for the physical and digital distribution of video games, motion pictures and eBooks throughout Poland.7 In 2014, CD PROJEKT sold share blocks multiple times resulting in an ownership of remaining 8.29% of total CDP.pl shares.8

The shareholder structure has been nearly consistent since the IPO at Warsaw Stock Exchange. Nearly 36% of the stocks are held by key persons who are associated with the company (see Graph 6)9. Around 44% is free float and remaining 20% is in the hands of three different institutional investors. Until 2014, no dividends have been paid.10 Source: Yahoo! Finance CD PROJEKT´s board of management consists of five persons who all refer to

Graph 8: Overview of The Witcher themselves as passionate gamers. President of the board is Adam Kicinski who has been Awards an active part of CDR since CDP.pl was founded in 1994 and currently acts as the Joint CEO. During the premiere of The Witcher in 2007 he became the sole director of CD PROJEKT RED. The second Joint CEO Marcin Iwinski is the company’s Co-Founder who graduated and additionally received an MBA from the Warsaw University Faculty of Management. Since the beginning, he is responsible for managing international contacts and growth of the group. Furthermore the board is consisting of Piotr Nielubowicz (CFO), Adam Badowski (Studio Head) and Michal Nowakowski (SVP Business Development).11

Important information: Because of the majority divestment of CDP.pl shares in 2014, this report includes historical Source: Company information figures consolidating CDP.pl, but forecasts only account for numbers resulting from the ownership of 8.29% of shares.

CFA Research Challenge CD Projekt SA (CDR) 2015-02-10

Graph 9: Overview of Gaming Industry Overview and Competitive Positioning Market Development (in USD bn) 102.9 95.2 88.1 24.7 Growing global games market… 81.5 23.8 75.5 23.8 2.1 Recent analyses point towards a growing global games market with a CAGR of 8.0% 23.6 2.9 12.3 23.4 2.6 10.5 between 2013 and 2017. A high share is kept by console games with nearly 25% of the 8.8 3.3 22.6 4.5 6.5 20.0 market, growing at a CAGR of 11.7%. The highest growth rate can be observed in the tablet 4.5 17.6 12 12.8 15.5 8.2 7.9 7.6 and smartphone segments with close to 48% and 19%, respectively (see Graph 9). 7.6 7.3 23.7 17.9 19.4 21.9 15.1 Digital beats retail… 7.6 7.3 7.9 8.6 9.3 The way of distributing game content is in a disruptive stage, shifting from retail to digital 2013 2014 2015 2016 2017 distribution that offers the gamer direct consumption and additional gimmicks while it heavily Social/casual TV/Console boosts margins for the developers. Depending on the methodology, the split is already Handhelds Smartphone Tablet PC/MAC nearing 50:50 with strong trends towards further growth in the digital distribution segment MMO'S (see Graph 14), thus higher net receipts in the future in the higher double-digit percentage point range.13 Additionally, global console games revenue will reach approx. USD31.9bn in Source: Newzoo 14 2018, with physical console games revenue increasing only by a 0.6% CAGR over the Graph 10: Best-Selling Video forecast period. Games Super Genres by Units Sold, 2013 CDR, operating in the adult segment of RPG, will profit from segment growth… As graph 10 shows, RPG as a genre accounts for approx. 7% of all genres. We expect growth in the adult segment of the RPG market due to an aging demographic and increasing disposable income. 15 In addition to fundamental market drivers such as an improving economy, another major factor to influence the entertainment software market will be a shift in demographics. This shift includes the aging of current video game customers and growth of the teen and tween population, thus forming a much larger potential customer base. This segment referred to as “hardcore gamers” (defined by a certain number of hours spent on gaming) has purchased a number of games highly above average and was the responsible force behind many of the best-selling AAA titles. According to recent market analyses, this group is expected to continue to grow on the medium term.16

Promising gamers segmentation… Source: NPD Group/Retail Tracking CDR’s titles so far are not intended for young children but with their mature themes they Service target primarily young & middle aged men in their Mid 20’s to 40’s. In combination with the RPG segment focus, this proves as a valuable market positioning, since this customer base Graph 11: Age of Game Players has a much higher than average disposable income as well as a certain level of brand loyalty compared to other gamers.17 Therefore, the possibility of substitution is relatively low since both the AAA titles are not easily replaced by something similar and customers already 29% appreciate the brand with franchise fans comprising more than 8 million units sold of the 39% previous Witcher titles. Furthermore, more than 4.5 million gamers have illegally downloaded The Witcher II alone that might lead to additional sales in the future. Additionally to the own customer base, the hardcore RPG segment has expanded in recent years essentially with major releases of AAA titles such as Elder Scrolls Skyrim, Mass Effect, Dragon Age Origin and Diablo 3. The Witcher III is a strong candidate to replicate recent development such as 32% the sales growth of Elder Scrolls IV and V (see Graph 16).

under 18 19-35 36+ Momentum as a strong sales driver… The game’s multiple delays have actually improved its prospects to win over this segment of Source: Entertainment Software the market. With an initial release date planned for in Q4-14, the two subsequent delays Association Report, 2014 pushed the current release date to May 19, 2015. This being a reason for several downgrades of competing analysts, we see upsides much more valuable than the downside

Graph 12: Sex of Game Players from postponed cash flows: over the course of the timeframe mentioned, the hardware install base has increased manifold with both PS4 and Xbox One experiencing strong sales in the holiday season of 2014 – e.g. Sony sold 4.1 million units of their PlayStation 4 during the holiday season alone.18 With 8th generation consoles still in the early stage of the hardware cycle, there is still a very limited number of games available that fully showcase the power of the new consoles. Positively, this implies that The Witcher III will only face limited 48% 52% competition in terms of other highly rated RPG titles (see Appendices 27, 28). This will also encourage fans of other genres, particularly action & adventure games to purchase a Witcher unit. In line with this reasoning is the outstanding average review score of The Witcher III, a strong indicator for the future success of a premium title. Most large gaming websites such as IGN, Gamespot and Giantbomb have given the previous games glowing reviews and the game has a Metacritic score of 88 out of 100, and review score together male female 19 with excellent rating from the gamer base. Source: Entertainment Software Association Report, 2014 As previously mentioned, the release date of TWIII shows a limited number of other major multiplatform releases in the same period. The next major game that might challenge The Witcher III in the sales charts will be Batman Arkham Night, an action-adventure video game

developed by Rocksteady Studios and published by Warner Bros. Interactive Entertainment

CFA Research Challenge CD Projekt SA (CDR) 2015-02-10

Graph 13: Global Gaming Industry which is also publishing TWIII in major markets. Like TWIII, the game will release on PS4, Growth Rate Estimates Xbox One and Microsoft Windows.20 In addition, TWIII will have a much larger release in the North American market due to its co-publishing agreement with Warner Brothers.21 Newzoo$ 6.7% CDR’s Competitive Strategy in a nutshell… With the release of the third installment of the Witcher franchise, The Witcher III on May 19 DFC$ 6.0% 2015, CDR is sure to have its largest and most anticipated release yet. The Game studio is specializing in the RPG segment of the gaming market and is now expanding from being a Gartner$ 10.5% solely PC focused developer and publisher to one that delivers multiplatform AAA releases.

Track-record of establishing a strong brand… IDG$ 9.3% CDR has built international reputation in recent years and earned praise from gamers for phenomenal visual design and organic storytelling in the past Witcher titles. In order to PwC$ 7.2% continue being a successful publisher it is important to develop well established franchises that can provide regular cash flows, for e.g. 28 of the top 30 brands of 2013 were established brands with a track-record of producing successful titles.22 In addition to The Source: Newzoo Note: CAGR over different periods Witcher, CDR has started working towards a second intellectual property in the form of Cyberpunk 2077, which we expect to be released in Q1-16, slightly later than CDR expects Graph 14: Digital vs. Physical (Q4-15), due to the current delays related to The Witcher III.23 CDR also hopes to further Sales in US in 2010-2013 strengthen its inroads into the American market as it can rely on an established fan base of the numerous novels published on the Cyberpunk franchise such as by William Gibson, Rudy Rucker and others as well as multiple games released throughout the last three 47% decades, including a US-wide hit of a tabletop game with thousands of descriptive pages 68% 59% 71% written by the fan community.24 Naturally, this pushes expectations but also provides CDR with the possibility of establishing a less volatile cash flow cycle driven by sequels to the popular franchises. 53% 41% 29% 32% Circumstances are different this time… CDR has come far from its release of the original Witcher game in August 2007. Starting 2010 2011 2012 2013 with the image of a small unknown development studio in Poland, CDR has cemented its place in the RPG game segment by creating two critically acclaimed titles in the Witcher Total Physical Format franchise. The two previous titles have developed mass fan following and have built brand Total Digital Format recognition to the point that CDR is cited by the president of the Unites States as an 25 Source: The NPD Group example of Poland’s place in the modern global economy. By building brand recognition

Graph 15: Console Base at the and franchise reputation, CDR has gained much higher exposure in trade shows and major End of 2014 in mm Units gaming events. The Witcher III has already received 170+ awards previous to its release 18.8 including titles for most awaited game of 2015. The Witcher III is cited as a major upcoming release by both Microsoft and Sony. The game was even showcased at Microsoft’s E3 press conference 2014, a huge step up from its initial release of Witcher I in the Atari section 11.2 together with numerous legal troubles.26 This will be the first multiplatform release of CDR, meaning it will be the first time The Witcher will also appear on the PlayStation platform. This bodes well for the sales of the game as the PS4 has the largest install base of all 8th generation consoles accounting for 18.9m units (Xbox One: 11.3m) as of January 24 2015 as well as the largest user base on PSN.27 PS4 Xbox One Rest of World Japan Intellectual property expansion is not limited to franchises themselves… Europe America In addition to new titles, CDR has developed an in-house game engine called REDengine 3.

Source:VGChartz It was created for the purpose of developing open world video game environments. The new engine produces better quality computer graphics via high dynamic range rendering with the Graph 16: Sales of Latest Editions of Elder Scrolls & Diablo in mm 64-bit precision. It also creates "more life-like" visuals — better graphics, better lighting Units effects, better in-depth views. In the past, CDR relied on licensing BioWare's proprietary Aurora Engine for its games. By producing its own engine CDR also has the ability to license 18.1 off its technology to other developers and studios in the future. This represents a potential cash flow generator for CDP in the future while already decreasing future development costs.

5.9 The product is better protected than previously… Though piracy has been a major concern in the past – it is less so this time around as the game will be available through multiple online marketplaces (incl. Steam, GOG, PSN, Xbox Elder Scrolls V: Diablo III** Live). When CDR re-released a DRM-free version of The Witcher II and experienced a Skyrim* significant drop-off in illegal downloads, management decided to make The Witcher III DRM- free from launch. PS Xbox PC * The game released for all platforms As a result, in our opinion RPG is the most attractive genre to produce in, because costs are in 2011 relatively high leading to higher entry barriers for possible competition than in other genres. ** The game released for PC in 2012, consoles in 2014 Furthermore, clients tend to be loyal and willing to invest in their gaming experience. There Source:VGChartz is a low number of direct competitors, even though they are powerful resulting in a situation close to oligopoly.

CFA Research Challenge CD Projekt SA (CDR) 2015-02-10

Table 3: Target Price Composition Investment Summary

Valuation method Weights PPS We issue a strong BUY recommendation on CDR with a target price of PLN 20.99 Target (DCF) 0.75x 19.63 (USD5.65), representing an upside of 29.5% to the current market price of PLN 16.20 Target (Multiples) 0.25x 25.04 (USD4.36) as of closed markets on 2015/02/10. The target price is derived from the Target price 20.99 Discounted Cash Flow to the Firm method as well as the comparable companies analysis (both attached below), weighted 75:25 respectively. Being aware of the riskiness of the Market price 15/02/10 16.20 CDR security, we are basing our recommendation on the company’s exceptionally strong Upside 29.54% game pipeline, which represents a step up into the cycle of market leaders in offline RPG.

Source: Team estimates On the other hand, volatility will still be an issue on the medium term due to a lack of resources to produce as stable a pipeline as peers such as Activision Blizzard or Electronic Arts, the latter being heavily diversified among genres, platforms, target customers and development cycles. This volatility can be observed on CDR’s sales and margin structure (see Graph 17). On the long term, we expect CDR to expand its pipeline among three to Graph 17: Sales and Margins four franchises, thus flattening sales and consequently cash flows. 480,000 100.0% 380,000 80.0% Relatively plain field combined with heavily growing console install base… 280,000 60.0% Due to a lack of blockbuster releases in the RPG segment, CDR will most likely profit from

180,000 40.0% reduced competition in Q2 and Q3-15 after the release of The Witcher III. This trend will be

80,000 20.0% accompanied by the heavily growing install base of the PlayStation 4 and the XBOX One systems, each selling several millions of units shortly before the Christmas sale 2014 and (20,000) 0.0% thus fueling forecasts of unit sales far beyond the recent generation of consoles (see 2012A2013A 2014E 2015E 2016E 2017E 2018E 2019E 2020E Appendix 37). Thus, momentum is favorable and the next Witcher title is to be the title to Sales EBITDA (%) profit from it. Source: Team estimates Characteristics and circumstances are promising… CDR’s management is perceived as both highly specialized in the gaming industry, due to Graph 18: EBIT Margin over Time up to 20 years of experiences, and skilled business-wise. Not only did one overcome initial 28 216,264 very unfavorable contracts and legal troubles, e.g. with Atari, but also expanded the 180,903 206,225 franchise in a few years to be the most anticipated game – featured on Microsoft’s press 169,634 conference at the E3. Furthermore, the loyal customer or rather fan base with disposable income is far more promising than the mobile app crowd with short attention spans towards

76,740 one product, little tolerance towards delays and high price sensitivity. 60,941 28,367 14,874 Digital distribution will boost margins… (4,354) The market dynamics are going to increase developers’ margins on the short to medium term significantly with net receipts almost twice as high as retail (see Appendix 35). 2012A 2013A 2014E 2015E 2016E 2017E 2018E 2019E 2020E Depending on methodology and market study, it can be assumed that in the near future, Source: Team estimates the large majority of game titles sold will be distributed digitally.

CDR starts diversifying operationally… Table 4: Upside DCF vs. Current One large factor to mention related to diversification potential is GOG Galaxy, to which we Upside vs. market price (PLN 16.20) Perpetual growth rate (%) connect excellent growth potential. Nonetheless, CDR underwent certain, for now smaller, 2.0 2.5 3.0 3.5 4.0 investments to decrease volatility: to mention are the smartphone application based on 9.0 24.2% 30.6% 38.0% 46.9% 57.4% The Witcher franchise as well as a tabletop game and soon-to-come accessories such as 9.5 16.8% 22.3% 28.5% 35.9% 44.5% 29 10.0 10.4% 15.1% 20.4% 26.6% 33.7% a comic book series published together with Dark Horse Comics. 10.5 4.8% 8.8% 13.4% 18.6% 24.6% WACC (%) WACC 11.0 -0.2% 3.3% 7.2% 11.7% 16.8% The security is not fully understood by analysts…

Source: Team estimates One major problem with gaming securities is the lack of substantial insight from equity analysts. Within less than two years, the recommendations moved from PLN 7-10 to PLN 21 and back based (mostly) on nothing but a delay of The Witcher III release or other short term effects that did not disrupt either the general business model or future cash flow Graph 19: Porters Five Forces - Overview projections, merely delayed them by 12 to 16 months – thus nothing more than a discount correction. After deeply analyzing CDR, we are convinced that there is substantial upward potential that will fully be skimmed off as soon as early signs of future success will be visible. We therefore do not perceive the valuation as aggressive but rather proactive instead of reactionary.

High risk, higher reward – CDR as a promising security… Due to the abovementioned volatility and delays, the security is definitely classified as “high risk – high reward”. Nonetheless, CDR contains numerous upside risks as well, just to mention the sales forecast, optimization potential in the capital structure, economies of scale that we did not account for in their total potential capacity due to a conservative approach and the massive cash position that can be used to expand on a broad scale, Source: Team estimates finance acquisitions and/or pay dividends. Therefore, we recommend CDR as a security with huge potential of beating any index in the upcoming twelve months.

CFA Research Challenge CD Projekt SA (CDR) 2015-02-10

Graph 20: Recent Stock Price Movements and News Flow of CDR

Table 5: Target Price Composition Valuation

Valuation method Weights PPS The valuation consists of two parts – a Discounted Cash Flow (DCF) valuation as well as a Target (DCF) 0.75x 19.63 comparable companies valuation based on market multiples. A weighted composite Target (Multiples) 0.25x 25.04 (75:25) of these two valuations forms the target price of PLN 20.99 (see Table 5). Target price 20.99 Market price 15/02/10 16.20 Discounted Cash Flow valuation

Upside 29.54% The DCF model (FCFF) is based on CDR’s 3y-cycle of game development and thus Source: Team estimates forecasts six years from 2015 to 2020, covering two full cycles (see Appendix 31). This Table 6: DCF Output (PGR) approach is chosen to generate an average scenario for the terminal value of CDR. Key to the company’s valuation are the upcoming premium game releases, which we forecast to Perpetual growth method (PGR) be in Q2-15 (The Witcher III), Q1-16 (Cyberpunk 2077), Q2-18 (next The Witcher franchise PV 2015E - 2020E 492,921 game) and Q1-19 (next AAA title). By using an average over 2018-’20, the terminal value PV of Terminal Value 1,100,534 assumes CDR to maintain its current two-game approach. This implies significant upside PV of Real Options 64,375 potential for the longer-term valuation and thus CDR’s terminal value, which is currently conservatively planned with a perpetual growth rate of 3% per annum, which is in line with Enterprise Value 1,657,830 the current analyst consensus. We justify this ratio with CDR’s massive upside potential Net Debt (206,392) versus its high risk profile, the high volatility combined with a heavy pressure on its core Equity Value 1,864,222 franchise The Witcher and already immense expectations regarding the upcoming Implied EV/EBITDA 2015E 9.2x franchise Cyberpunk 2077. After significant portions of these sales have materialized, a revision of the growth rate will be essential. The current assumptions of the DCF model Implied EBIT exit multiple 11.7x lead to an enterprise value (EV) of PLN 1,657,830 and an equity value (QV) of PLN Implied EV/EBIT 2015E 9.4x 1,864,222 or PLN 19.63 per share. The equity value is higher than the enterprise value Source: Team estimates due to a substantial net cash position (see Table 6, Appendix 31).

Graph 21: EPS over Time Terminal value and WACC with strong influence due to delayed cash flows… 2.08 2.02 The DCF model is not only sensitive to CDR’s forecasted sales and the terminal value 1.78 1.54 assumptions, but also strongly to the WACC. This is even more so than usual, since most of the value will be generated in the long term rather, having the terminal value account for 0.73 0.84 c. 66.4% of EV. Thus, slight changes in the discount factor affect the value immensely. In 0.30 CDR’s case, the short to medium term equity ratio of 100% increases WACC and poses as 0.16 (0.03) massive optimizing potential. Due to this ratio, we currently estimate CDR’s WACC at c. 10.23% p.a. (see Table 7, Appendix 33). By optimizing the capital structure to lower WACC

2012A 2013A 2014E 2015E 2016E 2017E 2018E 2019E 2020E by one percentage point, the valuation would increase by PLN 2.66 per share.

Source: Team estimates Significant expansion potential… Table 7: WACC as of 2015/02/09 Another significant influence factor on future valuations is the utilization of cash generated Derivation of WACC by the upcoming AAA games. Different scenarios include organic growth by expanding the Equity ratio 100.0% project pipeline and adding locations, acquisitions of promising game developers or Tax rate 19.0% dividend payment. While the latter would be a first time for CDR, the management already Risk-free rate 2.29% openly speculated on buying value-add resources in the past (mobile gaming) but decided 30 Levered beta 1.13x later on to develop themselves. Nonetheless, this shows that management assesses Equity risk premium 7.03% takeover possibilities on a continuous basis, which becomes a more realistic scenario with Cost of equity 10.23% hundreds of millions in the cash account. Furthermore, we assess acquisitions in the core WACC 10.23% business of premium games to have a much higher likelihood of generating shareholder 31 Source: Team computation value compared to the “freemium” business of mobile gaming. To estimate the value of

CFA Research Challenge CD Projekt SA (CDR) 2015-02-10

Table 8: Peer Group Multiples these options, we incorporate the binominal options pricing model by Cox, Ross and 2015E and 2016E 32 Rubinstein. This methodology leads to an additional value of c. PLN 64.3m due to 2015E EV/EBIT P/E possessing the option to expand, abandon or not exercise whereas expand would mean EA 13.4x 21.3x an increase in operations e.g. by opening another location and abandon would resemble a Take-Two 8.6x 19.6x potential sale of CDR at a discount in case the huge upcoming projects should turn out to be unsuccessful (see Appendix 39). Ubisoft 9.3x 13.9x

Activision 11.1x 18.4x Discrepancies from typical valuation drivers… Ncsoft 12.5x 19.5x On the other hand, typical valuation drivers such as CAPEX are not of major importance in Square 9.9x 19.5x this case, due to the nature of the game development business, heavily relying on Median 10.5x 19.5x Inventories together with Cost of Goods Sold. With a relatively small fixed asset base, CDR’s valuation is not majorly affected by changed in these positions. 2016E EV/EBIT P/E EA 11.9x 19.0x Comparable companies valuation Take-Two 7.2x 15.8x Ubisoft 8.3x 12.9x With a DCF model this sensitive to certain key drivers, the comparable companies Activision 9.3x 14.8x valuation based on enterprise multiples offers the second side to the story that is the Ncsoft 10.3x 16.2x current sentiment in the entertainment software industry. By weighting the DCF model Square 8.4x 16.5x heavily but including the comparable companies valuation, we use a standard approach to derive a more balanced target price. Median 8.8x 16.0x

Source: Team calculations, Peer group selection… CapitalIQ The peer group, of which the multiples are obtained, consists of similar game development companies, none of which is a perfect pure-play candidate but with numerous similarities. Graph 22: Peer Group vs. CDR Since CD PROJEKT thinks globally and its game series The Witcher is well-known and Margins: EBIT (Columns) and Net has been selling globally, our peer group consists of the global top-tier players. We have Income (Line) 2014E chosen the companies based on their size and the genre of the games published. All of the companies are significantly bigger than CDR, but all of them are also more mature, have more titles and release some of them on a yearly basis. In the appendix section we have described each company briefly (Appendix 23).

