Thunderful Group’s Q1 figures was aligned with preliminary numbers, and net sales came in 22% below our expectations. The deviation in sales is primarily explained by lower sales in Bergsala and NGS, which both declined 33% and 50%, respectively. Although we had expected a weaker quarter for Bergsala due to the age of Nintendo Switch, the sharp decline in Q1 was much larger than expected. Due to the tough comparables in Q2, where Bergsala was boosted by The Legend of Zelda: Tears of the Kingdom and The Super Mario Bros Movie, we expect the y/y decline to accelerate in the coming quarter.

Adj EBITDA for the group was significantly lower than our estimates, amounting to SEK-29m compared to our estimate of SEK27m; the deviation is primarily explained by Games, which had an adj EBITDA of SEK-20m compared to our estimate of SEK27m.

As anticipated, the Q1 figures were weak, with both segments performing significantly below expectations. We maintain our view that the Games segment is the most disappointing, with a negative adjusted EBITDA of SEK-20m. In light of the preliminary Q1 figures, we sought further clarity regarding the lower profitability in the quarter. On that note, we see somewhat lower capitalized costs of approximately SEK7m compared to Q1 2023. Meanwhile, the company states that the reduced workforce has not yet taken effect in the quarter. Hence, the lower profitability seems to stem from higher personnel costs coupled with lower capitalized costs, an effect that should be lower in the coming quarters. Regarding distribution, we believe nothing stood out compared to the preliminary figures.

Net sales for Games came in at SEK69m (107), 11% below our estimates of SEK77m. There were no major game releases in the quarter, and Steamworld Build has continued to deliver below management’s expectations in Q1 (the game was released in December 2023). Compared to Q1 2023, Games had a lower contribution from co-development and the Partner business, whereas both Coatsink and Robot Teddy had higher one-time revenues last year.

Although sales were only somewhat lower than expected, we were surprised by the lower margin in the quarter. Adj EBITDA came in at SEK-20m (58), with a margin of -28% (54%). As described above, the lower margin seems to stem from higher personnel costs coupled with lower capitalized costs.

In terms of the pipeline, the company made some significant changes in the quarter and divested/closed down 12 game projects, whereas 3 are internal developments. The majority of the games in the pipeline are undisclosed titles, but among those disclosed, we are most excited about Aska, Steamworld Heist 2, and Replaced, all expected to launch in 2024. The company wrote down approximately SEK72m related to games in the quarter.

Net sales for Distribution reached SEK323m (448) and decreased -26% y/y, 24% below our estimates of SEK427m. Looking at profitability, Adj EBITDA in Distribution amounted to SEK-2m (19), with a margin of -1% (4%), lower than our estimate of SEK6m. The negative deviation stems primarily from lower sales and profitability in Bergsala, while Amo Toys delivered better than expected in terms of sales and profitability. The company has decided to divest NGS after the quarter for approximately SEK76m, an expected move that is expected to have a positive cash flow effect in Q2 and onwards.

Inventory, in relation to distribution sales, decreased from 26% in Q4 to 22% in Q1. This does not align with the historical seasonality pattern, where inventory is usually higher in Q1 compared to Q4. We expect the inventory build-up that typically occurs in Q2 to be offset somewhat by the divestment of NGS, which had roughly SEK100m in inventory at the date of the transaction signing.

By incorporating receivables and accounts payables into inventory, we get a core net working capital metric (assuming that the majority of receivables and accounts payables are associated with the distribution segment). The EBITA/Core NWC ratio peaked at 45%. Since then, a positive trend has emerged, until this quarter, when it reached 9%. We deem this level too low for the segment to achieve robust cash generation, and we see potential for further improvements.

Cash flow from operations for the quarter was SEK-155m (64), negatively affected by the lower profitability and working capital changes. Free cash flow amounted to SEK-200m, and Thunderful Group ended the period with a Net debt of SEK647m (up from SEK402m in the previous quarter), which equals a Net debt / Adj EBITDA ratio of 4.6x on an LTM basis. The cash balance, including unutilized credit facilities, amounted to SEK131m at the end of the quarter.

Typically, Q2-Q3 is weak cash flow quarters due to a build-up in working capital. However, we observe that the company significantly reduced its accounts payables in Q1 (down from SEK574m at the end of Q4 to SEK72m). This reduction can also be compared to accounts payables of SEK343m in Q1 2023 and SEK275m in Q1 2022. Therefore, assuming no changes in payment terms, we anticipate a positive impact on cash flow in the coming quarters from higher accounts payables in Q2-Q3, offsetting the negative effect from inventory build-up. Additionally, the cash flow will benefit from the divestment of NGS. On the negative side, the company has short-term earn-outs of SEK83m expected to be paid out in H2 2024.

The company has received a waiver from its bank, which is conditional upon the divestment of certain assets. Given the management's responses during the Q1 presentation, we do not rule out further divestments in addition to Headup and NGS.

Although we can see a scenario where the current cash position, coupled with the divestment of NGS, reduced negative working capital impact, and strong game launches in the upcoming quarters (especially Steamworld Heist 2), might be sufficient for the company to achieve positive cash flow, we maintain our view that there still exists a significant risk for a capital injection. We include a capital injection of SEK100m in our bear case, resulting in a dilution of 46%.

We are revising our estimates downward for 2025e-2026e following the report, anticipating that the reduced games pipeline will have a greater impact on Games’ sales from 2025 onwards. However, we are raising our estimates for 2024e as we adjust our assumptions somewhat for Aska and Steamworld Heist 2. The most significant disappointment in the quarter was profitability, and the company provided mid-term guidance of 35% in adjusted EBITDA margins. Consequently, we are adjusting our margin assumptions downward for both the short and medium terms.

• Sales increased by 7% for 2024e and lowered by 4-7% 2025e-2026e
• Adjusted EBITDA lowered by 64% for 2024e and 29% 2025e-2026e

Following the significant sales decline in Bergsala, we are lowering our sales estimates for this segment quite significantly while making slight upward adjustments for Amo Toys, which outperformed our expectations. Furthermore, in light of the divestment of NGS, we have revised our estimates, with the transaction expected to close in Q2.

• Sales lowered by 34% for 2024e and 25-18% 2025e-2026e.
• Adjusted EBITDA lowered by 24% for 2024e and 17-2% 2025e-2026e

DCF valuation

Following the Q1 2024 report and our revised estimates, we update our valuation range. Our new valuation range is SEK1-7 (3-18), with a base case of SEK4(8). Our base case of SEK4 corresponds to an EV/Adj EBITA multiple of 5.7x(25e). We apply a WACC of 12% in all scenarios.