Enad Global 7 AB (publ)

STO:EG7

Earnings Call Transcript 2022-Q1

[Ludvig Andersson, executive]

Hello. Welcome to this Q1 presentation with Enad Global 7. My name is Ludvig Andersson, and I will be your moderator during this call. Together with me to present, we have our acting CEO, Ji Ham; and our Deputy CEO and CFO, Fredrik Ruden.

After the presentation, we will have a quick Q&A session and we'll try to answer as many questions as we can. [Operator Instructions] But now, over to you, Ji.

[Ji Ham, executive]

Great. Thanks, Ludvig. Welcome.

Let's go to the first slide. A quick recap introduction of the company. EG7 is an emerging gaming group with a broad set of expertise across a number of vectors in gaming: Games as a Service with Daybreak and Big Blue Bubble, with our portfolio of live service games; game development, so we have investments across first-party titles that we're making in both live service as premium products; publishing pipeline that we're building out with Fireshine formerly known as Sold Out in both physical and growing digital pipeline with indie titles; and leader in AAA game marketing and asset development with Petrol who has been representing Activision and Call of Duty marketing for the last over a decade.

Additionally, it's a very solid foundation of recurring revenue and profit base. 53% of our net revenues and 78% of our adjusted EBITDA come from our live service -- game portfolio in Q1. We currently have 10 titles in the live service portfolio and that excludes 12 titles from Innova, which we'll talk about more as we're divesting that business as we announced in April. And our live service portfolio has sustainability, predictability and the long life cycle as evidenced by a game like EverQuest, which has been running successfully now over 23 years.

Our portfolio of assets are highly diversified and it provides a nice attractive risk-reward balance. We have this steady and reliable performance from live Games and Service segments with diversified third-party clients that continue to be repeat clients with our Service segment and a great upside with the manageable risk from our balanced portfolio of investments that we're making in new titles, first-party; third-party indie game publishing from Fireshine; and big existing live game upgrades that we're investing in with Lord of the Rings Online as well as DC Universe Online.

And we continue to focus on driving growth and we're doing that through both M&A, which has been core to how we've grown today, and also continuing to demonstrate our ability to drive organic growth as we have done so for this quarter and the quarter before that.

Next slide. Here's the financial highlights from the quarter. We're very excited to report very strong results for the quarter, above expectations. Our net revenues came in at SEK 452 million. That represents 49% year-over-year growth; and organic growth-wise, 25%, and that's excluding Innova and Magic contribution.

Adjusted EBITDA of SEK 112 million, representing 25% margin, consistent with our performance last year and third consecutive quarter of meeting or beating expectations.

We have been delivering on the promises that we're making, meeting expectation in Q3 last year and Q4 and Q1 now delivering beyond that. Our performance was led by Service segment this quarter, Fireshine and Petrol, exceptional performance by those 2 business units, and M&A in the first quarter in January that we closed Magic Online transaction.

Next slide, please, operational highlights from this quarter. We're continuing to grow our live games portfolio, which is the foundation of our recurring revenues and profitability. Magic Online transaction closed in January. And along with that, now we're up to 10 live games and that's once again excluding Innova's 12 games on their platform as we will be carving that out.

And we're increasing our new game pipeline. Fireshine, they've been transitioning from just physical to digital as well. And they're building out a great third-party indie game publishing pipeline. Had a very successful release with Core Keeper in Q1, 0.5 million units sold within the first couple of weeks of releasing, currently at 90% positive reviews on Steam, which is phenomenal. And then the pipeline continues to grow currently with 6 more third-party indie digital titles for 2022, 2023 and this represents a great additional growth opportunity for Fireshine as well as the overall group.

And we have Innova situation related to Russia risk. We are fully execution mode currently in terms of divesting Innova. And this is meant to fully eliminate Russia-related risk or perceived risk related to that, that has impacted our stock over the last 3 months. Decisive action by the Board to be able to carve this out and eliminate the risk. There's no material impact to the rest of our group as all the other business have de minimis sort of exposure to Russia. And upon Innova divestiture, we will no longer have Russia-related risk within the group.

