11 Bit Studios Price: PLN 280.00 Free Float: 80% 12M EFV: PLN 377.0 (↑) 12M Range: PLN 159.60 – 286.00

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35/2018/RP (72) April 26, 2018

Analyst: Tomasz Rodak, CFA, [email protected], +48 (22) 504 33 23

Sector: TMT – IT software & services Market Cap: US$ 178 m Fundamental rating: Buy (→) Bloomberg code: 11B PW Market relative: Overweight (→) Av. daily turnover: US$ 0.76 m 11 bit studios Price: PLN 280.00 Free float: 80% 12M EFV: PLN 377.0 (↑) 12M range: PLN 159.60 – 286.00

Guide to adjusted profits Oops, 11 bit studios did it again No factors necessitating adjustments.

Frostpunk was released on Tuesday and managed to dethrone Key data Playerunknown’s Battlegrounds (a multimillion ‘perpetual’ seller) IFRS, consolidated 2017 2018E 2019E 2020E Sales PLN m 19.5 79.8 53.4 75.2 from the 1st spot of Steam bestsellers for over 2.5 days. The EBITDA PLN m 9.2 62.6 40.0 60.6 game received a universal acclaim scoring 87/8.8 from critics/ EBIT PLN m 7.5 58.9 36.0 53.8 gamers at metacritic.com (reviews aggregator) beating This War Net profit PLN m 3.6 48.2 29.6 45.0 EPS PLN 1.60 21.72 13.35 20.31 of Mine’s score of (83/8.4). Effectively, 11 bit studios proved that EPS yoy chg % -74 1,254 -39 52 the success of This War of Mine was not just a lucky strike, but the Net debt PLN m -28.2 -69.6 -91.1 -135.8 Company, indeed, possessed a unique sense of gamers’ taste, P/E x 174.5 12.9 21.0 13.8 P/CE x 117.8 12.0 18.5 12.0 which allows the developer to repeatedly produce blockbuster EV/EBITDA x 64.1 8.8 13.2 8.0 games. EV/EBIT x 78.7 9.4 14.7 9.0 Gross dividend yield % 0.0 0.0 0.0 0.0 DPS PLN 0.00 0.00 0.00 0.00 The debut of Frostpunk is a positive surprise to us, therefore No. of shares (eop) m 2.2 2.2 2.2 2.2 we increase our sales forecast for the game to 963,000 (PC) in Source: Company, DM BOŚ SA estimates FY18 (vs. 640,000) previously. Also, expecting the increase in scale of Project 8, we upgrade the estimate of Project 8’s cost Stock performance 295 of development to PLN 15 million (from PLN 11.5 million) and WIG 11 bit studios 275 assume that Project 8 will sell 20% more copies than Frostpunk 255 (our FY18 forecast implies 50% better sales volume of Frostpunk 235 than This War of Mine). Effectively, we increase our FY18 and 215

FY19 net profit forecasts for 11 bit studios to PLN 48.2 million and 195

PLN 29.6 million (from PLN 34.7 and PLN 18.7 million respectively). 175

This boosts our 12M EFV to PLN 377.0 per share, up by 49% (from 155 PLN 253 per share). 135 115

