Update Equity Research 27 May 2020 Embracer Group Sector: Gaming Pipeline in Focus FAIR VALUE RANGE BEAR BASE BULL Redeye reiterates its positive view of Embracer Group. The Q4 report was solid, and the 65.0 130.0 170.0 update to the pipeline has not led to any significant changes to our forecasts. A substantial amount of available capital for M&A indicates that something big could be in the making. Embracers' quality and M&A track-record should justify a premium valuation; the company EMBRAC.ST VERSUS OMXS30 is still valued in line with peers based on Oper. EBIT multiples. We believe that the growth EMBRAC OMXS30 journey of Embracer Group will continue for many years more. 140 120 Solid report, focus on pipeline 100 Q4 was a solid report with better than expected margins. The biggest takeaway was 80 60 increased pipeline visibility; the planned release schedule indicates 2x the amount of new 40 release (of capital invested) we saw during FY20. Earlier expected AAA titles have been 20 moved to FY22; this year, we will see a multitude of mid-sized games instead. The pipeline 0 27-maj 25-aug 23-nov 21-feb 21-maj adjustments have only led to small forecast changes for our part. More M&A will come REDEYE RATING Despite the market’s “cravings” of deals, no new M&A was announced. We feel confident that management will not stress in making acquisitions just because the market wants 5 them to. At the end of the quarter, the company had cash and unutilized credit facilities of 4 4 approximately SEK 5bn. In addition to this, the company raised SEK 1.6bn after the close of the quarter through a directed share issue. The company now states that they might consider temporary financial leverage for the right deal. Also, Embracer can issue 10% new People Business Financials shares if they need to. With the current cash position, some leverage, and a share issue (to the seller), Embracer has about SEK 10bn in available capital for M&A. Big things could be in the making, time will tell. KEY STATS A quality company at a fair price Ticker EMBRAC.ST Our Base-case of 130 SEK per share is unchanged. Embracer trades at an EV/Oper. EBIT Market Nasdaq multiple of 23x on our FY21 estimate, in line with the median valuation for the Nordic Share Price (SEK) 10 9 gaming peers. Embracer’s track-record in M&A, broad game portfolio, shareholder focus, and growth potential deserve a premium valuation in our view. Embracer is a company that Market Cap (MSEK) 43509 seldom will look cheap. We regard it far better to buy quality at a fair price than a fair Net Debt 20E (MSEK) - 700 company at a low price, and that is what you currently get in Embracer. Free Float 6 0 % Avg. daily volume (‘000) 100 0 KEY FINANCIALS (SEKm) FY19 FY20 FY21E FY22E FY23E FY24E Net sales 508 5754 7390 8721 10269 11604 ANALYSTS EBITDA 273 1592 3210 3665 4487 5192 Kristoffer Lindstrom Oper. EBIT 202 880 1959 2403 2944 3414 [email protected] EPS (adj.) 2018 2019 2020E 2021E 2022E 2023E EPS (adj.) 1.8 3.5 -0.3 1.0 2.1 3.0 Tomas Otterbeck EV/Sales 1.2 0.9 6.0 5.1 4.3 3.8 [email protected] EV/EBITDA 13.6 13.8 13.8 12.1 9.9 8.5 EV/Op. EBIT 24.3 24.3 22.6 18.4 15.0 13.0 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] REDEYE Equity Research Embracer Group 27 May 2020 A solid report Estimates vs Outcome Embracer Group FY19- FY20- FY20- Diff % MSEK Q4* Q4 Q4E Net sales 1 631 1 339 1 310 2% of which New releases Games 781 345 250 38% Backlog Games 254 559 584 -4% Partner Publishing/Film 596 436 476 -9% Gross profit 889 673 706 -5% EBITDA 619 495 444 11% Operational EBIT 396 286 241 19% Revenue growth 158% -18% -20% Gross profit margin 55% 50% 54% EBITDA margin 38% 37% 34% Opr. EBIT margin 24% 21% 18% Source: Redeye Research *FY19-Q4 w as the fith quarter of the extended year 19/20, but for easier comparison, w e call it Q4. Summary: • Solid report with better than expected margins • Increased pipeline visibility, the planned release schedule indicates 2x the amount of new release (of capital employed) we saw during FY20. AAA titles likely moved to FY22. This year we will see a multitude of mid-sized games instead • The Saber acquisition going well and SnowRunner (the first game released as an Embracer company) have exceeded management expectations Embracer showed yet another stable quarter. The net sales were almost