Update Equity Research 7 November 2019 Embracer Group Sector: Gaming Q2’FY20 preview and a Q&A session FAIR VALUE RANGE BEAR BASE BULL Q2 preview 60.0 100.0 125.0 Embracer Group will present their Q2 report for the Financial year of 2020 on the 14th of November. On the Group level, we project that the net sales will reach about SEK 1 008m, with an Operational EBIT of SEK 157m. We expect to see a drop year over year in net sales EMBRAC.ST VERSUS OMXS30 as there is less Partner Publishing volumes, but a high Operational EBIT growth in the OMXS 30 region of 59% thanks to strong games sales. Embracer Group 300 Q&A session 250 200 On the 31st of October, the share of the Embracer Group fell sharply. The reason for that 150 was a published "short case" on the stock." Market talk" arose with a lot of claims regarding 100 Embracer Groups' accounting praxis, underlying profitability, and valuation. In this special 50 report , we present a type of Q&A session where we share our view on the following 0 questions: 05-nov 03-feb 04-maj 02-aug • What is EV/Invested Capital? REDEYE RATING • Has the cash flow been weak? • Is Koch Medias profitability much lower than what Embracer Group has previously communicated? 5 4 4 • Was Metro Exodus Koch Media's primary asset? • Does the difference in accounting principles create an artificial boost in earnings post acquisitions? People Finance • Is the decline in the physical distribution for the gaming industry a risk for Business Embracer? Unmotivated share price drop creates an opportunity KEY STATS Our view is the following: As it seems like that the short case rest on a dubious valuation Ticker EMBRAC.ST Market Nasdaq approach, false claims, weird conclusions, and directly incorrect facts view the share drop as totally unmotivated (nothing has changed with the business). In our view, the decline in Share Price (SEK) 241.2 share price has led to an attractive opportunity for long-term investors to invest in a Market Cap (MSEK) 25045 genuinely quality growth company at attractive levels. Net Debt 19E (MSEK) - 2602 Free Float 50 % Avg. daily volume (‘000) 940 KEY FINANCIALS (SEKm) 2017 2018 2019E 2020E 2021E 2022E Net sales 508 5754 5572 6939 8118 9092 ANALYSTS EBITDA 273 1592 1815 2478 2899 3420 Kristoffer Lindstrom EBIT 188 575 556 941 1234 1546 [email protected] EPS (adj.) 1.82017 3.52018 3.82019E 6.62020E 9.02021E 11.32022E Tomas Otterbeck EV/Sales 19.9 3.2 4.0 3.1 2.6 2.3 [email protected] EV/EBITDA 37.0 11.7 12.4 8.7 7.4 6.1 EV/EBIT 53.6 32.4 40.4 23.0 17.4 13.6 P/E 77.0 59.9 63.5 36.5 26.8 21.4 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 7 November 2019 Q2’FY20 preview Embracer Group will present their Q2 report for the financial year of 2020 on the 14th of November. On the Group level, we project that the net sales will reach about SEK 1 008m, with an Operational EBIT of SEK 157m. We expect to see a drop year over year in net sales as there is less Partner Publishing volumes, but a high Operational EBIT growth in the region of 59% thanks to strong Games sales. Quarterly estimates Embracer Group FY19- FY20- MSEK Q2* Q2E Net sales 1 273 1 008 of which New releases Games 117 249 Backlog Games 259 310 Partner Publishing/Film 897 448 Gross profit 377 524 EBITDA 215 313 Operational EBIT 99 157 EBIT 91 36 Revenue growth 1403% -21% Gross profit margin 30% 52% EBITDA margin 17% 31% Opr. EBIT margin 8% 16% EBIT margin 7% 4% Source: Redeye Research *FY19-Q2 w as the third quarter of the extended year 19/20, but for easier comparison, w e call it Q2. Key drivers: • Games: o New releases. We believe that new releases will create an income of about SEK 249m with a significant contribution from the latest acquisitions. During FY19’Q2 last year, Games had SEK 117m in revenue from new releases, compared to the releases during that time the line-up, this year feels much stronger. We might be a little conservative on the new release front, but it’s extremely hard to estimate these kinds of income flows. o Main releases include among others; ▪ Remnant: From the Ashes. Gunfires Remnant can only bee see as a real success. According to third-party data, it looks like the game sold approx. 