Embracer Group: A Scandinavian growth company
The name Embracer Group might not ring a bell for a lot a people. Nevertheless, this Swedish company it is one of the largest gaming companies in the world (18th based on market cap). The company is quite different from most of the other gaming companies, which you will learn throughout this analysis. As it has been added to eToro, I thought it was time to write about the company.
This is not a financial advice. I am not a financial advisor and I only do these post in order to do my own analysis and elaborate about my decisions, especially for my copiers and followers. If you consider investing in any of the ideas I present, you should do your own research or contact a professional financial advisor, as all investing comes with a risk of losing money. You are also more than welcome to copy me.
This analysis will be a bit different from what you are used to read in my blog. Tencent Music Entertainment did their IPO in December 2018, meaning I don't have access to the historical numbers dating back longer than that. So instead of using the principles I have learned from my Phil Town workshop, I use the principles I have learned from the GOAT academy. I should also mention that most of the numbers I use in this analysis is from Finbox, which I believe is a great tool to easily get the numbers you need from various companies.
Before I start with the analysis, I should mention that I do not currently own shares in Embracer Group. I do however own shares in other gaming companies: Microsoft, Sony, and Tencent (both Tencent shares and through Prosus). If you would like to see or copy my portfolio, you can read how to access it here. Even though I own shares in other gaming companies, I will not be biased in this analysis.
Embracer Group was in 2008 in Sweden as Nordic Games Publishing. In 2011 it bought the assets of JoWooD Entertainment after it went bankrupt and in 2013 it did the same thing with THQ and changed their name to THQ Nordic. After more acquisitions they finally changed their name to Embracer in 2019. They describe themselves as the parent company of businesses led by entrepreneurs in PC, console, mobile and board games, and other related media. Their structure is that Embracer Group is the parent company, and under this parent company there are 10 operative groups, 119 studios, and over 850 franchises. Some of the most known franchises are Saints Row, Goat Simulator, Dead Island, Darksiders, Metro, World War Z, and Borderlands. Each of their operative groups run independently from each other, and the management of Embracer Group believes that these operating groups should make their own decisions. The strategy of Embracer Group is to continuously add new studios to their group and grow by volume. The benefits of having a parent group is that the different operative groups can rely on advantages such as access to growth capital, distribution and marketing, know-how and development synergies from the parent group They believe in a diversified portfolio, and in the latest conference call, management said that no single IP is estimated to generate more than 5 % of group revenues, and in a previous interview management has said that they want to focus in a diversified pipeline. It also means that without a large franchise, it is hard to find a moat for Embracer. Hence, I do not think they have a moat now but may build one in the future.
Their CEO is Lars Wingefors. He is not only the CEO but also the co-founder and the largest shareholder (owning 24,2 % of the shares). He is an entrepreneur by nature and started selling comic books as a teenager. At 15 years old he was Sweden's leading mail order retailer in comic books. He used his experience from selling comic books to start Nordic Games Holding that sold second-hand video games. It later ended up as Nordic Games Publishing as mentioned in the previous paragraph. He believes that "freedom rocks", which means that he will let entrepreneurs, creators and other management making their own decisions. He elaborates about it in an interview where he has stated that he doesn't want to create a single, monolithic business that could destroy a lot of value. As Embracer Group has more than 200 games, he believed it allows Embracer Group to be brave and take more risks in product development, as it would pay off over time. My own impressions of Lars Wingefors in the conference calls are that he is a very enthusiastic and positive person as well. I really like his entrepreneurship, his management style of letting each operative group work in their own way, and he also has a lot of skin in the game as CEO, co-founder, and largest shareholder. Hence, I feel very confident in the management.
I believe that Embracer Group focuses more on diversification than a moat now. It isn't necessarily a bad strategy, and they could build a moat on some franchises moving forward. I do like the management a lot. Later I will do a discounted cash flow model to calculate a price for Embracer Group but before I do so, let us just have a look at some key financial metrics.
Down below we see some key financial metrics Embracer Group over the last three years. As I got the numbers from Finbox, the numbers are in dollars and not in Swedish kroner. The numbers I use in this analysis will be in dollars except for my calculation of the share price, which I have changed from dollars to Swedish kroner by today's exchange rate. Revenue has surged from 2020 to 2021, which is due to acquisitions. The gross profit margin is also growing year over year, which is very nice to see. The operating margin is higher 2021 than in 2020 but doesn't meet the 2019 numbers. The one thing that is noticeable is how EBIT hasn't proportionally grown like the other numbers. According to management is because of the number of investments they have made, and they feel comfortable that EBIT will rise long-term. All in all, the numbers are fine, but I hope to see a higher operating margin and EBIT moving forward.
