THQ Nordic (THQNO.ST)

Home , 4A Games, Agents of Mayhem, Dambuster Studios, Darksiders, Deep Silver, Fishlabs

COMPANY ANALYSIS 1 March 2018

Summary

List: Power-up! Market Cap: 11,190 MSEK  The company had an immense release schedule with loads of Industry: Gaming new content during the quarter. The reported numbers beat CEO: Lars Wingefors Chairman: Kicki Wallje-Lund our estimates. Even though that THQ Nordic produced a

record quarter, the thing stole the spotlight was the

announcement of the acquisition of Koch Media; we get into OMXS 30 THQ Nordic detail about the acquired company in this research update. 160  The acquisition is a prime example of THQ Nordic’s 140 acquisition strategy. We believe that the market is yet to fully 120 100 grasp the underlying value and cash flow generating 80 capabilities of THQ Nordic’s growing IP portfolio, which was 60 enhanced significantly by the acquirement. 40 20  We raised our Base-case valuation to 140 SEK per share 0 28-Feb 29-May 27-Aug 25-Nov 23-Feb based on a Back-Of-The-Envelope assessment on the same day as the acquisition. Following a more in-depth analysis, we increase our fair value estimate further to 168 SEK per share. We argue that the new addition to the Group was acquired at a low price and that the long-term possibilities following the purchase are vast.

Redeye Rating (0 – 10 points)

Management Ownership Profit outlook Profitability Financial strength

8.0 points 9.0 points 7.0 points 6.0 points 8.0 points

Key Financials

2016 2017 2018E 2019E 2020E Share information Revenue, MSEK 302 508 3,666 3,909 4,300 Share price (SEK) 141.0

Growth 42% 68% 622% 7% 10% Number of shares (m) 79.4 EBITDA 132 273 929 1,009 1,212 Market Cap (MSEK) 11,190 EBITDA margin 44% 54% 25% 26% 28% Net cash (MSEK) 255

EBIT 95 188 616 696 849 Free float (%) 50 % EBIT margin 31% 37% 17% 18% 20% Daily turnover (’000) 60 Pre-tax earnings 93 182 616 696 849 Net earnings 72 139 480 543 662 Net margin 24% 27% 13% 14% 15%

Analysts: Kristoffer Lindstrom 2016 2017 2018E 2019E 2020E

Dividend/Share 0.00 0.00 0.00 0.00 2.50 [email protected]

2016 2017 2018E 2019E 2020E EPS adj. 1.00 1.75 6.05 6.85 8.34 P/E adj. 33.0 77.0 23.3 20.6 16.9 Tomas Otterbeck EV/S 7.4 19.9 3.0 2.7 2.3 [email protected] EV/EBITDA 16.9 37.0 11.8 10.5 8.1

Important information: All information regarding limitation of liability and potential conflicts of interest can be found at the end of the report.

Redeye, Mäster Samuelsgatan 42, 10tr, Box 7141, 103 87 Stockholm. Tel +46 8-545 013 30. E-post: [email protected] THQ Nordic

Redeye Rating: Background and definitions

The aim of a Redeye Rating is to help investors identify high-quality companies with attractive valuation.

Company Qualities

The aim of Company Qualities is to provide a well-structured and clear profile of a company’s qualities (or operating risk) – its chances of surviving and its potential for achieving long-term stable profit growth.

We categorize a company’s qualities on a ten-point scale based on five valuation keys; 1 – Management, 2 – Ownership, 3 – Profit Outlook, 4 – Profitability and 5 – Financial Strength.

Each valuation key is assessed based a number of quantitative and qualitative key factors that are weighted differently according to how important they are deemed to be. Each key factor is allocated a number of points based on its rating. The assessment of each valuation key is based on the total number of points for these individual factors. The rating scale ranges from 0 to +10 points.

The overall rating for each valuation key is indicated by the size of the bar shown in the chart. The relative size of the bars therefore reflects the rating distribution between the different valuation keys.

Management Our Management rating represents an assessment of the ability of the board of directors and management to manage the company in the best interests of the shareholders. A good board and management can make a mediocre business concept profitable, while a poor board and management can even lead a strong company into crisis. The factors used to assess a company’s management are: 1 – Execution, 2 – Capital allocation, 3 – Communication, 4 – Experience, 5 – Leadership and 6 – Integrity.

Ownership Our Ownership rating represents an assessment of the ownership exercised for longer-term value creation. Owner commitment and expertise are key to a company’s stability and the board’s ability to take action. Companies with a dispersed ownership structure without a clear controlling shareholder have historically performed worse than the market index over time. The factors used to assess Ownership are: 1 – Ownership structure, 2 – Owner commitment, 3 – Institutional ownership, 4 – Abuse of power, 5 – Reputation, and 6 – Financial sustainability.

Profit Outlook Our Profit Outlook rating represents an assessment of a company’s potential to achieve long-term stable profit growth. Over the long-term, the share price roughly mirrors the company’s earnings trend. A company that does not grow may be a good short-term investment, but is usually unwise in the long term. The factors used to assess Profit Outlook are: 1 – Business model, 2 – Sale potential, 3 – Market growth, 4 – Market position, and 5 – Competitiveness.

Profitability Our Profitability rating represents an assessment of how effective a company has historically utilised its capital to generate profit. Companies cannot survive if they are not profitable. The assessment of how profitable a company has been is based on a number of key ratios and criteria over a period of up to the past five years: 1 – Return on total assets (ROA), 2 – Return on equity (ROE), 3 – Net profit margin, 4 – Free cash flow, and 5 – Operating profit margin or EBIT.

Financial Strength Our Financial Strength rating represents an assessment of a company’s ability to pay in the short and long term. The core of a company’s financial strength is its balance sheet and cash flow. Even the greatest potential is of no benefit unless the balance sheet can cope with funding growth. The assessment of a company’s financial strength is based on a number of key ratios and criteria: 1 – Times-interest-coverage ratio, 2 – Debt-to-equity ratio, 3 – Quick ratio, 4 – Current ratio, 5 – Sales turnover, 6 – Capital needs, 7 – Cyclicality, and 8 – Forthcoming binary events.

