Stillfront: Focus on organic growth and cash flow

Research Update

2023-02-17

07:11

Redeye updates on Stillfront following the company's Q4-report which saw stronger EBITDA than expected while revenue was softer than expected. The company also issues new financial targets with focus on organic growth and cash flow generation.

HA

DZ

Hjalmar Ahlberg

Danesh Zare

Strong profitability in Q4

Stillfront reported revenue of SEK1,781m in Q4 which was 4% below our forecast of SEK1,855m. The company met a tougher marketing environment than expected which led to lower UA spend than normal. This resulted in lower growth but also strong profitability where EBITDA came in 8% above our expectations. Coming to the outlook for 2023, the company expects to return to positive organic growth in H2 2023.

New targets focus on organic growth and cash flow

In connection with the Q4-report, Stillfront also held a CMD and launched new financial targets where the focus is on organic growth and cash flow generation. In summary, the company targets organic growth above market supported by selective and accretive M&A while it aims to achieve an EBITDAC-margin (EBITDA less capitalised development costs) of 26-29% (in 2022 the EBITDAC-margin was c23%).

Lowered estimates and valuation

While we view Stilfront's new financial targets positively, we have also lowered our assumptions on the back of a lower-than-expected growth outlook resulting in 2023-24E EBITDA coming down 4-7%. We have also updated our rating on Stillfront resulting in an increased discount rate which together with the lower estimates yields a new base case of SEK33 (SEK45).

Key Financials

SEKm202120222023e2024e2025e
Revenues5,456.07,057.07,232.07,652.88,100.3
Revenue Growth36.7%29.3%2.5%5.8%5.8%
Organicgrowth-7.8%-1.6%0.4%5.8%5.8%
AdjEBITDAC1,5041,5991,7681,9502,113
AdjEBITDACmargin27.6%22.7%24.5%25.5%26.1%
EBITDA2,125.02,595.02,708.52,906.53,084.7
EBIT1,804.02,004.01,949.02,102.32,235.6
Net Income597.0546.0570.7760.7860.7
EV/EBITDA10.44.84.84.03.2
EV/EBIT12.26.26.75.54.5

Strong profitability in Q4

Stillfront reported revenue of SEK1,781m for Q4 2022 which was somewhat lower than our forecast of SEK1,855m. Looking at the performance per game segment, Simulation, Action & RPG was close to our expectations while Strategy and Casual & Mash-up were below our forecasts. However, this should also be seen with regard to UA costs which were lower than forecasted where the company comments that the marketing landscape in Q4 was more difficult than expected.

On EBITDA, the company reported SEK672m (EBITDA-margin of 38%) compared to our forecast of SEK622m (EBITDA-margin 34%). The background for the stronger than expected EBITDA was mainly due to the lower than expected UA costs (coming in at SEK439m vs our forecast of SEK532m) while gross margin was in line with our forecast. Reported EBIT came in lower than our estimate due to a one-off amortization relating to developed games with a shortened economic lifetime.

New targets focus on organic growth and cash flow

In connection with the Q4-report, Stillfront also held a CMD and launched new financial targets where the focus is on organic growth and cash flow generation. The background for this is that Stillfront sees that it is entering a new phase, "the synergy phase", which comes after its scale phase where the company focused on building size during 2019-22. In the synergy phase, the company will focus on achieving stronger synergies between its studios built around the company’s global platform, Stillops. This is where the company sees a unique competitive advantage through collaboration and data sharing between studios where some concrete examples are game engine sharing and its global marketing hub.

As such, while the former targets were highly focused on growth (the target set in 2020 was to increase revenue by around 3x by 2023 through organic growth and M&A) the new growth target is more modest with the aim to achieve organic growth above market supported by selective and accretive M&A. Furthermore, Stillfront also launched a new profitability target, "EBITDAC-margin", which is EBITDA less capitalized product development where it aims to achieve 26-29%. In 2022, the EBITDA-margin was around 23% and the company expects the improvement to come from increased ad revenue (which has higher gross margin), better operational efficiency (purchasing power and standardisation) and improved product development. The latter is the main driver where Stillfront aims to lower product development in relation to revenue by imposing tougher requirements on development projects.

