Remedy: Discounted premium growth

Research Update

2022-10-03

08:21

Redeye lowers its expectations and valuation on Remedy. However, we expect a steady build-up period will be initiated at the beginning of 2023 when game projects move into the next phase of development. The Remedy stock is traded at half its value since our research update in April where we lowered our estimates and valuation. As in our initial coverage report in late 2018, we yet again state that Remedy offers investors “Premium at a discount”.

Tomas Otterbeck

Viktor Lindström

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Lower expectations

As we have communicated after the profit warning in August and the Q2 report we have lowered our expectations regarding the EBIT levels in 2022 and 2023 and the revenue growth this year. Revenue is expected to be unchanged compared to last year, meaning EUR 45 million in revenue (the previous estimate was EUR 49.3 million). EBIT is expected to be around EUR -3.8 million.

Acquisition target

We believe Remedy is one of the most obvious acquisition targets in the Nordic gaming industry. On the top of our buyer's list sits Epic Games, and the timing is most likely after the release of Alan Wake 2. Secondly “most likely” we believe one of the three biggest players in the industry is a potential buyer namely Sony, Tencent, and Microsoft (in that order). Thirdly on our buyer's list, we see Take-Two, the owner of the Remedy-created IP Max Payne.

Valuation

Our base case assumes relatively successful launches of the upcoming new games based on Alan Our base case assumes relatively successful launches of the upcoming new games based on Alan Wake, Control and Max Payne. We have lower expectations of its live-service games, due to a nonexistent track record. Our lowered expected EBIT levels in the upcoming years combined with an increased WACC due to higher interest rates give us a new fair value range of EUR 14-55 per share (17-60) with a base case of EUR 32 per share (38).

EURm	2020	2021	2022e	2023e	2024e
Revenues	41.1	44.7	45.0	54.6	75.9
Revenue Growth	29.9%	8.8%	0.5%	21.4%	39.1%
EBITDA	14.3	13.6	-1.7	0.99	17.8
EBIT	13.2	12.3	-3.8	-1.2	14.0
EBIT Margin	32.1%	27.5%	-8.5%	-2.2%	18.5%
Net Income	13.2	10.1	-3.3	-0.96	11.2
EV/Revenue	10.9	10.3	5.8	5.0	3.5
EV/EBIT	34.1	37.6	-67.9	-226	19.0

Case

De-risked high quality

Remedy is one of the last legendary independent game studios left in the world. The founder and top management own more than 30% of the company. The biggest gaming platforms are screaming for quality content and Remedy will continue to grasp this opportunity. The studio has therefore a lucrative risk-reward in its coming projects and is an obvious takeover target that de-risk the case further.

Evidence

An "Epic" release in 2023

In 2023 Alan Wake 2 will be released, Remedy’s strongest self-owned IP. We expect the total budget is approximately EUR 60 million (in comparison to the game Control with a budget of EUR 30 million). The higher budget, the financially strong publisher Epic Games, and the strength from the Alan Wake IP are three strong arguments that the game will likely sell at least twice as much as the game Control. For these reasons, we believe investors should have high expectations of the company’s growth prospects.

Supportive Analysis

Remedy is one of three critically acclaimed game studios that have been hand-picked by Epic Games for the first strategic “publishing push” with favorable terms almost unheard of for developers. The agreement between Epic Games and Remedy announced at the end of March 2020 is fully funded by Epic with at least a 50% profit share for Remedy and full ownership of the IP.

Challenge

A big budget for a niched game

Remedy creates relatively niched games. In its upcoming game (Alan Wake 2), which will be released in 2023 the budget is double as high as in its latest game. We estimate the game must sell 2.15 million copies before Remedy can receive a 50% profit share. For a relative niche product, this is a rather high sales number.

Challenge

Uncertain profitability in 2025

In 2024-2025 Remedy will launch two online multiplayer games according to our assumptions. This is new territory for Remedy and at least one of the games (Vanguard) will be free-to-play. The immediate financial impact will therefore likely be protracted, meaning lower revenue for a longer period of time for both of these live-service games. This could hurt the profitability in 2025 according to our estimates regarding the game pipeline.

