EG7: Tough comps in a transition year

Research Update

2024-02-14

07:00

Redeye updates on EG7 post Q4-results which came in lower than expected, driven mainly by Big Blue Bubble which saw a faster revenue decline than we expected. On the back of this, we have adopted a more cautious view on 2024 while also lowering our 2025-26E forecasts somewhat. Still, we highlight that 2024 will be a transition year ahead of stronger growth in 2025-26E as ongoing growth investments starts to yield revenue.

Hjalmar Ahlberg

Tomas Otterbeck

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Q4-results below forecast

EG7’s Q4-results was lower than forecasted, where the main deviation was seen in Big Blue Bubble owing to a faster-than-expected revenue decline from My Singing Monsters. The company saw solid cash generation, supporting a slight sequential increase in net cash despite continued growth investments.

Tough comps in 2024, back to growth in 2025

While we had anticipated 2024 to be a transition year, it now looks to be slightly more challenging than we previously expected, and this was reflected in the company’s 2024E guidance, which was lower than our forecast. However, the company continues to invest for growth, where the Cold Iron project supports improvement in 2025 with further upside in 2026 on the back of H1Z1.

Lowered estimates and valuation range

We have lowered our 2024E EBITDA by c11% while 2025-26E EBITDA is down 5-7%. On the back of the estimate cuts, our base case is lowered to SEK44 (SEK50) which implies an EV/EBITDA valuation of 8x 2024. The share currently trades at less than 2x 2024 EBITDA, suggesting the market is sceptical about the company achieving its targets. In our view, successful game launches in 2024 (MechWarrior Clans), continued progress on the Cold Iron project, and H1Z1 moving into the production phase could be triggers for improved market confidence and a higher valuation.

Key financials

SEKm	2022	2023	2024e	2025e	2026e
Revenues	2,045.5	2,173.2	1,913.3	2,226.5	2,763.9
Revenue Growth	-5.5%	6.2%	-12.0%	16.4%	24.1%
EBITDA	482.7	542.0	414.1	492.9	687.7
EBITDA Margin	23.6%	24.9%	21.6%	22.1%	24.9%
EBIT	395.4	427.5	318.1	351.7	490.2
Net Income	-281.2	156.0	142.6	167.8	271.7
EV/Sales	1.2	0.5	0.3	0.3	0.2
EV/EBITDA	4.8	2.1	1.5	1.1	0.6
EV/EBIT	5.8	2.6	1.9	1.6	0.9

Q4-results below forecast

EG7 reported revenue of SEK473m and EBITDA of SEK98m for Q4 2023 which was lower than our forecasts of SEK504m and SEK119m respectively. The main deviation on topline stems from Big Blue Bubble where revenue from My Singing Monsters declined faster than we had expected during the quarter. The company comments that it expects My Singing Monsters to stabilize at a new normal level during H1 2024. The lower-than-expected revenue in Big Blue Bubble also resulted in softer EBITDA-margin than expected and is also the main contributor to the weaker-than-expected EBITDA. The company saw strong cash flow during the quarter with an operating cash flow of SEK100m while net investments were SEK63m. The company ended 2023 with a net cash position of SEK481m while it budgeted for investments of around SEK264m for 2024. The table below summarize Q4-results outcome compared to our forecasts.

EG7 result outcome
SEKm	Q4 22	Q1 23	Q2 23	Q3 23	Q4 23E	Q4 23A	Diff
Group revenue	559	572	483	517	504	473	-6%
Growth Y/Y (%)	-2%	43%	4%	16%	-10%	-15%

COGS	-181	-151	-140	-167	-166	-161	-3%
Personnel expenses	-196	-200	-203	-177	-186	-182	-2%
Other external costs	-55	-57	-81	-55	-54	-68	27%

EBITDA adj	179	190	113	141	119	98	-17%
EBITDA-margin	32%	33%	23%	27%	24%	21%

D&A	-362	-51	-67	-72	-56	-54	-3%
Ow acquistion related	-33	-32	-32	-33	-32	-32	1%