To conduct the multipliers pricing, we have used two ratios: P/E and EV/EBIT. Both of them are based on forward medians for 2015E and 2016E. Forward EV/EBIT are close to the peer group median. In 2015 there is a discount that amounts to 8%, though in 2016 there is a premium at the level of 1%. The situation with P/E ratio varies significantly. The discount amounts to 45% and 41% (2015 and 2016, respectively), which suggests a big upside potential for CDR's price.

Financial Analysis

Key ratios Actuals Estimates 2012A 2013A 2014E 2015E 2016E 2017E 2018E 2019E 2020E 2015E Profitability

EBITDA margin 18.9% 12.7% 0.0% 49.4% 50.3% 38.2% 50.2% 47.4% 32.3% Operating profit margin 17.3% 10.5% (3.2%) 48.5% 49.3% 36.0% 49.3% 46.3% 30.2% Net profit margin 17.1% 10.4% (1.9%) 41.9% 46.2% 40.9% 45.0% 43.0% 31.3% Return on assets 13.9% 6.8% (1.0%) 30.7% 25.8% 9.4% 19.8% 16.2% 6.3% Return on equity 18.6% 8.9% (1.7%) 49.2% 36.0% 12.8% 26.7% 20.5% 8.2%

Liquidity

Current ratio 248.4% 272.5% 174.3% 277.5% 412.3% 393.9% 455.4% 580.8% 464.8% Quick ratio 172.1% 157.0% 78.2% 207.5% 351.1% 314.6% 390.7% 524.4% 401.7% Cash ratio 61.4% 88.2% 47.8% 151.7% 279.5% 275.8% 322.3% 445.6% 373.9%

Efficiency

Cash conversion cycle (in days) 123.3 191.7 312.1 205.9 188.0 667.6 285.2 233.9 383.8 Total asset turnover 80.9% 65.3% 54.4% 73.2% 56.0% 22.9% 44.0% 37.6% 20.1% Inventory turnover 491.6% 273.6% 154.3% 367.4% 449.4% 134.0% 351.6% 434.7% 166.5% Inventory to assets 16.4% 23.9% 35.2% 19.9% 12.5% 17.1% 12.5% 8.6% 12.1%

Source: Team calculations, Financial leverage CapitalIQ Long-term debt to assets 0.5% 0.7% 0.5% 1.5% 1.0% 0.7% 0.6% 0.5% 0.4%

Long-term debt to equity 0.6% 1.0% 0.9% 2.3% 1.4% 0.9% 0.8% 0.6% 0.5%

Total debt to equity 29.5% 28.0% 63.6% 48.0% 29.8% 30.4% 26.8% 20.0% 25.5%

2.3% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% Interest-bearing debt to assets 3.1% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% Interest-bearing debt to equity Shareholder ratios

Earnings per share (in PLN) 0.30 0.16 -0.03 1.54 1.78 0.73 2.08 2.02 0.84 Dividend payout ratio 0% 0% 0% 0% 0% 0% 0% 0% 0%

CFA Research Challenge CD Projekt SA (CDR) 2015-02-10

Graph 23: FCF over Time Sales growth not sacrificing operating margins despite project volatility… 200,000 Taking into account that management plans a game development cycle to take three years 160,000 and the current pipeline of two upcoming titles, the company is exposed to heavy volatility 120,000 in sales figures and operating margins. Nonetheless, despite of the forecasted heavy sales 80,000 growth, we expect CDR to be able to improve its operating margins significantly. This is 40,000 partially offset by the mentioned volatility of each 3y project. However, even though the 0 third year after a major release (2014, 2017, 2020 etc.) naturally shows the weakest

2012A 2013A 2014E 2015E 2016E 2017E 2018E 2019E 2020E margins, the average over the 3y cycle improves drastically from the recent 2012-’14 to the upcoming 2018-’20 cycle (see Appendix 6). Due to the upcoming releases of CDR’s two Source: Team estimates largest game projects, two further large game releases in 2018 and 2019 (ETA) and economies of scale considering development, distribution and corporate overhead, we expect CDR to report a cycle average of 43.3% EBITDA margin in 2018-’20 with an Graph 24: DuPont Analysis average ROE of 18.5% compared to the 2012-’14 cycle with 10.5% and 8.6%, ROE respectively. A major driver of this development is the rising share of digitally distributed

8.6% | 18.5% games (see Graph 14) with drastically higher net receipts for CDR (see Appendix 35).

ROA Assets / Equity The luxury problem of cash & cash equivalents…

6.6% | 14.1% 144.3% | 130.6% As the cash ratio and the balance sheet item Cash & Cash Equivalents show, CDR will ceteris paribus build up a massive cash position. The management did not comment on how to utilize this cash either in its 2013-‘16 strategy report or during the analyst meeting. NI / Sales Sales / Assets Possibilities include organic growth such as recently seen in Krakow, acquisitions or 8.6% | 39.8% 67.2% | 33.9%

dividend payments. The latter as well as acquisitions would be a first time for CDR that Source: Team calculations always focused on organic growth and constant reinvestment of profits. We therefore see a significant potential to flatten the company’s margin volatility or pay dividends in the future, both of value for investors even though we would prefer to see expansion projects with positive influence on future cash flows combined with a healthy dividend payout ratio. Graph 25: Net Income over Time Despite of the unknown utilization of cash, we see the strong cash generation as one of

197,784 CDR’s most valuable characteristics. 191,594 169,217 Perks of being underleveraged… 146,614 The management’s strategy in terms of leverage has been clear until now, taking as little

79,634 debt as possible and paying back these positions as soon as possible. While in recent 69,254 28,125 projects with heavy volatility and delayed releases this approach seems reasonable and 14,851 takes off debt service pressure of CDR’s cash flows, the question arises whether CDR (2,540) should take on debt to decrease its WACC and finance expansion projects. Reasons range from the current low interest environment to the company’s more stable cash flows in the 2012A 2013A 2014E 2015E 2016E 2017E 2018E 2019E 2020E future that could absorb debt service better than a few years ago (see Graph 23, Appendix Source: Team calculations 3). Together with the strong cash generation (see Graph 26), the optimization potential of CDR’s capital structure offers immense flexibility in financing new ventures such as new locations and/or a three- to four-game approach. We value this as significant upside potential. Graph 26: Cash Ratio over Time

445.6% 373.9% Inventories as a central item… 279.5% 322.3% Since inventories cover development costs of future games, this item is much more 275.8% valuable than fixed asset positions or analyses derived from CAPEX. With two major games in development and two games being sold from Q1-16 to Q2-18, this position is still 151.7% 88.2% exposed to high volatility (see inventory turnover). However, the inventories will account for 61.4% 47.8% less of CDR’s asset base, thus decreasing operational risk. Also due to economies of scale, we expect the forecasted development of this item to increase shareholder value. Adding further game projects to the current two-game approach will further help stabilizing 2012 2013 2015 2016 2017 2018 2019 2020 2014 cash flows in the medium to long term. Source: Team estimates

Corporate Governance and Social Responsibility

CDR's corporate responsibility is relatively highly rated… CDR, as the company listed on the Warsaw Stock Exchange, is subjected to corporate governance rules set forth in the "Code of Best Practice for WSE Listed Companies."33 This 34 document can be accessed on the Warsaw Stock Exchange website. We have evaluated CDR's corporate governance based on this document and the categories listed in it. All of the categories are of the same importance. According to our subjective evaluation, the company's score is 9 out of a maximum of 10 points. We value this score as very high. More details concerning the calculation of the score can be found in the Appendix 42.

Our evaluation is also partially confirmed by the Individual Investors Association (IIA), which has analyzed CDR, including quality of its communication with the market.35

According to IIA, the communication of the company with the market is very good. The company organizes meetings with the investors, management board members are present

CFA Research Challenge CD Projekt SA (CDR) 2015-02-10

on the conferences and meetings organized for investors. What is more, the founder, joint CEO and main shareholder, Mr. Kicinski often shows up at TV programmes and is keen on sharing current news about the company.

Financial reports include descriptions of all of the important financial data as well as all of

the factors that have influence on the company. One negative aspect is CDR’s lack of published information on the growth strategy. The website includes all of the important information about the company. There are posted videos from the conferences as well as many presentations.

Investment risks

Graph 27: Downside Risk Matrix 1. Downside risks

Operational risk | Threat of poor quality of The Witcher III: Wild Hunt (DR1) DR1 Since the premiere of The Witcher III has been already postponed two times due to the delay in the development process, there is a risk of delivering the product not meeting the DR4 DR6 expectations of the gamers. On the other hand, the delay might be also a good sign showing that the company cares about high standard of the game and wanted to prolong its DR5 DR3 development process to ensure that the quality is of highest standards and that the gamers Impact will be fully satisfied with its quality. It is also already the third game in the series, being DR2 DR7 developed by the same team. The company in an official letter on the delay expressed that it cares much more about the gamers rather than the investors, what has been also LOW HIGH positively met by the gamers. All of the aforementioned arguments limit that particular risk. LOW HIGH Probability Operational risk | Another delay of the release of The Witcher 3: Wild Hunt (DR2) Source: Team estimates Initially, the game was planned to be released in the second half of 2014. Then the management decided to postpone the release to February 2015. In December 2014 the management released the information that the premiere will be postponed again, to 19th of May 2015. It seems to be the final date and the game should be fully developed until then, though there is still a risk of further delays what may influence both the development budget as well as revenues.

Operational risk | Delays of the releases of the next games (DR3) Furthermore, there is also a risk of the delays in the upcoming games: Cyberpunk 2077 and the next titles that we have included in our forecasts. If that happens, it will have a negative influence on the valuation and consequently on the stock's price. On the other hand, the delays in the releases of the games appear quite often among all of the companies from the industry. What is more, the gamers appreciate high quality of games and they seem to understand the company and the reason behind the delay, so it is not a major risk in our opinion and when the company has to choose between high quality and being fast with the release, the first option is the right choice.

Operational risk | Questionable attractiveness of next AAA titles (DR4) The Witcher is a successful sequel so far and we expect the 3rd game to outsell the two previous versions, but so far CDR is a one-title publisher. The management has already released the information about the next game - Cyberpunk 2077. The plot will be based on the Cyberpunk comics. So far, the feedback from the gamers is positive and they are expecting its premiere, especially those from USA due to the popularity of those comics. Still it is hard to predict whether this game will be as successful as the Witcher sequel. It is also difficult to predict the attractiveness and quality of the next games.

Operational risk | Risk of losing key employees (DR5) The probability of losing key management is almost equal to zero, since the members hold shares of the company and are very passionate about it. The situation with the rest of the employees is different. More and more game developing companies are present on the polish market. Some of them might want to acquire the creative, talented and already

experienced professionals that developed in the biggest and most successful polish player. We believe that the risk is limited, since CDR is still the bigger and the most successful polish game developer with global recognition and a huge potential.

Financial risk | FOREX risk (DR6)

Since majority of the sales is generated outside of Poland and the management's strategy is to become an even more global company, CDR is exposed to exchange rate fluctuation (especially USD/PLN and EUR/PLN). Appreciation of the Polish currency decreases foreign revenues in both the game development business unit as well as GOG – the digital distribution platform.

CFA Research Challenge CD Projekt SA (CDR) 2015-02-10

External risk | The risk of low base of PCs meeting high hardware requirement (DR7) Both currently developed The Witcher III: Wild Hunt and Cyberpunk 2077 have high hardware requirements. The same will probably apply to the games that will be developed

in the future. On the other hand, the target audience for CDR games is relatively old and is into new releases of good games, so they probably change PCs quite often so that they meet the requirements.

2. Upside risks

Graph 28: Upside Risk Matrix Operational risk | Higher sales on digital distribution platforms (UR1) It is quite possible that a higher proportion will be distributed digitally. The digital distribution is more attractive for game developers and publishers, because of the higher margins than in the physical distribution. Moreover, CDR owns their own digital distribution platform, which could increases the revenues and lower the cost due to loyalty purchases UR4 UR6 of the fan base.

UR5 UR2 UR3 Operational Risk | More customers due to recommendations (UR2)

Impact The Witcher I and II were very successful and popular video games, which resulted in a big UR7 fan base of The Witcher. Witcher III is already the most expected video game in 2015 and in the case that it will be reviewed positively, this could boost the sales due to the free

LOW HIGH UR1 advertising on social media platforms, since the most trusted advertising is a recommendation of a friend.36 LOW HIGH

Probability Operational Risk | Selling the Engine (UR3)

Source: Team estimates The recently improved game engine named REDengine 3 by CD Projekt RED will be used in the upcoming games The Witcher III and Cyberpunk 2077. The new engine provides a previously non-existent possibility to combine a non-linear story with an open world. This provides the possibility for CDR to sell licenses to other game developers. Additionally, the experience gained from using the engine for The Witcher 3 and synergies can be used to decrease the developing time and costs of Cyberpunk 2077.

Operational Risk | Successful introduction of GOG Galaxy (UR4) GOG is developing a DRM-free online client called GOG Galaxy. It was announced to be released in 2015, and will include features like cross-play which allows to connect with people using the competing online platform Steam. This may encourage customers to buy The Witcher III on GOG.com, especially if they could increase the games catalog with more online playable AAA games.

Operational Risk | Merchandising of the brand The Witcher© (UR5) CDR owns the trademark rights of The Witcher and filmed the story of The Witcher in a 13- part series, which was broadcasted exclusively in Poland in 2001 and distributed on DVD in Germany in 2010. The Witcher III game may increase the popularity and fame worldwide even further, which could result in a new production of a movie and ensure additionally cash inflows.

Financial upside risk | Optimization of capital structure (UR6) At this time CDR is mainly financed with equity. Establishing for example a new subsidiary, headquartered in a tax haven, CDR could use tax advantages connected with the use of debt financing to optimize their capital structure. With the small total debt to equity ratio of CDR, an increase of the ratio would lead to a higher value of the company because of the tax shelter effect and a massively lower WACC.

Operational upside risk | Expansion of operations to three- or four-game approach and new locations (UR7) In the case the company is developing well in the near future and providing high revenues, CD Project could use the money and expand e.g. with an additional location, resulting in a faster development of Cyberpunk 2077 or simultaneously developing additional games. This massive upside potential has been implemented in our real options analysis (see Appendix 39).

CFA Research Challenge CD Projekt SA (CDR) 2015-02-10

Appendices

Appendix 1: Consolidated Statement of Financial Position (CDR)

Actuals Estimates Averages

As of Dec-31 2012A 2013A 2014E 2015E 2016E 2017E 2018E 2019E 2020E '12-14 '18-20

Goodwill 46,417 46,417 46,417 46,417 46,417 46,417 46,417 46,417 46,417 46,417 46,417 Intangible assets 34,801 36,403 38,351 47,218 51,141 55,306 63,630 72,823 78,266 36,518 71,573 Tangible assets 10,755 11,187 5,468 5,924 7,018 7,608 8,387 10,360 10,340 9,137 9,696 Finanical assets 0 0 0 0 0 0 0 0 0 0 0

Total fixed assets 91,973 94,007 90,236 99,559 104,576 109,331 118,433 129,600 135,022 92,072 127,685

Other long-term assets 249 285 315 321 331 342 353 364 376 283 365 Inventories 33,367 51,966 88,892 95,262 81,590 126,393 124,889 102,559 152,551 58,075 126,666 Accounts receivable and other assets 48,457 30,938 28,071 75,990 95,519 61,942 132,012 143,042 67,434 35,822 114,163

Accounts receivable 31,247 17,064 24,175 77,220 95,340 64,224 128,248 138,063 64,336 24,162 110,215 Other receivables 4,635 3,856 -977 -5,735 -4,398 -6,934 -982 138 -2,016 2,505 -953 Income tax receivable 0 901 145 10 10 10 10 10 10 349 10 Other financial assets 855 805 2,730 2,813 2,927 3,046 3,169 3,298 3,432 1,463 3,300 Prepaid expenses 11,720 8,312 1,997 1,682 1,640 1,596 1,567 1,533 1,672 7,343 1,590 Cash and cash equivalents 26,866 39,684 44,154 206,459 372,619 439,835 621,803 809,769 905,242 36,901 778,938 Total current assets 108,690 122,588 161,117 377,712 549,729 628,170 878,703 1,055,370 1,125,227 130,798 1,019,767

Deferred tax assets 1,980 755 591 509 461 569 605 540 690 1,109 612 Total assets 202,892 217,635 252,259 478,100 655,097 738,413 998,094 1,185,874 1,261,315 224,262 1,148,428

Equity 151,530 167,368 153,884 310,021 487,357 560,710 768,243 968,519 1,001,831 157,594 912,864

Shareholders' equity 151,530 166,500 147,592 298,137 469,788 540,784 741,913 935,805 966,425 155,207 881,381 Minority interest 0 868 6,292 11,884 17,568 19,925 26,330 32,714 35,406 2,387 31,483

Long-term liabilities 946 1,590 1,384 6,956 6,694 5,016 6,126 5,563 4,574 1,307 5,421

Liabilities due to banks 0 0 0 0 0 0 0 0 0 0 0 Other financial liabilities 235 177 376 387 403 419 437 454 473 263 454 Deferred revenues 679 1,376 980 6,540 6,265 4,571 5,666 5,084 4,079 1,012 4,943 Provisions for employee benefits 26 37 28 28 26 25 24 24 23 30 24 Other provisions 6 0 0 0 0 0 0 0 0 2 0

Short-term liabilities 43,758 44,991 92,413 136,115 133,336 159,474 192,954 181,711 242,110 60,387 205,592

Liabilities due to banks 4,745 21 9 2 0 0 0 0 0 1,592 0 Accounts payable 33,930 24,738 24,002 94,455 102,675 48,680 119,884 126,063 87,941 27,557 111,296 Other payables 4,020 18,218 60,610 12,049 1,708 84,765 53,802 39,391 135,781 27,616 76,325 Deferred revenues 197 211 7,242 29,034 27,928 23,917 18,100 15,021 17,078 2,550 16,733 Provisions for employee benefits 238 145 122 135 154 177 177 177 177 168 177 Other financial liabilities 277 260 379 388 402 416 431 446 462 305 446 Tax liabilities 184 1,270 20 15 433 1,476 524 576 634 491 578 Other provisions 167 128 29 37 36 44 36 36 36 108 36 Deferred tax liabilities 6,658 3,686 4,578 25,009 27,710 13,214 30,772 30,082 12,799 4,974 24,551 Total liabilities and equity 202,892 217,635 252,259 478,100 655,097 738,413 998,094 1,185,874 1,261,315 224,262 1,148,428

�� = ��

Due to the volatility of CDR’s development cycle of new games, the comparative measurement chosen is averages over the three years lasting development cycle of a new major gaming title. Consequently, a development can be observed when comparing the cycle average from 2012 to 2014 to the one from 2018 to 2020.

CFA Research Challenge CD Projekt SA (CDR) 2015-02-10

Appendix 2: Consolidated Statement of Comprehensive Income (CDR)

Actuals Estimates CAGR (in %) in PLN '000 as of Dec-31 2012A 2013A 2014A 2015E 2016E 2017E 2018E 2019E 2020E '12-16 '12-20

Sales of products 83,891 21,989 18,518 207,651 233,332 93,950 282,165 275,014 111,687 27.5% 20.6% Sales of services 4,506 62,220 61,354 108,350 105,817 66,663 121,940 138,286 131,907 14.0% 13.2% Sales of goods and materials 75,643 57,963 57,269 34,034 27,514 8,702 34,951 32,485 10,476 -15.3% -9.5% Total sales 164,040 142,172 137,140 350,035 366,663 169,315 439,057 445,784 254,070 12.2% 11.1%

Costs of products and services sold (37,308) (40,388) (51,389) (114,168) (116,683) (66,832) (137,056) (146,115) (109,282) 14.9% 13.2% Value of goods and materials sold (52,310) (42,798) (51,359) (22,289) (25,528) (9,709) (31,155) (30,194) (11,660) -14.4% -7.4% Cost of materials (89,618) (83,186) (102,747) (136,457) (142,211) (76,541) (168,211) (176,309) (120,942) 4.3% 6.0%

Gross profit 74,422 58,986 34,393 213,578 224,452 92,775 270,845 269,476 133,128 21.2% 16.7% Other operating income 3,056 3,420 7,303 6,632 8,998 10,994 10,641 11,545 14,115 11.6% 11.4% General & admin. expenses (13,063) (12,856) (12,225) (12,126) (15,323) (18,362) (25,633) (28,867) (33,616) 3.1% 9.7% Sales and marketing exp. (25,243) (28,018) (29,376) (33,859) (31,723) (19,341) (33,220) (39,422) (30,958) 0.5% 2.5% Other operating expenses (8,188) (3,519) (35) (1,403) (2,011) (1,349) (2,048) (1,516) (613) -14.0% -10.8%

EBITDA 30,984 18,013 60 172,822 184,393 64,715 220,585 211,216 82,056 43.1% 29.8% D&A (2,617) (3,139) (4,414) (3,189) (3,490) (3,775) (4,321) (4,991) (5,316) 0.5% 4.1% EBIT 28,367 14,874 (4,354) 169,634 180,903 60,941 216,264 206,225 76,740 48.2% 32.8% Interest income 4,031 2,995 2,900 12,242 25,177 23,475 23,233 28,701 23,187 35.3% 25.2% Interest expense (4,111) (679) (1,145) (2,053) (3,081) (2,176) (3,427) (5,174) (5,215) 3.5% 9.8% EBT 28,287 17,190 (2,599) 179,823 203,000 82,239 236,071 229,753 94,711 48.8% 33.1% Income tax (162) (2,339) 59 (33,209) (33,782) (12,985) (38,286) (38,159) (15,077) 78.9% 49.6% Net income (loss) 28,125 14,851 (2,540) 146,614 169,217 69,254 197,784 191,594 79,634 45.6% 31.3%

Key financials analysis Actuals Estimates YoY growth (in %) 2012A 2013A 2014A 2015E 2016E 2017E 2018E 2019E 2020E