Company analysis 2 THQ Nordic

Index A major deal ...... 4 Q4 a record quarter! ...... 4 We raise our valuation further ...... 5 The acquisition of Koch Media...... 6 Games division ...... 8 Key franchises: ...... 8 Confirmed releases 2018 ...... 11 Projections for the Games division...... 12 Partner Publishing – stable busniess ...... 13 Film –cash generation ...... 14 Cost estimates, a look on the pro forma ...... 15 Next quarter ...... 16 Full year projections for Group ...... 17 Investment case ...... 18 A large part of the asset value is still untapped ...... 18 Focus on long-term value and buying cheap ...... 19 Counterarguments (Bear-points) ...... 19 Valuation ...... 20 Peer valuation ...... 21 Scenario analysis ...... 22 Bear-case ...... 22 Bull-case ...... 23

Company analysis 3 THQ Nordic

A major deal

The company had an immense release scheme with loads of new content during quarter, and the reported numbers beat our estimate both on the sales and profit level. Even though that THQ Nordic produced a record quarter, the thing stole the spotlight was the announcement of the acquisition of Koch Media. In this research update we will:

 Briefly discuss about the quarterly outcome  Describe Koch Media business  Get into detail about our updated projections  Discuss about changes to our valuation

Q4 a record quarter!

Estimates vs Outcome THQ Nordic 2016- 2017- 2017E- Diff % MSEK Q4 Q4 Q4

Net sales 128 255 230 11% of which New releases 47 190 175 of which Catalog 82 65 55 EBITDA 59 156 138 13% EBIT 48 102 94 8%

Revenue growth 30% 99% 79% EBITDA margin 46% 61% 60% EBIT margin 38% 40% 41%

Source: Redeye Research

As discussed earlier the release schedule during the period was a massive one with no less than 11 new products that came to market, 9 of which was based on THQ Nordic’s own IPs. New releases produced net sales of SEK 190m, about 9% above our estimate. The Catalog revenue also came in above our projections. We are delighted with the outcome. Still, some titles have not reached their expected potential. On the cost side, the Cost of sales was lower than anticipated while other costs and staff related expenses were slightly higher. All in all the margin levels was almost spot-on to our estimates. During Q4 the company showed that they could handle a massive amount of new content and bring this to market with quality delivery.

During the full year of 2017 THQ THQ Nordic Nordic grew their net sales with mSEK 2015 2016 2017 68% and landed at SEK 508m, of Net sales 213 302 508 which SEK 269m was quarterly Of which NR 53 269 new releases, and SEK 239m was Of which Catalog 214 239 catalog sales. The EBIT came in at Total OPEX -146 -207 -319 EBIT 67 95 188 SEK 188m, up almost 98% compared to 2016. Numbers and Net sales growth 20% 42% 68% growth like this are no minor feat EBIT margin 31% 31% 37% Source: Redeye Research to accomplish!

Company analysis 4 THQ Nordic

We raise our valuation further Based on an Back-Of-The-Envelope assessment we raised our Base-case valuation to on the same day as the acquisition to 140 SEK per share. Following a more in-depth analysis we increase our fair value estimate to 168 SEK per share. We argue that the acquisition is conducted at a low price and that the long-term possibilities following the purchase are vast. As shown in the graph below we see about a 20% potential to our Base-case valuation from today’s levels. THQ Nordic is a quality company, in a growth industry, with highly capable management; a company like that seldom trades at the cheap. Still, we argue that the market is yet to fully appreciate the value enchantment possibilities following the acquisition of Koch Media.

THQ Nordic price, Base-case valuation and valuation potential

180 40%

160 30%

140 case

120 20% -

100 10% 80

SEK per shareper SEK 60 0%

40 Basepotentialto % -10% 20

0 -20% Jun-17 Jul-17 Aug-17 Sep-17 Oct-17 Nov-17 Dec-17 Jan-18 Feb-18

Potential to Base-case THQN price Base-case

Source: Redeye Research

One of our core pillars in the investment case of THQ Nordic looks like the following:

“THQ Nordic’s core strategy is to acquire IPs at depressed prices and then enhancing their value, thus keeping risks at low and create significant investment returns for shareholders”

The price paid is undoubtedly low, now the value enhancement focus of Koch Media’s asset will come into play.

Company analysis 5 THQ Nordic

The acquisition of Koch Media For detailed information on the deal, we believe investors should look at the presentation at THQ Nordics IR site, found here.

Koch Media will act as an independent company and maintains full operational focus on executing it's on their business plan for 2018, and no operational changes are intended. In the long-term, there will most likely be apparent revenue synergy implementation from partnerships from both groups’ IPs, assets and development capacity, distribution power, office proximity and more. But we find it great that this type of synergies or cost- cutting is not the primary reasons for the purchase.

Following the acquisition, the listed THQ Nordic AB will propose a name change at the next AGM to better reflect the new structure of the Group. The company also states that they will investigate the possibilities of debt financing to continue to be active in value-enhancing acquisitions.

The acquisition of Koch Media is a major one. The price tag amounts to an enterprise value of EUR 121m. The deal is funded mostly with cash and a small share part (1.2% share dilution) directed to the company’s founder Dr. Klemens Kundratitz. We do find it great that Dr. Kundratitz will own shares in the group as it aligns management with other minority shareholders.

From April to EV SALES Adj EBIT EV/S EV/EBIT December 2017 (MSEK) 2017* 2017** (9 months) Koch Media produced 1192 3070 357 0.4x 3.3x net sales of SEK 2 548m with an Source: Redeye Research adjusted EBIT of *Estimated full year performance SEK 296m. In **Adjusted for impairment 2017 the reported EBIT was adversely affected by an impairment related to two titles which did not meet expectations. If we assume a similar seasonality pattern as THQ Nordic has shown during the past years and just this assumption, then we estimate that the full year adjusted EBIT for Koch Media amounted to about SEK 357m during 2017. These assumptions generate the almost mind-blowing EBIT multiple of 3.3x. We want to highlight that the larger Gaming peers trade at a range of about 10-35x trailing 12 months EBIT.