EBIT adj *	159	170	78	103	95	76	-20%
EBIT adj (%)	28%	30%	16%	20%	19%	16%

EBIT	-184	139	25	43	63	45	-28%

Net income reported	-103	88	2	10	47	56	20%

EPS reported	-1.19	1.01	0.02	0.11	0.53	0.64	21%

Source: Redeye Research, * Adjusted excludes amortization of acquired assets

Tough comps in 2024, back to growth in 2025

As we highlighted ahead of the Q4-report, we expect 2024 to be a year with limited growth potential on the back of tough comps for Big Blue Bubble while growth investments will not start to yield revenue until 2025. Our view remains unchanged following the Q4-report, although 2024 looks to be somewhat more challenging than we expected ahead of the report, owing mainly to a faster-than-expected decline for Big Blue Bubble and partly due to a weaker near-term outlook for the company’s work-for-hire business. The company’s guidance for 2024 was also somewhat lower than our 2024 estimates ahead of the results (revenue guidance of SEK1.8bn with EBITDA-margin of 22-25% while we forecasted revenue of SEK1.9bn and EBITDA-margin of 24%).

However, while 2024 looks to be somewhat tougher, the company’s investments in new games continue and EG7 comments that it is making solid progress for the Cold Iron project with a targeted release for mid-2025. The company also reiterated its 2026 target of SEK3bn of revenue and SEK1bn EBITDA. As illustrated in the chart below, we expect Daybreak to become a larger revenue contributor to the group which is driven by the ongoing growth investments. In addition to the Cold Iron project, EG7 also targets to release a game based on the H1Z1 IP in 2026 where production is expected to start in H2 2024.

EG7: Segment revenue 2021-26E

Source: Redeye Research

Lowered estimates

Overall, we remain positive about EG7’s growth potential over the coming years. However, as we adopt a faster revenue decline trajectory for Big Blue Bubble, we have lowered our 2024E EBITDA by c11%. Looking into 2025-26E we have lowered our EBITDA by 5-7%, also mainly on the back of lower contribution from Big Blue Bubble. Our revenue and EBITDA forecast for 2026 stands at SEK2.6bn and SEK0.7bn, which is lower than the company’s target of SEK3bn and SEK1bn. We expect to move closer towards the company’s targets as the Cold Iron project moves forward and as H1Z1 moves into the production phase. The tables below summarize our updated estimates for the group and per segment.

EG7: Key financials
SEKm	2022	2023	Q1 24E	Q2 24E	Q3 24E	Q4 24E	2024E	2025E	2026E
Group revenue	1,866	2,045	433	420	482	487	1,822	2,120	2,632
Growth Y/Y (%)	12%	10%	-24%	-13%	-7%	3%	-11%	16%	24%

COGS	-626	-619	-130	-116	-154	-161	-560	-656	-790
Personnel expenses	-742	-763	-183	-184	-185	-186	-737	-762	-778
Other external costs	-209	-262	-45	-44	-58	-56	-202	-315	-509

EBITDA adj	483	542	97	98	109	110	414	493	688
EBITDA adj (%)	26%	27%	22%	23%	23%	23%	23%	23%	26%

EBIT adj *	395	428	75	77	83	83	318	352	490
EBIT adj (%)	21%	21%	17%	18%	17%	17%	17%	17%	19%

EBIT	-276	252	43	45	51	51	190	224	362

Net income	-281	156	32	34	38	38	143	168	272

EPS	-3.23	1.76	0.36	0.38	0.43	0.43	1.61	1.89	3.07

Source: Redeye Research, * Adjusted excludes amortization of acquired assets

EG7: Revenue and EBITDA per segment
SEKm	2022	2023	Q1 24E	Q2 24E	Q3 24E	Q4 24E	2024E	2025E	2026E
Group Revenue	1,866	2,045	433	420	482	487	1,822	2,120	2,632
Daybreak	831	753	191	180	187	187	745	988	1,362
Big Blue Bubble	310	572	80	80	80	80	320	300	300
Piranha	90	133	25	25	40	40	130	143	157
Toadman	13	49	18	20	25	25	88	109	142
Fireshine	394	354	75	75	100	100	350	376	452
Petrol	229	184	45	40	50	55	190	204	220

Growth	36%	21%	-34%	-17%	-4%	5%	-15%	20%	27%
Daybreak	18%	-9%	-5%	-5%	3%	3%	-1%	33%	38%
Big Blue Bubble	184%	84%	-63%	-45%	-35%	-7%	-44%	-6%	0%
Piranha	-2%	49%	-50%	2%	44%	32%	-2%	10%	10%
Toadman	76%	272%	218%	85%	75%	35%	78%	25%	30%
Fireshine	0%	-10%	53%	-4%	-16%	-6%	-1%	8%	20%
Petrol	40%	-20%	-5%	12%	-2%	10%	3%	8%	8%