Next slide, please. Now we want to spend a little bit of time on Russia-related risks and impact and mitigation plan that we already had in motion. We announced on April 19 that we will be divesting Innova. We'll be walking through now the business impact Innova as well as EG7 overall and sort of what the outcome will be based on our mitigation plan.

Next slide, please. Business impact from Russia, related risks. So we looked at it both ways. One is what's the impact on Innova, which primarily operates in Russia and the surrounding regions. As its primary revenue sources in Russia, Innova has been facing pretty meaningful challenges since the conflict started late February. They have significant loss of active player base. The currency volatility also not helpful, and also cancellation of multiple products that they had lined up for Q1 and beyond for the rest of this year. And there's this uncertainty around the length and the overall severity of the business impact going forward.

On the group level, when you look at EG7 as a whole, the impact is almost entirely contained and isolated to Innova. Innova contribution to the group was limited at 14% of net revenue and 18% of adjusted EBITDA for the last 12 months ending March 31. It has de minimis impact on the rest of our group companies who have limited to little to no exposure in Russia at all, and rest of the group is performing according to plan and performing ahead of plan as demonstrated by the strong Q1 results.

So once again, the impact -- business impact from perception of Russia-related risk is quite limited, isolated to Innova and not material to the group, our operations performance and its future.

Next slide, please. Equity capital markets impact on EG7. So this provides a illustration of the impact on our equity and valuation over the last 3 months since the unfortunate events in Ukraine and the conflict started from February 24 to yesterday. So Ukraine invasion started February 24. At that time, day after is when we actually came out with our Q4 earnings announcement. Significant, indeed, great performance. We saw a little bit of an uptick after that with our stock price. Since then, it's been on this downward trend, which we believe is largely related to Russia-related headlines as we have not had any other meaningful news out there.

So over this period, our stock has declined by 55%. And based on that decline, we're currently trading at 3.5x pro forma adjusted EBITDA as of May 24, yesterday. And the pro forma adjusted EBITDA is LTM for March 31 and that's fully excluding any Innova contribution. Even so, the trading multiple is at 3.5x.

When you look at the chart on the right, relative impact comparison. So a decline in our market cap, 55%. Second column shows the dilution from Innova deal when we originally closed on the transaction last April. In 2021, it was financed 100% with stock and the company issued 11% of its stock to finance that. And the third column, Innova LTM net revenue contribution, 14% of the group; and then adjusted EBITDA contribution, 18% of the group.

When you compare those percentages compared to the loss of revenue the overall group over the last 3 months, there's this outsized impact compared to the actual business and financial impact the company has actually been dealing with.

Next slide, please. Innova divestiture summary here, transaction summary. As we announced on April 19, this transaction is related to us selling Innova to the existing management team at Innova. Transaction value is agreed at EUR 32 million. It's going to be fully financed with vendor loan from the group. And we're targeting closing as soon as possible and we're anticipating that should be sometime in the summer of this year. And subject to approvals, including shareholders, as well as regulatory approvals within the jurisdiction.

Financial impact from this write-down of SEK 1.1 billion of assets. The entire amount of the asset was financed with stock at the time of the initial transaction, noncash impact, once again, with 11% dilution to our equity at the time. And there's SEK 330 million of asset for the vendor loan that we will be booking. However, due to the uncertainties that continues to be there in Russia, and we have no idea how long that's going to last, as a result, we expect or we believe that this loan could be subject to potential revaluation going forward.

On the right side, pro forma P&L. This illustrates the group's performance excluding Innova. Maybe starting at the far right with LTM Q1 2022, total group net revenue, adjusted EBITDA, SEK 1.8 billion and SEK 429 million, respectively. Innova contribution to that was SEK 255 million of net revenues and SEK 70 million of adjusted EBITDA. Excluding that, we end up at SEK 1.6 billion of net revenue and SEK 351 million of adjusted EBITDA, which, by the way, is the number that we're utilizing, that 3.5x multiple, on the prior slide.