Sales 20.4% (13.3%) (3.5%) 155.2% 4.8% (53.8%) 159.3% 1.5% (43.0%) Cost of materials 64.4% (7.2%) 23.5% 32.8% 4.2% (46.2%) 119.8% 4.8% (31.4%) Gross profit (8.9%) (20.7%) (41.7%) 521.0% 5.1% (58.7%) 191.9% (0.5%) (50.6%) Other operating income (66.3%) 11.9% 113.5% (9.2%) 35.7% 22.2% (3.2%) 8.5% 22.3% General & admin. expenses 12.7% (1.6%) (4.9%) (0.8%) 26.4% 19.8% 39.6% 12.6% 16.5% Sales and marketing exp. (33.5%) 11.0% 4.8% 15.3% (6.3%) (39.0%) 71.8% 18.7% (21.5%) Other operating expenses (29.4%) (57.0%) nm nm 43.3% (32.9%) 51.8% (26.0%) (59.5%)

EBITDA 1.0 (42%) nm nm 7% (65%) 241% (4%) (61%) D&A 32% 20% 41% (28%) 9% 8% 14% 16% 7% EBIT 3% (48%) nm nm 7% (66%) 255% (5%) (63%) Interest income 123.8% (26%) (3%) 322% 106% (7%) (1%) 24% (19%) Interest expense 87.4% (83%) 69% 79% 50% (29%) 57% 51% 1% EBT 4% (39%) nm nm 13% (59%) 187% (3%) (59%) Income tax (95.0%) 1344% nm nm 2% (62%) 195% (0%) (60%) Net income (loss) 17% (47%) nm nm 15% (59%) 186% (3%) (58%)

in % as of sales 2012A 2013A 2014A 2015E 2016E 2017E 2018E 2019E 2020E

Cost of materials 54.6% 58.5% 74.9% 39.0% 38.8% 45.2% 38.3% 39.6% 47.6% Gross profit 45.4% 41.5% 25.1% 61.0% 61.2% 54.8% 61.7% 60.4% 52.4% Other operating income 1.9% 2.4% 5.3% 1.9% 2.5% 6.5% 2.4% 2.6% 5.6% General & admin. expenses 8.0% 9.0% 8.9% 3.5% 4.2% 10.8% 5.8% 6.5% 13.2% Sales and marketing exp. 15.4% 19.7% 21.4% 9.7% 8.7% 11.4% 7.6% 8.8% 12.2% Other operating expenses 5.0% 2.5% 0.0% 0.4% 0.5% 0.8% 0.5% 0.3% 0.2%

EBITDA 18.9% 12.7% 0.0% 49.4% 50.3% 38.2% 50.2% 47.4% 32.3% D&A 1.6% 2.2% 3.2% 0.9% 1.0% 2.2% 1.0% 1.1% 2.1% EBIT 17.3% 10.5% -3.2% 48.5% 49.3% 36.0% 49.3% 46.3% 30.2% Interest income -2.5% -2.1% -2.1% -3.5% -6.9% -13.9% -5.3% -6.4% -9.1% Interest expense 2.5% 0.5% 0.8% 0.6% 0.8% 1.3% 0.8% 1.2% 2.1% EBT 17.2% 12.1% -1.9% 51.4% 55.4% 48.6% 53.8% 51.5% 37.3% Income tax 0.1% 1.6% 0.0% 9.5% 9.2% 7.7% 8.7% 8.6% 5.9% Net income (loss) 17.1% 10.4% -1.9% 41.9% 46.2% 40.9% 45.0% 43.0% 31.3%

� �� = − � � ��

Due to the volatility of CDR’s development cycle of new game titles, the compound annual growth rate has been adapted to account for averages of one development cycle compared to the averages of a previous one rather than single years. By using this methodology, the cycle 2012 to 2014 can be compared to the succeeding ones from 2015 to 2017 and 2018 to 2020.

CFA Research Challenge CD Projekt SA (CDR) 2015-02-10

Appendix 3: Statement of Cash Flows (CDR)

Actuals Estimates CAGR (in %) in PLN '000 as of Dec-31 2012A 2013A 2014A 2015E 2016E 2017E 2018E 2019E 2020E '12-16 '12-20

Net income 28,125 14,851 (2,540) 146,614 169,217 69,254 197,784 191,594 79,634 Depreciation & Amortization 2,617 3,139 4,414 3,189 3,490 3,775 4,321 4,991 5,316 Change in Pension Accruals (long-term) 29 (93) (23) 13 19 23 0 0 0 Change in Pension Accruals (4) 11 (9) 0 (2) (1) (1) 0 (1)

Operating CF I 30,767 17,908 1,842 149,815 172,724 73,051 202,104 196,585 84,949 40.9% 28.5%

Change in assets Change in Inventories (2,255) (18,599) (36,926) (6,370) 13,672 (44,803) 1,504 22,330 (49,992) Change in prepaid expenses 3,695 3,408 6,315 315 42 44 29 34 (139) Change in other financial assets 3,374 50 (1,925) (83) (114) (119) (124) (129) (134) Change in Accounts receivable 302 14,183 (7,111) (53,046) (18,119) 31,116 (64,023) (9,815) 73,727 Change in other receivables (3,427) 779 4,833 4,759 (1,338) 2,536 (5,952) (1,120) 2,154 Change in other lt assets 20 (36) (30) (6) (10) (11) (11) (11) (12) Change in income tax receivables 1,632 (901) 756 135 0 0 0 0 0 Change in defered tax (1,336) 1,225 164 82 48 (108) (36) 65 (149) Change in other deferred items 0 0 0 0 0 0 0 0 0

Change in long-term liabilities Change in other financial liabilities (98) (58) 199 11 16 16 17 18 18 Change in deferred income tax liabilities 0 0 0 0 0 0 0 0 0 Change in deferred revenues 335 697 (396) 5,560 (276) (1,694) 1,095 (581) (1,006) Change in other provisions (3) (6) 0 0 0 0 0 0 0

Change in short-term liabilities Change in accounts payables 363 (9,192) (736) 70,453 8,220 (53,995) 71,204 6,179 (38,121) Change in other payables (2,023) 14,198 42,392 (48,562) (10,341) 83,057 (30,963) (14,411) 96,390 Change in deferred revenues 107 14 7,031 21,792 (1,106) (4,011) (5,817) (3,078) 2,057 Change in other financial liabilities 37 (17) 119 9 14 14 15 15 16 Change in tax liabilities 21 1,086 (1,250) (5) 418 1,043 (952) 52 58 Change in other provisions (444) (39) (99) 8 (1) 8 (8) 0 0 Change in deferred items 0 0 0 0 0 0 0 0 0 Change in deferred tax (216) (2,972) 892 20,431 2,702 (14,497) 17,558 (690) (17,283)

Operating CF II 30,851 21,728 16,070 165,299 166,550 71,648 185,641 195,441 152,535 34.3% 25.6%

Capex (4,741) (5,173) (643) (12,511) (8,506) (8,531) (13,423) (16,157) (10,739) Investing Cash Flow (4,741) (5,173) (643) (12,511) (8,506) (8,531) (13,423) (16,157) (10,739) 18.7% 16.1%

Free Cash Flow (Operating & Investing) 26,110 16,555 15,427 152,787 158,044 63,117 172,218 179,284 141,795 36.4% 26.8%

Change in liabilities due to banks (8,659) (4,724) (12) (7) (2) 0 0 0 0 Change in long-term liabilities due to banks 0 0 0 0 0 0 0 0 0 Change in equity (404) 119 (16,368) 3,932 2,434 1,742 3,344 2,298 (49,013) Change in minority shares 0 868 5,424 5,592 5,684 2,357 6,405 6,384 2,691 Change in accounts to shareholders 0 0 0 0 0 0 0 0 0 Change in balancing items for active own shares 0 0 0 0 0 0 0 0 0

Change in cash 17,047 12,818 4,471 162,304 166,160 67,216 181,968 187,966 95,473 50.3% 33.6%

Cash beginning balance 9,819 26,866 39,684 44,155 206,459 372,619 439,835 621,803 809,769 Cash ending balance 26,866 39,684 44,155 206,459 372,619 439,835 621,803 809,769 905,242 44.8% 40.3%

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CFA Research Challenge CD Projekt SA (CDR) 2015-02-10

Appendix 4: Consolidated Common-Size Statement of Financial Position (CDR)

% of assets Actuals Estimates Averages

2012A 2013A 2014E 2015E 2016E 2017E 2018E 2019E 2020E '12-14 '18-20

Goodwill 22.9% 21.3% 18.4% 9.7% 7.1% 6.3% 4.7% 3.9% 3.7% 20.9% 4.1% Intangible assets 17.2% 16.7% 15.2% 9.9% 7.8% 7.5% 6.4% 6.1% 6.2% 16.4% 6.2% Tangible assets 5.3% 5.1% 2.2% 1.2% 1.1% 1.0% 0.8% 0.9% 0.8% 4.2% 0.8% Finanical assets 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%

Total fixed assets 45.3% 43.2% 35.8% 20.8% 16.0% 14.8% 11.9% 10.9% 10.7% 41.4% 11.2%

Other long-term assets 0.1% 0.1% 0.1% 0.1% 0.1% 0.0% 0.0% 0.0% 0.0% 0.1% 0.0% Inventories 16.4% 23.9% 35.2% 19.9% 12.5% 17.1% 12.5% 8.6% 12.1% 25.2% 11.1%

Accounts receivable and other assets 23.9% 14.2% 11.1% 15.9% 14.6% 8.4% 13.2% 12.1% 5.3% 16.4% 10.2%

Accounts receivable 15.4% 7.8% 9.6% 16.2% 14.6% 8.7% 12.8% 11.6% 5.1% 10.9% 9.9% Other receivables 2.3% 1.8% -0.4% -1.2% -0.7% -0.9% -0.1% 0.0% -0.2% 1.2% (0.1%) Income tax receivable 0.0% 0.4% 0.1% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.2% 0.0% Other financial assets 0.4% 0.4% 1.1% 0.6% 0.4% 0.4% 0.3% 0.3% 0.3% 0.6% 0.3% Prepaid expenses 5.8% 3.8% 0.8% 0.4% 0.3% 0.2% 0.2% 0.1% 0.1% 3.5% 0.1%

Cash and cash equivalents 13.2% 18.2% 17.5% 43.2% 56.9% 59.6% 62.3% 68.3% 71.8% 16.3% 67.5%

Total current assets 53.6% 56.3% 63.9% 79.0% 83.9% 85.1% 88.0% 89.0% 89.2% 57.9% 88.7%

Deferred tax assets 1.0% 0.3% 0.2% 0.1% 0.1% 0.1% 0.1% 0.0% 0.1% 0.5% 0.1%

Total assets 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%

Equity 74.7% 76.9% 61.0% 64.8% 74.4% 75.9% 77.0% 81.7% 79.4% 70.9% 79.4%

Shareholders' equity 74.7% 76.5% 58.5% 62.4% 71.7% 73.2% 74.3% 78.9% 76.6% 69.9% 76.6% Minority interest 0.0% 0.4% 2.5% 2.5% 2.7% 2.7% 2.6% 2.8% 2.8% 1.0% 2.7%

Long-term liabilities 0.5% 0.7% 0.5% 1.5% 1.0% 0.7% 0.6% 0.5% 0.4% 0.6% 0.5%

Liabilities due to banks 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% Other financial liabilities 0.1% 0.1% 0.1% 0.1% 0.1% 0.1% 0.0% 0.0% 0.0% 0.1% 0.0% Deferred revenues 0.3% 0.6% 0.4% 1.4% 1.0% 0.6% 0.6% 0.4% 0.3% 0.5% 0.4% Provisions for employee benefits 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% Other provisions 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%

Short-term liabilities 21.6% 20.7% 36.6% 28.5% 20.4% 21.6% 19.3% 15.3% 19.2% 26.3% 18.0%

Liabilities due to banks 2.3% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.8% 0.0% Accounts payable 16.7% 11.4% 9.5% 19.8% 15.7% 6.6% 12.0% 10.6% 7.0% 12.5% 9.9% Other payables 2.0% 8.4% 24.0% 2.5% 0.3% 11.5% 5.4% 3.3% 10.8% 11.5% 6.5% Deferred revenues 0.1% 0.1% 2.9% 6.1% 4.3% 3.2% 1.8% 1.3% 1.4% 1.0% 1.5% Provisions for employee benefits 0.1% 0.1% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.1% 0.0% Other financial liabilities 0.1% 0.1% 0.2% 0.1% 0.1% 0.1% 0.0% 0.0% 0.0% 0.1% 0.0% Tax liabilities 0.1% 0.6% 0.0% 0.0% 0.1% 0.2% 0.1% 0.0% 0.1% 0.2% 0.1% Other provisions 0.1% 0.1% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.1% 0.0%

Deferred tax liabilities 3.3% 1.7% 1.8% 5.2% 4.2% 1.8% 3.1% 2.5% 1.0% 2.3% 2.2%

Total liabilities and equity 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%

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CFA Research Challenge CD Projekt SA (CDR) 2015-02-10

Appendix 5: Consolidated Common-Size Statement of Comprehensive Income (CDR)

% of revenues Actuals Estimates Averages

2012A 2013A 2014E 2015E 2016E 2017E 2018E 2019E 2020E '12-14 '18-20

Sales of products 51.1% 15.5% 13.5% 59.3% 63.6% 55.5% 64.3% 61.7% 44.0% 26.7% 56.6% Sales of services 2.7% 43.8% 44.7% 31.0% 28.9% 39.4% 27.8% 31.0% 51.9% 30.4% 36.9% Sales of goods and materials 46.1% 40.8% 41.8% 9.7% 7.5% 5.1% 8.0% 7.3% 4.1% 42.9% 6.5% Total revenues 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%

Cost of products and services sold (22.7%) (28.4%) (37.5%) (32.6%) (31.8%) (39.5%) (31.2%) (32.8%) (43.0%) (29.5%) (35.7%) Value of goods and materials sold (31.9%) (30.1%) (37.4%) (6.4%) (7.0%) (5.7%) (7.1%) (6.8%) (4.6%) (33.1%) (6.2%) COGS (54.6%) (58.5%) (74.9%) (39.0%) (38.8%) (45.2%) (38.3%) (39.6%) (47.6%) (62.7%) (41.8%)

Gross profit 45.4% 41.5% 25.1% 61.0% 61.2% 54.8% 61.7% 60.4% 52.4% 37.3% 58.2%

General and administrative costs (8.0%) (9.0%) (8.9%) (3.5%) (4.2%) (10.8%) (5.8%) (6.5%) (13.2%) (8.6%) (8.5%) Selling costs (15.4%) (19.7%) (21.4%) (9.7%) (8.7%) (11.4%) (7.6%) (8.8%) (12.2%) (18.8%) (9.5%) Other operating income 1.9% 2.4% 5.3% 1.9% 2.5% 6.5% 2.4% 2.6% 5.6% 3.2% 3.5% Other operating expenses (5.0%) (2.5%) (0.0%) (0.4%) (0.5%) (0.8%) (0.5%) (0.3%) (0.2%) (2.5%) (0.3%)

EBITDA 18.9% 12.7% 0.0% 49.4% 50.3% 38.2% 50.2% 47.4% 32.3% 10.5% 43.3%

Depreciation (1.6%) (2.2%) (3.2%) (0.9%) (1.0%) (2.2%) (1.0%) (1.1%) (2.1%) (2.3%) (1.4%)

EBIT 17.3% 10.5% (3.2%) 48.5% 49.3% 36.0% 49.3% 46.3% 30.2% 8.2% 41.9%

Interest income 2.5% 2.1% 2.1% 3.5% 6.9% 13.9% 5.3% 6.4% 9.1% 2.2% 7.0% Interest expenses (2.5%) (0.5%) (0.8%) (0.6%) (0.8%) (1.3%) (0.8%) (1.2%) (2.1%) (1.3%) (1.3%)

EBT 17.2% 12.1% (1.9%) 51.4% 55.4% 48.6% 53.8% 51.5% 37.3% 9.1% 47.5%

Income taxes (0.1%) (1.6%) 0.0% (9.5%) (9.2%) (7.7%) (8.7%) (8.6%) (5.9%) (0.6%) (7.7%)

Net income (loss) 17.1% 10.4% (1.9%) 41.9% 46.2% 40.9% 45.0% 43.0% 31.3% 8.6% 39.8%

Attributable to: Equity holders 17.1% 10.4% (1.8%) 40.3% 44.5% 39.4% 43.5% 41.5% 30.2% 8.6% 38.4% Minority interests 0.0% 0.1% (0.1%) 1.6% 1.7% 1.5% 1.5% 1.5% 1.1% (0.0%) 1.4%

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CFA Research Challenge CD Projekt SA (CDR) 2015-02-10

Appendix 6: Key Financial Ratios (CDR)

Key ratios Actuals Estimates Averages

2012A 2013A 2014E 2015E 2016E 2017E 2018E 2019E 2020E '12-14 '18-20

Profitability

EBITDA margin 18.9% 12.7% 0.0% 49.4% 50.3% 38.2% 50.2% 47.4% 32.3% 10.5% 43.3% Operating profit margin 17.3% 10.5% (3.2%) 48.5% 49.3% 36.0% 49.3% 46.3% 30.2% 8.2% 41.9% Net profit margin 17.1% 10.4% (1.9%) 41.9% 46.2% 40.9% 45.0% 43.0% 31.3% 8.6% 39.8% Return on assets 13.9% 6.8% (1.0%) 30.7% 25.8% 9.4% 19.8% 16.2% 6.3% 6.6% 14.1% Return on equity 18.6% 8.9% (1.7%) 49.2% 36.0% 12.8% 26.7% 20.5% 8.2% 8.6% 18.5%

Liquidity

Current ratio 248.4% 272.5% 174.3% 277.5% 412.3% 393.9% 455.4% 580.8% 464.8% 231.7% 500.3% Quick ratio 172.1% 157.0% 78.2% 207.5% 351.1% 314.6% 390.7% 524.4% 401.7% 135.8% 438.9% Cash ratio 61.4% 88.2% 47.8% 151.7% 279.5% 275.8% 322.3% 445.6% 373.9% 65.8% 380.6%

Efficiency

Cash conversion cycle (in days) 123.3 191.7 312.1 205.9 188.0 667.6 285.2 233.9 383.8 209.0 301.0 Total asset turnover 80.9% 65.3% 54.4% 73.2% 56.0% 22.9% 44.0% 37.6% 20.1% 66.8% 33.9% Inventory turnover 491.6% 273.6% 154.3% 367.4% 449.4% 134.0% 351.6% 434.7% 166.5% 306.5% 317.6% Inventory to assets 16.4% 23.9% 35.2% 19.9% 12.5% 17.1% 12.5% 8.6% 12.1% 25.2% 11.1%

Financial leverage

Long-term debt to assets 0.5% 0.7% 0.5% 1.5% 1.0% 0.7% 0.6% 0.5% 0.4% 0.6% 0.5% Long-term debt to equity 0.6% 1.0% 0.9% 2.3% 1.4% 0.9% 0.8% 0.6% 0.5% 0.8% 0.6% Total debt to equity 29.5% 28.0% 63.6% 48.0% 29.8% 30.4% 26.8% 20.0% 25.5% 40.3% 24.1% Interest-bearing debt to assets 2.3% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.8% 0.0% Interest-bearing debt to equity 3.1% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 1.1% 0.0%

Shareholder ratios

Earnings per share (in PLN) 0.30 0.16 -0.03 1.54 1.78 0.73 2.08 2.02 0.84 0.14 1.65 Dividend payout ratio 0% 0% 0% 0% 0% 0% 0% 0% 0% 0.0% 0.0%

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CFA Research Challenge CD Projekt SA (CDR) 2015-02-10

Appendix 7: Statement of Financial Position (CD Projekt RED, Games Development Business)

Actuals Estimates Averages

As of Dec-31 2012A 2013A 2014E 2015E 2016E 2017E 2018E 2019E 2020E '12-14 '18-20

Goodwill 0 0 0 0 0 0 0 0 0 0 0 Intangible assets 1,657 3,017 3,811 4,402 4,622 4,853 5,338 5,872 6,166 2,828 5,792 Tangible assets 2,311 3,114 3,161 3,289 3,560 4,007 4,338 4,882 5,285 2,862 4,835 Investments in subsidiaries 0 0 17,867 17,867 17,867 17,867 17,867 17,867 17,867 5,956 17,867

Total fixed assets 3,968 6,131 24,839 25,558 26,049 26,727 27,543 28,621 29,317 11,646 28,494

Other long-term assets 16 17 70 70 70 70 70 70 70 34 70 Inventories 26,295 44,514 88,892 95,262 81,590 126,393 124,889 102,559 152,551 53,234 126,666

Accounts receivable and other assets 14,818 7,768 14,716 60,104 62,233 24,254 69,600 64,879 25,604 12,434 53,361

Accounts receivable 13,146 3,487 7,951 53,743 55,659 21,477 62,289 58,040 22,534 8,195 47,621 Other receivables 1,432 3,035 6,076 5,971 6,184 2,386 6,921 6,449 2,504 3,514 5,291 Income tax receivable 0 900 28 10 10 10 10 10 10 309 10 Other financial assets 0 0 0 0 0 0 0 0 0 0 0 Prepaid expenses 240 346 660 380 380 380 380 380 557 415 439 Cash and cash equivalents 11,607 5,030 16,854 132,096 260,842 314,649 462,222 605,577 657,733 11,164 575,177

Total current assets 52,720 57,312 120,461 287,462 404,666 465,296 656,711 773,015 835,888 76,831 755,205

Deferred tax assets 7 13 253 250 250 250 250 250 250 91 250

Total assets 56,711 63,473 145,623 313,340 431,035 492,343 684,574 801,956 865,525 88,602 784,018

Equity 39,787 44,883 55,374 170,623 299,369 353,170 500,753 644,106 696,254 46,681 613,704

Shareholders' equity 39,787 44,883 55,374 170,623 299,369 353,170 500,753 644,106 696,254 46,681 613,704 Minority interest 0 0 0 0 0 0 0 0 0 0 0

Long-term liabilities 176 572 538 4,543 4,109 3,739 3,044 2,546 3,091 429 2,894

Liabilities due to banks 0 0 0 0 0 0 0 0 0 0 0 Other financial liabilities 36 65 55 57 59 61 64 66 69 52 66 Deferred revenues 137 501 477 4,481 4,044 3,671 2,974 2,474 3,016 372 2,821 Provisions for employee benefits 3 6 6 6 6 6 6 6 6 5 6 Other provisions 0 0 0 0 0 0 0 0 0 0 0