How come the price is, at least by the looks of it, cheap? As we understand it two factors lead to the low price tag:

Company analysis 6 THQ Nordic

 The majority shareholder of Koch Media wanted a good buyer where the company could grow and was not looking for the highest price  2017 was the first year in over a decade where the company reported a loss. If you want a low price, you shouldn’t buy at “peak” performance, but rather at a dip and this is what THQ Nordic, with Lars Wingefors at the helm did.

Koch Media is divided into three segments; Games, Partner Publishing and Film. The company is the number 1 publishing partner in Europe. During nine month period stretching from April-December 2017 the sales mix was as shown below:

Games Partner Publishing Film

8% 26%

67%

EUR 68m* EUR 175m* EUR 20m*

* For period FY 2017/18 p months Apr-Dec

Company analysis 7 THQ Nordic

Games division The Games divisions include the publishing labels Deep Silver and Ravenscourt. The division has about 340 internal developers and 415 external with three large and praised studies; Volition, Dambuster Studios, and Deep Silver Fishlabs. The Games segment owns 15 key IPs and has 14 projects under development. The most significant IPs are Saints Row, Dead Island, and Metro. Down below is a brief historical description of key event s and releases:

Key franchises: Metro: Deep Silver has long-term exclusive rights to make Metro games. The first title was released in 2010. The series has so far generated about EUR 95m revenues with about 12m copies sold.

Metro Exodus is in development and set to be released during 2018; the exact date is yet to be announced. The game has been in development by the external studio 4A Games for about three years. We find it likely that the game has had a development budget of at least SEK 500m.

Company analysis 8 THQ Nordic

Exodus is commonly referred as one of the most anticipated releases of 2018. The two first games in the series, 2033 and Last Night, has been critical acclaimed with high user score rating and a Metacritic of 8.1 and 8.6 respectively. During 2014 a remaster was released for both titles, both with about 2 million owners on Steam. Exodus was revealed on E3 2017. During that time the top 50 videos on YouTube had roughly 8 million views. In December developer published a Game Awards trailer. Related videos have been viewed more than 3.5 million times.

Given the strong reception, franchise sales figures, media buzz and views on YouTube it is safe to say that the release of Metro Exodus holds excellent promise.

Dead Island: Dead Island was the first major hit from Deep Silver. The first game in the series was released in 2011. A couple of expansions and remasters has been taken to market between 2013-2016. The franchise has had EUR 185m in lifetime income with 14m+ copies sold.

Dead Island 2 is under development; the release date is yet to be announced. We believe the game has a similar budget as Metro Exodus and YouTube stats imply another strong title for the franchisee. The development of the game has not been without hiccups. Lead developer has been changed two times and the game was originally scheduled to be released in 2015 but has been delayed. The game is being developed by the UK based Sumo Digital.

Saints Row: The Saints Row franchise is most likely the most well- known game series developed by Volition and published by Deep Silver. The first game came to market in 2006, and three additional sequels have then ben released. The series has generated USD 600m in lifetime sales with 32m+ copies sold. The two games Red faction and Agents of Mayhem

Company analysis 9 THQ Nordic are based in the same fictional universe as Saints Row. The second installment in the series sold roughly 2 million units during its release month, the third game in the series sold about 3.8 million copies during its first year.

Nothing has been said about an upcoming game in the series, but we know that Volition is working on an AAA title. We find it likely that it is Saints Row 5 that is in the making. Agents of Mayhem were a flop, and Koch Media took an impairment related to the game of about EUR 50m during 2017.

Financial performance Games division net sales (MEUR)

160

140

120

100

60 Net sales MEUR Netsales

Source: Redeye Research

In most cases, the full year sales have exceeded EUR 100m. During 13/14, where income were close to EUR 140m as both Saints Row IV, and Dead Island Riptide was released. The Games division has a vast library of games with extensive backlog sales. In the nine months ending 2017, the company had the lousy release of Agents of Mayhem, but the sales figure still amounted to EUR 68m. This relatively high number was mostly due to the Backlog and minor releases.

Company analysis 10 THQ Nordic

Confirmed releases 2018 Kingdom Come: Deliverance Kingdom Come is a game developed by Warhorse Studios. Deep Silver is the publisher of all formats and platforms except on digital PC. The game was released on the 13th of February. The developer confirmed that the title had sold roughly 500k units on its third day, at the same time about 250k (50% of total sales) owners was indicated on Steam by Steam spy. On the 22nd of February, Warhorse Studios stated on social media that the game had sold roughly 1 million copies across all platforms. At the same time, almost 0.5 million was indicated on Steamspy. Since the 22nd the sales rise has slowed down somewhat.

Kingdom Come: Deliverance copies sold

1200000 1mn

1000000

800000 500k 600000

Copiessold 400000

200000

Steam copies Other platforms

Source: Steamspy & Redeye Research

Metro Exodus As explained earlier Metro Exodus is confirmed for release during 2018, likely H2’18. We believe that the game will stand for a majority of the Game divisions game sales during the year.

Dakar18 Dakar is a new racing IP confirmed during 2018. We will only make some conservative estimates for the title as we have relatively little information to base our projections on.

Company analysis 11 THQ Nordic

Projections for the Games division Making predictions for the Games division is no easy task as there are a lot of unknown factors and limited historical numbers. We do not know exactly how the sales will be recognized as THQ Nordic today follows GAAP K4 and Koch Media IFRS. Al in all; we expect that Metro Exodus is the most prominent contributor during the year. Our full year projections amount to EUR 110m, for our Group estimate we have adjusted this figure as we assume that Koch Media is consolidated from the acquisition date.

