UBSFF - Ubisoft: I Like The Risk/Reward Profile Here

2023-07-14 11:00:57 ET

Summary

• Ubisoft's stock price has fallen over 75% in the last five years due to the company's strategy of releasing similar games annually, which has led to a decline in interest from gamers.
• The company plans to increase the number of talent working on the Assassin's Creed franchise by 40% and is also focusing on live service games and mobile gaming, which could potentially turn around its fortunes.
• Despite a decline in profitability and efficiency since 2018, Ubisoft's financials are considered healthy, with the company's intrinsic value estimated at $5.77 a share.

Investment Thesis

With earnings around the corner and the stock price down over 75% in the last 5 years, I wanted to take a look at Ubisoft ( UBSFY ) to see what happened over that period, give my opinion on what I think happened and what is the outlook for the next couple of years. I believe that the company can turn itself around and reward shareholders if they become a company that will start to listen to the people who like to play their games. With quite conservative estimates in my opinion, the company is a buy at these levels, however, caution is needed because the announced games in the future may not perform very well.

What Happened?

What I think best describes the company’s poor performance in the last 5 years is this quote I vividly remember from Far Cry 3 where the villain Vaas asked the protagonist "Have I ever told you the definition of insanity". Easily one of the coolest cutscenes I've seen when I was just a wee lad. Of course, Vaas paraphrased a little bit from Einstein’s (supposedly) original quote, but the meaning is the same. Insanity is doing the same thing over and over and expecting different results. I believe Ubisoft is a victim of this. Over the past decade, the company churned out year after year Assassin's Creed games (a lot of them), Ghost Recon games, and Just Dance, while only mixing in a couple of newer IPs like Watch Dogs and The Division. A lot of people, including me, gave up on these older franchises. I stopped after AC 3 and recently tried out AC Origins, which played like a completely different game. The next iterations of AC played similarly to Origins, so I never got into them, because that's not what I remembered from those games.

I've had the biggest gripe with how the company kept releasing AC games almost on an annual basis, turning the franchise into a Call of Duty type of game and it did not work for them at all. Releasing an almost identical game year after year and expecting a change is not how it should be. Coincidently (or not) right before the release of Odyssey, which came just about a year after Origins, the company's stock price tanked and then got a resurgence when COVID hit, only to continue tanking further in the recent years to lows the company hasn't seen since 2015. Re-skins of games has not worked for a while and the company needs to change this, so let's look at what is in store.

Outlook

Here We Go Again

Unfortunately, the company is not changing things anytime soon. In their latest fiscal year report , CEO Yves Guillemot said that the company is going to increase the number of talent working on the Assassin's Creed franchise by 40%. I suppose it is understandable, although disappointing that the company is taking the comfortable path in the future. Assassin’s Creed is a very successful franchise, selling over 200m units worldwide , so of course the company will keep going, but I don’t want to see a repeat of a yearly release again. The franchise deserves better. There are already at least 5 games in the AC franchise to come in the future, AC Mirage, then some projects codenamed Red, Jade, Hexes, and Invictus. Personally, Hexes seems the most exciting one out of the 4 projects and I am also somewhat excited about Mirage because from seeing a couple of trailers, it does look like it's going back to the classic feel of the franchise.

Live Service

The latest iteration in the Division series which is the 2 ^nd one is still going quite strong across all platforms. I've seen many people enjoying that type of live-service game, especially now that the game is free on PlayStation 5.

Another massive game that is going strong after 8 years is Rainbow Six Siege, which still gets around 35k+ daily players on Steam alone, and that doesn’t count consoles and Ubisoft Connect.

There is a lot of potential for the company if it can keep succeeding in the Live Service segment and it is not going to stop there as I believe the two big games that will be coming shortly are going to bring in a good player base, The Division Heartland and xDefiant.

These two games will be free-to-play, which means they will be riddled with microtransactions, however, as long as these transactions are not predatory and not Pay-to-win, I think it’ll be fine.

I am especially excited for xDefiant. I haven’t played a Call of Duty game in years, and I cannot bring myself to pay for a new game every year just to play an arcade shooter game mode, and I think xDefiant will scratch that itch for me. I don't know about you, but I am tired of BRs. The death match on Apex Legends didn't do it for me, unfortunately.