0.08 (m) Given the current 35% valuation gap and a potential 0.06 0.04

lume 0.02 further upside to our valuation (in case of more frequent 0.00 V o 7 20 1 2017 Frostpunk’s DLCs releases (currently we assume only one DLC) 2017 2017 2017 2017 2017 2017 2017 2018 2018 2018 2018 05 . 04 . 06 . 07 . 08 . 09 . 10 . 11 . 12 . 01 . 02 . 03 . 04 . or better performance of the publishing segment) we uphold Source: Bloomberg our LT fundamental Buy and ST market-relative Overweight recommendations. Upcoming events 1. Release of 1Q18 financial results: May 10 2. Debut of Moonlighter: May 29 Excellent sale of Frostpunk 3. Debut of Children of Morta: 3Q18 (our assumption) 4. Release of 2Q18 financial results: August 30, 2018 On the basis of several factors (incl. steam ranks, peak number 5. Release of Frostpunk DLC: 2H18 (our assumption) 6. Debut of Frostpunk (PS4, X1): 4Q18 (our assumption) of players, steam number of reviews, historical sales stats) we 7. Release of 3Q18 financial results: November 14 estimate that the Company may sell 550,000 copies of Frostpunk 8. Debut of Project 8: 4Q20 (our assumption) 9. Debut of Project 9: 4Q22 (our assumption) in 2Q18 (10 weeks from its release). Moreover, we browsed the sales stats of other peer games (Fig. 1) and estimated (on the Catalysts Risk factors basis of 1Q vs. 2Q and 1Q vs. 3Q volume relations) that Frostpunk 1. High earning potential of Frostpunk 1. Delay/ failure of Frostpunk/ Project 8 2. Announcements regarding further Frostpunk’s 2. Potential supply of shares from insiders may sell 963,000 and 776,000 copies in, respectively, FY18 and development and Project 8 FY19, which is, respectively, 50% and 16% higher than TWOM 3. Entering the Chinese market 4. Further development of the publishing segment sold in the same period from release. The Company might release 5. Proven track record of high quality games sales numbers on Friday’s afternoon. We expect that around 6. Very good cash position 220,000 copies will have been sold until then, which should easily return the cost of Frostpunk’s development and marketing (c. PLN 10 million). 11 bit studios

Further development of Frostpunk The full program assumes issuing a maximum of 100,000 warrants (potential dilution of up to 4.5%). If assumptions City builders have nearly endless possibilities of adding DLC’s. of the program are fulfilled, the shares will be acquired at Currently the base game of Frostpunk consists of three scenarios. price which is an average share price from 2H16 with 10% 11 bit studios will surely release additional scenarios in the future. discount (c. PLN 102.6 per share – our calculation). Our We currently assume only one DLC in our forecast (in 2H18; price previous forecasts would not guarantee the fulfillment of the of US$ 9.99) and we project the sale volume at 10% of the base ongoing motivation scheme in the full amount. However, if the game. However in the middle of May, the Company will organize Company fulfills our current forecasts, the program will be the investors meeting and will inform about its plans of further fulfilled in the full scale. The full equity dilution is assumed in Frostpunk’s development. Potential frequent release of DLC’s our valuations. creates positive upside to our forecasts. 1Q18 results preview Consoles version in 4Q18? 11 bit studios will release its 1Q18 consolidated results on May 10. According to the management, the Company needs additional Due to Frostpunk’s release the Company delayed the sales two more quarters to release consoles version of Frostpunk. In our activities for TWOM to 2Q18, therefore we expect rather weak model, we conservatively delay the release of consoles version to reading. We forecast 23% yoy drop in revenues which would 4Q18 (from 3Q18). Moreover, after browsing the sales data of peer result in PLN -0.3 million net profit. 1Q18 results will have a minor games on consoles, we decided to leave our 1Q sales forecasts impact for investors in view of Frostpunk’s relase. unaltered at c. 120,000, in spite of significantly higher assumptions for a PC version. City builders are not too attractive for consoles Financial forecasts players due to their complicated controls and rather static gameplay. Due to the excellent debut of Frostpunk we modify or 2018-20E Project 8 bigger than expected? forecasts for 11 bit studios accounting for: (i) higher sales assumptions for Frostpunk, (ii) higher cost and sales assumptions The management claimed that the final shape ofProject 8 (P8) is for Project 8, (iii) delay of consoles versions of Frostpunk to 4Q18 dependent on the scale of Frostpunk’s success. We believe that (from 3Q18 previously). Frostpunk’s success justifies the increase of P8. Therefore, we increase our estimate of P8’s cost of production to PLN 15 million We assume that a PC version of Frostpunk will sell 963,000 (from PLN 11.5 million; vs. PLN 8 million for Frostpunk) and copies in 2018 (vs. 640,000 previously assumed). We assume increase the sales assumptions to 120% of Frostpunk’s sales that PS4 and XboxOne versions will be released in 4Q18 (prev. volumes (vs. 110% previously). We assume that P8 will debut in 3Q18) and will sell 120,000 copies in Q1 (no change). We expect 4Q20 and will cost US$ 34.99 at its debut (vs. US$ 29.99). 11bit’s new title to debut in 4Q20 (no change) and assume a 20% higher sales volume than for Frostpunk (prev. 10% higher). Motivation program will be fulfilled Valuation and recommended actions The ongoing motivation program for 2017-2019 is dependent on two results criteria: We increase our 12M EFV (50%-50% weighted average of DCF and peer-relative approach) to PLN 377 per share (by aaIn 2017-2019: cumulative revenues exceeds PLN 126.4 million 49%), which implies 35% share price upside. With (i) P/E (on (33% weigh), the average 2018E-20E EPS) at 15.1x the Company trades with c. 34% discount vs. its peers (2018-20E P/E at 23.1x), effectively aaIn 2017-2019: cumulative gross profit (before tax) exceeds we reiterate our LT fundamental Buy and ST market-relative PLN 71.2 million (67% weigh), Overweight recommendations.