Net sales* Games (MEUR) & sales drivers apr 15- mar 16 jul 16- mar 17 apr 17- dec 17 15/16 16/17 9m 17/18 9m 2018E 2019 --->

98 47 68 110

Sales drives: Confirmed 2018 TBC

Released prior period started 22 titles from Ravenscourt Homefront: The Revolution Agents of Mayhem Metro Exodus Dead Island 2 3 minor titles from Deep Silver Dead Island Definite Edition Lets Sing 2018 Kingdom Come: Deliverence Shenmue III Backlog sales Dead Isalnd Riptide Definite Ed. Backlog sales Dakar 18 AAA from Volition Dead Island Retro Revenge Backlog sales AAA from Bambuster Yet to be disclosued... 7 more projects Mighty No.9 Deadlight: Directors Cut Lets Sing 2017 3 titles from Ravenscourt Backlog sales Source: Redeye Research *Approximated based on visual graphics

Company analysis 12 THQ Nordic

Partner Publishing – stable busniess

Partner Publishing sales development and projection

250

200 175 175

150

MEUR 100

Source: Redeye Research

Partner Publishing produced a net sales of EUR 175m during the nine- month period ending 2017. The business seems stable and has historically generated full-year revenues in the region for EUR 150m. We have somewhat limited insight into key drivers during the last years; overall the income is produced through a myriad of publishing deals. The partner publishing division of Koch Media is the market leader in Europe with 11 offices across the world with mostly Blue-chip customers. We believe that about 50% of the yearly income is generated during the high-season, i.e., Q4. For 2018 we make the cautious estimate of full-year net sales of EUR 175m.

The publishing segments support their clients in various functions, including among others; strategic planning, product launches, manufacturing, local distribution, development support, co-publishing deal options, and marketing. The distribution center lies in Höfen, Austria, and the division is operational in most of the larger European countries.

Company analysis 13 THQ Nordic

Film –cash generation

Film sales development and projection

30 25 25 20

MEUR 20

Source: Redeye Research

The Film division had net sales of EUR 20m during the last nine months of 2017. The historical revenue levels have varied quite extensively, which is expected given the nature of the movie business. Koch Media Home Entertainment is an independent distributor and coproduces of films and sales through both digital and physical channels. The library includes various niches such as ”cult classics” in Germany and Horror movies in Italy. The segment has over 1,500 film titles in rights in their catalog, about 250 license partners and to 10 international productions released per year. We have a low insight into various upcoming releases and key drivers the coming years so we will make the conservative assessment that the division will generate an income of roughly EUR 25m during 2018.

Company analysis 14 THQ Nordic

Cost estimates, a look on the pro forma

Pro forma April-Dec 2017 (adjusted) THQ Koch Adj. Pro forma Net sales 426 2 548 -41 2 934 Capitalized work 67 221 0 287 Other income 2 218 -1 220 Cost of sales -123 -1 670 41 -1 753 % sales 29% 66% 60% Gross profit 371 1 317 1 688 Other external expenses -65 0 0 -65 % sales 15% 0% 2% Personal expenses -76 -381 0 -457 % sales 18% 15% 16% Other operating expenses 0 -456 1 -455 % sales 0% 18% 16% EBITDA 231 480 711 Depreciation of PP&E -2 -11 0 -12 % sales 0% 0% 0% Amortization of int. Assets -73 -173 53 -193 % sales 17% 7% 7% EBIT 156 296 53 505

Gross profit margin 75% 44% 49% EBITDA margin 47% 16% 21% EBIT margin 32% 10% 15% Source: THQ Nordic

Estimating cost levels for the combined company is no easy task. The best data point is the pro forma statement that THQ Nordic presented in their investor presentation in conjunction with the acquisition of Koch Media. Overall, we will mostly base our cost level estimates, in relation to sales, on the pro forma levels.

We do believe we will see a slightly higher margin during 2018 due to the following reasons:

 Poor releases within Games for Koch likely dampened margins compared to a “good” year during 2018  THQ Nordic has higher margins than Koch Media and will probably show significant growth during 2018 due to significant releases  We expect that the margins will expand the coming years as THQ Nordic asset is released at high profitability and the Games division experience improved product launches  Increased focus on asset care of Koch Media IP portfolio due to THQ Nordic’s expertise in the area

Company analysis 15 THQ Nordic

Next quarter Release schedule during Q1’17 for THQ Nordic, Koch Media excluded:

Quarterly estimates THQ Nordic 2017- 2018E- MSEK Q1 Q1

Net sales 82 548 EBITDA 42 90 EBIT 32 52

Revenue growth 90% 569% EBITDA margin 51% 16% EBIT margin 39% 9%

Source: Redeye Research

The following bullets summarize the key drivers during Q1:

 Release of MX vs ATV All out, but late in the quarter  Likely a strong backlog sales due to significant releases during Q4’17. The backlog income level is an effect of earlier game launches and legacy title sales.  Kingdom Come: Deliverance looks like a success, and had at this writing sold approximately 500k copies with Deep Silver as a publisher. The title sales will dampen the gross margin as Warhorse Studios own the IP  The acquisition of Koch Media, of course, is the most significant driver of the increased sales; we use the assessment of consolidated from the acquisition date of 14th February  Transaction-related extra costs in the region of SEK 30m will dampen the profit to some degree compared to a “normal” quarter

We expect that the Group will produce net sales in the region of SEK 548m. We want to highlight the reader of the extreme difficulties of making these estimates; this is, however, our best guess at the current moment with the limited information we have at hand. We are rather confident in our full- year profit projections, but the quarterly split is harder to gauge, and the exact accounting praxis (THQ Nordic reports according to GAAP K3 and Koch IFRS) of sales is not known to us. We project an EBIT margin in the region of 9%, which corresponds to an EBIT of SEK 52m.

Company analysis 16 THQ Nordic

Full year projections for Group

THQ Nordic estimates mSEK 2015 2016 2017 2018E 2019E 2020E

Net sales 213 302 508 3 666 3 909 4 300 Total OPEX -146 -207 -319 -3 050 -3 213 -3 451 EBIT 67 95 188 616 696 849

Net sales growth 20% 42% 68% 622% 7% 10% EBIT margin 31% 31% 37% 17% 18% 20% Source: Redeye Research

Like we have discussed earlier; sales is hard to predict as we do not know exactly how the accounting will work as THQ Nordic reports according to GAAP K3 and Koch Media follows IFRS. We find a profit measure as EBIT should not be affected to the same degree, but of course, the margin levels will vary because of different sales recognition praxis. As the Group is now less dependent on the more substantial releases to create cash flow we find it likely that a title like Biomutant could come to market in 2019 instead of 2018. The focus is to create a great game and experience, not nurture the markets short-term thinking of the market. Yearly projections differ depending on which year a more significant title is released, but it does not matter for the valuation.

