THQQF - Embracer: Space Marine 40k II Has Potential They Own Middle-Earth

2023-12-03 09:43:12 ET

Summary

• Embracer is exposed to iconic franchises, even owning Middle-Earth Enterprises.
• It has had access to the Star Wars IP in the past as well, through Dark Horse in comics, and also through games, with the KOTOR remake among announced titles.
• Tabletop games are looking to have a good Christmas season, and restructurings are coming in to help boost profits as we wait for next year's possible blockbusters.
• A deleveraging play with a pretty low multiple, despite quality assets. Could be interesting.

Embracer ( THQQF ) was a massive pandemic darling. Consistent with some other pandemic plays, it's come down a lot, and video game sales are still dealing with some leech of players back into normal post-pandemic life, and Embracer in particular is suffering with some difficult comps last year due to the release of some big hits, and also the pretty underwhelming performance of some newly published titles including Payday 3, which had no business being a bit of a failure. In particular, Embracer is also shedding a lot of headcount, around 5%, in line with the restructuring plan. We are quite optimistic about the potential contribution of the new Space Marine game next year, which should build on the last release's cult following and the interim growth of the IP. Also, they have a lot of other IPs to leverage, including a storied partnership with Star Wars through several of its brands. This company has a massive stake in some of the biggest fandoms in geek culture.

Very Brief Primer

They have the following segment split in Q2:

Their PC/Console and Mobile gaming businesses are based on publishing and development. Embracer owns a lot of studios like Saber and Gearbox responsible for major franchises like Borderlands and also some games under the Warhammer IP, specifically Space Marine 40000 II which should come out next year. Their catalogue is top-tier. They also publish games from external studios. Developers earn royalties, while publishers market and commercialize the game, incurring marketing expenses, etc., and pay royalties to the developers on sales.

In tabletop, they sell tabletop games like Exploding Kittens, and in the service and entertainment business they have a smattering of activities, including managing IPs as well as providing services to 3rd parties. They actually acquired Middle-Earth Enterprises, meaning worldwide rights to motion pictures and merchandising and so forth, some details here . Obviously, extremely valuable. S&E also contains Dark Horse comics, which was 3rd in market share behind DC and Marvel in the late 2000s thanks to Hellboy and the rights to Star Wars and working on the Star Wars Expanded Universe at the time. That's also restarted, both Marvel and Dark Horse now make SW comics.

Q2 Comments

They have had exposure to some really popular unexpected hits like Valheim last year, a game that took over despite a small budget and indie studio, and they have a large catalogue of recurring titles like Saints Row and Neverwinter.

"Although we were up against tough comps versus last year in the quarter with the release of Saints Row and the platform deal relating to Valheim last year, our full year sales increased in the quarter."

Johan Ekström, CFO of Embracer

Organic growth was weak in all segments except for in tabletop games and the entertainment and services segment, which grew 15% organically in sales and 47% in adjusted profit. Comprehensive organic growth was -2%, driven by PC/Console games business, down -17% exaggerated by tough comps, -10% in mobile gaming driven by post-Covid declines in casual gaming.

Adjusted EBIT was down 14% on higher costs on marketing to push some recent releases, and there not really being the ROI on that yet, in particular Payday 3 which had a bad launch as it's an online-only game and servers were not functioning at all on release.

"Marketing expenses outside of the Mobile segment remain at a relatively high level and is mainly due to giving the support to larger releases such as Remnant II and Payday 3 and also supporting the healthy performance that we see in the Tabletop segment in the quarter."

- Johan Ekström

They've only done about 1.8 billion EUR in EBIT this quarter, so to hit the 7-9 billion EUR EBIT target they are going to have to take action on the cost side in addition to completing the release schedule laid out. They've already laid off around 5% of people, and they were dodgy with the questions about doing more, indicating that it's probably being considered. They are also considering divestment of assets that they've acquired.

"As you know, in order to achieve this objective, we have laid out a set of targets in different areas of focus. We aim to deliver savings of at least SEK 2.9 billion in CapEx, of at least SEK 0.8 billion in OpEx by the end of the financial year 2023/2024. We also target to nearly halve the net debt position to below SEK 8 billion by the end of financial year 2023/2024."

"...the financial savings will be seen over the second half of the year."

"Since the end of Q2, in respect of due process and commercial sensitivity, we will not comment on the specifics, but further restructurings, closures, bouts are in process and that will lead to additional headcount reduction."

- Müge Bouillon, CFO of subsidiary Asmodee

Looking Forward

We like that tabletop has seemed to have cemented itself as a mainstream product, with people putting it on Christmas lists driving organic growth. This seems to indicate enduring wallet share wins from the pandemic.

For next year, we also wanted to call out the potential of the new Space Marine game. They are developing it with Saber, not publishing it. The first instalment from a decade ago sold more than 1 million copies, which is really solid - one of the few bright spots for THQ before they went bankrupt. The IP has grown since then, with the real life tabletop game under Games Workshop ( GMWKF ) massively expanding. Vermintide II sold 10 million copies over 2 years. This isn't an Embracer game, but it makes the point that Warhammer really sells well. Space Marine II could be a major winner. Supposing they're getting a 10% royalty, if the game sells around 1 million copies at full price in the next calendar cycle, it could alone account for 7% of revenues on run-rate figures. It could overperform that.

Also, Payday is a much loved franchise. Revenues there should have a long-tail as people give it a chance once they get over the launch issues.

There could be other exciting announcements on the horizon. Maybe a KOTOR remake from Star Wars? Although. that seems to be dead in the water for now.

The multiple is around 4-6x EV/EBIT depending on which figures you take for EBIT forecasts. They have quite a lot of debt, which is a concern, but they should be able to keep leveraging their properties, including Middle-Earth which has just gotten started, to help deleverage there. A cheap story, with a deleveraging angle and iconic franchises. A lot to like.

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