Overall, we think the new targets are good metrics to highlight Stillfront's strong cash generation and stable profitability which should be attractive to investors. The charts below illustrate Stillfront's growth and EBITDAC development during 2019-22 and our forecasts for 2023-25E where we expect a gradual trajectory towards the target.

Continued uncertain near-term outlook

While we view Stillfront's updated financial targets positively, the near-term growth outlook remains uncertain. The company expects that it will return to positive organic growth in H2 2023 supported by the overall market returning to growth. Ahead of the report we had expected organic growth of around 3% for 2023E while we now expect this to be zero with continued negative organic growth in Q1-Q2. We have also lowered our 2024E growth to 6% from 8% on the back of a lower market growth outlook, and our 2023-24E EBITDA is down 4-7%. The table below summarise key financials for 2020-25E.

Valuation range lowered due to higher discount rate

The lowered estimates and growth assumptions also impact our valuation range negatively. Additionally, we have updated our rating on Stillfront on the back of some revisions to the model as well as to reflect the performance of the company which has been weaker than expected during 2020-22. The updated rating lowers the total score for Stillfront which leads to an increase of the discount rate to 10.5% from 9.5%. All in all, this results in a new base case of SEK33 (SEK45) while the new bull case is SEK49 (SEK62) and the bear case is SEK26 (SEK31). The table below summarise the valuation scenarios.

Bear case SEK26 (SEK31)Base case SEK33 (SEK45)Bull case SEK49 (SEK62)
Our bear case assumes Stillfront’s grows slower than the market and needs to increase UA investment above historical levels.Our base case scenario assumes growth in line with market and UA investments in line with current levels.Our bull case scenario assumes stronger than market growth with increasing returns on UA investments.
Average sales growth of about 5% from 2024-28 and EBITDA-margin at around 35%.Average sales growth of about 7% between 2024-28 and an EBITDA-margin gradually improving towards 40%.Average sales growth of about 10% between 2024-28 and EBITDA-margin gradually increasing towards 45%.
Terminal growth of 2% with terminal EBITDA-margin of 35%.Terminal growth of 2% with terminal EBITDA-margin of 37.5%.Terminal growth of 2% with terminal EBITDA-margin of 42.5%.

Investment thesis

Case

Diversified gaming portfolio with focus on high return on UA investments

We believe Stillfront has an attractive and diverse gaming portfolio with a large number of games focusing on several different genres creating a low dependence on individual games. Coupled with a focus on strong returns on user acquisition we believe the company is well positioned to deliver profitable growth over the coming years. With a highly fragmented gaming market, the company is also likely to continue growing by M&A albeit with smaller impact than historically due to its increased size. Overall, this should yield continued earnings growth in Stillfront supporting our positive view on the company.

Evidence

Solid profitability and cash generation supports business model

Stillfront’s focus on directing UA investments to the games and channels that yields best returns are seen in its solid profitability and cash generation. With EBITDA-margins of around 35-40% the company has higher profitability than free-top-play sector peers. With a focus on long-life games it also has limited investment requirements which can be seen in a solid cash conversion (historically around 40-50% FCF/EBITDA excluding acquisitions).

Challenge

High competition for M&A and mixed track record

Stillfront has mainly grown its business through M&A having carried through more than 20 acquisitions since 2016. While most acquisitions have been done at attractive valuations and performed well, there are examples of weaker performance as well as high valuations which creates uncertainty of the potential for future M&A. High valuations are also an indication of another challenge for Stillfront where competitors also aim to consolidate the industry creating upwards pressure on valuations which also lowers the potential returns from M&A.

Valuation

Base case DCF supported by strong profitability and cash generation

We find a base case valuation of SEK33 per share Stillfront which is derived from a DCF-valuation. The base case implies an EV/EBITDA multiple of 8x on our 2023E EBITDA while the share has historically traded in a range of 5x to 15x twelve months forward EBITDA. Our base case assumes growth of 5% between 2024-38E and an average EBITDA-margin margin of 39% for the same period. The terminal growth is set to 2% by 2039 with an EBITDA-margin of 37.5%.