2018 will be an excellent year for the Group. Drivers include:  THQ Nordic major releases like Darksiders 3, MX vs. ATV All Out, Battle Chasers on Nintendo Switch and possible Biomutant (still not confirmed).  Koch Media Games will release Metro Exodus, Dakar 18. Kingdom Come: Deliverance has already been published, and shows great reception from the players.  Continued uptake of the Backlog sales  Games yet to be disclosed released to the market  10-15 more minor title published by THQ Nordic  Stable development of Koch Media Partner Publishing and the Film division

As discussed earlier we have based our cost assumptions on the pro forma statement and remained quite conservative. On the more long-term, we expect to see steadily increasing margins, due to synergies and an increased focus on the profitable backlog development and asset care for the Koch Media IP portfolio. The gross profit margin for the new Group will be lower compared to the old THQ Nordic due to the publishing. Our growth rates in the years after 2020 is assumed to be closer to the market as Partner Publishing that at least historically has grown at slower rates will continue to be a significant part of the Groups sales mix.

Company analysis 17 THQ Nordic

Investment case

The acquisition of Koch Media is a prime example of THQ Nordic’s acquisition strategy and why we continue to be positive to the investment case. We believe that the market is still to fully grasp the underlying value and cash flow generating capabilities of THQ Nordic’s growing IP portfolio, which was enhanced to a significant degree following the purchase of the European publisher.

We believe that the markets overall low understanding of the Gaming industry and focus on the short-term creates an opportunity for the investor who see the bigger picture in THQ Nordic. The following bullet points summarize our investment thesis;

 The company showed significant growth during 2017 but a large part of the IP portfolio is still not generating any income, this will change in the coming years

 THQ Nordics IP portfolio grew significantly following acquiring Koch Media, the asset care possibilities and thus value enhancement is vast

 Owner operator with a highly skilled management team with the right focus on long-term value creation

 The core strategy is to acquire IPs at depressed prices and then enhancing their value, Koch Media acquisition as a prime example

A large part of the asset value is still untapped The company showed significant growth during 2017, but a large part of the IP portfolio is still not generating any income. Development projects including a few AAA will be released in the years to come. This will take revenues and the profits to entirely new levels.

THQ Nordics IP portfolio grew significantly following acquiring Koch Media. We believe that the company will use its asset care expertise and unlock a lot of value from the long tail part o0f the game asset in the coming years

Some key franchises included in the IP portfolio are Darksiders, MX vs. ATV, Red Faction, Delta Force, Titan Quest, SpellForce, Saints Row, Dead Island, Metro and 100+ more.

Company analysis 18 THQ Nordic

Focus on long-term value and buying cheap THQ Nordic is what we like to call an owner-operator company where the management team owns 50%+ of capital, has extensive experience from the industry and is highly committed to building “something big.” We believe there should be a premium on the valuation because of the strong shareholder focus

THQ Nordic’s core strategy is to acquire IPs at depressed prices and then enhancing their value. We view the Koch Media acquisition as a prime example of this approach. This focus will continue to keep risks at low levels and create significant investment returns for shareholders going onwards

Many public companies suffer from a short-term quarterly focus; this could not be further from the case when it comes to THQ Nordic. We find the long-term thinking as a distinct advantage; we also believe this way of business will further increase following the Koch acquisition as the company will be less dependent on single releases for cash flow.

Our forecast, and therefore also our DCF valuation, does not factor in possible future value-adding acquisitions of IPs or companies, but it is a fact that THQ Nordic will continue to acquire, and will do so with bravura.

Counterarguments (Bear-points) It is always sensible to develop some counterarguments to an investment thesis. Below, we present some bear-points that an investor should consider and have in mind if the future development is not favorable.

 Title risks of larger releases – Despite THQ Nordic’s extensive portfolio there is always some title risk when releasing larger projects. Disappointing releases and/or reviews could dampen investors’ enthusiasm and hurt the company’s financials.  Rising competition in bidding for acquisitions – As THQ Nordic is entering a new level as a company, so will the future acquisitions in terms of size and target reputation. Going from an unknown player to a more established company might make it harder to find cheap deals.  Management is paramount – Just as much we love a strong and committed management team, it is also a fact that relying on a few key individuals also poses a risk.

Company analysis 19 THQ Nordic

Valuation

In our Base-case scenario, we model that the investment in new releases continues at a high phase the coming years. We want to highlight that our Base-case assumes moderate success for Groups larger projects; this is to keep a “margin of safety” in our favor. The size, regarding income, of the company, has increased significantly following the Koch Media acquisition, and the Group now has a huge partner publishing business. We model a CAGR the coming years of about 6%, close to market growth. Profitability wise we believe it is possible that the gross margins will expand as the revenue streams from the own IPs will grow faster than the publishing revenue and that the Group turns their profitable asset care focus on Koch Media IP asset. There is of course also the inherent scalability of THQ Nordic’s business model that will come into play. We model an average EBIT margin of 20% during our forecast period.

In the terminal year, we use the conservative assumption of an FCF growth of 2% and an EBIT margin of 20%; this indicated an “exit” EV/EBIT multiple of 13x, lower than what other diversified Gaming companies trade at today. We believe these assumptions warrant a large degree of safety. Our estimate does not take into account any future value-creating acquisitions of IPs or game studios.