When you look at Q1 though, the contribution has declined given the difficulties that they're facing. Group total net revenue of SEK 452 million and SEK 113 million of adjusted EBITDA in Q1. Innova contribution, 11.6% of that at SEK 52.6 million and 5.4% of adjusted EBITDA with SEK 6.1 million contribution. And pro forma, excluding that, the group is generating SEK 400 million of net revenue and adjusted EBITDA of SEK 107 million for the quarter.

Next slide, please. So upon closing and the completion of this transaction, the outcome that the company will have is this: relatively small setback, Innova will be carved out. Innova has not been a core element of our business plan since the management transition last fall. In Q1, contributed only 11.6% of net revenue and only 5.4% of adjusted EBITDA. Along with this, no more Russia-related risk and baggage. No negative impact to the rest of the group. And we'll be back to focusing on execution and growth without distractions of Innova and then Russia-related risk going forward.

Next slide, please. Fredrik?

[Fredrik Ruden, executive]

Thank you, Ji. So in the first quarter, EG7 delivered SEK 452 million in net revenue, corresponding to a quarterly growth of 49%; and an organic growth, excluding Innova and Magic Online, of 25%; in local currencies, 13% organic growth.

Then next, the net revenue in the last 12 months show constant increase from one consecutive quarter to the other. By end of Q1, the LTM net revenue amounted to SEK 1.819 billion, corresponded to 153% growth against comparable figure last year. And this is mainly driven by M&A activities, but also with organic growth. This strong growth is delivered with profitability.

And the adjusted EBITDA margin amounted to 25%. Excluding Innova, the margin was 27%. The higher-than-expected margin comes from historical high margins in the Service segment.

This picture further highlight the strength in our company with one stable part of predictable revenues and one with greater volatility. Meanwhile, both segments show stable LTM growth. The last 12 months net revenue in the Game segment amounted to SEK 953 million, corresponding to 284% growth explained mainly by M&A but also organic growth. The foundation for our predictable and sustainable net revenue and cash flow inside diversified and well-balanced live games portfolio. This is a key differentiator for the group.

And net revenue from these assets, excluding Innova, amounted in the first quarter to SEK 241 million, corresponding to 53% of net revenue. That figure was 47% in Q4, and the increase is mainly attributable to the contribution from Magic Online. And that also highlights that we are becoming even more predictable in Q1 compared to Q4.

The last 12 months net revenue in the Service segment amounted to SEK 866 million, corresponding to 84% growth explained by M&A and also organic growth. This part of the business show greater volatility and is attached with generally lower margins. But in this particular quarter, both Petrol and Fireshine continue with strong momentum in a better controlled pandemic situation. One of the key drivers for Petrol's strong performance was the creative marketing arts around Elden Ring. The key driver for our publisher Fireshine was the early access release of the indie game, Core Keeper, which is also a proof of concept of the digitalization of the business in Fireshine.

Daybreak is the most important contributor in the Game segment, generating SEK 212 million in net revenue and SEK 75 million in EBITDA, corresponding to 35% EBITDA margin. Big Blue Bubble contributed with SEK 26 million in net revenue and SEK 12 million in EBITDA, corresponding to a very strong margin of 46%. In this segment, we also include Piranha, Toad Studios (sic) [ Toadman Studios ] and Antimatter Game.

Going to the Service segment. As mentioned, Fireshine had an extraordinary strong quarter, specifically with the Core Keeper title in the first quarter, and generated SEK 90 million in net revenue and SEK 80 million in adjusted EBITDA. And that gave a historical high margin of 20%. That margin was 15% in Q4 last year. Core Keeper is also a key factor for the accelerated digital transformation in Fireshine, something that we expect also to see with the new 6 indie games to be released '22 to '23.