Group EBITDA	483	542	97	98	109	110	414	493	688
Daybreak	233	163	43	41	42	42	168	230	409
Big Blue Bubble	182	356	44	44	44	44	176	158	150
Piranha	31	49	8	8	12	12	39	43	47
Toadman	-23	-34	-3	2	3	3	6	27	36
Fireshine	69	40	9	9	13	13	44	47	56
Petrol	22	-3	3	3	4	4	14	20	22
Holdings	-31	-30	-8	-8	-8	-8	-32	-32	-32

EBITDA-margin	26%	26%	22%	23%	23%	23%	23%	23%	26%
Daybreak	28%	22%	23%	23%	23%	23%	23%	23%	30%
Big Blue Bubble	59%	62%	55%	55%	55%	55%	55%	53%	50%
Piranha	35%	37%	30%	30%	30%	30%	30%	30%	30%
Toadman	n.m.	-68%	-14%	10%	12%	12%	6%	25%	25%
Fireshine	17%	11%	13%	13%	13%	13%	13%	13%	13%
Petrol	10%	-1%	8%	8%	8%	8%	8%	10%	10%

Source: Redeye Research

Valuation

On the back of the estimate cuts, our base case is lowered to SEK44 (SEK50) while our new bull case stands at SEK77 (SEK85) and our bear case at SEK15 (SEK24). Our base case implies an EV/EBITDA valuation of 8x 2024 while the share currently trades at less than 2x 2024 EBITDA, suggesting that the market is sceptical about the company achieving its targets. In our view, successful game launches in 2024 (MechWarrior Clans), continued progress on the Cold Iron project, and H1Z1 moving into the production phase could be triggers for improved market confidence and a higher valuation. The table below summarizes key assumptions for the valuation scenarios.

EG7: Fair Value Range
SEK	Bear Case	Base Case	Bull Case

Value per share	15	44	77

Revenue CAGR 2025-2029	4%	14%	17%
Revenue CAGR 2030-2039	2%	4%	6%
Growth Terminal	2%	2%	2%

EBITDA-margin 2025-2039	17%	28%	33%
EBITDA Terminal	15%	28%	33%

Source: Redeye Research

Investment thesis

Case

Solid live game portfolio with upside from new franchises

With an active history of M&A, EG7 has built a solid portfolio of live service games which is dominated by titles from its Daybreak studio including among other DC Universe, Everquest 1&2, Lord of The Rings and Magic the Gathering Online. This is complemented by the mobile games-focused studio Big Blue Bubble and a service segment focusing on publishing and marketing. This creates a low-risk diversified game portfolio with solid cash generation. Going forward, the company aims to add growth by building game franchises on proven IPs from its own portfolio and external IPs. On the back of this, the company targets to achieve revenue of SEK3bn and EBITDA of SEK1bn by 2026.

Evidence

Long life games and stable profitability

With a large part of EG7’s revenue being derived from its Game segment (c. 60-70%) and the majority of this coming from long-life games with recurring revenue, EG7 can generate stable revenue and profitability. The games have strong brands and have been enjoyed for many years by its players supporting the stable revenue generation. The company’s service segment has also seen strong performance on the back of successful games in its publishing business further improving the company’s overall profitability. Coming to growth from the new game franchises, the company has built a pipeline of three games that will be released during 2024-26E.

Challenge

Limted growth in live games and unproven model for game franchises

We think the main challenge for EG7 is to grow its live service Games portfolio. While this generates stable profitability and strong cash generation, the inflow of new players is limited in our view and implies low overall growth potential for EG7. While the new game franchises are set to improve growth, the company has not proven this business model yet.

Valuation

DCF-valuation supported by strong cash generation and growth upside from game franchises

We find a base case valuation of SEK44 per share for EG7 which is derived from a DCF-valuation. The base case implies an EV/EBITDA multiple of 8x on our 2024E EBITDA. Our base case assumes growth of 14% between 2025-29E and 4% between 2029-38E with a terminal growth of 2%. We assume EBITDA-margin to be around 26% in 2025-29E and 29% for 2029-38E while the terminal EBITDA-margin is set to 28%.