Please note that the figures have been removed from this publication intentionally.

2 BASIC DEFINITIONS Banks A/R turnover (in days) = 365/(sales/average A/R)) Net Interest Margin (NIM) = net interest income/average assets Inventory turnover (in days) = 365/(COGS/average inventory)) NIM Adjusted = (net interest income adjusted for SWAPs)/average assets A/P turnover (in days) = 365/(COGS/average A/P)) Non interest income = fees&commissions + result on financial operations (trading gains) + FX gains Current ratio = ((current assets – ST deferred assets)/current liabilities) Interest Spread = (interest income/average interest earning assets)/ (interest cost/average interest bearing liabilities) Quick ratio = ((current assets – ST deferred assets – inventory)/current liabilities) Cost/Income = (general costs + depreciation + other operating costs)/ (profit on banking activity + other Interest coverage = (pre-tax profit before extraordinary items + interest payable/interest payable) operating income) Gross margin = gross profit on sales/sales ROE = net profit/average equity EBITDA margin = EBITDA/sales ROA = net income/average assets EBIT margin = EBIT/sales Non performing loans (NPL) = loans in ‘substandard’, ‘doubtful’ and ‘lost’ categories Pre-tax margin = pre-tax profit/sales NPL coverrage ratio = loan loss provisions/NPL Net margin = net profit/sales Net provision charge = provisions created – provisions released ROE = net profit/average equity ROA = (net income + interest payable)/average assets DM BOŚ S.A. generally values the covered banks via two methods: comparative method and fundamental target fair EV = market capitalization + interest bearing debt – cash and equivalents P/E and target fair P/BV multiples method. The advantage of the former is the fact that it incorporates the current market EPS = net profit/ no. of shares outstanding assessment of the value of the company’s peers. The weakness of the comparative method is the risk that the valuation CE = net profit + depreciation benchmark may be mispriced. The advantage of the fundamental target fair P/E and target fair P/BV multiples method is Dividend yield (gross) = pre-tax DPS/stock market price its independence of the current market valuation of the comparable companies. The weakness of this method is its high Cash sales = accrual sales corrected for the change in A/R sensitivity to undertaken assumptions, especially those Cash operating expenses = accrual operating expenses corrected for the changes in inventories and A/P, related to the residual value calculation. Assumptions used in valuation can change, influencing thereby the level of the depreciation, cash taxes and changes in the deferred taxes valuation. Among the most important assumptions are: GDP growth, forecasted level of inflation, changes in interest DM BOŚ S.A. generally values the covered non bank companies via two methods: comparative method and DCF rates and currency prices, employment level and change in wages, demand on the analysed company products, raw method (discounted cash flows). The advantage of the former is the fact that it incorporates the current market material prices, competition, standing of the main customers and suppliers, legislation changes, etc. Changes in the assessment of the value of the company’s peers. The weakness of the comparative method is the risk that the environment of the analysed company are monitored by analysts involved in the preparation of the recommendation, valuation benchmark may be mispriced. The advantage of the DCF method is its independence from the current estimated, incorporated in valuation and published in the recommendation whenever needed. market valuation of the comparable companies. The weakness of this method is its high sensitivity to undertaken assumptions, especially those related to the residual value calculation. Please note that we also resort to other valuation techniques (e.g. NAV-, DDM- or SOTP-based), should it prove appropriate in a given case.