Petrol also had a strong momentum in Q1, generating SEK 54 million in revenue and SEK 30 million in EBITDA. This is also a very strong margin of 24%. And they benefited from specifically 2 marketing campaigns rolled out in Q1.

Innova, we have talked about that. They generated SEK 6 million in EBITDA and SEK 53 million in revenue.

So I would like to manage expectations going forward. The first quarter was strong, driven by good balance between the solid and stable revenue base from the live service portfolio and the more volatile part of the -- from the indie game publishing side and the successful marketing campaigns in Petrol. This gave the best first quarter in our history with SEK 452 million in net revenue, a really strong 25% margin representing the growth, as mentioned a few times, of 49%, organic growth of 25%. And in local currencies, that organic growth is 13%.

Looking at the longer perspective, the last 12 months and excluding Innova, we have had a growth of approximately 7%. In the right chart, we can see that the growth started to come in Q4 and accelerated up in Q1, fueled by the Magic acquisition and strong performance in the Service segment.

And taking the divestment of Innova in consideration and also where we are trading at the moment, we have a target to reach SEK 1.6 billion to SEK 1.7 billion in net revenue in 2022 with sustained margins. And that sustained margin statement is backed by the fact that we already delivered 25% margin in Q1. And excluding Innova, that would have been 27%. And that we will reach a strong season by end of this year. And net revenue in April amounted to SEK 147 million, and that reflect the normal seasonality in our business.

A few words about net debt-to-EBITDA and cash. The cash has, despite strong operational cash flow of SEK 50 million, decreased somewhat in from SEK 484 million to SEK 449 million. This is explained by SEK 38 million in investment and that we have a negative FX revaluation effect in financing activities of SEK 47 million.

Cash debt is slightly increasing. That is also due to FX revaluation of the cash part of remaining purchase considerations. So adjusting for FX, we would have come out at the same level as Q4. But now we end up at 0.3, still a low net debt-to-EBITDA ratio, which gives us some flexibility to manage the balance sheet going forward.

And with that, I'm handing back to Ji.

[Ji Ham, executive]

Thanks, Fredrik. Okay. So we'll cover some of the -- our plans and prospects going forward. We're looking ahead.

Next slide, please. So we break this down into 3 groups: short term, medium term, long term. Starting with the short-term value drivers. First thing on the list is Innova divestiture, being able to put Russia-related risk behind us or perception of that. And we hope to be done with that before sometime this summer.

And then we have new game releases that we continue to make great progress on for 2022, Block N Load 2, Evil versus Evil and Fireshine's indie title pipeline for 2022 and '23 that they continue to build out.

Magic Online integration and service, we're making great progress there. It's a game that was owned by Wizards of the Coast for 20 years. So carving out and transitioning, it does take time but we're making great progress there. And once we're done with that, we expect to be able to start investing heavily into growing that again.

And Lord of the Rings Online boost from the Amazon TV show that's coming out this fall. So we expect a nice uplift from that.

And continuing evaluation of various M&A opportunities, which M&A, as you could see, is across all 3 columns here as that's one of the core strategies for the group.

Medium-term value drivers. Major updates to Magic Online. Lord of the Rings Online update, as we've discussed in the past. And same thing for DC Universe Online revamp.

New games that we are investing in for the medium term, Power Chord from Big Blue Bubble, IGI and '83 from Antimatter Games. Minimal effect from Toadman and Fireshine's indie titles.

Long-term value drivers. We want to be investing in diversified portfolio of new Games as a Service products with core first-party IPs that we own and also investing in third-party digital publishing pipeline with Fireshine to be able to expand that bigger and be able to also go upmarket beyond indie titles and M&A.

Reprioritization of long-term investment focus. As we disclosed regarding Marvel, we will be discontinuing the large Marvel project investment. This is primarily driven by our desire to better manage our investment concentration risk as Marvel was a significant investment and a large portion of our overall cash flows for the next number of years with over SEK 500 million that was dedicated to funding that project. And now we'll be able to diversify that into investments across multiple smaller projects. Time line, that's more medium term to longer term. That's spread out. We're no longer making one bet, but being able to make multiple for better diversification and better portfolio management and lowering that risk.