Valuation

An obvious takeover target

Only a few independent major game studios are left after the recent years accelerated consolidation in the industry. We are certain that Remedy has a high position in the shopping list amongst many major players. Potential buyers are Epic Games, Sony, Microsoft, and Take-Two Interactive we believe. This fact considerably de-risks an investment in Remedy we argue despite the relatively high valuation multiples in a short-term perspective.

Game pipeline

Our financial projections are of course very much dependable on our assumptions regarding game releases. As illustrated in the table below the estimated time in all development stages has broad ranges. When a game is in full production the alpha stage for example can be 12-24 months.

Both Vanguards and Condor are multiplayer online games. Those types of games often are released during its alpha stage in so-called “Early Access”. Both these games could therefore be launched earlier than our estimates. The development is partly financed by Tencent and 505 Games (Digital Bros) in Vanguard and Condor respectively.

Vanguard had a team of 40 people in August. According to CEO Tero Virtala the postponed Vanguard scale-up with better process efficiency, was positive from a corporate perspective he told us in Remedy’s earnings call. During Q2 Condor moved from "proof of concept" to the "product readiness phase". Approximately 50 people can now scale up to 70 people.

The single-player game codenamed “Heron” is a sequel to Control. The game will be a collaboration between 505 Games and Remedy. However, we believe Remedy will likely collaborate with another publisher or platform owner, like Sony.

Financials

Q2-report comments

Revenue was somewhat weaker than expected, approximately 6% weaker. The cost-base was relatively in line with our expectations. With no production capitalization during the quarter the EBIT was below our estimate. Redeye estimates the development fees and thus the revenue will increase gradually from this level.

In our table below we lowered our previous communicated revenue estimate with 15%. Shortly after the profit warning on August 1 we wrote that revenue will probably be 5-10% lower in 2022 than our previous estimate. And Q2 will be the weakest quarter of them all, due to gradually unticking development fees in all the game projects according to our assumptions.

Financial projections

As we have communicated after the profit warning in August and the Q2 report we have lowered our expectations regarding the EBIT levels in 2022 and 2023 and the revenue growth this year. We have also lowered personnel expenses in 2022-2024 while we have increased our estimates regarding external development costs (shown as COGS). Meaning more game development is expected to be outsourced.

Estimate changes

2022: Revenue is expected to be unchanged compared to last year, meaning EUR 45 million in revenue (the previous estimate was EUR 49.3 million). EBIT is expected to be around EUR -3.8 million compared to our previous estimate of EUR 6.3 million. We however already have noticed that revenues were expected to be around break-even levels following the Q2 result.

2023: We still estimate a revenue level of around EUR 55 million in 2023. The majority of the revenue boost comes from development fees from Max Payne Remake but also from Vanguard we assume. We expect Max Payne is entirely financed by Rockstar Games and around 80% of Vanguard is financed by Tencent.

According to our estimates, EBIT will be around EUR -1.2 million in 2023 (EUR 4.9 million).

2024: Remedy will acquire royalty income from Alan Wake 2 (released in 2023) during 2024 we assume. The majority of the revenue boost will come from this royalty according to our estimates.

As always, it is hard to predict the optionality in Remedy. It is, however, quite certain that Remedy will continue to make platform deals, which will lower the risk further in this already somewhat de-risked business case.

Valuation Scenarios

WACC has been increased to 9.5% (9%) in all scenarios due to higher interest rates.

Base Case EUR 32 (38)

CAGR of about 21% between 2022-2026 with EBIT margin expanding to 27% (34%).

Terminal growth of 2% with terminal EBIT margin of 33%.

Our base case assumes relatively successful launches of Alan Wake, Control and Max Payne. We have lower expectations of its live-service games, due to a nonexistent track record.

Bear Case EUR 14 (17)

CAGR of about 12% between 2022-2026 with EBIT margin expanding to 22% (30%).

Terminal growth of 2% with terminal EBIT margin of 25%.

Our bear case assumes mixed commercial results in launches of Alan Wake, Control and Max Payne. We have lower expectations of its live-service games, due to a nonexistent track record.