Short-term liabilities 14,499 17,310 88,588 116,548 103,397 125,337 153,084 128,403 156,392 40,132 145,960

Liabilities due to banks 1,301 0 7 0 0 0 0 0 0 436 0 Accounts payable 997 963 11,007 77,450 83,501 33,542 101,272 98,234 39,704 4,322 79,736 Other payables 12,067 16,180 77,430 22,079 4,416 76,995 41,210 21,252 104,518 35,226 55,660 Deferred revenues 75 71 39 16,913 15,374 14,686 10,496 8,810 12,065 62 10,457 Provisions for employee benefits 20 20 20 20 20 20 20 20 20 20 20 Other financial liabilities 33 69 51 50 50 50 50 50 50 51 50 Tax liabilities 0 0 5 0 0 0 0 0 0 2 0 Other provisions 6 7 28 36 36 44 36 36 36 14 36 Deferred tax liabilities 2,249 708 1,124 21,626 24,160 10,097 27,693 26,901 9,787 1,360 21,460

Total liabilities and equity 56,711 63,473 145,623 313,340 431,035 492,343 684,574 801,956 865,525 88,602 784,018

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CFA Research Challenge CD Projekt SA (CDR) 2015-02-10

Appendix 8: Statement of Comprehensive Income (CD Projekt RED, Games Development Business)

Actuals Estimates CAGR (in %) in PLN '000 as of Dec-31 2012A 2013A 2014A 2015E 2016E 2017E 2018E 2019E 2020E '12-16 '12-20

Sales of products 44,246 23,208 19,452 210,256 235,937 96,555 284,770 277,619 114,292 35.7% 25.6% Sales of services 165 0 0 0 0 0 0 0 0 nm nm Sales of goods and materials 3,067 371 15,402 34,987 28,467 9,655 35,904 33,438 11,429 25.4% 17.6% Total sales 47,478 23,579 34,854 245,243 264,404 106,210 320,675 311,056 125,721 34.1% 24.4%

Costs of products and services sold (13,126) (6,133) (7,874) (66,372) (74,033) (29,739) (89,789) (87,096) (35,202) 35.8% 25.7% Value of goods and materials sold (2,394) (204) (14,719) (23,201) (26,440) (10,621) (32,067) (31,106) (12,572) 23.1% 17.8% Cost of materials (15,520) (6,337) (22,592) (89,573) (100,474) (40,360) (121,856) (118,201) (47,774) 31.6% 23.1%

Gross profit 31,958 17,242 12,262 155,670 163,931 65,850 198,818 192,855 77,947 35.8% 25.4% Other operating income 1,595 525 2,411 3,412 6,257 8,683 7,315 7,600 10,546 26.3% 21.1% Sales and marketing expenses (2,850) (6,419) (15,506) (12,945) (16,653) (10,090) (17,087) (19,593) (11,943) 8.2% 7.8% General & admin. expenses (4,538) (6,779) (6,347) (7,473) (8,600) (10,863) (16,702) (16,982) (19,740) 7.3% 13.1% Other operating expenses (1,632) (133) (1,676) (2,983) (3,777) (3,264) (4,144) (3,864) (3,062) 19.5% 13.9%

EBIT 24,533 4,436 (8,857) 135,680 141,157 50,317 168,199 160,016 53,748 59.2% 38.7%

Interest income 1,144 2,017 1,767 7,837 20,005 17,757 16,133 20,300 13,319 44.9% 29.3% Interest expense (1,106) (385) (1,460) (1,243) (2,215) (1,646) (2,142) (3,335) (2,676) 9.6% 12.0%

EBT 24,571 6,068 (8,550) 142,274 158,947 66,428 182,189 176,981 64,390 59.8% 38.8%

Income tax (2,842) (972) 1,176 (27,032) (30,200) (12,621) (34,616) (33,626) (12,234) 72.6% 46.2%

Net income (loss) 21,729 5,096 (7,373) 115,242 128,747 53,807 147,573 143,354 52,156 57.6% 37.6%

Key financials analysis Actuals Estimates YoY growth (in %) 2012A 2013A 2014A 2015E 2016E 2017E 2018E 2019E 2020E

Sales (2.4%) (50.3%) 47.8% 603.6% 7.8% (59.8%) 201.9% (3.0%) (59.6%) Cost of materials 11.0% (59.2%) 256.5% 296.5% 12.2% (59.8%) 201.9% (3.0%) (59.6%) Gross profit (7.8%) (46.0%) (28.9%) nm 5.3% (59.8%) 201.9% (3.0%) (59.6%) Other operating income (60.5%) (67.1%) 359.2% 41.5% 83.4% 38.8% (15.8%) 3.9% 38.8% Sales and marketing expenses (35.4%) 125.2% 141.6% (16.5%) 28.6% (39.4%) 69.3% 14.7% (39.0%) General & admin. expenses (39.4%) 49.4% (6.4%) 17.7% 15.1% 26.3% 53.8% 1.7% 16.2% Other operating expenses (58.9%) (91.9%) nm 78.0% 26.6% (13.6%) 27.0% (6.8%) (20.7%)

EBIT 7% (82%) nm nm 4% (64%) 234% (5%) (66%)

Interest income 348.6% 76% (12%) 343% 155% (11%) (9%) 26% (34%) Interest expense 29.4% (65%) 279% (15%) 78% (26%) 30% 56% (20%)

EBT 10% (75%) nm nm 12% (58%) 174% (3%) (64%)

Income tax 4.8% (66%) nm nm 12% (58%) 174% (3%) (64%)

Net income (loss) 11% (77%) nm nm 12% (58%) 174% (3%) (64%)

in % as of sales 2012A 2013A 2014A 2015E 2016E 2017E 2018E 2019E 2020E

Cost of materials 32.7% 26.9% 64.8% 36.5% 38.0% 38.0% 38.0% 38.0% 38.0% Gross profit 67.3% 73.1% 35.2% 63.5% 62.0% 62.0% 62.0% 62.0% 62.0% Other operating income 3.4% 2.2% 6.9% 1.4% 2.4% 8.2% 2.3% 2.4% 8.4% Sales and marketing expenses 6.0% 27.2% 44.5% 5.3% 6.3% 9.5% 5.3% 6.3% 9.5% General & admin. expenses 9.6% 28.8% 18.2% 3.0% 3.3% 10.2% 5.2% 5.5% 15.7% Other operating expenses 3.4% 0.6% 4.8% 1.2% 1.4% 3.1% 1.3% 1.2% 2.4%

EBIT 51.7% 18.8% -25.4% 55.3% 53.4% 47.4% 52.5% 51.4% 42.8%

Interest income 2.4% 8.6% 5.1% 3.2% 7.6% 16.7% 5.0% 6.5% 10.6% Interest expense 2.3% 1.6% 4.2% 0.5% 0.8% 1.5% 0.7% 1.1% 2.1%

EBT 51.8% 25.7% -24.5% 58.0% 60.1% 62.5% 56.8% 56.9% 51.2%

Income tax 6.0% 4.1% -3.4% 11.0% 11.4% 11.9% 10.8% 10.8% 9.7%

Net income (loss) 45.8% 21.6% -21.2% 47.0% 48.7% 50.7% 46.0% 46.1% 41.5%

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CFA Research Challenge CD Projekt SA (CDR) 2015-02-10

Appendix 9: Common-Size State of Financial Position (CD Projekt RED, Games development business)

% of assets Actuals Estimates Averages

2012A 2013A 2014E 2015E 2016E 2017E 2018E 2019E 2020E '12-14 '18-20

Goodwill 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% Intangible assets 2.9% 4.8% 2.6% 1.4% 1.1% 1.0% 0.8% 0.7% 0.7% 3.4% 0.7% Tangible assets 4.1% 4.9% 2.2% 1.0% 0.8% 0.8% 0.6% 0.6% 0.6% 3.7% 0.6% Investments in subsidiaries 0.0% 0.0% 12.3% 5.7% 4.1% 3.6% 2.6% 2.2% 2.1% 4.1% 2.3%

Total fixed assets 7.0% 9.7% 17.1% 8.2% 6.0% 5.4% 4.0% 3.6% 3.4% 11.2% 3.7%

Other long-term assets 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% Inventories 46.4% 70.1% 61.0% 30.4% 18.9% 25.7% 18.2% 12.8% 17.6% 59.2% 16.2%

Accounts receivable and other assets 26.1% 12.2% 10.1% 19.2% 14.4% 4.9% 10.2% 8.1% 3.0% 16.2% 7.1%

Accounts receivable 23.2% 5.5% 5.5% 17.2% 12.9% 4.4% 9.1% 7.2% 2.6% 11.4% 6.3% Other receivables 2.5% 4.8% 4.2% 1.9% 1.4% 0.5% 1.0% 0.8% 0.3% 3.8% 0.7% Income tax receivable 0.0% 1.4% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.5% 0.0% Other financial assets 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% Prepaid expenses 0.4% 0.5% 0.5% 0.1% 0.1% 0.1% 0.1% 0.0% 0.1% 0.5% 0.1% Cash and cash equivalents 20.5% 7.9% 11.6% 42.2% 60.5% 63.9% 67.5% 75.5% 76.0% 13.3% 73.0%

Total current assets 93.0% 90.3% 82.7% 91.7% 93.9% 94.5% 95.9% 96.4% 96.6% 88.7% 96.3%

Deferred tax assets 0.0% 0.0% 0.2% 0.1% 0.1% 0.1% 0.0% 0.0% 0.0% 0.1% 0.0%

Total assets 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%

Equity 70.2% 70.7% 38.0% 54.5% 69.5% 71.7% 73.1% 80.3% 80.4% 59.6% 78.0%

Shareholders' equity 70.2% 70.7% 38.0% 54.5% 69.5% 71.7% 73.1% 80.3% 80.4% 59.6% 78.0% Minority interest 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%

Long-term liabilities 0.3% 0.9% 0.4% 1.4% 1.0% 0.8% 0.4% 0.3% 0.4% 0.5% 0.4%

Liabilities due to banks 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% Other financial liabilities 0.1% 0.1% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.1% 0.0% Deferred revenues 0.2% 0.8% 0.3% 1.4% 0.9% 0.7% 0.4% 0.3% 0.3% 0.5% 0.4% Provisions for employee benefits 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% Other provisions 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%

Short-term liabilities 25.6% 27.3% 60.8% 37.2% 24.0% 25.5% 22.4% 16.0% 18.1% 37.9% 18.8%

Liabilities due to banks 2.3% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.8% 0.0% Accounts payable 1.8% 1.5% 7.6% 24.7% 19.4% 6.8% 14.8% 12.2% 4.6% 3.6% 10.5% Other payables 21.3% 25.5% 53.2% 7.0% 1.0% 15.6% 6.0% 2.6% 12.1% 33.3% 6.9% Deferred revenues 0.1% 0.1% 0.0% 5.4% 3.6% 3.0% 1.5% 1.1% 1.4% 0.1% 1.3% Provisions for employee benefits 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% Other financial liabilities 0.1% 0.1% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.1% 0.0% Tax liabilities 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% Other provisions 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% Deferred tax liabilities 4.0% 1.1% 0.8% 6.9% 5.6% 2.1% 4.0% 3.4% 1.1% 2.0% 2.8%

Total liabilities and equity 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%

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CFA Research Challenge CD Projekt SA (CDR) 2015-02-10

Appendix 10: Common-Size Statement of Comprehensive Income (CD Projekt RED, Games Development Bus.)

% of revenues Actuals Estimates Averages

2012A 2013A 2014E 2015E 2016E 2017E 2018E 2019E 2020E '12-14 '18-20

Sales of products 93.2% 98.4% 55.8% 85.7% 89.2% 90.9% 88.8% 89.3% 90.9% 82.5% 89.7% Sales of services 0.3% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.1% 0.0% Sales of goods and materials 6.5% 1.6% 44.2% 14.3% 10.8% 9.1% 11.2% 10.7% 9.1% 17.4% 10.3% Total revenues 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%

Cost of products and services sold 27.6% 26.0% 22.6% 27.1% 28.0% 28.0% 28.0% 28.0% 28.0% 25.4% 28.0% Value of goods and materials sold 5.0% 0.9% 42.2% 9.5% 10.0% 10.0% 10.0% 10.0% 10.0% 16.0% 10.0% COGS 32.7% 26.9% 64.8% 36.5% 38.0% 38.0% 38.0% 38.0% 38.0% 41.5% 38.0%

Gross profit 67.3% 73.1% 35.2% 63.5% 62.0% 62.0% 62.0% 62.0% 62.0% 58.5% 62.0%

General and administrative costs 9.6% 28.8% 18.2% 3.0% 3.3% 10.2% 5.2% 5.5% 15.7% 18.8% 8.8% Selling costs 6.0% 27.2% 44.5% 5.3% 6.3% 9.5% 5.3% 6.3% 9.5% 25.9% 7.0% Other operating income 3.4% 2.2% 6.9% 1.4% 2.4% 8.2% 2.3% 2.4% 8.4% 4.2% 4.4% Other operating expenses 3.4% 0.6% 4.8% 1.2% 1.4% 3.1% 1.3% 1.2% 2.4% 2.9% 1.7%

EBIT 51.7% 18.8% (25.4%) 55.3% 53.4% 47.4% 52.5% 51.4% 42.8% 15.0% 48.9%

Interest income 2.4% 8.6% 5.1% 3.2% 7.6% 16.7% 5.0% 6.5% 10.6% 5.3% 7.4% Interest expenses 2.3% 1.6% 4.2% 0.5% 0.8% 1.5% 0.7% 1.1% 2.1% 2.7% 1.3%

EBT 51.8% 25.7% (24.5%) 58.0% 60.1% 62.5% 56.8% 56.9% 51.2% 17.7% 55.0%

Income taxes 6.0% 4.1% (3.4%) 11.0% 11.4% 11.9% 10.8% 10.8% 9.7% 2.2% 10.4%

Net income (loss) 45.8% 21.6% (21.2%) 47.0% 48.7% 50.7% 46.0% 46.1% 41.5% 15.4% 44.5%

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CFA Research Challenge CD Projekt SA (CDR) 2015-02-10

Appendix 11: Statement of Key Financial Ratios (CD Projekt RED, Games Development Business)

Key ratios Actuals Estimates Averages

2012A 2013A 2014E 2015E 2016E 2017E 2018E 2019E 2020E '12-14 '18-20

Profitability

Operating profit margin 51.7% 18.8% (25.4%) 55.3% 53.4% 47.4% 52.5% 51.4% 42.8% 15.0% 48.9% Net profit margin 45.8% 21.6% (21.2%) 47.0% 48.7% 50.7% 46.0% 46.1% 41.5% 15.4% 44.5% Return on assets 38.3% 8.0% (5.1%) 36.8% 29.9% 10.9% 21.6% 17.9% 6.0% 13.8% 15.2% Return on equity 54.6% 11.4% (13.3%) 67.5% 43.0% 15.2% 29.5% 22.3% 7.5% 17.6% 19.7%

Liquidity

Current ratio 363.6% 331.1% 136.0% 246.6% 391.4% 371.2% 429.0% 602.0% 534.5% 276.9% 521.8% Quick ratio 182.3% 73.9% 35.6% 164.9% 312.5% 270.4% 347.4% 522.2% 436.9% 97.3% 435.5% Cash ratio 80.1% 29.1% 19.0% 113.3% 252.3% 251.0% 301.9% 471.6% 420.6% 42.7% 398.0%

Efficiency

Total asset turnover 83.7% 37.1% 23.9% 78.3% 61.3% 21.6% 46.8% 38.8% 14.5% 48.3% 33.4% Inventory turnover 180.6% 53.0% 39.2% 257.4% 324.1% 84.0% 256.8% 303.3% 82.4% 90.9% 214.2% Inventory to assets 46.4% 70.1% 61.0% 30.4% 18.9% 25.7% 18.2% 12.8% 17.6% 59.2% 16.2%

Financial leverage

Long-term debt to assets 0.3% 0.9% 0.4% 1.4% 1.0% 0.8% 0.4% 0.3% 0.4% 0.5% 0.4% Long-term debt to equity 0.4% 1.3% 1.0% 2.7% 1.4% 1.1% 0.6% 0.4% 0.4% 0.9% 0.5% Total debt to equity 36.9% 39.8% 161.0% 71.0% 35.9% 36.5% 31.2% 20.3% 22.9% 79.2% 24.8% Interest-bearing debt to assets 2.4% 0.2% 0.1% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.9% 0.0% Interest-bearing debt to equity 3.4% 0.3% 0.2% 0.1% 0.0% 0.0% 0.0% 0.0% 0.0% 1.3% 0.0%

Shareholder ratios

Earnings per share (in PLN) 0.23 0.05 -0.08 1.21 1.36 0.57 1.55 1.51 0.55 0.07 1.20

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CFA Research Challenge CD Projekt SA (CDR) 2015-02-10

Appendix 12 Statement of Financial Position (GOG, Online Distribution Business)

Actuals Estimates Averages

As of Dec-31 2012A 2013A 2014E 2015E 2016E 2017E 2018E 2019E 2020E '12-14 '18-20

Goodwill 0 0 0 0 0 0 0 0 0 0 0 Intangible assets 685 924 916 944 982 1,022 1,063 1,107 1,152 842 1,107 Tangible assets 13 300 1,929 2,295 2,685 3,141 3,674 4,299 5,029 747 4,334 Investments in subsidiaries 0 0 0 0 0 0 0 0 0 0 0

Total fixed assets 698 1,224 2,845 3,239 3,667 4,163 4,738 5,405 6,180 1,589 5,441

Other long-term assets 0 0 0 0 0 0 0 0 0 0 0 Inventories 0 0 0 0 0 0 0 0 0 0 0

Accounts receivable and other assets 8,847 7,389 7,812 9,224 9,404 9,593 9,791 9,999 10,217 8,016 10,002

Accounts receivable 4,445 4,547 3,169 4,638 4,731 4,825 4,922 5,020 5,121 4,054 5,021 Other receivables 1,543 174 3,245 3,343 3,479 3,620 3,767 3,920 4,079 1,654 3,922 Income tax receivable 0 0 117 0 0 0 0 0 0 39 0 Other financial assets 0 0 0 0 0 0 0 0 0 0 0 Prepaid expenses 2,859 2,668 1,281 1,243 1,194 1,147 1,102 1,058 1,017 2,269 1,059

Cash and cash equivalents 13,594 16,487 22,629 44,766 67,043 73,798 91,753 118,156 153,024 17,570 120,978

Total current assets 22,441 23,876 30,441 53,990 76,447 83,391 101,544 128,155 163,241 25,586 130,980

Deferred tax assets 33 13 1 1 0 0 0 0 0 16 0

Total assets 23,172 25,113 33,287 57,230 80,114 87,554 106,282 133,560 169,421 27,191 136,421

Equity 10,947 14,243 13,966 23,098 30,709 33,082 39,768 48,361 50,966 13,052 46,365

Shareholders' equity 10,947 14,243 13,966 23,098 30,709 33,082 39,768 48,361 50,966 13,052 46,365 Minority interest 0 0 0 0 0 0 0 0 0 0 0

Long-term liabilities 38 24 17 15 14 14 13 12 12 26 12

Liabilities due to banks 0 0 0 0 0 0 0 0 0 0 0 Other financial liabilities 0 0 0 0 0 0 0 0 0 0 0 Deferred revenues 36 19 12 10 11 12 12 11 12 22 12 Provisions for employee benefits 2 5 5 5 3 2 1 1 0 4 1 Other provisions 0 0 0 0 0 0 0 0 0 0 0

Short-term liabilities 12,187 10,846 19,304 34,117 49,391 54,458 66,501 85,186 118,444 14,112 90,044

Liabilities due to banks 0 1 0 0 0 0 0 0 0 0 0 Accounts payable 10,087 8,512 7,520 17,371 24,506 21,350 31,259 45,766 67,005 8,706 48,010 Other payables 1,743 2,063 4,587 4,698 11,992 22,439 27,230 32,745 45,835 2,798 35,270 Deferred revenues 18 17 7,182 12,033 12,459 9,193 7,489 6,100 4,969 2,406 6,186 Provisions for employee benefits 155 57 0 0 0 0 0 0 0 71 0 Other financial liabilities 0 0 0 0 0 0 0 0 0 0 0 Tax liabilities 184 196 15 15 433 1,476 524 576 634 132 578 Other provisions 0 0 0 0 0 0 0 0 0 0 0 Deferred tax liabilities 0 0 0 0 0 0 0 0 0 0 0

Total liabilities and equity 23,172 25,113 33,287 57,230 80,114 87,554 106,282 133,560 169,421 27,191 136,421

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Due to the volatility of CDR’s business model, the comparative measurement chosen is averages over the three years lasting development cycle of a new major gaming title. Consequently, a development can be observed when comparing the cycle average from 2012 to 2014 to the one from 2018 to 2020.

