EQUITY RESEARCH 23 November 2016 Funcom Investment summary Background: Norwegian-United States game developer with more than 20 years of experience. Funcom is an Oslo Stock Exchange listed game developer with around 100 employees in Norway and USA. The company was established in 1993 and since its inception raised approx. USD 190m in fresh equity and launched several major games. Funcom has been a loss maker for most of the time. This reflects the fact that the games had failed to meet sales expectations and the Company failed to manage its costs. However, over the last few years the company has made aggressive cost cuts. Costs have fallen faster than revenues, thus profitability has improved. This is reflected by the fact that last year’s EBITDA was the highest in ten years. After financial restructuring last spring the Company has managed to significantly reduce losses. This, combined with a strengthened balance sheet, suggests that the road to becoming a profitable company with a healthy balance sheet has become much shorter. Conan Exiles game release in January 2017: Expect a strong share price rally before the launch Conan Exiles- Funcom’s fifth major online multiplayer game launch is due end of January 2017. Conan Exiles target the popular Open World Survival Segment. The game’s main objective is to survive, build and dominate in the hostile lands of Conan the Barbarian. History shows that investor should buy, build a position and dominate Funcom in the four months preceding the major game launch. An expectation driven share price rally has materialized ahead of every major game release in the past. Should Funcom achieve a similar market cap as it did before previous major launches, its share price may reach: NOK 6.5 (Deamfall), NOK 12 (Age of Conan), NOK 6.2 (The Secret World) or NOK 2.1 (Lego Minifigures) We expect that the share price should rise to at least NOK 2.1 before the launch as the backdrop seems much stronger now rather than before the Lego launch. First, during the Lego launch Funcom struggled with legal problems (Financial Crime Police-investigation of possible insider trading). Second, the balance sheet was much weaker then. Finally, the valuation of the peer group is higher today. Funcom desperately needs success: New CEO and credible strategy implemented It is difficult to forecast the chance of success (CoS) in the gaming industry. However, we would like to highlight that we have a positive impression of the new CEO, Mr. Rui Manuel Monteiro Casais. He is the former CTO of the company. He is young, humble, hard-working and possesses deep and detailed knowledge of the industry. The new strategy: one major and two minor game launches per year, carries lower risk and has a higher success chance of producing sustainable profitability. Funcom also seems more aware of its strengths and weaknesses than before. The company is now actively focusing on the “sweet spots” of the gaming industry where it has a reasonable chance to have some advantage over its competitors. EQUITY RESEARCH 23 November 2016 Funcom share price sensitivity analysis in NOKs (EV/EBITDA to Conan Exiles units sold in millions) (Considers convertible loan as shares) Number of Conan Exiles units sold (in millions) 0,5 0,75 1 2 3 4 5 5 1,87 2,78 3,68 7,30 10,91 15,43 19,95 7,5 2,60 3,96 5,31 10,74 16,16 22,94 29,72 2017 10 3,33 5,14 6,95 14,18 21,41 30,44 39,48 EV / EBITDA 12,5 4,06 6,32 8,58 17,62 26,65 37,95 49,25 15 4,79 7,50 10,21 21,06 31,90 45,46 59,02 Source: Orion Securities Share price and valuation: Massive trigger ahead Historically, Funcom’s share has always enjoyed a strong expectations driven rally ahead of major game launches, especially during the last 3-4 months before the release. It is reasonable to expect the same scenario before Conan Exiles release, especially since the starting point valuation of the Company seems low, both, compared to previous launches, the peer group and start-ups with no history. The development of Funcom’s share price after its major game launch will solely depend on the sales development. In the table above, we have analysed Funcom’s potential share price with respect to Conan Exiles copies sold and EV/EBITDA. The Company’s management seems confident that the sales should end up somewhere between 500.000 and 2.000.000 units in 2017. Given the table above this should place Funcom’s share price somewhere between NOK 2,60 and NOK 14,18. However, should Conan Exiles sales come in below 250.000 copies, the Company may experience solvency issues and shareholders might lose most or even all of their investment. We are certain about two potential