THQ Nordic: Base-case Assumptions 2018-27 DCF-value CAGR Sales 6% WACC 7.5% EBIT margin (avg) 20% Net presenst value FCF 4 840 ROIC (avg) 22% Net present value of Terminal 8 209

Terminal EV 13 049 Terminal growth FCF 2.0% Net cash 252 Terminal EBIT margin 20% Value minorities 0 Exit EV/EBIT multiple 13x DCF-value 13 301 Estimated Fair value 168 Todays share price 138.0 Potential/Risk 21%

Source: Redeye Research

On the same day as the acquisition, we raised our Base-case valuation to 140 SEK per share. Today, following a closer look we increase our fair value estimate to 168 SEK per share. We argue that the acquisition is conducted at a low price and that the long-term possibilities following the purchase are vast. The potential to our Base-case valuation amounts to about 20%. THQ Nordic is a quality company, in a growth industry, with highly capable management; a company like that seldom trades at the cheap. We argue that the market is yet to fully appreciate the value enchantment possibilities following the acquisition of Koch Media. We also find that the valuation of today puts too little premium on the competent management team and the possibility of future value-enhancing acquisitions and deals.

Company analysis 20 THQ Nordic

Peer valuation In the same manner, as how we treat our other Gaming companies, we have divided our peer-valuation into peer groups of Swedish and International Gaming to display valuation differences between sub-segments in the gaming industry better. Our prime valuation metric is EV/EBIT as it, at least in some way, take into account the investment needs of gaming companies. Following the Koch Media acquisition, the margin level of THQ Nordic has dropped, as such we find a lower EV/S multiple is justified than before.

Swedish Gaming: At Redeye we also have coverage of Stillfront, G5 and Starbreeze. Overall, the companies within this peer group are expected to deliver healthy profit growth in the coming years.

International Gaming: The companies in this peer -group are the “whales” of the gaming industry. Most of these enterprises act both as publisher, developers and platform owners. Most of them are also active in all sub-segments of the industry (cross platform in all genres). THQ Nordic is similar to these companies as they have an extensive cross-selling IP portfolio. Still the size of these firms makes a comparison not directly applicable.

Peer valuation SALES EV/Sales EV/EBIT EBIT margin CAGR EV

Company (MSEK) 2018E 2019E 2018E 2019E 2020E 16-19E 2018E 2019E 2020E Swedish Gaming

Paradox Interactive 13 125 11.9x 9.8x 32.1x 24.3x 21.3x 35% 43% 43% 44% Stillfront 3 770 2.6x 2.5x 15.8x 10.2x 9.0x 115% 16% 24% 25% Starbreeze 3 270 3.0x 2.6x 21.1x 16.5x 16.2x 76% 18% 22% 22% G5 Entertainment 2 674 1.8x 1.5x 14.7x 10.3x 9.1x 22% 12% 14% 14% Median 3 520 2.8x 2.5x 18x 13x 13x 55% 17% 23% 24% International Gaming Tencent 4 327 311 10.0x 7.6x 32.1x 24.3x 21.3x 53% 31% 31% 29% Nintendo 463 533 5.8x 4.4x 36.0x 18.0x 13.8x 43% 16% 24% 29% Activision 452 120 7.4x 7.0x 21.1x 16.5x 16.2x 5% 35% 42% 40%

EA 286 725 6.8x 6.3x 21.8x 18.9x 16.5x 5% 31% 33% 36% Take-Two 95 297 5.9x 4.1x 24.6x 14.3x 13.1x 13% 24% 29% 32% Ubisoft 78 292 4.7x 3.8x 29.7x 19.2x 16.0x 17% 16% 20% 22% Bandai Namco 42 963 0.9x 0.8x 9.3x 7.9x 7.4x 1% 9% 11% 11% CD projekt 22 890 17.9x 5.4x 36.6x 8.4x 13.2x 38% 49% 64% 52% Median 191 011 6.4x 4.9x 27x 17x 15x 15% 28% 30% 31% Peer Group median 97 265 4.6x 3.7x 23x 15x 14x 35% 22% 27% 27% THQ Nordic 10 087 2.8x 2.6x 16x 14x 12x 104% 17% 18% 20%

at Base-case 13 049 3.6x 3.3x 21x 19x 15x

Source: Bloomberg & Redeye Research

Today THQ Nordic trades EV/EBIT2018E of 16x. We believe that THQ Nordic’s history of acquisitions, growth prospects and IP portfolio strength should warrant for a premium valuation compared to most peers. We find that EV/EBIT is the best multiple to evaluate the relative valuation on.

Company analysis 21 THQ Nordic

Scenario analysis At Redeye we emphasize on the use of scenario-based analysis, as such, we always present a Base, Bear and Bull-case valuation. Our different cases create a Valuation range, which can be used to gauge implied future fundamental development at various share prices.

Bear-case In our Bear-case, we have used much more conservative assumptions regarding the success of the larger upcoming releases. We also model a much slower growth long-term growth of new release revenue, as in this scenario the earlier disappointments makes the company more cautious of new larger projects. However, the catalog revenue continues to develop at a healthy phase. The lower assumed growth leads to less operational leverage, and we model a less aggressive margin uptake and that no real synergies between Koch Media and THQ Nordic manifest. In our Bear-case, we expect a CAGR of 4% the coming ten years with an average EBIT margin of about 15%.

THQ Nordic: Bear-case Assumptions 2018-27 DCF-value CAGR Sales 4% WACC 7.5% EBIT margin (avg) 15% Net presenst value FCF 2 669 ROIC (avg) 17% Net present value of Terminal 3 752

Terminal EV 6 421 Terminal growth FCF 2.0% Net cash 82 Terminal EBIT margin 14% Value minorities 0 Exit EV/EBIT multiple 12x DCF-value 6 503 Estimated Fair value 82 Todays share price 138.0 Potential/Risk -41%

Source: Redeye Research

Our Bear-case assumptions generate an estimated value of 82 SEK per share. Given our assumptions and that THQ Nordic is genuinely committed to making value-adding acquisition and investments, the scenario must be seen as conservative.

Company analysis 22 THQ Nordic

Bull-case In our Bull-case we assume a larger success for the upcoming major releases during 2017, 2018 and 2019, the company then reinvest those cash flows into even greater projects, which also works out well. In this scenario, some sales and cost synergies between Koch Media and the “old” THQ Nordic creates higher margins and sales growth. The estimated CAGR amounts to 9% the coming ten years with an EBIT margin of about 23%. Our assumptions in the Bull-case regarding commercial success for the larger upcoming releases should not be seen as any “Blue-sky” scenario with overly positive estimates.