CFA Research Challenge CD Projekt SA (CDR) 2015-02-10

Appendix 13: Statement of Comprehensive Income (GOG, Online Distribution Business)

Actuals Estimates CAGR (in %) in PLN '000 as of Dec-31 2012A 2013A 2014A 2015E 2016E 2017E 2018E 2019E 2020E '12-16 '12-20

Sales of products 42,250 0 0 0 0 0 0 0 0 nm nm Sales of services 4,108 63,806 66,879 74,729 68,839 57,394 75,106 93,136 119,221 6.9% 8.8% Sales of goods and materials 0 0 0 0 0 0 0 0 0 nm nm Total sales 46,358 63,806 66,879 74,729 68,839 57,394 75,106 93,136 119,221 2.1% 5.5%

Costs of products and services sold (28,112) (39,860) (43,549) (48,670) (45,208) (41,324) (49,767) (61,078) (78,059) 3.3% 6.0% Value of goods and materials sold 0 0 0 0 0 0 0 0 0 nm nm Cost of materials (28,112) (39,860) (43,549) (48,670) (45,208) (41,324) (49,767) (61,078) (78,059) 3.3% 6.0%

Gross profit 18,246 23,946 23,329 26,058 23,631 16,070 25,339 32,058 41,162 0.1% 4.6% Other operating income 60 64 60 90 132 193 282 413 604 14.5% 24.3% Sales and marketing expenses (7,270) (10,235) (12,841) (11,968) (10,326) (8,609) (11,266) (13,970) (17,883) 0.3% 4.0% General & admin. expenses (1,404) (1,966) (2,086) (2,937) (3,779) (4,594) (5,788) (7,449) (9,485) 12.9% 17.2% Other operating expenses (15) (370) (36) (51) (74) (108) (159) (232) (340) -9.4% 6.3%

EBIT 9,617 11,439 8,426 11,193 9,584 2,952 8,408 10,820 14,058 -3.6% 1.4%

Interest income 182 156 136 687 588 181 516 664 863 20.6% 17.6% Interest expense (577) (623) (300) (962) (824) (254) (723) (930) (1,208) 5.3% 7.4%

EBT 9,222 10,972 8,262 10,918 9,348 2,879 8,202 10,554 13,713 -3.4% 1.5%

Income tax (975) (1,457) (1,215) (2,074) (1,776) (547) (1,558) (2,005) (2,605) 3.2% 6.0%

Net income (loss) 8,247 9,515 7,047 8,843 7,572 2,332 6,644 8,549 11,107 -4.6% 0.7%

Key financials analysis Actuals Estimates YoY growth (in %) 2012A 2013A 2014A 2015E 2016E 2017E 2018E 2019E 2020E

Sales 66.2% 37.6% 4.8% 11.7% (7.9%) (16.6%) 30.9% 24.0% 28.0% Cost of materials nm 41.8% 9.3% 11.8% (7.1%) (8.6%) 20.4% 22.7% 27.8% Gross profit (26.7%) 31.2% (2.6%) nm (9.3%) (32.0%) 57.7% 26.5% 28.4% Other operating income 57.9% 6.7% (6.9%) 50.8% 46.4% 46.4% 46.4% 46.4% 46.4% Sales and marketing expenses (61.8%) 40.8% 25.5% (6.8%) (13.7%) (16.6%) 30.9% 24.0% 28.0% General & admin. expenses 88.2% 40.0% 6.1% 40.7% 28.7% 21.6% 26.0% 28.7% 27.3% Other operating expenses (69.4%) nm nm 40.8% 46.4% 46.4% 46.4% 46.4% 46.4%

EBIT 89% 19% (26%) 33% (14%) (69%) 185% 29% 30%

Interest income (70.0%) (14%) (13%) 405% (14%) (69%) 185% 29% 30% Interest expense 52.2% 8% (52%) 221% (14%) (69%) 185% 29% 30%

EBT 73% 19% (25%) 32% (14%) (69%) 185% 29% 30%

Income tax 74.7% 49% (17%) 71% (14%) (69%) 185% 29% 30%

Net income (loss) 73% 15% (26%) 25% (14%) (69%) 185% 29% 30%

in % as of sales 2012A 2013A 2014A 2015E 2016E 2017E 2018E 2019E 2020E

Cost of materials 60.6% 62.5% 65.1% 65.1% 65.7% 72.0% 66.3% 65.6% 65.5% Gross profit 39.4% 37.5% 34.9% 34.9% 34.3% 28.0% 33.7% 34.4% 34.5% Other operating income 0.1% 0.3% 0.2% 0.0% 0.0% 0.2% 0.1% 0.1% 0.5% Sales and marketing expenses 15.3% 16.0% 19.2% 16.0% 15.0% 15.0% 15.0% 15.0% 15.0% General & admin. expenses 3.0% 8.3% 3.1% 3.9% 5.5% 8.0% 7.7% 8.0% 8.0% Other operating expenses 0.0% 1.6% 0.1% 0.0% 0.0% 0.1% 0.0% 0.1% 0.3%

EBIT 20.7% 17.9% 12.6% 15.0% 13.9% 5.1% 11.2% 11.6% 11.8%

Interest income 0.4% 0.7% 0.4% 0.3% 0.2% 0.2% 0.2% 0.2% 0.7% Interest expense 1.2% 2.6% 0.9% 0.4% 0.3% 0.2% 0.2% 0.3% 1.0%

EBT 19.4% 46.5% 23.7% 4.5% 3.5% 2.7% 2.6% 3.4% 10.9%

Income tax 2.1% 6.2% 3.5% 0.8% 0.7% 0.5% 0.5% 0.6% 2.1%

Net income (loss) 17.4% 40.4% 20.2% 3.6% 2.9% 2.2% 2.1% 2.7% 8.8%

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Due to the volatility of CDR’s business model, the compound annual growth rate has been adapted to account for averages of one development cycle compared to the averages of a previous one rather than single years. By using this methodology, the cycle 2012 to 2014 can be compared to the succeeding ones from 2015 to 2017 and 2018 to 2020.

CFA Research Challenge CD Projekt SA (CDR) 2015-02-10

Appendix 14: Common-Size Statement of Financial Position (GOG, Online Distribution Business)

% of assets Actuals Estimates Averages

2012A 2013A 2014E 2015E 2016E 2017E 2018E 2019E 2020E '12-14 '18-20

Goodwill 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% Intangible assets 3.0% 3.7% 2.8% 1.6% 1.2% 1.2% 1.0% 0.8% 0.7% 3.1% 0.8% Tangible assets 0.1% 1.2% 5.8% 4.0% 3.4% 3.6% 3.5% 3.2% 3.0% 2.3% 3.2% Investments in subsidiaries 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%

Total fixed assets 3.0% 4.9% 8.5% 5.7% 4.6% 4.8% 4.5% 4.0% 3.6% 5.5% 4.1%

Other long-term assets 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% Inventories 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%

Accounts receivable and other assets 38.2% 29.4% 23.5% 16.1% 11.7% 11.0% 9.2% 7.5% 6.0% 30.4% 7.6%

Accounts receivable 19.2% 18.1% 9.5% 8.1% 5.9% 5.5% 4.6% 3.8% 3.0% 15.6% 3.8% Other receivables 6.7% 0.7% 9.7% 5.8% 4.3% 4.1% 3.5% 2.9% 2.4% 5.7% 3.0% Income tax receivable 0.0% 0.0% 0.4% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.1% 0.0% Other financial assets 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% Prepaid expenses 12.3% 10.6% 3.8% 2.2% 1.5% 1.3% 1.0% 0.8% 0.6% 8.9% 0.8% Cash and cash equivalents 58.7% 65.7% 68.0% 78.2% 83.7% 84.3% 86.3% 88.5% 90.3% 64.1% 88.4%

Total current assets 96.8% 95.1% 91.5% 94.3% 95.4% 95.2% 95.5% 96.0% 96.4% 94.5% 95.9%

Deferred tax assets 0.1% 0.1% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.1% 0.0%

Total assets 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%

Equity 47.2% 56.7% 42.0% 40.4% 38.3% 37.8% 37.4% 36.2% 30.1% 48.6% 34.6%

Shareholders' equity 47.2% 56.7% 42.0% 40.4% 38.3% 37.8% 37.4% 36.2% 30.1% 48.6% 34.6% Minority interest 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%

Long-term liabilities 0.2% 0.1% 0.1% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.1% 0.0%

Liabilities due to banks 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% Other financial liabilities 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% Deferred revenues 0.2% 0.1% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.1% 0.0% Provisions for employee benefits 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% Other provisions 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%

Short-term liabilities 52.6% 43.2% 58.0% 59.6% 61.7% 62.2% 62.6% 63.8% 69.9% 51.3% 65.4%

Liabilities due to banks 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% Accounts payable 43.5% 33.9% 22.6% 30.4% 30.6% 24.4% 29.4% 34.3% 39.5% 33.3% 34.4% Other payables 7.5% 8.2% 13.8% 8.2% 15.0% 25.6% 25.6% 24.5% 27.1% 9.8% 25.7% Deferred revenues 0.1% 0.1% 21.6% 21.0% 15.6% 10.5% 7.0% 4.6% 2.9% 7.2% 4.8% Provisions for employee benefits 0.7% 0.2% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.3% 0.0% Other financial liabilities 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% Tax liabilities 0.8% 0.8% 0.0% 0.0% 0.5% 1.7% 0.5% 0.4% 0.4% 0.5% 0.4% Other provisions 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% Deferred tax liabilities 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%

Total liabilities and equity 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%

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CFA Research Challenge CD Projekt SA (CDR) 2015-02-10

Appendix 15: Common-Size Statement of Comprehensive Income (GOG, Online Distribution Business)

% of revenues Actuals Estimates Averages

2012A 2013A 2014E 2015E 2016E 2017E 2018E 2019E 2020E '12-14 '18-20

Sales of products 91.1% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 30.4% 0.0% Sales of services 8.9% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 69.6% 100.0% Sales of goods and materials 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% Total revenues 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%

Cost of products and services sold 60.6% 62.5% 65.1% 65.1% 65.7% 72.0% 66.3% 65.6% 65.5% 62.7% 65.8% Value of goods and materials sold 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% COGS 60.6% 62.5% 65.1% 65.1% 65.7% 72.0% 66.3% 65.6% 65.5% 62.7% 65.8%

Gross profit 39.4% 37.5% 34.9% 34.9% 34.3% 28.0% 33.7% 34.4% 34.5% 37.3% 34.2%

General and administrative costs 3.0% 3.1% 3.1% 3.9% 5.5% 8.0% 7.7% 8.0% 8.0% 3.1% 7.9% Selling costs 15.7% 16.0% 19.2% 16.0% 15.0% 15.0% 15.0% 15.0% 15.0% 17.0% 15.0% Other operating income 0.1% 0.1% 0.1% 0.1% 0.2% 0.3% 0.4% 0.4% 0.5% 0.1% 0.4% Other operating expenses 0.0% 0.6% 0.1% 0.1% 0.1% 0.2% 0.2% 0.2% 0.3% 0.2% 0.2%

EBIT 20.7% 17.9% 12.6% 15.0% 13.9% 5.1% 11.2% 11.6% 11.8% 17.1% 11.5%

Interest income 0.4% 0.2% 0.2% 0.9% 0.9% 0.3% 0.7% 0.7% 0.7% 0.3% 0.7% Interest expenses 1.2% 1.0% 0.4% 1.3% 1.2% 0.4% 1.0% 1.0% 1.0% 0.9% 1.0%

EBT 19.9% 17.2% 12.4% 14.6% 13.6% 5.0% 10.9% 11.3% 11.5% 16.5% 11.3%

Income taxes 2.1% 2.3% 1.8% 2.8% 2.6% 1.0% 2.1% 2.2% 2.2% 2.1% 2.1%

Net income (loss) 17.8% 14.9% 10.5% 11.8% 11.0% 4.1% 8.8% 9.2% 9.3% 14.4% 9.1%

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CFA Research Challenge CD Projekt SA (CDR) 2015-02-10

Appendix 16: Statement of Key Financial Ratios (GOG, Online Distribution Business)

Key ratios Actuals Estimates Averages

2012A 2013A 2014E 2015E 2016E 2017E 2018E 2019E 2020E '12-14 '18-20

Profitability

Operating profit margin 20.7% 17.9% 12.6% 15.0% 13.9% 5.1% 11.2% 11.6% 11.8% 17.1% 11.5% Net profit margin 17.8% 14.9% 10.5% 11.8% 11.0% 4.1% 8.8% 9.2% 9.3% 14.4% 9.1% Return on assets 35.6% 37.9% 21.2% 15.5% 9.5% 2.7% 6.3% 6.4% 6.6% 31.5% 6.4% Return on equity 75.3% 66.8% 50.5% 38.3% 24.7% 7.0% 16.7% 17.7% 21.8% 64.2% 18.7%

Liquidity

Current ratio 184.1% 220.1% 157.7% 158.2% 154.8% 153.1% 152.7% 150.4% 137.8% 187.3% 147.0% Quick ratio 184.1% 220.1% 157.7% 158.2% 154.8% 153.1% 152.7% 150.4% 137.8% 187.3% 147.0% Cash ratio 111.5% 152.0% 117.2% 131.2% 135.7% 135.5% 138.0% 138.7% 129.2% 126.9% 135.3%

Efficiency

Total asset turnover 200.1% 254.1% 200.9% 130.6% 85.9% 65.6% 70.7% 69.7% 70.4% 218.4% 70.3% Inventory to assets 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%

Financial leverage

Long-term debt to assets 0.2% 0.1% 0.1% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.1% 0.0% Long-term debt to equity 0.3% 0.2% 0.1% 0.1% 0.0% 0.0% 0.0% 0.0% 0.0% 0.2% 0.0% Total debt to equity 111.7% 76.3% 138.3% 147.8% 160.9% 164.7% 167.3% 176.2% 232.4% 108.8% 191.9% Interest-bearing debt to assets 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% Interest-bearing debt to equity 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%

Shareholder ratios

Earnings per share (in PLN) 0.09 0.10 0.07 0.09 0.08 0.02 0.07 0.09 0.12 0.09 0.09

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CFA Research Challenge CD Projekt SA (CDR) 2015-02-10

Appendix 17: Statement of Financial Position (Other, Investment Business)

Actuals Estimates Averages

As of Dec-31 2012A 2013A 2014E 2015E 2016E 2017E 2018E 2019E 2020E '12-14 '18-20

Goodwill 0 0 0 0 0 0 0 0 0 0 0 Intangible assets 48,764 57,949 58,345 66,255 69,568 73,046 80,351 88,386 92,805 55,019 87,181 Tangible assets 6,519 6,090 1,391 1,691 2,475 2,579 2,986 4,371 3,904 4,667 3,753 Investments in subsidiaries 48,043 47,251 22,917 22,917 22,917 22,917 22,917 22,917 22,917 39,404 22,917

Total fixed assets 103,326 111,290 82,653 90,863 94,960 98,542 106,254 115,674 119,626 99,090 113,851

Other long-term assets 206 241 245 251 261 272 283 294 306 231 295 Inventories 66 0 0 0 0 0 0 0 0 22 0

Accounts receivable and other assets 15,142 3,830 36,154 30,274 47,495 51,709 76,234 91,777 55,225 18,375 74,412

Accounts receivable 241 69 14,201 19,986 36,097 39,068 62,183 76,149 37,827 4,837 58,720 Other receivables 14,007 2,918 19,167 7,417 8,406 9,526 10,797 12,236 13,868 12,031 12,300 Income tax receivable 0 1 0 0 0 0 0 0 0 0 0 Other financial assets 855 805 2,730 2,813 2,927 3,046 3,169 3,298 3,432 1,463 3,300 Prepaid expenses 39 37 56 59 66 69 85 94 98 44 92 Cash and cash equivalents 568 14,975 14,672 39,597 54,733 61,387 77,827 96,037 104,485 10,072 92,783

Total current assets 15,776 18,805 50,826 69,872 102,229 113,096 154,060 187,814 159,711 28,469 167,195

Deferred tax assets 160 236 331 252 205 313 349 284 434 242 356

Total assets 119,468 130,572 134,055 161,238 197,655 212,224 260,946 304,067 280,076 128,032 281,696

Equity 106,035 120,060 124,730 149,655 184,951 200,463 246,427 288,514 265,195 116,942 266,712

Shareholders' equity 106,035 120,060 124,730 149,655 184,951 200,463 246,427 288,514 265,195 116,942 266,712 Minority interest 0 0 0 0 0 0 0 0 0 0 0

Long-term liabilities 191 555 829 2,397 2,571 1,263 3,069 3,004 1,471 525 2,515

Liabilities due to banks 0 0 0 0 0 0 0 0 0 0 0 Other financial liabilities 102 35 321 331 344 358 373 388 404 153 388 Deferred revenues 68 503 491 2,049 2,210 888 2,680 2,599 1,051 354 2,110 Provisions for employee benefits 15 17 17 17 17 17 17 17 17 16 17 Other provisions 6 0 0 0 0 0 0 0 0 2 0

Short-term liabilities 13,241 9,638 7,649 8,409 9,191 9,989 10,977 11,974 13,006 10,176 11,986

Liabilities due to banks 0 1 2 2 0 0 0 0 0 1 0 Accounts payable 11,437 9,295 6,507 7,157 7,873 8,660 9,526 10,479 11,527 9,080 10,511 Other payables 1,449 81 688 709 738 768 799 831 865 739 832 Deferred revenues 35 36 21 88 95 38 115 111 45 31 90 Provisions for employee benefits 63 67 102 115 134 157 157 157 157 77 157 Other financial liabilities 124 59 328 338 352 366 381 396 412 170 396 Tax liabilities 0 0 0 0 0 0 0 0 0 0 0 Other provisions 133 99 1 1 0 0 0 0 0 78 0 Deferred tax liabilities 1 319 847 776 943 510 472 574 405 389 483

Total liabilities and equity 119,468 130,572 134,055 161,238 197,655 212,224 260,946 304,067 280,076 128,032 281,696

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CFA Research Challenge CD Projekt SA (CDR) 2015-02-10

Appendix 18: Statement of Comprehensive Income (Other, Investment Business)

Actuals Estimates CAGR (in %) in PLN '000 as of Dec-31 2012A 2013A 2014A 2015E 2016E 2017E 2018E 2019E 2020E '12-16 '12-20

Sales of products 0 0 0 0 0 0 0 0 0 nm nm Sales of services 6,199 6,471 6,105 42,957 46,313 18,604 56,169 54,485 22,021 33.8% 24.3% Sales of goods and materials 3 2 0 0 0 0 0 0 0 nm nm Total sales 6,202 6,473 6,105 42,957 46,313 18,604 56,169 54,485 22,021 33.8% 24.3%

Costs of products and services sold (546) (651) (816) (4,612) (2,929) (1,256) (2,987) (3,429) (1,508) 27.9% 16.4% Value of goods and materials sold (3) (3) 0 0 0 0 0 0 0 nm nm Cost of materials (549) (654) (816) (4,612) (2,929) (1,256) (2,987) (3,429) (1,508) 27.8% 16.4%

Gross profit 5,653 5,819 5,289 38,345 43,384 17,348 53,182 51,056 20,514 34.5% 25.0% Other operating income 450 1,085 2,742 1,682 1,011 377 1,030 1,183 452 -5.4% -5.1% Sales and marketing expenses (1,641) (1,356) (1,596) (10,739) (6,538) (2,436) (6,661) (7,652) (2,926) 27.5% 15.8% General & admin. expenses (7,085) (4,601) (5,852) (6,431) (7,658) (7,620) (7,857) (9,151) (9,105) 3.6% 4.5% Other operating expenses (424) (635) (189) (122) (64) (24) (65) (74) (28) -25.7% -20.0%

EBIT -3,047 312 394 22,735 30,135 7,645 39,630 35,362 8,907 nm nm

Interest income 5,386 13,868 17,764 8,934 9,800 10,753 11,800 12,953 14,221 -3.7% 0.6% Interest expense (363) (345) (13,251) (897) (1,090) (1,325) (1,610) (1,957) (2,379) -21.3% -9.0%

EBT 1,976 13,835 4,907 30,772 38,846 17,073 49,820 46,359 20,749 26.9% 21.2%

Income tax 166 (253) (872) (5,847) (3,550) (1,561) (3,856) (4,271) (1,982) 50.1% 29.9%

Net income (loss) 2,142 13,582 4,035 24,925 35,295 15,512 45,964 42,087 18,767 25.1% 20.6%

Key financials analysis Actuals Estimates YoY growth (in %) 2012A 2013A 2014A 2015E 2016E 2017E 2018E 2019E 2020E

Sales (11.5%) 4.4% (5.7%) 603.6% 7.8% (59.8%) 201.9% (3.0%) (59.6%) Cost of materials 11.8% 19.1% 24.8% 465.2% (36.5%) (57.1%) 137.8% 14.8% (56.0%) Gross profit (13.2%) 2.9% (9.1%) 625.0% 13.1% (60.0%) 206.6% (4.0%) (59.8%) Other operating income (89.1%) 141.1% 152.7% (38.6%) (39.9%) (62.7%) 173.4% 14.9% (61.8%) Sales and marketing expenses 20.9% (17.4%) 17.7% 572.9% (39.1%) (62.7%) 173.4% 14.9% (61.8%) General & admin. expenses 38.6% (35.1%) 27.2% 9.9% 19.1% (0.5%) 3.1% 16.5% (0.5%) Other operating expenses (84.3%) 49.8% (70.2%) (35.2%) (48.1%) (62.7%) 173.4% 14.9% (61.8%)

EBIT (307%) (110%) 26% 5670% 33% (75%) 418% (11%) (75%)

Interest income 682.8% 157% 28% (50%) 10% 10% 10% 10% 10% Interest expense (40.6%) (5%) 3741% (93%) 22% 22% 22% 22% 22%

EBT 27% 600% (65%) 527% 26% (56%) 192% (7%) (55%)

Income tax nm nm 245% 570% (39%) (56%) 147% 11% (54%)

Net income (loss) 38% 534% (70%) 518% 42% (56%) 196% (8%) (55%)

in % as of sales 2012A 2013A 2014A 2015E 2016E 2017E 2018E 2019E 2020E

Cost of materials 8.9% 10.1% 13.4% 10.7% 6.3% 6.8% 5.3% 6.3% 6.8% Gross profit 91.1% 89.9% 86.6% 89.3% 93.7% 93.2% 94.7% 93.7% 93.2% Other operating income 7.3% 16.8% 44.9% 3.9% 2.2% 2.0% 1.8% 2.2% 2.1% Sales and marketing expenses 26.5% 20.9% 26.1% 25.0% 14.1% 13.1% 11.9% 14.0% 13.3% General & admin. expenses 114.2% 71.1% 95.9% 15.0% 16.5% 41.0% 14.0% 16.8% 41.3% Other operating expenses 6.8% 9.8% 3.1% 0.3% 0.1% 0.1% 0.1% 0.1% 0.1%

EBIT -49.1% 4.8% 6.5% 52.9% 65.1% 41.1% 70.6% 64.9% 40.4%

Interest income 86.8% 214.2% 291.0% 20.8% 21.2% 57.8% 21.0% 23.8% 64.6% Interest expense 5.9% 5.3% 217.1% 2.1% 2.4% 7.1% 2.9% 3.6% 10.8%

EBT 31.9% 213.7% 80.4% 71.6% 83.9% 91.8% 88.7% 85.1% 94.2%

Income tax nm 3.9% 14.3% 13.6% 7.7% 8.4% 6.9% 7.8% 9.0%

Net income (loss) 34.5% 209.8% 66.1% 58.0% 76.2% 83.4% 81.8% 77.2% 85.2%

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CFA Research Challenge CD Projekt SA (CDR) 2015-02-10