Bull Case 54 (60)

CAGR of about 26% between 2022-2026 with EBIT margin expanding to 30% (36%).

Terminal growth of 2% with terminal EBIT margin of 36%.

Our bull case assumes successful launches of Alan Wake, Control and Max Payne. We also have relatively high expectations of its live-service games.

Income statement
EURm	2020	2021	2022e	2023e	2024e
Revenues	41.1	44.7	45.0	54.6	75.9
Cost of Revenue	1.5	0.02	15.3	17.5	18.1
Operating Expenses	25.3	31.1	31.4	36.1	40.0
EBITDA	14.3	13.6	-1.7	0.99	17.8
Depreciation	0.00	0.26	0.46	0.55	1.2
Amortizations	0.00	0.79	1.7	1.6	1.2
EBIT	13.2	12.3	-3.8	-1.2	14.0
Shares in Associates	0.00	0.00	0.00	0.00	0.00
Interest Expenses	0.00	0.00	0.00	0.00	0.00
Net Financial Items	0.00	0.00	0.00	0.00	0.00
EBT	13.2	12.3	-3.8	-1.2	14.0
Income Tax Expenses	0.00	2.2	-0.49	-0.24	2.8
Net Income	13.2	10.1	-3.3	-0.96	11.2

Cash flow
EURm	2020	2021	2022e	2023e	2024e
Operating Cash Flow	11.8	5.2	-0.42	-2.1	15.1
Investing Cash Flow	-6.3	-16.6	-9.5	-9.8	-11.2
Financing Cash Flow	-1.3	39.1	-2.2	0.67	0.19

Balance sheet
Assets
Non-current assets
EURm	2020	2021	2022e	2023e	2024e
Property, Plant and Equipment (Net)	0.00	2.6	11.7	20.9	30.9
Goodwill	2.2	0.00	0.00	0.00	0.00
Intangible Assets	7.7	15.1	13.4	11.8	10.5
Right-of-Use Assets	0.00	0.00	0.00	0.00	0.00
Other Non-Current Assets	0.00	3.6	3.6	3.6	2.6
Total Non-Current Assets	9.9	21.3	28.7	36.3	44.1
Current assets
EURm	2020	2021	2022e	2023e	2024e
Inventories	0.00	0.00	0.00	0.00	0.00
Accounts Receivable	14.2	17.1	15.7	19.1	19.0
Other Current Assets	0.55	10.1	9.0	10.9	7.6
Cash Equivalents	23.7	51.4	39.2	27.9	32.0
Total Current Assets	38.5	78.6	63.9	57.9	58.5
Total Assets	48.4	99.9	92.6	94.2	102.6
Equity and Liabilities
Equity
EURm	2020	2021	2022e	2023e	2024e
Non Controlling Interest	0.00	0.00	0.00	0.00	0.00
Shareholder's Equity	35.4	87.3	81.8	81.5	92.9
Non-current liabilities
EURm	2020	2021	2022e	2023e	2024e
Long Term Debt	2.8	1.8	1.8	1.8	1.8
Long Term Lease Liabilities	0.00	0.00	0.00	0.00	0.00
Other Long Term Liabilities	0.00	0.00	0.00	0.00	0.00
Total Non-Current Liabilities	2.8	1.8	1.8	1.8	1.8
Current liabilities
EURm	2020	2021	2022e	2023e	2024e
Short Term Debt	0.00	0.00	0.00	0.00	0.00
Short Term Lease Liabilities	0.00	0.00	0.00	0.00	0.00
Accounts Payable	0.00	0.00	0.00	0.00	0.00
Other Current Liabilities	10.2	10.7	9.0	10.9	7.6
Total Current Liabilities	10.2	10.7	9.0	10.9	7.6
Total Liabilities and Equity	48.4	99.9	92.6	94.2	102.3
Cash flow
EURm	2020	2021	2022e	2023e	2024e
Operating Cash Flow	11.8	5.2	-0.42	-2.1	15.1
Investing Cash Flow	-6.3	-16.6	-9.5	-9.8	-11.2
Financing Cash Flow	-1.3	39.1	-2.2	0.67	0.19

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