THQ Nordic: Bull-case Assumptions 2018-27 DCF-value CAGR Sales 9% WACC 7.5% EBIT margin (avg) 23% Net presenst value FCF 7 045 ROIC (avg) 25% Net present value of Terminal 12 904

Terminal EV 19 950 Terminal growth FCF 2.0% Net cash 466 Terminal EBIT margin 22% Value minorities 0 Exit EV/EBIT multiple 13x DCF-value 20 415 Estimated Fair value 257 Todays share price 138.0 Potential/Risk 86%

Source: Redeye Research

Our Bull-case assumptions generate an estimated value of 257 SEK per share. Our scenario still does not take into account any future value enhancing acquisitions of IPs or game studios, which we will treat, act as a positive value-adding option.

THQ Nordic: Fair value range

0 50 100 150 200 250 300 Last price: 138

0 50Bear-case: 10082 Base150-case: 168200 Bull250-case: 257 300

Company analysis 23 THQ Nordic

Summary Redeye Rating

The rating consists of five valuation keys, each constituting an overall assessment of several factors that are rated on a scale of 0 to 2 points. The maximum score for a valuation key is 10 points.

Rating changes in the report No changes in Rating.

Management 8.0p The management team of THQ Nordic is by our measures highly competent with extensive experience from the Gaming industry. The company continuously put emphasis on a shareholder focus to generate long-term value creation by keeping to their core strategy; acquiring IPs at the cheap and increase their value by asset care. The operational team with Klemenz Kreuzer and Reinhard Pollice at the helm has been within the Gaming industry their entire professional life and shows profound experience. Lars Wingefors is an entrepreneur by heart; he started his first business at the age of 13 and has been selling video games for more than 20 years. We find the management of THQ Nordic as trustworthy as they have never tried to misguide the market; instead, they always make conservative statements and educate the market about their business.

Ownership 9.0p The ownership structure of THQ Nordic is, in our view, one of its key strengths. All the key personnel has substantial holdings in the company with the founder Lars Wingefors controlling more than 50+% of the votes. The significant holdings create a focus on long-term value creation and not meeting short-term financial goals that a company led by “hired guns.” In addition to the substantial holdings of the management team, some of the most renowned institutional owners show up on the shareholder's list of THQ Nordic. Given the fact that the company is listed on Nasdaq First North this is quite the feat, as that listing reduces the possibility for institutional funds to own shares in the firm. Profit outlook 7.0p THQ Nordic has a large portfolio of game franchises with multiple streams of income and a massive player base. Some of the IPs, like Darksiders, Spellforce, Red Faction and MX vs. ATV, Saints Row, Dead Island and Metro has a large following and good reputation in the gamer community; this creates a pricing power and demand for new products. Following the acquisition of Koch Media THQ Nordic has become a power-house, but as the gaming industry is so massive, they are still a relatively small player.

Profitability 6.0p

During the past years, THQ Nordic has been growing heavily and still producing more than satisfying margins and return on asset. The future profitability levels will vary due to game release schemes as the business model inherits a high degree of scalability. Long-term increasing margins as the company continues to grow and the revenue streams from their own IPs increase even further.

Financial strength 8.0p THQ Nordic is an unleveraged company with a strong cash position. One of the company’s core strategies is to acquire game IPs from companies in financial distress; this has led to a conservative approach regarding putting on debt. The income streams are diversified with a large portfolio of IPs and different games. Overall the video game industry is not sensitive to the business cycle which dampens the financial risk of downturns.

Company analysis 24 THQ Nordic

Income statement 2016 2017 2018E 2019E 2020E DCF valuation Cash flow, MSEK Net sales 302 508 3,666 3,909 4,300 WACC (%) 7.5 % Total operating costs -170 -235 -2,737 -2,900 -3,087 EBITDA 132 273 929 1,009 1,212

Depreciation 0 0 0 0 0 Amortization -37 -84 -313 -313 -364 Impairment charges 0 0 0 0 0 Assumptions 2017-2023 (%) EBIT 95 188 616 696 849 Average sales growth 7.9 % Fair value e. per share, SEK 168 EBIT margin 20.1 % Share price, SEK 141.0 Share in profits 0 0 0 0 0 Net financial items -2 -6 0 0 0 Exchange rate dif. 0 0 0 0 0 Profitability 2016 2017 2018E 2019E 2020E Pre-tax profit 93 182 616 696 849 ROE 34% 20% 37% 30% 27% ROCE 41% 26% 47% 38% 35% Tax -21 -43 -136 -153 -187 ROIC 138% 91% 138% 54% 58% Net earnings 72 139 480 543 662 EBITDA margin 44% 54% 25% 26% 28% EBIT margin 31% 37% 17% 18% 20% Balance 2016 2017 2018E 2019E 2020E Net margin 24% 27% 13% 14% 15% Assets Current assets Data per share 2016 2017 2018E 2019E 2020E Cash in banks 167 627 255 625 1,382 EPS 1.00 1.75 6.05 6.85 8.34 Receivables 47 90 1,063 1,173 1,290 EPS adj 1.00 1.75 6.05 6.85 8.34 Inventories 18 30 220 235 258 Dividend 0.00 0.00 0.00 0.00 2.50 Other current assets 0 0 0 0 0 Net debt -1.93 -7.89 -3.22 -7.88 -17.42 Current assets 232 747 1,539 2,033 2,930 Total shares 72.03 79.36 79.36 79.36 79.36 Fixed assets