Appendix 19: Common-Size Statement of Financial Position (Other, Investment Business)

% of assets Actuals Estimates Averages

2012A 2013A 2014E 2015E 2016E 2017E 2018E 2019E 2020E '12-14 '18-20

Goodwill 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% Intangible assets 40.8% 44.4% 43.5% 41.1% 35.2% 34.4% 30.8% 29.1% 33.1% 42.9% 31.0% Tangible assets 5.5% 4.7% 1.0% 1.0% 1.3% 1.2% 1.1% 1.4% 1.4% 3.7% 1.3% Investments in subsidiaries 40.2% 36.2% 17.1% 14.2% 11.6% 10.8% 8.8% 7.5% 8.2% 31.2% 8.2%

Total fixed assets 86.5% 85.2% 61.7% 56.4% 48.0% 46.4% 40.7% 38.0% 42.7% 77.8% 40.5%

Other long-term assets 0.2% 0.2% 0.2% 0.2% 0.1% 0.1% 0.1% 0.1% 0.1% 0.2% 0.1% Inventories 0.1% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%

Accounts receivable and other assets 12.7% 2.9% 27.0% 18.8% 24.0% 24.4% 29.2% 30.2% 19.7% 14.2% 26.4%

Accounts receivable 0.2% 0.1% 10.6% 12.4% 18.3% 18.4% 23.8% 25.0% 13.5% 3.6% 20.8% Other receivables 11.7% 2.2% 14.3% 4.6% 4.3% 4.5% 4.1% 4.0% 5.0% 9.4% 4.4% Income tax receivable 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% Other financial assets 0.7% 0.6% 2.0% 1.7% 1.5% 1.4% 1.2% 1.1% 1.2% 1.1% 1.2% Prepaid expenses 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% Cash and cash equivalents 0.5% 11.5% 10.9% 24.6% 27.7% 28.9% 29.8% 31.6% 37.3% 7.6% 32.9%

Total current assets 13.2% 14.4% 37.9% 43.3% 51.7% 53.3% 59.0% 61.8% 57.0% 21.8% 59.3%

Deferred tax assets 0.1% 0.2% 0.2% 0.2% 0.1% 0.1% 0.1% 0.1% 0.2% 0.2% 0.1%

Total assets 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%

Equity 88.8% 91.9% 93.0% 92.8% 93.6% 94.5% 94.4% 94.9% 94.7% 91.2% 94.7%

Shareholders' equity 88.8% 91.9% 93.0% 92.8% 93.6% 94.5% 94.4% 94.9% 94.7% 91.2% 94.7% Minority interest 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%

Long-term liabilities 0.2% 0.4% 0.6% 1.5% 1.3% 0.6% 1.2% 1.0% 0.5% 0.4% 0.9%

Liabilities due to banks 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% Other financial liabilities 0.1% 0.0% 0.2% 0.2% 0.2% 0.2% 0.1% 0.1% 0.1% 0.1% 0.1% Deferred revenues 0.1% 0.4% 0.4% 1.3% 1.1% 0.4% 1.0% 0.9% 0.4% 0.3% 0.8% Provisions for employee benefits 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% Other provisions 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%

Short-term liabilities 11.1% 7.4% 5.7% 5.2% 4.6% 4.7% 4.2% 3.9% 4.6% 8.1% 4.3%

Liabilities due to banks 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% Accounts payable 9.6% 7.1% 4.9% 4.4% 4.0% 4.1% 3.7% 3.4% 4.1% 7.2% 3.7% Other payables 1.2% 0.1% 0.5% 0.4% 0.4% 0.4% 0.3% 0.3% 0.3% 0.6% 0.3% Deferred revenues 0.0% 0.0% 0.0% 0.1% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% Provisions for employee benefits 0.1% 0.1% 0.1% 0.1% 0.1% 0.1% 0.1% 0.1% 0.1% 0.1% 0.1% Other financial liabilities 0.1% 0.0% 0.2% 0.2% 0.2% 0.2% 0.1% 0.1% 0.1% 0.1% 0.1% Tax liabilities 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% Other provisions 0.1% 0.1% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.1% 0.0% Deferred tax liabilities 0.0% 0.2% 0.6% 0.5% 0.5% 0.2% 0.2% 0.2% 0.1% 0.3% 0.2%

Total liabilities and equity 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%

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CFA Research Challenge CD Projekt SA (CDR) 2015-02-10

Appendix 20: Common-Size Statement of Comprehensive Income (Other, Investment Business)

% of revenues Actuals Estimates Averages

2012A 2013A 2014E 2015E 2016E 2017E 2018E 2019E 2020E '12-14 '18-20

Sales of products 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% Sales of services 13.4% 10.1% 9.1% 57.5% 67.3% 32.4% 74.8% 58.5% 18.5% 10.9% 50.6% Sales of goods and materials 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% Total revenues 13.4% 10.1% 9.1% 57.5% 67.3% 32.4% 74.8% 58.5% 18.5% 10.9% 50.6%

Cost of products and services sold 1.2% 1.0% 1.2% 6.2% 4.3% 2.2% 4.0% 3.7% 1.3% 1.1% 3.0% Value of goods and materials sold 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% COGS 1.2% 1.0% 1.2% 6.2% 4.3% 2.2% 4.0% 3.7% 1.3% 1.1% 3.0%

Gross profit 12.2% 9.1% 7.9% 51.3% 63.0% 30.2% 70.8% 54.8% 17.2% 9.7% 47.6%

General and administrative costs 15.3% 7.2% 8.8% 8.6% 11.1% 13.3% 10.5% 9.8% 7.6% 10.4% 9.3% Selling costs 3.5% 2.1% 2.4% 14.4% 9.5% 4.2% 8.9% 8.2% 2.5% 2.7% 6.5% Other operating income 1.0% 1.7% 4.1% 2.3% 1.5% 0.7% 1.4% 1.3% 0.4% 2.3% 1.0% Other operating expenses 0.9% 1.0% 0.3% 0.2% 0.1% 0.0% 0.1% 0.1% 0.0% 0.7% 0.1%

EBIT (6.6%) 0.5% 0.6% 30.4% 43.8% 13.3% 52.8% 38.0% 7.5% (1.8%) 32.7%

Interest income 11.6% 21.7% 26.6% 12.0% 14.2% 18.7% 15.7% 13.9% 11.9% 20.0% 13.8% Interest expenses 0.8% 0.5% 19.8% 1.2% 1.6% 2.3% 2.1% 2.1% 2.0% 7.0% 2.1%

EBT 4.3% 21.7% 7.3% 41.2% 56.4% 29.7% 66.3% 49.8% 17.4% 11.1% 44.5%

Income taxes nm 0.4% 1.3% 7.8% 5.2% 2.7% 5.1% 4.6% 1.7% nm 3.8%

Net income (loss) 4.6% 21.3% 6.0% 33.4% 51.3% 27.0% 61.2% 45.2% 15.7% 10.6% 40.7%

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CFA Research Challenge CD Projekt SA (CDR) 2015-02-10

Appendix 21: Statement of Key Financial Ratios (Other, Investment Business)

Key ratios Actuals Estimates Averages

2012A 2013A 2014E 2015E 2016E 2017E 2018E 2019E 2020E '12-14 '18-20

Profitability

Operating profit margin (6.6%) 0.5% 0.6% 30.4% 43.8% 13.3% 52.8% 38.0% 7.5% -1.8% 32.7% Net profit margin 4.6% 21.3% 6.0% 33.4% 51.3% 27.0% 61.2% 45.2% 15.7% 10.6% 40.7% Return on assets 1.8% 10.4% 3.0% 15.5% 17.9% 7.3% 17.6% 13.8% 6.7% 5.1% 12.7% Return on equity 2.0% 11.3% 3.2% 16.7% 19.1% 7.7% 18.7% 14.6% 7.1% 5.5% 13.4%

Liquidity

Current ratio 119.1% 195.1% 664.5% 830.9% 1112.3% 1132.2% 1403.4% 1568.5% 1228.0% 326.3% 1400.0% Quick ratio 118.6% 195.1% 664.5% 830.9% 1112.3% 1132.2% 1403.4% 1568.5% 1228.0% 326.1% 1400.0% Cash ratio 4.3% 155.4% 191.8% 470.9% 595.5% 614.6% 709.0% 802.0% 803.4% 117.2% 771.5%

Efficiency

Total asset turnover 5.2% 5.0% 4.6% 26.6% 23.4% 8.8% 21.5% 17.9% 7.9% 4.9% 15.8% Inventory to assets 0.1% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%

Financial leverage

Long-term debt to assets 0.2% 0.4% 0.6% 1.5% 1.3% 0.6% 1.2% 1.0% 0.5% 0.4% 0.9% Long-term debt to equity 0.2% 0.5% 0.7% 1.6% 1.4% 0.6% 1.2% 1.0% 0.6% 0.4% 0.9% Total debt to equity 12.7% 8.5% 6.8% 7.2% 6.4% 5.6% 5.7% 5.2% 5.5% 9.3% 5.5% Interest-bearing debt to assets 0.2% 0.1% 0.5% 0.4% 0.4% 0.3% 0.3% 0.3% 0.3% 0.2% 0.3% Interest-bearing debt to equity 0.2% 0.1% 0.5% 0.4% 0.4% 0.4% 0.3% 0.3% 0.3% 0.3% 0.3%

Shareholder ratios

Earnings per share (in PLN) 0.02 0.14 0.04 0.26 0.37 0.16 0.48 0.44 0.20 0.07 0.38

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CFA Research Challenge CD Projekt SA (CDR) 2015-02-10

Appendix 21: Broker Recommendations on CDR Stock

Source: www.finanse.wp.pl

CFA Research Challenge CD Projekt SA (CDR) 2015-02-10

Appendix 22: CDR Shareholder and Company Structure

Short Profiles of CD Projekt RED, GOG, CDP.pl, CD Projekt Brands etc.

CD PROJEKT S.A. CD PROJEKT S.A. is the holding company of the CD PROJEKT Capital Group which focuses on the development of videogames as well as videogame and motion picture distribution

CD PROJEKT RED The CD PROJEKT RED studio is the game development division of CD PROJEKT S.A. To their activities belongs the creation of videogames and selling the associated distribution rights as well as manufacturing and selling tie-in products which exploit the commercial appeal of brands owned by the Company.

GOG.com GOG.com (formerly Good Old Games) is a sales platform for computer games and movies on the internet.

cdp.pl cdp.pl Sp. z o.o. is a video game and home video distribution company formerly named CD Projekt Sp. z o.o. and was sold in November 2014.

CD PROJEKT Brands S.A. CD PROJEKT Brands S.A. is a subsidiary of CD PROJEKT S.A., headquartered in Warsaw. The subsidiary holds the rights of “The Witcher” trademark

CFA Research Challenge CD Projekt SA (CDR) 2015-02-10

Appendix 23: Location of CD Projekt Offices

Warsaw Headquarter CDR Cracow Office CDR

Source: Company information

CFA Research Challenge CD Projekt SA (CDR) 2015-02-10

Appendix 24: Map of direct physical distribution of TWIII by CDR

Source: Company information

CFA Research Challenge CD Projekt SA (CDR) 2015-02-10

Appendix 25: Selected awards for The Witcher II

Title of Award Award issued by Best Adaptation or Use of License Gamespot Best PC Game of 2011 Gamasutra

Best PC of 2011 Egamer Studio of the Year (CD Projekt RED) Egamer Best PC Game of 2011 Kotaku

Best PC Game of 2011 Capsule Computers Best PC Game WhatifGaming Best Story Gametrailers

Best European PC Game Fun & Serious Game Festival Best Game Design European Games Awards Best Gameworld European Game Awards Best Special Edition European Game Awards Best European Script Fun & Serious Game Festival Best Graphics Technology WhatifGaming Best Looking Game Giant Bomb

Best Voice Acting WhatifGaming Fanboy Award for Best PC Game Gamesradar Best European RPG Game Fun & Serious Game Festival

Top 20 at Wired Wired Best Graphics GameBanshee

RPG of the Year GameBanshee Best RPG Narrative Gameinformer Best RPG Protagonist Gameinformer Best RPG Combat System Gameinformer Best Voice Cast Rpgsite

Best Story Vadejuegos Best RPG Vadejuegos Best PC Game Vadejuegos

Game of the Year Vadejuegos

Source: Company information

CFA Research Challenge CD Projekt SA (CDR) 2015-02-10

Appendix 26: Key Management Description of CDR (Source: Company information)

Name Position Held since Background and main responsibilities • Competed studies at Warsaw University Faculty of Physics, without diploma • CD Projekt Marketing Director (1999-2004) Associated to CD • Became sole-director of CD Projekt RED in 2006, including times of The President, Projekt since Adam Kicinski Witcher launch Joint CEO 1994, chairman • Proposed and saw through merger between CD Projekt and Optimus since 2010 • Recipient of Jan Wejchart Prize for Vision and Innovation by Polish Business Council • Graduate of Warsaw University Faculty of Management in management and Associated to CD marketing Co-Founder, Projekt since • Holder of MBA of Warsaw University Faculty of Management Joint CEO, Marcin Iwinski 1994, board • Manages business growth and international contacts Member of member since • Won the Polish edition of Entrepreneur of the Year by Ernst & Young together Board 1999 with Michal Kisincki in 2008 • Titled Polish Internet Person of the Year together with Michal Kicinski in 2010 • Completed studies at Warsaw University Faculty of Management in CFO , management and marketing Piotr Associated to CD Member of • Completed studies at Kozminki University, without diploma Nielubowicz Projekt since Board 1999, member of • Received PUNU insurance broker license in 1997 board since then • Worked for Funk Diot Greco Ltd. between 1995 and 1999 • Graduated from Lodz University Faculty of Philosophy and History Studio • Worked as a graphic designer at the agency Kolski and Partners Film & Adam Head, Associated to CD Advertising 1995-2002 Badowski Member of Projekt since 2002 • Free-lanced as a designer of video clips and adverts during Kolski time Board • Since 2002 working at CD Projekt as responsive for artistic direction

• Graduated from Nicolaus Copernicus University in Torun in English philology SVP • Completed postgraduate studies at Kozminski University in marketing and Business Michal Associated to CD management Developmen Nowakowski Projekt since 2005 • Worked at Egmont Sp.z o.o. (1999-2002) and Axel Springer Polske Sp. z.o.o. t, Member of (2002-2005) in videogames section Board • At CD Project he started as a Licensing Manager

• Completed studies at Warsaw University Faculty of Law and Administration Chairwoman • Holds solicitor’s license by Warsaw District Chamber of Solicitors Katarzyna of • Holds many other functions further to CD Projekt´s Supervisory board such as Szwarc Supervisory Director of the Legal Department of Mennica Polska S.A., Chairwoman of the Board Supervisory Board of Energopol Warszawa S.A.

• Graduate of Warsaw Polytechnic Faculty of Electronics Deputy • Has been involved with IT market since 1993 Piotr Chairman of • Began career at Baza Sp. Z o.o. and Westwood Pagowski Supervisory • Worked at Intel and Microsoft Board • Since 2011 General Director at HP Personal Systems Group in Poland • Completed studies at Warsaw Polytechnic Faculty of Technical Physics and Applied Mathematics • Completed postgraduate course at Technische Hochschule Aachen Supervisory Cezary • Obtained a technical sciences Ph.D Board Iwanski • Chairman and founder of KGHM TFI Member • Licensed investment advisor, CFA holder • Founder of Polish Institute of Directors • Supervisory Board member of many different companies

Supervisory • Graduate from University of Economics Grzegorz Board • Expert in Asset Management and Taxes in capital markets Kujawski Member • Chairman of Media-Inwestycje Warszawa Sp. z o.o.

• Completed studies at Warsaw University Faculty of Law and Administration • Manager of his own private legal practice with the focuses corporate expansion, Supervisory legal issues and economic advice Maciej Board • Managing Director of S.A.M.I. ARCHITEKCI Mariusz Lewandowski i Wspólnicy Majewski Member Sp. z o.o. • Worked at CD Projekt from 2004 to 2006, managed the growth of CD Projekt Localization Centre Sp z o.o.

CFA Research Challenge CD Projekt SA (CDR) 2015-02-10

Appendix 27: Timeline of Most Awaited Upcoming Video Games

Source: Stuff.tv

CFA Research Challenge CD Projekt SA (CDR) 2015-02-10

Appendix 28: Console and Studio Overview of Most Awaited Upcoming Videogames

Xbox Xbox Game Studio PS4 PC PS3 One 360 GTA 5 Rockstar X

Grim Fandango Remastered X X Evolve Turtle Rock Studios

Total War Attila Resident Evil Revelations 2 Capcom X X X X

Dying Light Techland Ready at Dawn and SCE The Order: 1886 X Santa Monica Studio Project CARS Slightly Mad Studios X X X Battlefield Hardline Electronic Arts

Bloodborne From Software Yoshi´s Wooly World Good-Feel/Nintendo X

Mighty No. 9 Capcom X X X X X Mortal Kombat X NetherRealm Studios X X X X X

The Witcher 3 CD Projekt RED X X X

Batman: Arkham Knight Rocksteady

Cyberpunk 2077 CD Projekt RED X X X

Star Wars Battlefront Electronic Arts X X X

Quantum Break Remedy X Tom Clancy´s Rainbow Six Ubisoft X X X Siege Uncharted 4: A Thief´s End Naughty Dog X

No Man´s Sky Hello Games X X

The Legend of Zelda Nintendo EAD

Rise of the Tomb Raider Crystal Dinamics X X

Halo 5: Guardians 343 Industries X

Tom Clancy´s The Division Ubisoft X X X Inside Limbo X X X X X Metal Gear Solid V: The Kojima Productions X X X X X Phantom Pain Mirror´s Edge Electronic Arts X X X Final Fantasy XV Square Enix X X

Crackdown Sunset Overdrive X Homefront: The Revolution Deep Silver Studios X X X

Street Fighter V Capcom X X Minecraft: Story Mode Telltale Games X X X X X

Amplitude Harmonix X X Source: Stuff.tv

CFA Research Challenge CD Projekt SA (CDR) 2015-02-10

Appendix 29: Porter’s Five Forces Analysis

Thread of new entrants 5 4 3 Thread of substitute 2 Bargaining power products 1 of suppliers 0 Legend

0 No threat to the business

Bargaining power Competition within 1 Insignificant threat to the of customers the industry business

2 Low threat to the business 3 Moderate threat to the business 4 Significant threat to the business

5 High threat to the business

Intensity of competitive rivalry | Moderate

There are some similar types of competitors available, which are also developing RPG’s. In addition, there are many game developers with different types of games (product differentiation), which can also be a direct threat for CDR. Nevertheless, games are not highly negative correlated, so that a customer may buy additionally a second game. The purchase of a game does not automatically mean that one cannot buy another game of the competition. Further, CDR enjoys high loyalty among the gamers, who are eagerly waiting for the end of the story of The Witcher trilogy.

Threat of new entrants | Insignificant

The presence of economies of scale forces new entrants to enter the market with a high cost of capital and risk. In addition, there is a high brand identification and customers loyalties for CDR. To cope with such factors, the newcomer has to take into account additional costs for advertising etcetera.

Bargaining power of suppliers | Low

The producers of hard copies represent only a small risk, as the costs relative to total costs are marginal, although about 50% of the sold games will be distributed physically. On the other hand, the distributors represent an increased risk, as they demand a considerable margin and a waiver of the major distributors is inalienable.

Bargaining power of buyers | Moderate

The biggest risk for the company are the customers who purchase the game. They can switch easily to another game and also provide the greatest cash inflows. Although there are many individual customers, but they have high requirements. Should the game not meet those requirements, then it does not result only with less revenues, but also in a loss of reputation, which can have a negative impact on future games and cash flows.

Threat of substitutes | Moderate

The threat of substitutes is considered to be moderate, even though the customer can switch easily to a different type of game. The Witcher 3: Wild Hunt is the most expected game in 2015 and is an AAA game. Additionally, no other RPG were announced to be released in the second and third quarter of 2015, except of Batman: Arkham Knight. For the last quarter of 2015 were expected several AAA games to be released, partly RPG and non RPG, which might have an impact on the sales of The Witcher 3: Wild Hunt.

