OTGLY - CD Projekt Red: Cyberpunk 2077 Still Has A Ways To Go With DLC And Anime Promotion

2023-03-04 08:43:53 ET

Summary

• CD Projekt Red is going to invest unprecedented amounts into a Cyberpunk DLC, which has a high potential of increasing LTVs for the game and the IP.
• At 20 million copies sold in 2022, there's a lot more scope considering how far the Witcher 3 went, and how much better adaptations into other media have been.
• The multiple is still pretty high, but that's how gaming companies are priced now. Makes sense considering something like Gwent has pretty recurring revenue.
• Phantom Liberty is going to be important, and this could bridge the gap with the Witcher Polaris and Sirius projects.
• Overall, we can understand the optimism around CDPR, but it's too expensive especially given the economics.

CD Projekt Red (OTGLY) is a company we happily initiate coverage on. There's a lot to say: Gwent provides some recurring income and seems to have a solid playerbase, Cyberpunk 2077 should continue to build more sales as it's a great game and performs better now than ever, the Cyberpunk DLC is going to likely increase lifetime sales further to match the Witcher 3, and new Witcher projects should continue to keep the company's base of games growing and successful. However, because of the economics of a project-focused company like CDPR, investors need to rely on management to not ruin goodwill and to provide high quality RP experiences in its new flagships. In light of this, the multiple at 33x on Q3 annualised data looks way too high.

Moving Parts

The economics of CDPR are that they release a big game every so often, performance jumps massively and then falls as the new title become owned by its market. CDPR gets valued based on how many good projects it has in the pipeline, and the potential of the projects is measured by watermarks set in previous years on other big releases.

Christmas 2020 is when Cyberpunk 2077 was being bought in massive quantities, and sales of course leaked into 2021. Launch issues aside, the game had a good soul and is becoming increasingly well-liked as patches have it performing way better.

2022 was not an especially strong year for gaming, with the pandemic being a tough comp, but CDPR did well thanks to driving sales in Q3 related to new interest in the game from the Cyberpunk: Edgerunners anime release and general improvement to the initially buggy game, that drew in a lot of deferred purchases. By the end of 2022 we are at around 20 million copies sold - the Witcher 3 got to 40 million copies across platforms , starting at around 6 million in the months right after release, and getting to 20 million in 2019.

The latest years have been good for the Witcher 3 and the Netflix ( NFLX ) show likely had something to do with it. Likewise, the Cyberpunk: Edgerunners release late in 2022 is going to similarly drive continued discovery of Cyberpunk and help give CDPR a second chance with those put off by news of the initial release. The Witcher 3 had the benefit of the releases of two major DLCs, the second one almost the size of a new game in terms of added content, that drove total sales price of the title up for the average customer, where some added DLCs after the fact and didn't buy the whole bundle which is usually priced promotionally.

With Cyberpunk 2077 already at half of the Witcher 3 sales, there is a lot of scope for more unit growth, on top of added sales to buyers so far of new DLCs, with Phantom Liberty already announced and hoped to be released this year . This will drive the value of the Cyberpunk buyer up as well as contribute to new sales with the bundle edition.

Starting in 2025, new Witcher projects will be released too. No more Geralt, but surely some good experiences benefiting from the increasingly powerful Witcher IP.

Bottom Line

Besides these major projects, there's also Gwent. In 2021, which represents a typical banner year of a major flagship release, we estimate Gwent accounted for about 5% of sales based on mobile revenue, and assumptions about PC revenue being about similar (conservative since PC is the primary platform for the game). The economics around Gwent are better than a typical flagship release in the sense that it is based on microtransactions (of kegs) and is more recurring. It's not insignificant, but the focus has to be on the new releases.

In 2023 we get Phantom Liberty, which we think will get us back to at least 75% of the 2021 results, based on what Blood and Wine did for the Witcher 3. Moreover, Cyberpunk is a slowburn product because people deferred purchases, and may come back to it after getting a taste of good SP experiences in 2022 with Elden Ring and others. In 2025, we get some major new titles, the Polaris projects which is another Witcher SP game, and Sirius which is a more mixed Witcher concept. Headcount is also being added for the codenamed 'Orion' Cyberpunk sequel.

If we were to use the multiple based on forward earnings, we'd propose, coarsely, an EPS of around 75% of the 2021 level, meaning around 66x PE, as a bear case. Q3 was the driving force of this year's results, so to be more generous we can annualise those figures and then 75% it. That gets us to 44x which is more fair in assumptions, but demonstrates a stretched valuation. We can assume total resilience in performance into 2023, but this may be aggressive considering that interest wanes with these properties pretty quickly, at least in that new sales can't be continuously produces, and also when Phantom Liberty get released the development costs are likely to be realised 40% upfront which will hurt the results a decent amount bit - COGS halved from 2020 which included that upfront COGS at release compared to 2021 (Phantom Liberty will be smaller but still, the budget is apparently unprecedented for a DLC, so it will bite!). Still, we get 33x being as generous as we feel it's possible.

33x certainly acknowledges the likely success of new Witcher titles and more Cyberpunk titles in the more distant future. Cyberpunk was a special situation of a particularly disappointing release, where expectations were lower for the Witcher 3 considering the prior profile of CDPR games, so there is a slower burn effect that does actually make the results easier to forecast. There are also more levers with content and adaptations to other media to drive penetration, as with Edgerunners and the Witcher series on Netflix. Things are better than they were in 2015 and 2016 when Witcher 3 came out. But still, the valuation is stretched given the current market. All it takes is another hit to goodwill to seriously impair this company. The last one with Cyberpunk should be possible to recover, because at its heart the game was excellent. This is not the sort of risk we'd take at this price at all.

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