Quality Rating

People: 3

EG7’s management team has a high share of ownership with the (proposed) chairman holding 9% and CEO 2% of shares. While the company has a mixed history the new management team has delivered improved and stable performance.

Business: 3

EG7’s game portfolio has a high tilt towards live service games which provides stable and recurring revenues. This also results in stable profitability and good cash flow as investments requirements are limited. On the other hand, this also limits growth potential.

Financials: 2

EG7 has a stable balance sheet with a small net cash position. The company has a significant goodwill in its balance sheet, although as this is mostly related to Daybreak Games we believe the write-down risk is limited. Most of EG7’s revenue generating operations has been acquired during 2020-21 creating a short history which lowers the rating.

Financials

Income statement
SEKm	2022	2023	2024e	2025e	2026e
Revenues	2,045.5	2,173.2	1,913.3	2,226.5	2,763.9
Cost of Revenue	805.9	746.9	651.5	761.8	921.3
Operating Expenses	756.9	884.3	847.7	971.8	1,155.0
EBITDA	482.7	542.0	414.1	492.9	687.7
Depreciation	45.9	42.0	45.6	53.0	65.8
Amortizations	580.0	72.5	50.4	88.1	131.6
EBIT	395.4	427.5	318.1	351.7	490.2
Shares in Associates	0.00	0.00	0.00	0.00	0.00
Interest Expenses	33.6	36.1	0.00	0.00	0.00
Net Financial Items	-33.6	-36.1	0.00	0.00	0.00
EBT	-309.6	215.8	190.1	223.7	362.2
Income Tax Expenses	-28.4	59.8	47.5	55.9	90.6
Net Income	-281.2	156.0	142.6	167.8	271.7
Balance sheet
Assets
Non-current assets
SEKm	2022	2023	2024e	2025e	2026e
Property, Plant and Equipment (Net)	29.1	30.3	30.3	30.3	30.3
Goodwill	3,284.9	3,181.7	3,181.7	3,181.7	3,181.7
Intangible Assets	622.5	667.8	753.6	802.5	872.0
Right-of-Use Assets	39.9	74.7	74.7	74.7	74.7
Other Non-Current Assets	110.4	154.2	154.2	154.2	154.2
Total Non-Current Assets	4,086.8	4,108.7	4,194.5	4,243.4	4,312.9
Current assets
SEKm	2022	2023	2024e	2025e	2026e
Inventories	17.3	14.0	18.2	21.2	26.3
Accounts Receivable	440.5	269.2	273.3	318.1	394.8
Other Current Assets	0.00	0.00	0.00	0.00	0.00
Cash Equivalents	407.8	480.9	541.3	601.0	733.4
Total Current Assets	865.6	764.1	832.9	940.3	1,154.6
Total Assets	4,952.4	4,872.8	5,027.4	5,183.7	5,467.4
Equity and Liabilities
Equity
SEKm	2022	2023	2024e	2025e	2026e
Non Controlling Interest	0.00	0.00	0.00	0.00	0.00
Shareholder's Equity	3,902.3	3,900.6	4,003.2	4,126.7	4,354.1
Non-current liabilities
SEKm	2022	2023	2024e	2025e	2026e
Long Term Debt	0.00	2.8	2.8	2.8	2.8
Long Term Lease Liabilities	17.5	52.5	52.5	52.5	52.5
Other Non-Current Lease Liabilities	315.6	355.3	355.3	355.3	355.3
Total Non-Current Liabilities	333.1	410.6	410.6	410.6	410.6
Current liabilities
SEKm	2022	2023	2024e	2025e	2026e
Short Term Debt	104.0	0.60	0.60	0.60	0.60
Short Term Lease Liabilities	23.6	25.0	25.0	25.0	25.0
Accounts Payable	84.8	33.9	54.7	63.6	79.0
Other Current Liabilities	504.5	502.1	533.4	557.2	598.2
Total Current Liabilities	716.9	561.6	613.6	646.5	702.8
Total Liabilities and Equity	4,952.3	4,872.8	5,027.4	5,183.7	5,467.4
Cash flow
SEKm	2022	2023	2024e	2025e	2026e
Operating Cash Flow	374.6	437.8	410.2	422.1	571.5
Investing Cash Flow	-58.1	-231.5	-309.8	-318.1	-394.8
Financing Cash Flow	-331.8	-126.0	-40.0	-44.3	-44.3

Rating definitions

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