CFA Research Challenge CD Projekt SA (CDR) 2015-02-10

Appendix 30: Stock Movements of CDR compared to WIG 20 and S&P500 and Major Company Events

Source: Yahoo! Finance and company information

CFA Research Challenge CD Projekt SA (CDR) 2015-02-10

Appendix 31: Discounted Cash Flow Analysis – Perpetual Growth Rate (CDR)

Key valuation assumptions Valuation date 10-Feb-2015 WACC (%) 10.2 Perpetual growth rate (%) 3.0 EBITDA exit multiple in 2020 (x) 13.4 Tax rate (%) 19.2

Projections Team projections until '20E; afterwards Terminal Value case based on '18-20 averages

as of 31-Dec (in PLNm) 15E 16E 17E 18E 19E 20E TV EBIT 169,634 180,903 60,941 216,264 206,225 76,740 166,410 Tax -33,209 -33,782 -12,985 -38,286 -38,159 -15,077 -30,508 + Depreciation -3,189 -3,490 -3,775 -4,321 -4,991 -5,316 -4,876 +/- change in NWC 11,037 3,772 -67,682 8,685 18,694 -14,386 3,360 - Capex -12,511 -8,506 -8,531 -13,423 -16,157 -10,739 -13,440 FCF 138,139 145,876 -24,483 177,561 175,594 41,853 130,698 Discounted FCF 118,077 127,395 -19,396 127,613 114,484 24,748 77,282 TV (Exit multiple) 1,292,647 TV (PGR) 1,100,534

Implied multiples (PGR) 2014E LTM 2015E EV/Sales (x) 12.1 6.8 4.7 EV/EBITDA (x) 27,776.8 19.2 9.6 EV/EBIT (x) -380.8 20.1 9.8

Perpetual growth method (PGR) % of EV Present value 2015E-2020E 492,921 29.7 Present value of terminal value 1,100,534 66.4 Present value of real options 64,375 3.9 Enterprise value 1,657,830 100.0 Net debt (206,392) Equity value 1,864,222 Implied EV/EBITDA 2015E 9.2 Implied EBIT exit multiple (x) 11.7 Implied EV/EBIT 2015E 9.4 Enterprise value sensitivity to perpetual growth rate (PLNk)

Perpetual growth rate (%) #### 2.0 2.5 3.0 3.5 4.0 9.0 1,703,753 1,802,111 1,916,862 2,052,476 2,215,213 9.5 1,590,868 1,674,414 1,770,814 1,883,281 2,016,195 10.0 1,492,215 1,563,870 1,645,761 1,740,250 1,850,488 10.5 1,405,280 1,467,257 1,537,498 1,617,774 1,710,399 WACC (%) WACC 11.0 1,328,104 1,382,113 1,442,874 1,511,735 1,590,434

Price per share (in PLN) Upside vs. market price (PLN 16.20) Perpetual growth rate (%) Perpetual growth rate (%) 2.0 2.5 3.0 3.5 4.0 2.0 2.5 3.0 3.5 4.0 9.0 20.12 21.15 22.36 23.79 25.50 9.0 24.2% 30.6% 38.0% 46.9% 57.4% 9.5 18.93 19.81 20.82 22.01 23.41 9.5 16.8% 22.3% 28.5% 35.9% 44.5% 10.0 17.89 18.64 19.51 20.50 21.66 10.0 10.4% 15.1% 20.4% 26.6% 33.7% 10.5 16.97 17.63 18.37 19.21 20.19 10.5 4.8% 8.8% 13.4% 18.6% 24.6% WACC (%) WACC WACC (%) WACC 11.0 16.16 16.73 17.37 18.10 18.92 11.0 -0.2% 3.3% 7.2% 11.7% 16.8%

Source: Team estimates

CFA Research Challenge CD Projekt SA (CDR) 2015-02-10

Appendix 32: Discounted Cash Flow Analysis – Alternative: Exit Multiple (CDR)

Key valuation assumptions Valuation date 10-Feb-2015 WACC (%) 10.2 Perpetual growth rate (%) 3.0 EBITDA exit multiple in 2020 (x) 13.4 Tax rate (%) 19.2

Projections Team projections until '20E; afterwards Terminal Value case based on '18-20 averages

Implied multiples (Exit multiple) 2014E LTM 2015E EV/Sales (x) 13.0 7.3 4.7 EV/EBITDA (x) 29,917.1 20.7 9.6 EV/EBIT (x) -410.1 21.6 9.8

Exit multiple method % of EV Present value 2015E-2020E 492,921 27.6 Present value of terminal value 1,292,647 72.4 Enterprise value 1,785,568 100.0 Net debt (206,392) Equity value 1,991,959 Implied EV/EBITDA 2015E 10.3 Implied PGR (%) 4.0 Implied EV/EBIT 2015E 10.5

EBITDA exit multiple (x) #### 13.0 13.5 14.0 14.5 15.0 9.0 1,847,220 1,898,758 1,950,297 2,001,835 2,053,373 9.5 1,805,672 1,855,839 1,906,006 1,956,173 2,006,340 10.0 1,765,354 1,814,192 1,863,030 1,911,868 1,960,706 10.5 1,726,222 1,773,772 1,821,322 1,868,872 1,916,422 WACC (%) WACC 11.0 1,688,236 1,734,537 1,780,839 1,827,141 1,873,442

Price per share (in PLN) Upside vs. market price (PLN 16.20) EBITDA exit multiple (x) EBITDA exit multiple (x) 13.0 13.5 14.0 14.5 15.0 13.0 13.5 14.0 14.5 15.0 9.0 21.63 22.17 22.71 23.26 23.80 9.0 33.5% 36.9% 40.2% 43.6% 46.9% 9.5 21.19 21.72 22.25 22.78 23.30 9.5 30.8% 34.1% 37.3% 40.6% 43.9% 10.0 20.77 21.28 21.79 22.31 22.82 10.0 28.2% 31.4% 34.5% 37.7% 40.9% 10.5 20.35 20.85 21.36 21.86 22.36 10.5 25.6% 28.7% 31.8% 34.9% 38.0% WACC (%) WACC (%) WACC 11.0 19.95 20.44 20.93 21.42 21.90 11.0 23.2% 26.2% 29.2% 32.2% 35.2%

Source: Team estimates

The exit multiple approach, replicating the 2015E EV/EBIT multiple of the peer group, confirms the initial DCF valuation with a significant premium. The approach was merely used to verify initial assumptions since the multiple-based approach is already accounted for in the comparable companies analysis.

CFA Research Challenge CD Projekt SA (CDR) 2015-02-10

Appendix 33: Forecast and Discounted Cash Flow Assumptions

1. Unit sales forecast

Due to the volatility of CDR’s two-game approach and the general project-driven industry, the sales forecast is one of the most important aspects of the DCF model at hand. While parts of sales decrease due to the sale of the former subsidiary CDP.pl, other long-awaited revenues will materialize in 2015, namely the revenues from The Witcher III. According to historic data of the previous The Witcher releases as well as data of comparable games published on VGChartz, we assume almost half of total sales to still affect the release year and the first five months after the release – for The Witcher III this is FY2015.

We generally assume, in line with CDR’s management, that the new premium titles will take three years to develop. On the sales front, after having analyzed the life cycle of The Witcher I and The Witcher II, we came to the conclusion that a five year lifecycle is sensible, although with most sales affecting the first twelve months after the release. The unit sales are estimated on a monthly basis according to our lifecycle approach for each of the upcoming premium titles as well as residual sales of previously published premium titles. This approach allows for differentiation between sales affecting the first year after the release and sales affecting the financial year of the release since, naturally, these dates will most likely not be congruent (see below). Due to this detailed approach, the unit figure for each year is much more specific than a generalized, probably annualized distribution of estimated units sold over a specified time period.

Illustrative monthly unit sales forecast for The Witcher III starting from release date (first 24 months)

1,600.00#

1,400.00#

1,200.00#

1,000.00#

800.00#

600.00#

400.00#

200.00#

0.00#

Month#1# Month#5# Month#7# Month#8# Month#9# Month#2# Month#3# Month#4# Month#6# Month#10#Month#11#Month#12#Month#13#Month#14#Month#15#Month#16#Month#17#Month#18#Month#19#Month#20#Month#21#Month#22#Month#23#Month#24#

Units#sold#(retail)# Units#sold#(Steam)# Units#sold#(GOG)# Units#sold#(PSN)# Units#sold#(XBOX#Live)#

Source: Team estimates

Illustrative monthly net receipt forecast for The Witcher III starting from release date (first 24 months)

40,000.00#

35,000.00#

30,000.00#

25,000.00#

20,000.00#

15,000.00#

10,000.00#

5,000.00#

0.00#

Net#receipts#(retail)# Net#receipts#(Steam)# Net#receipts#(GOG)# Net#receipts#(PSN)# Net#receipts#(XBOX#Live)#

Source: Team estimates

CFA Research Challenge CD Projekt SA (CDR) 2015-02-10

Unit sales forecast starting from release date (assuming a 5y life cycle)

Game Total units Year 1 Year 2 Year 3 Year 4 Year 5

The Witcher III 11,262.5 6,320.0 2,580.0 1,350.0 675.0 337.5 Cyberpunk 2077 7,883.8 4,424.0 1,806.0 945.0 472.5 236.3 Next Witcher game 13,515.0 7,584.0 3,096.0 1,620.0 810.0 405.0 Next AAA title 8,446.9 4,740.0 1,935.0 1,012.5 506.3 253.1

Source: Team estimates

Unit sales forecast and materializing financial year

Game Total units 2015 2016 2017 2018 2019 2020

The Witcher III 11,262.5 5,770.0 2,240.0 1,800.0 895.0 447.5 110.0 Cyberpunk 2077 7,883.8 0.0 4,319.0 1,736.0 1,022.0 521.5 260.8 Next Witcher game 13,515.0 0.0 0.0 0.0 6,924.0 2,688.0 2,160.0 Next AAA title 8,446.9 0.0 0.0 0.0 0.0 4,627.5 1,860.0 The Witcher I & II 290.00 200.00 90.00 0.00 0.00 0.00 0.00 Total 41,398.1 5,970.0 6,649.0 3,536.0 8,841.0 8,284.5 4,390.8

Source: Team estimates

Due to CDR’s general approach of quality above pace and due to the recent 12-weeks delay in the release of The Witcher III, we do not expect the team to finish and publish Cyberpunk 2077 in 2015, but much more likely in late Q1-16. Taking this into account, a large amount of the Cyberpunk 2077 units sold will materialize in 2016, combined with a smaller portion of The Witcher III unit sales. Consequently, 2016 will be even stronger than 2015 from the sales point of view. In total, we estimate Cyberpunk 2077, also due to the fact that the game is well anticipated and the underlying concept is known in the USA since the 1980’s, to be a successful game, however at a significant discount to The Witcher III.

In 2017, the third year in the release cycle and historically the weakest performer, CDR will not be able to maintain its newest unit sales peaks and rather show its typical volatility in revenues similar to 2014. However, with the next game from The Witcher franchise published in 2018, CDR can still rely on a basic level of games sold of the previous two AAA titles as well as a new, most likely much anticipated title from the already popular franchise. Even though management clearly specified that there will not be a fourth game of the Witcher trilogy, management made unmistakable statements that this game will not be the last of the franchise, already getting the fans’ hopes up three years before a potential release.37 Due to these aspects and an even wider radius than currently, we expect the next Witcher game to be sold at a premium compared to The Witcher III, producing an even higher figure of total units sold.

2019 will most likely be the year of the second AAA title, possibly a sequel of the Cyberpunk 2077 franchise or potentially, though more unlikely, something completely new. Consequently, similar to 2016, CDR will profit from sales of both AAA titles recently published and is forecasted to reach a similar level of unit sales. 2020, on the contrary, will be the weakest year of the cycle again, however at a higher level than 2017.

2. Revenue forecast

According to the same methodology of the unit forecast, the revenues from games sold are linked to the units on a monthly basis. The second step, however, involves the price at which the units will be sold. This is a two part planning approach: firstly, the retail and digital distribution prices were planned while secondly the split retail vs. digital distribution was assessed according to recent trends and in line with recent publications.38 Due to a severe shift in favor of digital distribution, CDR will profit much more from future units sold in terms of net receipts. Thus, console sales on PSN and XBOX Live will become much more influential than retail sales figures. Furthermore, the units sold for PC on GOG will fully proceed as net receipts. These sales figures form our estimate of CD Projekt RED and parts of the GOG sales.

Additionally, we forecast GOG to produce significantly larger revenues, on the one hand from distribution of the abovementioned games for PC, but on the other hand from the introduction of GOG Galaxy and a business model shift closer to Steampowered, that is producing substantial revenues from this kind of games releases. Currently, according to management, GOG charges c. 34% of revenues to third-party developers for using their distribution platform. This is higher than the competition which charges c. 30%. However, according to CDR’s management, this current comparative advantage is expected to vanish over the medium term. Therefore, our forecast lets the ratio converge to the competitors’ ratio over two years. Furthermore, other activities including CD Projekt Brands, the result of the intercompany transaction, are forecasted to produce revenues in the near future.

CFA Research Challenge CD Projekt SA (CDR) 2015-02-10

3. Cost of products, goods and materials sold

Conservatively, taking the highly volatile revenue forecast into account, we estimated the P&L items Cost of Products and Services Sold as well as Value of goods and materials sold at stable percentages of revenues based on historic figures. This implies certain upside potential since we expect economies of scale on the medium term. In order to keep the model stable, however, we decided to currently not implement aggressive synergy effects. This will be an item to revalue on the medium term. Similarly, the Selling Costs are linked to the COGS figure, therefore following the general growth curve.

4. Overhead

We expect the overhead of General and Administrative Costs to rise significantly. However, this position is forecasted based on historic figures with its own growth rate of [-5%,20%] depending on the quarters preceding or following major releases. In general, overhead will not follow the sales growth and thus not show the similar volatility.

5. Financial revenues

Financial revenues as well are forecasted conservatively based on historic figures connected to a growth rate. Thus, the figure inherits upside potential in terms of more aggressive planning depending on the interest level and CDR’s cash position.

6. Interest rate

Instead of using a marginal tax rate estimate derived from the peer group or historic figures, we decided to use the corporate tax rate of 19% p.a. on EBIT. This way, the upside potential of possibly 5-10% of EBIT is not yet capitalized and can be adapted in a valuation update. The conservative positions balance out the aggressively sounding, yet sensible, revenue forecasts.

7. WACC – as of 2015/02/09

� � �� = � + � 1 − � � + � ! � + � !

Risk-free rate The risk-free rate is based on current 10Y YTM government bonds (2.29% as of 2015/02/09). Based on Aswath Damodaran's computation of beta for the entertainment software sector39, unlevered by the market value debt to equity ratio for the sector. His dataset comprises 20 Beta (unlevered, entertainment software developers, including CD Projekt SA and parts of our peer group. Beta is corrected for cash) corrected for cash since the large cash portion in this subsector would severely lower beta of the company. Beta (levered) The levered beta is based on CDR's capital structure of equity to interest-bearing debt. Based on Aswath Damodaran's computation, the ERP for Poland is currently c. 7.03% Equity risk premium (Jan-15).40 Other academics, with smaller samples, come to different conclusions such as 6.3% (ERP) (P. Fernandez). Due to the sample size and computation method, we chose to follow A. Damodaran's computation of ERP. Cost of equity 10.23% based on CAPM Cost of debt Since CDR is currently not facilitating any credit line, the cost of debt is of no impact on WACC. Due to CDR's immense equity position and no interest-bearing debt, the cost of equity equals the WACC. Since we have no information on whether CDR's management is willing to change Capital structure the capital structure in the future, we kept this ratio stable. This, naturally, implies massive optimization potential in terms of income tax but also WACC, thus would severely boost a future valuation if changes of the capital structure were to be implemented. WACC 10.23%

CFA Research Challenge CD Projekt SA (CDR) 2015-02-10

Appendix 34: Discounted Cash Flow Assumptions – Other

1. Schematic price waterfall for AAA titles

With a significantly stronger brand and a much better sales position, CDR’s management believes it can maintain a higher price point for a longer time period than observed with previous titles. The price for CDR’s AAA titles on the Steampowered platform can be seen as a proxy for this trend: while The Witcher I started at a significantly lower price point, The Witcher II already raised the price by USD10, however only for a short timeframe. After several months, CDR released a limited enhanced edition, which pushed the price back up temporarily.41 According to CDR’s management, this development and a release of an enhanced edition is not to be repeated with The Witcher III and management strongly pursues a strategy of keeping the price point stable for the strongest months of the sales cycle. On the long term, we expect the much larger and more popular next generation titles to maintain a stable price higher than current averages of The Witcher I. However, units sold are most likely to decrease severely (see abovementioned sales forecast).

Due to lack of data, we forecast Cyberpunk 2077 to have a similar price waterfall than The Witcher III. This in mind, the price waterfall is an item to be assessed for alignment along the sales cycle in future quarterly updates.

$70.00

$60.00

$50.00

$40.00

$30.00

$20.00

$10.00

m4 m8 m12 m16 m20 m24 m28 m32 m36 m40 m44 m48 m52 m56 m60 m64 m68 m72 day one

The Witcher The Witcher 2 The Witcher 3 Cyberpunk 2077

Source: CDR management, team estimates

CFA Research Challenge CD Projekt SA (CDR) 2015-02-10

2. Forecast of Inventories – Development Cycle of Upcoming AAA Titles

180,000

160,000

140,000

120,000

100,000

80,000

60,000

40,000

20,000

31.03.201230.09.2012 31.03.2013 30.09.2013 31.03.2014 30.09.2014 31.03.2015 30.09.2015 31.03.2016 30.09.2016 31.03.2017 30.09.2017 31.03.2018 30.09.2018 31.03.2019 30.09.2019 31.03.2020 30.09.2020

Finished products Semi-finished products and production in progress Total inventories

Source: Team estimates

The inventory resembles a significant balance sheet item for CDR due to the recognition of game development costs as semi- finished goods. Therefore, this item is an indicator (from the cost aspect) for the value of current titles to be released. According to recent behavior, the forecast of inventories illustrates the build-up of semi-finished goods before major releases of CDR’s premium titles. These peaks can be observed in Q2-15, Q1-16, Q2-18 and Q1-19 with the next peak outside of the forecast period in Q2-21. At the time of release, major parts of the semi-finished goods are transferred into finished goods and continuously decreased according to sales.

CFA Research Challenge CD Projekt SA (CDR) 2015-02-10

3. Schematic Sample Royalty Split among Three Quarters

Sample Royalty report - classical retail

North America - 1st market quarter 2nd market North America - 3rd market quarter PC XBOX ONE / Playstation 4 quarter PC XBOX ONE / Playstation 4 Suggested Retail Price (SRP) $59.99 $59.99 … $49.99 $49.99

Sell in (units sold to retail) 200,000 200,000 … 10,000 20,000 Reatil gross sales $11,998,000 $11,998,000 … $499,900 $999,800 Average retail marigin 20% ($2,399,600) ($2,399,600) … ($99,980) ($199,960) Wholesaler Receipts $9,598,400 $9,598,400 … $399,920 $799,840

Units returned … 500 1,000 Units in retail (repriced) … 1,500 3,000 Cost of return … ($23,996) ($47,992) Cost of Price Protection … ($12,000) ($24,000) Price Protection & Returns … ($35,996) ($71,992) Product Placement / Sales Allowance 5% ($479,920) ($479,920) … ($19,996) ($39,992) Gross Revenue $9,118,480 $9,118,480 … $343,928 $687,856

Reserve taken (6 months) 15% ($1,367,772) ($1,367,772) … ($56,989) ($113,977) Reserve returned (after 2 months) … $1,367,772 $1,367,772 Distribution Fee 20% ($1,823,696) ($1,823,696) … ($68,786) ($137,571) No of units manufactured $120,000 $230,000 … $0 $10,000 Manufacturing & Distribution ($420,000) ($2,760,000) … $0 ($120,000) Net Receipts $9,024,024 … $3,280,005

Marketing spend by local distributor ($1,500,000) …

Amounts payable to CD PROJEKT S.A. $7,524,024 … $3,280,005

* theoretical data for model calculation purposes

Source: CDR management

The schematic royalty report presented above illustrates the split among revenues. Basically, the majority but not the entirety of revenues are materializing at time of sale. For a time period of six months however, a minority of gross sales functions as a buffer for returns, re-pricings, product placement and other costs related to the sale of CDR’s game titles. This way, there is only a second one-way transaction from the retailer to CDR instead of further correcting transactions back and forth. The forecasting model accounts for this fact by delaying a certain minority percentage of revenues six months after the initial sale. Due to an increased holiday activity in retail, this forecasting method is not only of cosmetic nature but rather discounts a significant amount of delayed revenues in the forthcoming financial year.

CFA Research Challenge CD Projekt SA (CDR) 2015-02-10

4. Development of Cash Flows over Time

250,000

200,000

150,000

100,000

50,000

(50,000) 2012A 2013A 2014E 2015E 2016E 2017E 2018E 2019E 2020E

Operating CF I Operating CF II Investing CF Free CF

Source: Team estimates

5. Key Performance Indicators over Time

480,000

380,000

280,000

180,000

80,000

(20,000)

2012A 2013A 2014E 2015E 2016E 2017E 2018E 2019E 2020E

Sales EBITDA EBIT EBT Net profit

Source: Team estimates

CFA Research Challenge CD Projekt SA (CDR) 2015-02-10

Appendix 35: Schematic Sample Royalty Report – Classical Retail Compared to Digital Distribution

Split of retail price in Europe and North America - video games distribution

Classical retail distribution Europe North America PC XBOX ONE / Playstation 4 PC XBOX ONE / Playstation 4 Suggested Retail Price (SRP) € 59.99 € 69.99 $59.99 $59.99 End client

Average retail marigin & VAT 40% (€24.00) (€28.00) 20% (€12.00) (€12.00) Retail Wholesaler Receipts €35.99 €41.99 $47.99 $47.99 Price Protection & Returns Retail Product Placement / Sales Allowance 5% (€1.80) (€2.10) (€2.40) (€2.40) Retail Gross Revenue €34.19 €39.89 $45.59 $45.59 Distribution Fee 20% (€6.84) (€7.98) (€9.12) (€9.12) Distributor Manufacturing & Distribution (€2.00) (€10.00) (€3.50) (€12.00) 1st party / manufacturing / transport Reserve calcaulation (+/-) 6 months 15% 15%

Net Receipts € 25.36 € 21.92 $32.97 $24.47 CD PROJEKT S.A. Marketing spend 42.27% 31.31% 54.97% 40.80%

Digital distribution Europe North America PC XBOX ONE / Playstation 4 PC XBOX ONE / Playstation 4 Suggested Retail Price (SRP) € 59.99 € 69.99 $59.99 $59.99 End client

[Average VAT in EU] 20% (€12.00) (€14.00) Distributor's Net Revenue € 47.99 € 55.99 $59.99 $59.99 Distributor Distribution Fee 30% (€14.40) (€16.80) 30% (€18.00) (€18.00) Distributor

Net Receipts € 33.59 € 39.19 € 41.99 € 41.99 CD PROJEKT S.A.

Source: CDR management

While data above does not match CDR’s exactly, it still illustrates the major difference between retail and digital distribution: margin for the developer. The abovementioned trend towards digital distribution significantly increases a developer’s margins. We accounted for this trend by adjusting the split of units sold via retail and via digital distribution, the latter producing essentially higher net receipts, thus higher revenues for CDR as a consolidated group. Furthermore, the minority of games sold on the GOG platform has the advantage of total sales flowing to CDR since the approx. 34% platform fees are consolidated as well, naturally. As a consequence, developers are heavily pushing digital distribution and the trend is expected to continue on the long term.