spot-on our projections while the Operational EBIT came in 19% higher. That the company showed a decline in net sales compared to last year was entirely in the cards; as during Q4'FY19, Embracer had a couple of major releases. The main reason we saw a better margin than we had expected was a far lower SG&A, probably a COVID19, and release schedule effect with fewer gaming conferences, events, and marketing. During the period, cash flow was robust and amounted to SEK 765.7m, fueled by both the high operating profit and reduced working capital. The biggest takeaway from the report was an update on the game pipeline ahead. Most notably; we won't see a AAA game during FY21, but instead a multitude of mid-sized releases. Still, the release schedule implies more than double capital tied up in development will come to the market during FY'21 compared to FY'20. Embracer expects that the first AAA game since Metro Exodus will be released in FY'22. 2 dsfdsf REDEYE Equity Research Embracer Group 27 May 2020 Games Embracer: New release sales, Finalized dev. & Sales return 900 4.0x 781 800 3.5x 700 3.0x 600 2.5x 500 2.0x 400 345 mSEK 321 291 1.5x 300 246 261 Sales return 190 200 1.0x 98 117 117 100 0.5x 30 15 34 0 0.0x New releases per quarter Finalized development Sales return New releases to fin. dev. Source: Redeye Research The sales within the Games area exceeded our expectations, fueled by a higher new release revenue, which came in at SEK 345m. The most significant contributors to new release revenue were Darksiders Genesis, Metro DLC, Metro Redux, Hunt: Showdown, and a couple of smaller titles. During the quarter, Embracer recorded SEK 165m in finalized development. The sale return landed at a high level of 2.1x, likely driven by the high market demand for gaming content. Embracer: Backlog sales, Finished Games asset & sales return 600 2.5x 555 545 559 524 500 2.0x 400 386 1.5x 300 259 254 mSEK 232 1.0x 200 salesx return 145 0.5x 100 71 52 51 65 0 0.0x Backlog Finished Games asset % return on released dev asset -1Q Source: Redeye Research The backlog sales, which amounted to SEK 559m, were in line with our projections and saw a stable development during the period. Key franchises like Metro Exodus (release on steam), 3 dsfdsf REDEYE Equity Research Embracer Group 27 May 2020 Kingdom Come: Deliverance, Wreckfest, and Milestone games. Update III of Satisfactory (Coffee Stain) was well received, and the business unit had its strongest quarter ever. Embracer: Sales development Games & sales mix 1200 90% 80% 1000 98 70% 82 800 45 36 60% 50% 600 83 467 515 794 442 40% % of sales of % 187 Net salesNet (mSEK) 400 30% 373 142 342 338 326 252 20% 200 178 352 330 333 119 255 307 10% 138 146 143 185 82 86 85 124 0 0% THQ Nordic Deep Silver Coffee Stain Own IPs % sales Digital % sales Source: Redeye Research Digital sales reached record levels and amounted to 78% of game sales. That the digital share continued to climb is an effect of consumer behavior of buying digital goods, which has increased even further with the COVID-19 outbreak. An enhanced digital sales are beneficial for Embracer’s gross profit margin. Amplifier Amplifier continues there work with establishing new studios and conduct smaller game investment. During the quarter, the unit set up a new game studio in Gothenburg called RiverEnd Games lead by industry veterans. They also increased their stake in Misc Games to 55% from 45% and acquired a small indie studio in Italy named DESTINYbit. Partner Publishing The business unit had net sales of about 9% below our projections. Partner Publishing is the segment within the Group that has been affected the most by COVID-19 in a negative way. Physical store sales have gone down dramatically, but most consumers then shifted to e- tailers instead. Still, Partner Publishing’s logistic hubs have remained operational. 4 dsfdsf REDEYE Equity Research Embracer Group 27 May 2020 Update on the pipeline We find that the most interesting info in the report was related to the pipeline in the coming years. We have previously expected to see two AAA games come to market during FY’21 (this financial year), now the company indicates that the first AAA release after Metro will take place in FY22. In isolation, that would mean less new release income then we previously expected.