KEY TO INVESTMENT RANKINGS This is a guide to expected price performance in absolute terms over the next 12 months: Buy – fundamentally undervalued (upside to 12M EFV in excess of the cost of equity) + catalysts which should close the valuation gap identified; Hold – either (i) fairly priced, or (ii) fundamentally undervalued/overvalued but lacks catalysts which could close the valuation gap; Sell – fundamentally overvalued (12M EFV < current share price + 1-year cost of equity) + catalysts which should close the valuation gap identified. This is a guide to expected relative price performance: Overweight – expected to perform better than the benchmark (WIG) over the next quarter in relative terms Neutral – expected to perform in line with the benchmark (WIG) over the next quarter in relative terms Underweight – expected to perform worse than the benchmark (WIG) over the next quarter in relative terms

The recommendation tracker presents the performance of DM BOŚ S.A.’s recommendations. A recommendation expires on the day it is altered or on the day 12 months after its issuance, whichever comes first. Relative performance compares the rate of return on a given recommended stock in the period of the recommendation’s validity (i.e. from the date of issuance to the date of alteration or – in case of maintained recommendations – from the date of issuance to the current date) in a relation to the rate of return on the benchmark in this time period. The WIG index constitutes the benchmark. For recommendations that expire by an alteration or are maintained, the ending values used to calculate their absolute and relative performance are: the stock closing price on the day the recommendation expires/ is maintained and the closing value of the benchmark on that date. For recommendations that expire via a passage of time, the ending values used to calculate their absolute and relative performance are: the average of the stock closing prices for the day the recommendation elapses and four directly preceding sessions and the average of the benchmark’s closing values for the day the recommendation expires and four directly preceding sessions.

Distribution of DM BOŚ’s current recommendations for the companies which DM BOŚ has supplied Distribution of DM BOŚ's current recommendations with material investment services within the last 12 months Buy Hold Sell Suspended Under revision Buy Hold Sell Suspended Under revision Numbers 39 34 7 4 1 Numbers 6 6 0 0 0 Percentage 46% 40% 8% 5% 1% Percentage 50% 50% 0% 0% 0%

Distribution of DM BOŚ’s current market relative recommended weightings for the companies which Distribution of DM BOŚ's current market relative recommended weightings DM BOŚ has supplied with material investment services within the last 12 months Overweight Neutral Underweight Suspended Under revision Overweight Neutral Underweight Suspended Under revision Numbers 36 26 18 4 1 Numbers 6 3 3 0 0 Percentage 42% 31% 21% 5% 1% Percentage 50% 25% 25% 0% 0% LT fundamental recommendation tracker Relative Price at issue/ EFV Analyst Recommendation Report date Reiteration date Distribution date Expiry date Performance performance reiteration* (12 months) 11 bit studios Tomasz Rodak Buy - 13.02.2017 - 14.02.2017 13.02.2018 28% 18% 164.50 220.00 - Tomasz Rodak - → - 07.03.2017 08.03.2017 - - - 182.15 220.00 → Tomasz Rodak - → - 11.04.2017 12.04.2017 - - - 192.00 220.00 → Tomasz Rodak - → - 30.05.2017 31.05.2017 - - - 184.50 220.00 → Tomasz Rodak - → - 12.07.2017 13.07.2017 - - - 174.40 220.00 → Tomasz Rodak - → - 20.08.2017 21.08.2017 - - - 189.00 261.00 ↑ Tomasz Rodak - → - 29.08.2017 30.08.2017 - - - 196.75 261.00 → Tomasz Rodak - → - 03.09.2017 04.09.2017 - - - 205.00 261.00 → Tomasz Rodak - → - 15.10.2017 16.10.2017 - - - 188.00 261.00 → Tomasz Rodak - → - 13.11.2017 14.11.2017 - - - 168.60 231.00 ↓ Tomasz Rodak - → - 15.11.2017 16.11.2017 - - - 164.25 231.00 → Tomasz Rodak - → - 10.12.2017 11.12.2017 - - - 175.00 231.00 → Tomasz Rodak - → - 10.01.2018 11.01.2018 - - - 201.00 231.00 → Tomasz Rodak Buy → 13.02.2018 - 14.02.2018 Not later than 33% 41% 210.50 231.00 → 13.02.2019 Tomasz Rodak - → - 14.02.2018 15.02.2018 - - - 209.00 253.00 ↑ Tomasz Rodak - → - 12.03.2018 13.03.2018 - - - 214.00 253.00 → Tomasz Rodak - → - 16.04.2018 17.04.2018 - - - 257.00 253.00 → Tomasz Rodak - → - 26.04.2018 27.04.2018 - - - 280.00 377.00 ↑ * prices at issue/reiteration are the closing prices at the report or reiteration date