CFA Research Challenge CD Projekt SA (CDR) 2015-02-10

Appendix 36: Selection of Peers

Share price Market cap Net debt EV EV/Sales EV/EBIT P/E Company Country (PLNm (LC) % 52WH (PLNm) (PLNm) ) 2015E 2016E 2015E 2016E 2015E 2016E

1. Electronic Arts Inc. United States 54.4 95.5 62,218 (8,487) 53,731 3.28x 3.12x 13.4x 11.9x 21.3x 19.0x 2. Take-Two Interactive Software Inc. United States 28.5 92.4 8,831 (1,862) 6,968 1.20x 1.13x 8.6x 7.2x 19.6x 15.8x 3. Ubisoft Entertainment SA France 17.4 95.8 7,840 201 8,041 1.22x 1.13x 9.3x 8.3x 13.9x 12.9x 4. Activision Blizzard Inc. United States 21.8 90.2 57,694 (1,965) 55,729 3.41x 3.11x 11.1x 9.3x 18.4x 14.8x 5. NCsoft Corporation South Korea 218500 95.0 14,702 (2,575) 12,127 4.09x 3.68x 12.5x 10.3x 19.5x 16.2x 6. Square Enix Holdings Co., Ltd. Japan 2494 92.5 9,394 (2,220) 7,173 1.29x 1.23x 9.9x 8.4x 19.5x 16.5x Median 2.29x 2.17x 10.5x 8.8x 19.5x 16.0x Average 2.42x 2.23x 10.8x 9.2x 18.7x 15.9x

CAGR 14E - 16E EBITDA Margin EBIT Margin Net Income Margin Sales EBITDA EBIT 2015E 2016E 2015E 2016E 2015E 2016E Company (%) (%) (%) (%) (%) (%) (%) (%) (%)

1. Electronic Arts Inc. 5.8% 11.5% 16.6% 28.3% 29.1% 24.5% 26.3% 17.8% 19.0% 2. Take-Two Interactive Software Inc. nm (15.3%) (11.7%) 14.9% 15.0% 14.0% 15.8% 7.8% 9.1% 3. Ubisoft Entertainment SA 12.1% 18.1% 46.5% 42.2% 43.0% 13.1% 13.7% 8.5% 8.6% 4. Activision Blizzard, Inc. 0.4% 3.4% 2.7% 33.2% 36.2% 30.8% 33.5% 19.2% 21.7% 5. NCsoft Corporation 9.8% 13.3% 15.8% 37.3% 38.9% 32.9% 35.5% 25.4% 27.5% 6. Square Enix Holdings Co., Ltd. 8.5% 22.4% 28.9% 17.3% 18.9% 13.1% 14.7% 8.7% 9.7% Median 8.5% 12.4% 16.2% 30.8% 32.6% 19.2% 21.0% 13.3% 14.4% Average 7.3% 8.9% 16.5% 28.9% 30.2% 21.4% 23.3% 14.6% 15.9%

2015E 2016E 2015E 2016E P/E peers median 19.5 16.0 EV/EBIT peers median 10.5 8.8 EPS 1.54 1.78 EBIT 169.6 180.9 Net cash 206 372 Equity Value 1981 1965

Price from P/E 30.13 28.47 Price from EV/EBIT 20.87 20.70 Weights for years 50% 50% 50% 50% Weights for multipliers 50% 50% Price from multipliers 25.04

Source: Capital IQ, team estimates and calculations

Key data and description of the peers

Electronic Arts Inc. | USA, California, Redwood City | Founded in 1982 | Number of employees 8,3k | 2014 Revenues 16,3 Bn PLN

Electronic Arts Inc. develops, markets, publishes, and distributes game software content and services for video game consoles, personal computers, mobile phones and tablets. The company operates through EA Games, EA SPORTS, Maxis, PopCap, and All Play segments. It provides action-adventure, casual, family, fantasy, first-person shooter, horror, science fiction, role-playing, racing, simulation, sports, and strategy games under the Battlefield, Mass Effect, Need for Speed, Dragon Age, The Sims, Bejeweled, and Plants v. Zombies, as well as EA SPORTS, Battlefield 4, FIFA Street, Maxis, Madden NFL, Medal of Honor, and Star Wars brand names. The company also offers casual games, such as cards, puzzles, and word games through its pogo.com, as well as on other platforms; and digital content and Internet-based advertising services.42

Take-Two Interactive Software Inc. | USA, New York | Founded in 1993 | Number of employees 2,5k | 2014 Revenues 3,6 Bn PLN

Take-Two Interactive Software, Inc. develops, publishes, and markets interactive entertainment for consumers worldwide. The company offers its products under the Rockstar Games and 2K labels. It develops and publishes action/adventure products under the Grand Theft Auto, Max Payne, Midnight Club, and Red Dead names through developing sequels, offering downloadable episodes and content, and releasing titles for smartphones and tablets. The company also develops brands in other genres, including the L.A. Noire, Bully, and Manhunt franchises. In addition, it publishes various entertainment properties across platforms and a range of genres, including shooter, action, role-playing, strategy, sports, and family/casual entertainment under the BioShock, Mafia, Sid Meier's Civilization, and XCOM series, as well as Borderlands franchise; and various sports simulation titles, including its flagship NBA 2K series, a basketball video game and the WWE 2K series. Further, the company develops and publishes titles for the casual and family-friendly games comprising Carnival Games and Let's Cheer, as well as has an agreement with Nickelodeon to publish video games. Its portfolio of brands also comprise Evolve, Rockstar Games Presents Table Tennis, Sid Meier's Pirates!, Spec Ops, and Spin.43

Ubisoft Entertainment SA | France, Montreuil-sous-Bois | Founded in 1986 | Number of employees 9,8k | 2014 Revenues 5,0 Bn PLN

CFA Research Challenge CD Projekt SA (CDR) 2015-02-10

Ubisoft Entertainment SA produces, publishes, and distributes video games for consoles, PCs, smart phones, and tablets in physical and digital formats worldwide. It offers its products under the Assassin's Creed, Driver, Far Cry, Imagine, Just Dance, Might & Magic, Petz, Prince Of Persia, Rabbids, Rayman, The Settlers, Tom Clancy's Ghost Recon, Tom Clancy's Rainbow Six, Tom Clancy's Splinter Cell, and Watch Dogs brands.44

Activision Blizzard Inc. | USA, California, Santa Monica | Founded in 2008 | Number of employees 6,8k | 2014 Revenues 16,2 Bn PLN

Activision Blizzard, Inc. publishes online, personal computer (PC), video game console, handheld, mobile, and tablet games. The company operates through three segments: Activision, Blizzard, and Distribution. The Activision segment develops and publishes interactive software products and content, as well as sells through retail channels and digital downloads. The Blizzard segment develops, hosts, and supports subscription-based massively multi-player online role-playing game; and develops, markets, and sells role-playing action and strategy games for the PC and iPad. It also maintains a proprietary online-game related service, Battle.net. The Distribution segment provides warehousing, logistical, and sales distribution services to third-party publishers of interactive entertainment software; its own publishing operations; and manufacturers of interactive entertainment hardware. The company serves retailers and distributors, including mass-market retailers, consumer electronics stores, discount warehouses, and game specialty stores through third-party distribution, licensing arrangements, and direct digital purchases. It operates primarily in the United States, Canada, the United Kingdom, France, Germany, Ireland, Italy, Sweden, Spain, the Netherlands, Australia, South Korea, and China.45

NcSoft Corporation | South Korea, Seongnam | Founded in 1997 | Number of employees 2,1k | 2014 Revenues 2,7 Bn PLN

NCSOFT Corporation develops and publishes massively multiplayer online games. Its online games include AION, Guild Wars, Lineage, Lineage2, Blade & Soul, Guild Wars 2, Wildstar, and Lineage Eternal. The company also publishes casual games, including LoveBeat and FreeRice. In addition, it is involved in the development of software; operation of baseball team; development of mobile game; and call centre services. The company primarily operates in Korea, Japan, Taiwan, the United States, and Europe.46

Square Enix Holdings Co., Ltd. | Japan, Tokyo | Founded in 1975 | Number of employees 3,6k | 2014 Revenues 5,3 Bn PLN

Square Enix Holdings Co., Ltd. provides content, services, and products in Japan, North America, Europe, and Asia. It operates through four segments: Digital Entertainment, Amusement, Publication, and Merchandising. The Digital Entertainment segment plans, develops, distributes, and operates digital entertainment content primarily in the form of games. This segment offers digital entertainment content for various customer usage environments, including personal computers and smart devices, as well as consumer game consoles comprising handheld game machines. The Amusement segment is involved in the operation of amusement facilities. This segment is also involved in the planning, development, distribution, rental, and sale of arcade game machines and related products for amusement facilities. The Publication segment publishes comic books, game strategy books, and comic magazines. The Merchandising segment plans, produces, distributes, and licenses derivative products, such as character goods and soundtracks.47

CFA Research Challenge CD Projekt SA (CDR) 2015-02-10

Appendix 37: Market Environment Data

1. Console base at the end of 2014 in mm units

America Europe Japan Rest of World Total PS4 7.58 7.45 1.02 2.72 18.77 Xbox One 6.92 2.97 0.05 1.30 11.24

Source: VGChartz

2. Sales of latest editions of Elder Scrolls & Diablo in mm units

PS Xbox PC Total Elder Scrolls V: Skyrim* 8.34 6.09 3.67 18.10 Diablo III** 0.92 0.32 4.63 5.87

* The game released for all platforms in 2011

** The game released for PC in 2012, consoles in 2014

Source: VGChartz

3. Console base evolution in 2010-2016E

120

100 Play Station 80 Play Station 2

60 Xbox Play Station 3 40 Xbox 360

20 Play Station 4 Xbox One 0

Source: VGChartz

CFA Research Challenge CD Projekt SA (CDR) 2015-02-10

Appendix 38: Monte Carlo Simulation

For simplicity, we performed a Monte Carlo simulation based on the risks which have the highest impact and / or are most likely to occur, that may affect our DCF. The upside and downside risks with normal distributions are modelled with specific standard deviations, based on our assessment. The key assumptions of the analysis are given in the following table:

Std. Risk Drawn Quantity Distribution Comment Dev. Downside risk of not meeting the expectations of the Poor quality of Witcher 3 Sales assumptions (Units) Normal 20% gamers Delay of the Release Discounting factor (%) Normal 15% Combined both releases Forex USD Ebit (PLN) Normal 5.29% Uncovered exchange rate risk Forex EUR Ebit (PLN) Normal 1.49% Uncovered exchange rate risk Higher sales on digital Ebitda Margin (%) Normal 25% Upside risk of decreasing the margin distribution platforms More customers due to rec. Sales assumptions (Units) Normal 25% Negatively correlated with DR1 Selling the Engine Sales assumptions (Units) Normal 25% Upside risk due to additional cash inflows Successful introduction of GOG Ebitda Margin (%) Normal 15% Upside risk of decreasing the margin Galaxy

Table 1: Source: Team estimates

The Monte Carlo simulation was performed with 2,000 iterations. Based on our assumptions there is a high volatility of the EV due to the high uncertainty of the risk factors, which are described in the report. The results of the simulation are presented below.

Statistics EV Distribution of the EV Trials 2,000 Base Case 1,593,455 140 Mean 1,657,830 120 Median 1,717,156 DCF Mode --- 100 Standard Deviation 458,483 80 Variance 210*109 60 Skewness -0.2045 Kurtosis 3.54 40 Number of iterations Number of Coeff. of Variation 0.27 20 Minimum (210,792) 0 Maximum 3,346,240 Range Width 3,557,032 Mean Std. Error 10,252

Table 2: Source: Team estimates

The simulation shows an average EV of PLN 1,657.8m, which is approx. PLN 64.4m higher than our expected base case. This results from the higher possibility of the up risks which may.

CFA Research Challenge CD Projekt SA (CDR) 2015-02-10

Appendix 39: Binomial Options Pricing Model (Real Options Theory based on Cox, Ross & Rubinstein)

Regarding the possibilities which CD Projekt S.A may have due to the increase of the cash position, we assume that the money will be mostly invested for an organic growth such as recently seen in Krakow or acquisitions. In the case the amount of sales will not meet our expectations we consider an additional scenario in which the company may be acquired or taken over from a competitor. With an already well-known brand The Witcher, the game engine REDengine and the knowledge of the developing team has CD Projekt S.A. some valuable assets. To fully evaluate the option of expansion and to assess the potential additional shareholder value, the Cox-Ross-Rubinstein option pricing methodology has been applied.

General assumptions: To simplify the problem we assumed that both options are exercisable every quarter in the next two years, since an expansion cannot take place instantly and an offer to sell a company needs time to be considered by the management. To compute the probabilities of growing or decreasing in value we used the standard deviation from the Monte Carlo Analysis of 28.77%. This results in the objective probabilities of obtaining the up state 54.3% and down state 45.7% volatilities respectively. Therefore, the up movement factor is 1.15 and the down movement 0.87.

Expand scenario: In this scenario we estimate that the option to expand the company will cost around additional PLN 100m and result in a sales growth of 5%. Furthermore, we assume an increase in fixed costs of around PLN 1.5m per year.

Selling scenario: In the case of poor sales figures we assumed that the value of the main assets will be worth around PLN 250m plus the present value of future cash flows at the point of acquiring. Additionally, we considered that the company will be sold with a 20% discount.

As a consequence, the optimal decision tree could be implemented, resulting in the following decisions from period 0 to 8. The results are presented below:

1.0 2.0 3.0 4.0 5.0 6.0 7.0 8.0 Expand Expand Expand Expand Expand Expand Expand Expand Expand Expand Expand Expand Expand Expand Expand Expand Keep option Keep option Keep option Expand Keep option Keep option Keep option Keep option Expand Keep option Keep option Keep option Keep option Keep option Keep option Keep option Abandon Keep option Keep option Abandon Keep option Abandon Abandon Abandon Abandon Abandon Abandon Abandon Abandon

The decision tree shows, based on the underlying assumptions, an optimal decision path of exercising the expand option after the second period of growth. In the negative scenario we would recommend to sell the company after the fifth quarter of declining. These two options are together, based on our assumptions, PLN 64.3m worth and provide additional value to the company, resulting in a total enterprise value of PLN 1,657.8m, an equity value of PLN 1,864.2m or PLN 19.63 per share. The share price without these options would be decreased by PLN 0.67 to PLN 18.96.

Methodology

The standard capital budgeting techniques, such as the DCF analysis, fail to consider the flexibility which the management has to change the business strategy due to a current market situation. This means that the DCF approach assumes that the management will not change their strategy once a decision is made and therefore underestimates the EV, in the case of an existent uncertainty. In the first step we used the results from the Monte Carlo Simulation calculated the probabilities of obtaining the up and down state volatilities and up and down movement factors. The next step included the EV from DCF analysis which was multiplied with the movement factors minus the free cash flows, resulting in an event tree. In the last step we valued both options with the risk free probability approach resulting in the decision tree.48

CFA Research Challenge CD Projekt SA (CDR) 2015-02-10

Appendix 40: DuPont Analysis of CDR in the years 2012-2020E

Source: Team estimates

CFA Research Challenge CD Projekt SA (CDR) 2015-02-10

Appendix 41: Risk Matrices: Downside vs. Upside

Downside risks

Upside risks

Source: Team estimates

CFA Research Challenge CD Projekt SA (CDR) 2015-02-10

Appendix 42: Corporate governance evaluation

Scope Weight Score Recommendations for Best Practice for Listed Companies 25% 9 Best Practice for Management Boards of Listed Companies 25% 9 Best Practice for Supervisory Board Members 25% 8 Best Practices of Shareholders 25% 10

Overall score 9

Source: Team estimates

CFA Research Challenge CD Projekt SA (CDR) 2015-02-10

Appendix 43: Glossary

AAA games – Premium games in the higher price region with substantial development costs and a longer life cycle

Activision - Activision Blizzard Inc.

CEO – Chief Executive Officer

CFO – Chief Financial Officer

DCF – Discounted Cash Flow

DRM – digital rights management

E3 – Electronic Entertainment Expo, the most important annual trade fair in the gaming industry

EA - Electronic Arts Inc.

EV – Enterprise Value

FCFF – Free Cash flow to the Firm

IIA - Individual Investor Association

MBA – Master of Business Administration

Mio – Million

NCsoft - NCsoft Corporation

PS4 – Sony PlayStation 4

RPG – role-playing games

S.A. – Spółka Akcyjna

S&P500 – Standard & Poor´s 500, American Stock Index

Square - Square Enix Holdings Co., Ltd.

SVP – Senior Vice President

Take-Two - Take-Two Interactive Software Inc.

TWI – The Witcher I

TWII – The Witcher II

TWIII – The Witcher III

Ubisoft - Ubisoft Entertainment SA

WACC – Weighted Average Cost of Capital

WIG20 – Index of Warsaw Stock Exchange

CFA Research Challenge CD Projekt SA (CDR) 2015-02-10

Appendix 44: References

1 CD Projekt Group website, https://www.cdprojekt.com/en/Capital_group/Business_profile, 2014/12/07 2 CD Projekt RED website, http://en.cdprojektred.com/news/, 2014/12/20, 2014/12/07 3 CD Projekt Group company presentation, 2014/11/21, ’CD Projekt Group – CFA Society meeting presentation’ 4 CD Projekt Group website, https://www.cdprojekt.com/en/Capital_group/Business_profile, 2014/12/10 5 GOG.com website, http://www.gog.com/galaxy, 2014/12/14 6 Forbes, 2012/5/18, ''The Truth Is, It Doesn't Work' - CD Projekt On DRM' 7 CD Projekt Group website, https://www.cdprojekt.com/en/Capital_group/Business_profile, 2014/16/07 8 Reuters, 2015/11/24, 'CD Projekt SA decreases its stake in cdp.pl to 8.29 pct' 9 Warsaw Stock Exchange website, http://www.gpw.pl/karta_spolki_en/PLOPTTC00011/#shareholders, 2015/01/03 10 CD Projekt Group website, https://www.cdprojekt.com/en/Investor_Relations/Stock_Exchange/Shareholders, 2015/01/03 11 CD Projekt Group website, https://www.cdprojekt.com/en/Capital_group/Managing_bodies, 2015/01/07 12 Newzoo, 2013, “Global Games Market Grows to $86.1bn in 2016”. 13 The NPD Group, “Games Market Dynamics: U.S.” 14 TechNavio, 2014, “Global Digital Game Market 2014-2018”, press release. 15 United States Bureau of Economic Analysis, 2015, “US Per Capita Disposable Personal Income”, United States Census Bureau, 2014, “2014 to 2060 Population Projections based on Census 2010”, World Health Organization – Regional Office for Europe, 2015, “Demographic trends, statistics and data on ageing”. 16 Wedbush, 2014, ”Post Hoc Ergo Proper Hoc; Why the Next Generation Will Be as Big as Ever“. 17 Waypoint, 2014, ”Are Gamers the Most Valuable Audience?“, Entertainment Software Association, 2014, “2014 Essential Facts About the Computer and Video Game Industry”. 18 CNET, 2015/01/05, ”Sony's PlayStation 4 sells 18.5 million units“. 19 Metacritic, 2015/02/09, Aggregate Score on The Witcher 2: Assassins of Kings (PC). 20 Official website, https://www.batmanarkhamknight.com, 2015/02/09. 21 Gamespot, 2013, “Warner Bros. bringing the Witcher 3 to North America”. 22 Wedbush, 2014, ”Post Hoc Ergo Proper Hoc; Why the Next Generation Will Be as Big as Ever“. 23 IGN, 2015/01/07, “Cyberpunk 2077 Still in Development as CD Projekt RED Focuses on The Witcher 3”. 24 Cyberpunk trivia website, http://cyberpunk.wikia.com/wiki/Cyberpunk_2020, http://cyberpunk.wikia.com/wiki/Datafortress_2020. 25 Gamespot, 2014/06/03, “Obama Mentions ‘The Witcher’ During Trip to Poland”. 26 Gamespot, 2014/06/09, “E3 2014: New The Witcher 3: Wild Hunt Gamplay on Xbox One”, PCGamesN, 2014, “How CD Projekt RED fought the publishers to win their independence”. 27 Digital Capital Advisors, 2014, “Gaming Sector: New Categories Take Center Stage”, VGChartz, 2015, “Global Hardware Totals”. 28 PCGamesN, 2014, “How CD Projekt RED fought the publishers to win their independence”. 29 CDR website / Dark Horse website, 2014, ”CD Projekt RED and Dark Horse present the world of The Witcher“. 30 Mergermarket, 2013/08/13, “CD Projekt looks to buy mobile game maker”, IGN, 2014/07/01, “CD Projekt RED announces The Witcher MOBA”. 31 Forbes, Mergermarket, 2014/05/09, “Candy Crush Maker Tries M&A Game”. 32 Cox, J. C.; Ross, S. A.; Rubinstein, M. (1979), “Option pricing: A simplified approach”, Journal of Financial Economics. 33 Statement regarding the implementation of corporate governance rules at the CD PROJEKT Capital Group in 2013 – supplementing the Management Board Report on CD PROJEKT Capital Group Activities in 2013. 34 http://www.corp-gov.gpw.pl/publications.asp?jezyk=angielski 35 http://www.sii.org.pl/5953/edukacja-i-analizy/raporty-analityczne/raport-cd-projekt-red.html (available in polish) 36 Nielsen.com, http://www.nielsen.com/us/en/insights/news/2013/under-the-influence-consumer-trust-in-advertising.html. 37 PCGamer, 2013/02/08, “CD Projekt RED: The Witcher 3 concludes trilogy, but not franchise”. 38 The NPD Group, 2014, “Games Market Dynamics: U.S.”. 39 Damodaran, A., 2015, “Betas by Sector”. 40 Damodaran, A., 2015, “Country Default Spreads and Risk Premiums”. 41 Witcher trivia website, http://witcher.wikia.com/wiki/The_Witcher_2:_Enhanced_Edition. 42 CapitalIQ, https://www.capitaliq.com/CIQDotNet/company.aspx?companyId=27963, 2015/02/10 43 CapitalIQ, https://www.capitaliq.com/CIQDotNet/company.aspx?companyId=371281&fromSearchProfiles=true, 2015/02/10 44 CapitalIQ, https://www.capitaliq.com/CIQDotNet/company.aspx?companyId=882201&fromSearchProfiles=true, 2015/02/10 45 CapitalIQ, https://www.capitaliq.com/CIQDotNet/company.aspx?companyId=4222231, 2015/02/10 46 CapitalIQ, https://www.capitaliq.com/CIQDotNet/company.aspx?companyId=1261518, 2015/02/10 47 CapitalIQ, https://www.capitaliq.com/CIQDotNet/company.aspx?companyId=884137, 2015/02/10 48 Copeland, Antikarow; 2003. “Real Options: A Practitioner’s Guide”.

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