UBSFF - Ubisoft: The Tencent Deal Is A Game Changer

Summary

• After news surfaced on September 6th that Tencent is set to double its stake in Ubisoft Entertainment SA, Ubisoft stock lost as much as 17.5%.
• In my opinion, the Tencent/Ubisoft deal implies a negative cross-read for investors.
• Acknowledging Tencent’s increased engagement, I believe an M&A driven upside catalyst has become less likely for Ubisoft.
• The argument that Ubisoft Entertainment should be valued at a similar multiple as what has been realized in the Activision/Microsoft deal cannot be an investment thesis anymore.
• I downgrade Ubisoft stock to "Hold," as I believe that investors are well advised to remain on the sideline until more details about the deal have been shared.

Thesis

In my coverage initiation article on Ubisoft Entertainment SA ( UBSFF , UBSFY ), written on the 9th of June, I highlighted that the company is undervalued as compared to fundamentals and a highly attractive M&A target for one of the world's leading tech/internet companies with metaverse/gaming ambitions. However, after news surfaced on September 6th that Tencent Holdings Limited ( TCEHY , TCTZF ) is set to double its stake in Ubisoft, the latter's stock lost as much as 17.5%. And the market reacted reasonably, as I argue in this article.

In short: With Tencent's increased engagement, a full takeover of Ubisoft seems now unlikely. Moreover, the implied Ubisoft share price of Tencent's purchase is much closer to Ubisoft's spot trading valuation than the 80/share initially suggested by Financial Times and Bloomberg .

About The Deal

On September 6, Ubisoft released a press statement that confirmed a deal between Tencent and the Guillemot family. According to the release, Tencent is investing a total of €300m in Guillemot Brothers Limited - a holding vehicle of the founding family - in exchange for a 49.9 percent stake in the company. The investment was structured as a combination of a €200m share purchase and a €100m capital raise. Post-transaction, Guillemot Brothers Limited will own 17,086,199 of Ubisoft shares, including 9,086,199 shares held via derivative contracts.

The derivative contract is very important, I argue, as it created some confusion regarding the implied share price of the transaction. If Tencent is investing €300 million to buy 49% of the 17,086,199 shares, then Ubisoft is valued at €80/share. However, if Tencent is investing €300 million in exchange for 49% of the Guillemot Brothers Limited equity - as I personally interpret the deal - then Tencent also owns a fair share of the 9,086,199 derivatives position. This would imply that the actual purchase price is closer to Ubisoft's spot valuation of ca. €40/share.

The footnote of the press release states (emphasis added):

The transaction values the 8,000,000 Ubisoft shares held by Guillemot Brothers Limited (including 1,050,167 Ubisoft shares held directly by certain family members and which will be transferred to Guillemot Brothers Limited), that are not owned through derivative contracts , at €80 per share for a post-money enterprise value of Guillemot Brothers of approximately €640 million.

In addition, as part of the deal, Tencent also has the right (but not the obligation) to increase its 4.5% direct stake in Ubisoft to a maximum of 9.99 percent - but is, at the same time, prohibited from increasing the stake further for 8 years.

What The Deal Implies for Ubisoft

In my opinion, the Tencent/Ubisoft deal implies a negative cross-read for investors. There are two important arguments to the thesis. First, investors should note that the increased engagement from Tencent will likely block any competing takeover ambitions towards Ubisoft (which was likely the motivation for the Guillemot family). At the same time, a full take-over by Tencent is unlikely, as the deal includes certain conditions that limit Tencent's ability to increase its equity stake in Ubisoft beyond 9.99% for the next 8 years.

Kepler Cheuvreux commented on the deal:

Even if on paper the deal does not create any poison pill (no blocking minority nor veto rights) and other players can still bid on Ubisoft, the speculative appeal diminishes in our view and makes Tencent the sole natural buyer of Ubisoft

Secondly, investors should consider that - according to my calculation - Tencent effectively doubled its equity stake without paying any premium for the shares. This is in sharp contrast to what the market initially has expected (remember: some sources suggested a 100% premium).

On the positive side, Tencent will likely continue to support and "defend" Ubisoft's creative autonomy. Moreover, the strengthened partnership will likely accelerate Ubisoft's ambitions in Asia, and particularly China, as well as the development of mobile compatibility for several of Ubisoft's major franchises. The company said :

The expansion of the concert with Tencent further reinforces Ubisoft's core shareholding around its founders and provides the company with the stability essential for its long-term development

... As a result of this transaction, Ubisoft's governance will remain unchanged and Tencent will not have any operational veto rights.

Likewise, Tencent President Martin Lau said :

We are excited to expand our engagement with the founders, the Guillemot family …

(Tencent) plans to bring some of Ubisoft's most well-known AAA franchises to mobile.

In sum, the market strongly disliked the news, and Ubisoft stock sold off as much as 17.5% on the trading day following the deal announcement.

Investor Takeaway

I continue to believe that Ubisoft is undervalued as compared to fundamentals, and my long-term outlook on the gaming company is positive. However, acknowledging Tencent's increased engagement, I believe an M&A driven upside catalyst has become less likely for Ubisoft. Accordingly, the argument that Ubisoft should be valued at a similar multiple as what has been realized in the Activision/Microsoft deal cannot be a solid investment thesis anymore.

Moreover, given that Tencent's implied purchase price for Ubisoft is perhaps closer to the spot trading price of €40/share, than what has been suggested by some media outlets (€80/share), investors have every right to act disappointed - as there was no purchase premium implied in the deal with Tencent.

That said, I downgrade Ubisoft stock to "Hold." I believe that investors are well advised to wait on the sideline until more details about the future ambitions of the Guillemot family and Tencent for Ubisoft have been shared.

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