Tangible assets 4 8 35 37 40 Valuation 2016 2017 2018E 2019E 2020E Associated comp. 0 0 0 0 0 EV 2,238.4 10,087. 10,934. 10,564. 9,807.7 Investments 0 0 0 0 0 2 6 5 Goodwill 0 24 309 309 309 P/E 33.0 77.0 23.3 20.6 16.9 Cap. exp. for dev. 0 0 0 0 0 P/E diluted 33.0 77.0 23.3 20.6 16.9 O intangible rights 229 541 1,360 1,516 1,668 P/Sales 7.9 21.1 3.1 2.9 2.6 O non-current assets 0 0 0 0 0 EV/Sales 7.4 19.9 3.0 2.7 2.3 Total fixed assets 232 573 1,703 1,862 2,017 EV/EBITDA 16.9 37.0 11.8 10.5 8.1 Deferred tax assets 0 2 2 2 2 EV/EBIT 23.6 53.6 17.8 15.2 11.6 P/BV 6.9 10.0 7.2 5.3 4.1 Total (assets) 465 1,322 3,244 3,897 4,949 Share performance Growth/year 15/17e 1 month 39.6 % Net sales 248.5 % Liabilities 3 month 75.7 % Operating profit adj 154.6 % Current liabilities 12 month 267.2 % EPS, just 146.2 % Short -term debt 29 0 0 0 0 Since start of the year 77.9 % Equity 112.2 % Accounts payable 80 208 1,650 1,759 2,150 O current liabilities 0 0 0 0 0 Current liabilities 108 208 1,650 1,759 2,150 Shareholder structure % Capital Votes Long-term debt 0 0 0 0 0 Lars Wingefors 45.5 % 59.0 % O long-term liabilities 0 0 0 0 0 Erik Stenberg 9.8 % 12.8 % Convertibles 0 0 0 0 0 Swedbank Robur Fonder 8.6 % 4.3 % Total Liabilities 108 208 1,650 1,759 2,150 Handelsbanken Fonder 6.2 % 3.1 % Deferred tax liab 11 37 37 37 37 CMB Holding AB 3.4 % 4.4 % Provisions 0 4 4 4 4 Didner & Gerge Fonder 2.4 % 1.2 % Shareholders' equity 345 1,073 1,554 2,097 2,759 Familjen Olsson med stiftelse 1.6 % 0.8 % Minority interest (BS) 0 0 0 0 0 Martin Larsson 1.6 % 0.8 % Minority & equity 345 1,073 1,554 2,097 2,759 RAM Fonder 1.6 % 0.8 % Avanza Pension 1.5 % 0.8 % Total liab & SE 465 1,322 3,244 3,897 4,949 Share information Free cash flow 2016 2017 2018E 2019E 2020E Reuters code THQNO.ST Net sales 302 508 3,666 3,909 4,300 List Total operating costs -170 -235 -2,737 -2,900 -3,087 Share price 141.0 Depreciations total -37 -84 -313 -313 -364 Total shares, million 79.4 EBIT 95 188 616 696 849 Market Cap, MSEK 11189.9 Taxes on EBIT 0 0 0 0 0 NOPLAT 95 188 616 696 849 Management & board Depreciation 37 84 313 313 364 CEO Lars Wingefors Gross cash flow 132 273 929 1,009 1,212 CFO Erik Stenberg Change in WC -14 73 279 -15 250 IR Gross CAPEX -163 -425 -1,444 -471 -519 Chairman Kicki Wallje-Lund

Free cash flow -45 -79 -236 523 944 Financial information

Capital structure 2016 2017 2018E 2019E 2020E Equity ratio 74% 81% 48% 54% 56% Debt/equity ratio 8% 0% 0% 0% 0% Net debt -139 -627 -255 -625 -1,382 Analysts Redeye AB Capital employed 206 447 1,298 1,472 1,377 Kristoffer Lindstrom Mäster Samuelsgatan 42, 10tr Capital turnover rate 0.6 0.4 1.1 1.0 0.9 [email protected] 111 57 Stockholm

Growth 2016 2017 2018E 2019E 2020E Tomas Otterbeck Sales growth 42% 68% 622% 7% 10% [email protected] EPS growth (adj) 0% 76% 245% 13% 22%

Company analysis 25 THQ Nordic

Revenue & Growth (%) EBIT (adjusted) & Margin (%)

5000 700.0% 900 40.0% 4500 600.0% 800 35.0% 4000 500.0% 700 30.0% 3500 600 3000 400.0% 25.0% 500 2500 300.0% 20.0% 400 2000 200.0% 15.0% 1500 300 100.0% 10.0% 1000 200 500 0.0% 100 5.0% 0 -100.0% 0 0.0% 2015 2016 2017 2018E 2019E 2020E 2015 2016 2017 2018E 2019E 2020E

Net sales Net sales growth EBIT adj EBIT margin

Earnings per share Equity & debt-equity ratio (%)

9 9 0.9 14.0% 8 8 0.8 12.0% 7 7 0.7 10.0% 0.6 6 6 8.0% 5 5 0.5 6.0% 4 4 0.4 4.0% 3 3 0.3 2 2 0.2 2.0% 1 1 0.1 0.0% 0 0 0 -2.0% 2015 2016 2017 2018E 2019E 2020E 2015 2016 2017 2018E 2019E 2020E

EPS, unadjusted EPS, adjusted Equity ratio Debt-equity ratio

Sales division Geographical areas

Conflict of interests Company description Kristoffer. Lindström owns shares in the company THQ Nordic : Founded in 2011, THQ Nordic is a global video game publisher and Yes developer. Based in Vienna, Austria and Karlstad, Sweden with Tomas. Otterbeck. owns shares in the company THQ Nordic: Yes subsidiaries in Germany and the USA, THQ Nordic brands include Darksiders, MX vs. ATV, Red Faction, Titan Quest and many more. THQ Redeye performs/have performed services for the Company and Nordic is meant to represent a core approach of doing much more than receives/have received compensation from the Company in connection “owning” a highly competitive portfolio of IPs. It revolves around with this. cherishing them, and aligning them with the very best development resources to expand upon them with the level of experience that communities and established fan bases expect and deserve. The company’s internal development studios are Grimlore Games based in Munich, Germany; Rainbow Studios based in Phoenix, Arizona; Mirage Game Studios AB based in Karlstad, Sweden and Foxglove Studios AB based in Stockholm, Sweden.

Company analysis 26 THQ Nordic

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Redeye Rating (2018-03-01)

Rating Management Ownership Profit Profitability Financial outlook Strength 7,5p - 10,0p 46 44 18 10 20 3,5p - 7,0p 74 67 103 35 46 0,0p - 3,0p 13 22 12 88 67 Company N 133 133 133 133 133

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Company analysis 27