Quality Rating

People: 3

Stillfront has a strong management team with strong insights into the free-to-play gaming sector. Insiders and founders have significant ownership that aligns incentives with other shareholders.  The track record is mixed with performance being weaker than expected in 2021 while the company has seen improved performance during 2022.

Business: 3

Stillfront’s products have high gross margins and a relatively stable customer base with good leverage in the business model. The underlying growth in the gaming industry is a key driver for continued future growth for the company. We think Stillfront has good potential for both organic growth and growth fueled by acquisitions the next coming years.

Financials: 2

Stillfront’s focus on high returns on user acquisition investments means the company creates profitable growth. The company has positive cash flows and high net margins on their products. Both stability and profitability are increasing steadily. However, organic growth performance has been mixed and return on asset and equity is low. Some of the acquisitions are funded by debt, and the company keeps itself at a healthy leverage ratio with a target of below 2x net debt to EBITDA. Gaming products are somewhat differentiated and are not affected by a greater extent of the business climate in the world.

Financials

Income statement
SEKm202120222023e2024e2025e
Revenues5,456.07,057.07,232.07,652.88,100.3
Cost of Revenue1,224.01,674.01,663.41,721.91,822.6
Operating Expenses2,107.02,788.02,860.13,024.53,193.0
EBITDA2,125.02,595.02,708.52,906.53,084.7
Depreciation58.073.079.684.289.1
Amortizations927.01,447.01,568.01,608.01,648.0
EBIT1,804.02,004.01,949.02,102.32,235.6
Shares in Associates0.000.000.000.000.00
Interest Expenses242.097.0300.0200.0200.0
Net Financial Items-242.0-97.0-300.0-200.0-200.0
EBT794.0752.0761.01,014.31,147.6
Income Tax Expenses197.0206.0190.2253.6286.9
Net Income597.0546.0570.7760.7860.7
Balance sheet
Assets
Non-current assets
SEKm202120222023e2024e2025e
Property, Plant and Equipment (Net)127.0157.0113.667.719.1
Goodwill12,752.016,043.016,043.016,043.016,043.0
Intangible Assets5,244.06,149.05,521.24,869.84,193.8
Right-of-Use Assets0.000.000.000.000.00
Other Non-Current Assets46.091.091.091.091.0
Total Non-Current Assets18,169.022,440.021,768.821,071.520,346.9
Current assets
SEKm202120222023e2024e2025e
Inventories0.000.000.000.000.00
Accounts Receivable747.0697.0867.8918.3972.0
Other Current Assets0.000.000.000.000.00
Cash Equivalents1,133.0989.01,978.33,428.05,004.3
Total Current Assets1,880.01,686.02,846.24,346.35,976.3
Total Assets20,049.024,126.024,614.925,417.726,323.2
Equity and Liabilities
Equity
SEKm202120222023e2024e2025e
Non Controlling Interest23.06.06.06.06.0
Shareholder's Equity9,772.014,237.014,807.715,568.516,429.2
Non-current liabilities
SEKm202120222023e2024e2025e
Long Term Debt3,950.04,635.04,635.04,635.04,635.0
Long Term Lease Liabilities0.000.000.000.000.00
Other Non-Current Lease Liabilities3,418.03,274.03,274.03,274.03,274.0
Total Non-Current Liabilities7,368.07,909.07,909.07,909.07,909.0
Current liabilities
SEKm202120222023e2024e2025e
Short Term Debt597.079.079.079.079.0
Short Term Lease Liabilities0.000.000.000.000.00
Accounts Payable1,035.0805.0723.2765.3810.0
Other Current Liabilities1,253.01,091.01,091.01,091.01,091.0
Total Current Liabilities2,885.01,975.01,893.21,935.31,980.0
Total Liabilities and Equity20,048.024,127.024,615.925,418.726,324.2
Cash flow
SEKm202120222023e2024e2025e
Operating Cash Flow1,620.02,028.01,965.62,444.52,588.9
Investing Cash Flow-4,176.0-3,758.0-976.3-994.9-1,012.5
Financing Cash Flow2,612.01,463.00.000.000.00

Rating definitions

The team

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