Mobile Gaming

It looks like Ubisoft is trying to bank on people having phones (looking at you Activision) and playing games, which I don’t blame them. Mobile gaming is the largest revenue generator worldwide. It rakes in more revenue than PC and consoles combined (and that was in '21 already), so naturally Ubisoft, after seeing that Diablo Immortal, even if it was hated, made bank for Activision (ATVI), wants a piece of that pie too! There is already an Assassin's Creed and a Division game in the works for mobile, but only time will tell if they will be successful.

So, it seems that the company is trying out something new, although not too much. xDefiant seems very promising to me and during the Ubisoft Forward 2023, the new IP that stuck out to me was Star Wars Outlaws. Let’s hope it’s good because the company has stiff competition there from Respawn Entertainment (EA).

Briefly on Financials

All the figures below will be in US dollars, which I got from a third-party website, so I don’t know what exchange rate it used. Expect slightly different figures but in the same ballpark.

As of FY22, the company had around $1.6B in cash and equivalents, against $1.2B in long-term debt. Many investors don't like debt, especially when it's almost as much as the company's market cap, however, leverage, if used correctly, is a good way of running a company as long as the annual interest expense is manageable. It is for Ubisoft because the interest coverage ratio is around 7x right now, which means that EBIT can pay off annual interest expense 7 times over.

Continuing on liquidity, the company’s current ratio is also quite healthy, standing at around 1.5 as of FY22, meaning if it needed to pay off all its short-term obligations at the same time, it would be able to and still have liquidity left over. The company seems to be financially healthy.

In terms of profitability and efficiency, I'm a little disappointed here but not surprised. ROA and ROE have been trending down since 2018, which is when the big hate started to come in for their cash-milking tendencies. If they are not able to turn this around, I'd be very skeptical about investing. The minimum I’d like to see is 5% for ROA and 10% for ROE, which the company did have in FY18, so it is achievable.

I am also not surprised by the small return on invested capital. It seems to be industry-wide, so I won’t go too hard on it, but I would like it to come back up at least to 2018’s levels also. Seems like no player in the industry has a decent moat or a competitive advantage.

In terms of margins, I would like to see improvements in net margins over the next couple of years and to at least return to 2018's levels also, because that seems to be their best year in the recent past. I’m sure the announced 200m euro cost-cutting initiative will help get closer to that goal.

Overall, the financials look alright. They’re not outstanding but also, I don’t see a big reason to get worried about either. As I said gaming industry is a tough one and to get attention for your product against some other video game company, you’d have to come up with something truly unique and outstanding, like the BR genre did a few years ago.

Valuation

I'm going to take a conservative approach and will follow what the company did in the last decade in terms of revenues. For my base case, I went with a 5.5% CAGR over the next decade. The company managed to achieve around 6% in the last 10 years, so that is my anchor. For the optimistic case, I went with 9.3% growth, and for the conservative case, I went with 3.5% growth.

These scenarios seem reasonable. It is hard to predict if the company will come out with a game that is going to be a cash cow for the next decade, but I could see a couple of games obtaining a decent player base.

In terms of margins, I left gross margins unchanged from FY22, because I don't think there could be much improvement there. For the operating margins, however, I have improved them by around 200bps or 2% by ’32, which will bring net margins from 4% to around 8% by ’32. Also, the company is paying a lot in taxes, so I left a similar tax rate throughout the model.

I’ll add a 25% margin of safety on top of these assumptions to keep it safe. With that said the company’s intrinsic value is $5.77 a share, implying that the company is priced fairly according to these growth assumptions.

Closing Comments

To be honest, I think the calculations are close to where the company should be, and I think that the company is about to turn around in the next couple of years, and I wouldn't be against opening a small position and keep following the news to see how these newly announced games will be received by the public. I am very excited about an arcade shooter like x Defiant and I will also give the Division a go. If the company manages to get the free-to-play model right, I can see these live service games making bank for the foreseeable future.

There's always the risk that the share price keeps coming down, but I feel like the risk/reward profile right now is more favorable than it was a couple of years ago. I really would like to see the company succeed because when I was a kid, I enjoyed their many games like Prince of Persia and AC specifically.

Oh, and what about Beyond Good and Evil 2? I'll cover that in another 5 years once they have something for us again.

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