Before we continue to the discounted cashflow model, I would like to investigate the risks and potential of Embracer Group. The largest risk and something I don't like is the dilution of shares. In 2017 Embracer Group had 432,2 million shares outstanding and in 2022 they have 1,134 billion shares outstanding! It is because they fund their acquisitions by issuing shares rather than taking up debt. It could be a good strategy to offer the management of acquisitions shares to keep them motivated but as a potential shareholder, I do not like this kind of dilution. Another risk is competition. The gaming industry is highly competitive, and when you face competition from some of the greatest companies in the world, it will always be a risk. Furthermore, Embracer Group doesn't have a franchise that gives them a moat, and it will be curious to see if relying on diversification moving forward, will keep them competitive. Different macro risks. It could both be political and economic. China has limited the time that children and teen-agers below 18 years old are allowed to game. As a company that rely on diversification, it could be a problem moving forward. Inflation and other economic headwinds could also hurt Embracer Group. If people have less money, they are probably going to limit how much money they are spending on video games, and research has shown that it is harder for gaming companies to increase prices to deal with inflation due to the competitive nature of the sector.
There are also potential for Embracer Group moving forward. Their diversification strategy. I know I previously mentioned that their diversification strategy results in a lack of moat. However, it could also be the strength of the company as they are not dependent on a single franchise. Right now, they have more than 216 development projects in the pipeline and 25 of them are AAA development projects that are planned for release until March 2026. I believe the strategy somehow makes the risk lower, and I see it as strength despite the lack of moat. Free cash flow is growing. I mentioned that dilution of shares is something I don't like. However, if you look at free cash flow per share, Embracer is executing despite the dilution. Since 2017, free cash flow per share has grown from $0,045 to $0,51 in 2021. It has grown each year except from 2018 to 2019. In their latest quarterly report, management said that "we anticipate gradually growing free cash flow". So far, they have delivered as promised. The gaming industry continues to grow. According to Accenture, they expect the gaming industry to grow by 15 % over the two years, and Newzoo expects the sector to grow by a CAGR of 7,4 %. There are also trends within the gaming industry that improves margins such as digital distribution. The management expects digital distribution to grow moving forward both for full-game sales and in-game content spend. Another growth opportunity in the gaming sector is games as a service (GAAS). According to the management, it gives games a longer life cycle and new ways to monetize the games through downloadable content and other in-game purchases.
I have now investigated the financials, risks, and potential of Embracer Group. I will now look at the price by doing a discounted cash flow model. To do so I will need some numbers that you can see below. The numbers are the 2021 numbers, which I could find at Finbox. However, the perpetuity growth rate and the discount rate are numbers I have come up with myself. The reason I chose 4 % as perpetuity growth rate is that it is usually a between the historical inflation rate of 2-3% and historical GDP growth of 4-5%. I decided to go with a higher option of 4%. The chosen discount rate of 12% is because it is usually between 9-12%. I decided to go with the highest one because of the current market conditions. Remember that all the numbers made in these calculations are in millions (and in dollars).
I also need to determine how much EBIT, Depreciation & Amortization and Net Working Capital will evolve over the next couple of years. I decided to use an EBIT growth of 30 % year over year. It is a bit lower than what I have read from other analysts that usually expects a growth in the mid-thirties. I calculated with a growth in Depreciation & Amortization of 40 % a year, which is significantly lower than the historical growth rate. Finally, I decided to keep the Net Working Capital at the 2021 numbers at -5. I haven't found a smart way to share all my spreadsheet here but once I did my calculations, I found that the intrinsic value of Embracer Grup to be $11,8 (118,9 Swedish kroner).
Having investigated Embracer Group, I find the company very interesting. I believe that the gaming sector is a sector that will see long-term growth, and Embracer Group does things differently than other companies. I usually prefer to invest in high moat companies, but I like the diversification strategy of Embracer Group, and if they hit on one of these 25 AAA development projects, they could end up with a moat in the future. Dilution is a problem when it comes to embracer, looking at the numbers at first, I was quite surprised to see the amount of dilution. However, Embracer Group is growing their free cash flow per share, so it isn't something that will keep me from investing in the company. I really like the management and that the CEO has such a large skin in the game. I already have quite a lot of exposure to the gaming industry, but I'm intrigued by Embracer Group and consider opening a position as it is trading around the 79 SEK area.
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