Update Equity Research 9 March 2020 Embracer Group Sector: Gaming Saber Deal Creating Value FAIR VALUE RANGE BEAR BASE BULL Redeye retains its positive stance on Embracer following another strong quarter, seeing 65.0 130.0 170.0 sales and operating profit all well ahead. Encouragingly, the recent acquisition of Saber Interactive fits excellently, in our view, and we are confident that we will see more value- enhancing deals. We are excited about the year ahead and view the current valuation as EMBRAC.ST VERSUS OMXS30 attractive, as we find the discount compared to peers unjustified. OMXS 30 Embracer Group 120 Stronger than expected 100 80 Embracer Group beat our expectations during Q3, the net sales landed 10% above our projections, and the Operational EBIT was 11% higher. Despite there being no major release 60 40 during the quarter, the Group showed both a strong top-line and profitability. The backlog 20 continued to shine. 0 Saber Interactive joining the ranks The big news, which was announced in conjunction with the Q3 report, was the acquisition REDEYE RATING of Saber Interactive, the largest deal to date for the Group. Saber is a US-based game developer with five studios, 600 developers, and more than 30m lifetime games sold. The studio has their own IPs, do licensed IPs and do also a have recurring revenue streams 5 from Work-For-Hire/ royalty-based projects. If Saber Interactive had been consolidated 4 4 during 2019, the Operational EBIT for Embracer Group would have increased by roughly 50%, from SEK 1 143m to SEK 1 734m. The total dilution, if all earn-outs are paid amounts to 11% of the capital, the net positive effect in increased earning-power compared to the People Business Financials dilution is rather apparent. Following the acquisition, we have raised our forecast of Operational EBIT for FY21 and FY22 by roughly 25%. Unwarranted discount to peers KEY STATS When the Saber deal was announced, we made a preliminary assessment of the financials Ticker EMBRAC.ST and raised our Base-case valuation to 130 SEK per share. We now reiterate the valuation Market Nasdaq and our positive stance towards the deal. Based on our FY21 estimate of Operational EBIT, Share Price (SEK) 94.0 Embracer is currently trading at a discounted to peers. Our Base-case implies an EV/Oper. EBIT multiple of 20x, a level we deem as fair and still somewhat cautious given Embracers Market Cap (MSEK) 28746 track-record of M&A and organic prospects. The pipeline for FY21 looks extremely strong, Net Debt 20E (MSEK) - 974 and we find that the long-term case is substantially strengthened through the latest Free Float 60 % acquisition of Saber Interactive. Exciting times ahead! Avg. daily volume (‘000) 900 KEY FINANCIALS (SEKm) 2017 18/19 FY20E FY21E FY22E FY23E Net sales 508 5754 5126 7844 9493 10632 ANALYSTS EBITDA 273 1592 1723 2960 3735 4176 Kristoffer Lindstrom Oper. EBIT 202 880 955 2010 2573 2924 [email protected] EBIT 188 575 238 736 1299 1701 Tomas Otterbeck EPS (adj.) 1.82017 3.52018 1.12019E 1.62020E 2.72021E 3.62022E [email protected] EV/Sales 19.9 3.2 5.6 3.7 3.0 2.7 EV/EBITDA 37 11.7 11.6 8.7 7.3 6.9 EV/Op. EBIT 50.0 20.9 30.1 14.3 11.2 9.8 P/E 77 59.9 85.5 58.8 34.8 26.1 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] REDEYE Equity Research Embracer Group 9 March 2020 On the report Embracer Group beat our Estimates vs Outcome Embracer Group expectations during FYQ3, the net FY19- FY20- FY20- Diff % sales landed 10% above our MSEK Q3* Q3 Q3E projections, and the Operational EBIT Net sales 1 381 1 509 1 373 10% was 11% higher. Despite there being of which New releases Games 321 291 353 -18% no major release during the quarter, Backlog Games 232 545 440 24% the Group showed both a strong top- Partner Publishing/Film 828 673 580 16% Gross profit 542 762 705 8% line and profitability. We want to EBITDA 326 519 460 13% empathize, yet again, that EBIT and Operational EBIT 194 302 271 11% net profit are of little worth when EBIT 152 91 109 -17% looking at Embracer because they Revenue growth 441% 9% -1% follow the K3 accounting standard, Gross profit margin 39% 51% 51% they depreciate their acquisitions over EBITDA margin 24% 