Market-relative recommendation tracker Relative Price at issue/ Relative Analyst Report date Reiteration date Distribution date Expiry date Recommendation reiteration* performance 11 bit studios Tomasz Rodak Overweight - 13.02.2017 - 14.02.2017 13.02.2018 164.50 18% Tomasz Rodak - → - 07.03.2017 08.03.2017 - 182.15 - Tomasz Rodak - → - 11.04.2017 12.04.2017 - 192.00 - Tomasz Rodak - → - 30.05.2017 31.05.2017 - 184.50 - Tomasz Rodak - → - 12.07.2017 13.07.2017 - 174.40 - Tomasz Rodak - → - 20.08.2017 21.08.2017 - 189.00 - Tomasz Rodak - → - 29.08.2017 30.08.2017 - 196.75 - Tomasz Rodak - → - 03.09.2017 04.09.2017 - 205.00 - Tomasz Rodak - → - 15.10.2017 16.10.2017 - 188.00 - Tomasz Rodak - → - 13.11.2017 14.11.2017 - 168.60 - Tomasz Rodak - → - 15.11.2017 16.11.2017 - 164.25 - Tomasz Rodak - → - 10.12.2017 11.12.2017 - 175.00 - Tomasz Rodak - → - 10.01.2018 11.01.2018 - 201.00 - Tomasz Rodak Overweight → 13.02.2018 - 14.02.2018 Not later than 13.02.2019 210.50 41% Tomasz Rodak - → - 14.02.2018 15.02.2018 - 209.00 - Tomasz Rodak - → - 12.03.2018 13.03.2018 - 214.00 - Tomasz Rodak - → - 16.04.2018 17.04.2018 - 257.00 - Tomasz Rodak - → - 26.04.2018 27.04.2018 - 280.00 - * prices at issue/reiteration are the closing prices at the report or reiteration date Institutional sales

Bartosz Janczy tel.: +48 (22) 504 32 46 [email protected]

Tomasz Grabowski tel.: +48 (22) 504 32 47 [email protected]

Marcin Kozerski tel.: +48 (22) 504 33 35 [email protected]