700k on Steam and 200K on PS4. The Steam figure sounds a little too high according to us as the game topped out at a PCCU of 50k. On the 31th of October the publisher Perfect World announced that the game had sold 1 million copies, we think about 900k during Q2 sounds reasonably. One thing we want to stress is that Embracer is no the publisher of the game, so the income will not be that excessive even though the substantial number of copies sold. Remnant was a new IP from Gunfire, so the thing we look forward to is the next plans for this new franchise. ▪ During the quarter, Wreckfest was launched on consoles. The game has received a strong critic rating. According to third-party data, it seems like they have sold roughly 225k copies on PS4 2 REDEYE Equity Research THQ Nordic 7 November 2019 during the quarter, the likely total sold on consoles should be in the region of 370-400k. ▪ MXGP 2019 from the newly acquired Milestone was also released during the quarter. We believe that the game satisfies it’s fan- base with good user scores, but actual sales figures are harder to estimate. Overall, we think that the game has sold similar volumes as their precursors. ▪ DLC mania: There have been a lot of DLC’s released, with the main ones are: Metro Exodus DLC, Darksiders 3 DLC, and MX vs. ATV All Out! DLC. Overall, we fell that the reception for the DLC’s has been good. ▪ Red faction Re-mars-tered on Switch was another release, and there have been a few more. o Backlog: We expect that games will have a backlog sales of SEK 310m, this corresponds to a growth of 20% compared to the same period last year. We believe the main drivers will be Metro and Satisfactory sales, bundles, and subscription service inclusion. We also noticed that Darksiders III was included in PlayStation plus, which most often lead to a type of fixed payment from Sony. Many of Milestones titles have already been included in different subscriber packages like PlayStation Now. • Partner Publishing: In conjunction with the last report, the management indicates that the business unit has notably fewer releases during the quarter compared to the same period last year. The new acquisition conducted during Q1 will add some top-line revenue. We expect to see a revenue level of roughly SEK 448m, a 50% drop compared to last year. • Profitability: We expect to see a healthy margin driven by digital sales and a relatively low-income share for Partner Publishing. Our assumptions lead to an Operational EBIT margin of 16%.. 3 REDEYE Equity Research Embracer Group 7 November 2019 A Redeye Q&A session On the 31th of October the share of Embracer Group fell sharply. The reason for that was a published “short case” on the stock. ”Market talk” arose with a lot of claims regarding Embracer Groups accounting praxis, underlying profitability and valuation. We view a part of the market talk as a direct distrust directed to the company’s management. One core part of our Investment Case in Embracer is their competent management team and strong shareholder focus. As such we find it prudent to present our view on the “market talk” that have reached our ears. We have had research coverage of Embracer Group for almost two and a half year soon, and thus far our track-record has not been that shabby. Embracer Group: Share price and Redeye Base-case valuation (adj. For share split) (SEK per share) 120.0 100.0 80.0 60.0 40.0 20.0 0.0 2017-07-28 2017-08-28 2017-09-28 2018-03-31 2018-04-30 2018-05-31 2018-06-30 2018-07-31 2018-12-31 2019-01-31 2019-02-28 2019-03-31 2019-04-30 2019-05-31 2019-06-30 2017-10-28 2017-11-28 2017-12-28 2018-01-28 2018-02-28 2018-08-31 2018-09-30 2018-10-31 2018-11-30 2019-07-31 2019-08-31 2019-09-30 2019-10-31 THQN Base-case Source: Bloomberg & Redeye Research As it seems like the short case rest on a dubious valuation approach, falls claims, weird conclusions, and directly incorrect facts view the share drop as totally unmotivated. In our view, this has created an opportunity to buy shares in one of the most interesting and quality companies within the gaming space at an attractive valuation. What is EV/Invested Capital? According to the market talk we have heard, the short case suggests using an EV to Invested Capital multiple to value Embracer Group.