34% 34% Opr. EBIT margin 14% 20% 20% five years. During Q3 alone there were EBIT margin 11% 6% 8% SEK 211m in acquisition-related Source: Redeye Research *FY19-Q3 w as the fourth quarter of the extended year 19/20, but depreciation, which had not been for easier comparison, w e call it Q3. there if the company followed IFRS accounting (as almost all peers). The backlog continued to shine and was one of the main reasons that the net sales came in above our forecast. The main driver here is the Metro Franchise but also KCD, Remnant, Satisfactory, Outward, and Wreckfest. As we discussed in our preview comment Metro was “re-released” on Steam on the 15th if February and Lars Wingefors, the CEO, commented at the report presentation that the game had sold about 200k copies on Steam during the first few days of the re-release. The sales return on the finished game asset has been stable in the last few quarters and amounted to 1.4x based on the asset recorded at the start of the quarter. The strong backlog development is an effect of the overall increased quality of the game portfolio with Metro as a shining star. Embracer: Backlog sales, Finished Games asset & sales return 600 2.5x 555 545 524 500 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 2 dsfdsf REDEYE Equity Research Embracer Group 9 March 2020 In terms of new releases, we already knew that this would be a slightly quite quarter. The most major ones where Darksiders Genesis, Shenmue III, and Let’s Sing 2020. The new release revenue came in below our expectations by 18%. It’s always tough to gauge new release revenue. There were SEK 146m in completed development, and those generated a sales return of 2.0x, compared to our estimate of SEK 158m in finalized development with a sales return of 2.2x. 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 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 All in all, Shenmue could have performed better, but Genesis exceeded both our and likely management expectations. The game sold more copies then Darksiders 3 during the same period last; still, the third installment in the series was a full-priced game. Genesis was released on consoles on the 14th of February; it will be interesting to follow the development. Partner Publishing and Film (PPF) showed stronger sales then we thought. Due to there being no major release, the business area showed a sales decline compared to last year, but this was already expected. The decline was not as steep as we had thought, mainly thanks to Codemasters Grid but also that the Film segment showed their strongest quarter ever. The high revenue level for Film was mostly thanks to the distribution of the German version of Oscar-winning Parasite. Significant releases in Q4 will be Doom Eternal and Persona 5 Royal Edition. In terms of gross margin profit, EBITDA, and Operational margin came in exactly as we thought. Strong digital sales drove the high profitability level, large share of own IPs, and less Partner Publishing sales. As a summary, the report was strong, and the backlog continues to show Embracer Group’s strength. We see a strong Q4 coming with Metro on Steam, Satisfactory Update 3, Metro DLC, Genesis on consoles, and more. The management also commented on Biomutant, we previously thought the game might be released in Q4, but that will not be the case. The game will be launched when it’s ready, the bar for only releasing high-quality is apparent in the management wording, which we obviously think is great. For us, it makes no difference if the cash-flow comes in Q4 or next year, all that matters is the quality of the product that comes to market to maximize the ROI. 3 dsfdsf REDEYE Equity Research Embracer Group 9 March 2020 The fourt leg The company also announced that Amplifier Game Invest would be their fourth leg within the Group, and both during and after the quarter Amplifier had helped set up several new studios. We like the strategy to nurture talent within the Group and have a type of new studio thinking within Amplifier. Amplifier will for now not be reported as a separate business segment when it comes to financials, as the revenue of the unit currently is minimal.