This material was produced by DM BOŚ based in Warsaw. Grzegorz Kołodziejczyk tel.: +48 (22) 504 33 34 The production of the recommendation report was completed on 27 April, 2018 at 8.00 a.m. [email protected] The recommendation was distributed on 27 April, 2018 at 8.10 a.m. Marcin Stosio The report is an investment research within the meaning of Commission Delegated Regulation (EU) 2017/565 of 25 April 2016 tel.: +48 (22) 504 33 37 [email protected] supplementing Directive 2014/65/EU of the European Parliament and of the Council as regards organisational requirements and operating conditions for investment firms and defined terms for the purposes of that Directive. Michał Zawada This report constitutes a recommendation within the meaning of Commission Delegated Regulation (EU) 2016/958 of 9 March tel.: +48 (22) 504 33 36 2016 supplementing Regulation (EU) No 596/2014 of the European Parliament and of the Council with regard to regulatory [email protected] technical standards for the technical arrangements for objective presentation of investment recommendations or other Andrzej Kowalczyk information recommending or suggesting an investment strategy and for disclosure of particular interests or indications of tel.: +48 (22) 504 33 78 conflicts of interest. This report is for information purposes only. [email protected] This report constitutes neither investment advice nor provides investment service as referred to in Article 76 of the Act on Financial Instruments Trading as of 29 July 2005 (Journal of Laws, 2017, Item 1768 as amended); it does not constitute any legal or tax advice, neither does it constitute an indication whether an investment is suitable or appropriate in an individual situation Research of an investor. Sobiesław Pająk, CFA Neither the information nor the opinions expressed in the report constitute a solicitation or an offer to buy or sell any securities (Equity strategy, TMT) referred herein. The opinions expressed in the report reflect independent, current judgment of DM BOŚ. This report was tel.: +48 (22) 504 32 72 prepared with due diligence and scrutiny. The information used in the report is based on all public sources such as press [email protected] and branch publications, company’s financial statements, current and periodic reports, as well as meetings and telephone conversations with company’s representatives prior to the date of report’s release. We believe the above mentioned sources of Sylwia Jaśkiewicz, CFA (Construction materials, Consumer staples information to be reliable, however we do not guarantee their accuracy and completeness. All estimates and opinions included & discretionary, Health care) herein represent our judgment as of the date of the issue. tel.: +48 (22) 504 33 75 DM BOŚ SA is an investment firm within the meaning of the Act on Financial Instruments Trading as of 29 July 2005 (Journal of [email protected] Laws, 2017, Item 1768 as amended). The legal entity supervising DM BOŚ is Polish Financial Supervision Authority in Warsaw (Komisja Nadzoru Finansowego, Pl. Powstańców Warszawy 1, 00-950 Warszawa, KNF in Polish abbreviation). Maciej Wewiórski (Residential construction, DM BOŚ, its management and supervisory bodies and employees do not take any responsibility for decisions taken on the Construction, Real estate) basis of this report and opinions stated herein. Investors bear all responsibility for investment decisions taken on the basis of the tel.: +48 (22) 504 33 07 contents of this report. The report is intended exclusively for private use of investors – retail and professional clients of DM BOŚ. [email protected] No part or excerpt of the report may be redistributed, reproduced or conveyed in any manner or form written or oral without the prior written consent of DM BOŚ. Michał Sobolewski, CFA, FRM (Financials) This report is released on the day it is issued to retail and professional clients of DM BOŚ upon the Agreement on providing tel.: +48 (22) 504 33 06 the recommendations prepared by DM BOŚ or any agreement containing the commitment of DM BOŚ to providing [email protected] recommendations on behalf of those clients. This report can be made available to other clients of DM BOŚ within time limits and upon terms as indicated by the General Manager of DM BOŚ. The short version of the report is made available to the Jakub Viscardi public no sooner than 7 days after the first release. (Telco, Consumer staples & discretionary, DM BOŚ follows internal regulations for handling of conflicts of interest which include in particular internal organizational and IT – hardware distribution, Utilities) tel.: +48 (22) 504 32 58 administration arrangements as well as information barriers established for prevention and avoidance of conflicts of interest [email protected] related to recommendations. A special organizational arrangement that constitutes an information barrier is so called Chinese walls prohibiting an uncontrolled flow of information among particular organizational units or employees of DM BOŚ. Where Łukasz Prokopiuk, CFA justified, DM BOŚ can create Chinese walls upon the realization of a particular project. Potential conflicts of interests referring (Chemicals, Mining, to a specific recommendation which is made available to the public or to a wide range of persons are disclosed either in the Mining – machinery, Oil & gas) tel.: +48 (22) 504 32 59 recommendation or in the document attached. [email protected] The person(s) responsible for covering the securities referred to in this report receives compensation based upon the overall profitability of DM BOŚ which includes profits derived from investment banking activities, although the analyst compensation is Tomasz Rodak, CFA not directly related thereto. (Consumer discretionary, Video games) DM BOŚ releases analytical reports via mail or electronic mail to selected clients (professional clients) and via indicated software tel.: +48 22 504 33 23 of DM BOŚ for logged customer pursuant to the notation as entered in the appropriate agreement on provision of the brokerage [email protected] services. Wojciech Romanowski DM BOŚ has not held any long or short position net exceeding 0.5% of the issuer’s basic capital in total for the companies Junior Analyst indicated. tel.: +48 22 504 33 88 [email protected] During the last 12 months DM BOŚ S.A rendered investment services on behalf of 11 bit studios pursuant to the agreement signed and received a remuneration by virtue of this. Copyright © 2018 by DM BOŚ S.A. Apart from the mentioned above, there are neither ties of any kind between DM BOŚ, the analyst/ analysts involved in the preparation of the report and the issuer(s) of securities as referred to in the report nor circumstances that can justifiably be Dom Maklerski Banku Ochrony expected to have a negative impact on objectivity of the recommendation with regard to interests or conflicts of interests on their Środowiska Spółka Akcyjna ul. Marszałkowska 78/80 part or on the part of any natural person or legal entity which pertains to the security or the issuer. 00-517 Warszawa DM BOŚ has not signed with the company/ companies any contracts for recommendation writing. www.bossa.pl The report was not shown to the analyzed company/companies before the distribution of the report to clients. Information: (+48) 0 801 104 104