scenarios regarding the Company’s future. The share will either be a major winner or loser on a 12-month horizon. Only a handful of stocks in the world has such a large price trigger ahead. The gaming industry: Opium to the people! The gaming industry generally enjoys superior valuations thanks to the credible growth story. Typically gaming companies that have succeeded with one game are valued as if every future game will also be successful. Conversely, gaming companies that have failed are valued as if every future game will also fail. Current Funcom’s share price seems to incorporate a discount of a much more negative sales outcome than we believe is reasonable. This is a direct reflection of negative prejudices. Other factors to consider: Tax assets of USD 22.6 million Funcom has little known but huge tax assets. The Company has a tax loss carried forward of USD 138 million which translates to USD 22.6 million in tax assets. While currently these tax assets are not assigned any value in the balance sheet, they could potentially be worth a lot. EQUITY RESEARCH 23 November 2016 Conan Exiles: Decent Chance of Success While expectations driven share price rally can be expected in the run-up to the launch of Conan Exiles in January, the share price development after the launch will solely depend on the sales development. According to our estimates, Funcom will need sales of just 300.000-350.000 copies of Conan Exiles in order to reach a break-even result in 2017. Any sales number that makes the bottom line turn positive constitutes, in our opinion, a success. The threshold for success seems low and very achievable. The total unit sales of the top ten Survival games are between 460.000-4.000.000 units on PC (2 to 3 times this number with consoles). Funcom’s Conan Exiles is the second largest survival segment game by budget. Additionally, the game highly benefits from material and technology used in “Age of Conan”, which was the largest investment for Funcom so far. “Age of Conan” sold 1.4 million copies at USD 60 each before it went to the free-to-play mode. Even though, the game was among the top three most selling games in the European market in 2008 it was not enough to compensate huge investments into the development of the game. The latest release in the Survival Segment was “Hurtworld”. It sold 500.000 copies so far despite its poor reviews and graphics. It would be surprising if Conan Exiles fails to outsell Hurtworld. In our opinion, Funcom seems to have found a sweet spot with the open world survival segment. Almost all of the competitors have been small developers with very limited budgets. Funcom’s previous competitors were large well developed companies with gigantic budgets. Survival segment top 10 games PC sales per year Source: Newzoo EQUITY RESEARCH 23 November 2016 Invetsor tool box - triggers and potential newsflow In general we expect the news flow to pick up speed starting November as Funcom’s marketing team will start advertising Conan Exiles January launch. This could be a major trigger for the Funcom share. Developers Diaries We expect Funcom to publish new Developers Diaries as the launch approaches: https://www.youtube.com/watch?v=OPxNDnhDiHY Press Coverage Funcom should also enjoy an increasing amount of press coverage as the launch date gets closer. Below are a few examples: https://www.youtube.com/watch?v=2Sz_XJwGqIM http://www.forbes.com/sites/archenemy/2016/01/30/conan-the-barbarian-returns-to-conquer-the-video-game- industry-in-conan-exiles/#136920ee7c7e Conan Exile Game Trailers We should also expect more game trailers: https://www.youtube.com/watch?v=4zLJZw0DGI4 During the launch During the launch of Conan Exiles we recommend to monitor Steamspy continuously. All steam sales during the launch in January will go directly through Steamspy. It will be possible to follow steam sales estimate (note that it will have a certain delay). In addition, attention should be paid to customer reviews and customer ratings. Expect violent share price movements as soon as the first data from Steamspy is available. The possibility to monitor the sales development through Steamspy is a major difference from previous launches and reduces the potential for asymmetric information in the market place. Net revenue model After talks with the Company, research and our field study, we expect Funcom to achieve 20 dollars in net revenue per copy of Conan Exiles sold. This is after VAT, Steam, royalties and is also adjusted for the discounts the game will sell at in certain periods. 20 dollars per copy net to the developer is higher than its competitors in the same segment.