Next slide, please. Okay. So in summary, we do want to highlight some of the key attributes for EG7 and what creates value for investors for EG7. So at the very top is attractive value. As noted earlier, we're currently trading at a significant discount to peers at 3.5x LTM pro forma adjusted EBITDA and that's excluding Innova contribution during that period. Even so, with yesterday's closing stock price, 3.5x EBITDA, which we do not believe is reflective of the fundamental value and the assets and the strength and the growth profile that EG7 has.

Proven track record of delivering. At this point now, along with Q1 overperformance, we have performed according to or beating plan for 3 consecutive quarters. And we expect to continue to do that going forward.

Unique risk-reward balance, especially at the current lower valuation levels, with the continuing growth that we're delivering organically as well as year-over-year, we believe that it's providing a unique opportunity for investors.

Strong growth, profitability and solid balance sheet. There's no distress here. Yes, there's been some distractions and noise around how much of an impact Russia situation has with the overall group. Hopefully, we covered that today to bring more clarity around that. But we're continuing to perform. We should not be trading at this level as if there's some distress. And we'll continue to win back investors' trust by performing.

Portfolio of world-class IPs. Yes, Marvel is no longer going to be part of our portfolio in terms of a new game, but we have DC Universe Online and Lord of the Rings Online, Dungeons and Dragons Online, great third-party IPs out here as well as our own first-party IPs, including My Singing Monsters, EverQuest, H1Z1 and Planetside.

Foundation of recurring revenue and profits, another unique attribute of what makes EG7 special. 53% of our net revenue come from live service games, and even a greater percentage, 78% of adjusted EBITDA from that same portfolio.

And we have a diversified and exciting pipeline of new games. And that's also very well risk managed, where we have a percentage of our investment going into first-party title, a number of investments going to third-party titles that we want to publish through Fireshine as well as major content update on existing titles, which provides the most predictable and lowest risk given that these are proven games with proven and sticky user base that we get to retarget with the investments that we make for major upgrades.

And lastly, no more Russia-related risk and noise once we're done with the Innova transaction, which we're working very hard to be able to complete as soon as possible.

That said, maybe we'll go to the next slide for Q&A.

[Ludvig Andersson, executive]

Thank you very much, Ji and Fredrik. So can you tell something about future M&A activities?

[Ji Ham, executive]

Sure. Yes. As noted, the M&A has been one of the primary drivers for EG7's growth over the last number of years. And this year, this quarter, we were already able to successfully close a Magic Online transaction. We continue to evaluate opportunities.

Yes, there are certain limitations now we have with the current stock trading level where stock or equity is no longer going to be something that we could actively utilize for transactions. But we have a very strong balance sheet, significant cash on the balance sheet as well as additional capacity from capital markets to be able to source and be able to transact going forward.

So we will continue to aggressively evaluate. But good news is that, along with M&A in Q1, we're delivering on organic growth as well, 25% in Q1 and 28% in Q4 and we'll continue that trend.

[Ludvig Andersson, executive]

Thank you. Do you have any estimate regarding the results?

[Ji Ham, executive]

Yes. I think Fredrik covered this really well. So we are targeting SEK 1.6 billion to SEK 1.7 billion of net revenue for the year, and that's excluding Innova. And in terms of the margin, for Q1, we delivered 25% adjusted EBITDA margin. Without Innova -- or excluding Innova, that margin would have been 27%. So we expect to be able to maintain margins at that level for the remainder of the year.

[Ludvig Andersson, executive]

Thank you. What are likely effects from new games, such as Elden Ring, on your current portfolio, both short and long term?

[Ji Ham, executive]

Yes. So one of the -- Elden Ring, by the way, amazing game. And I think it will probably end up being not only one of the best games this year but over the last decade. But with that said, I think when you look at our portfolio of games, when you look at the history, especially something like EverQuest that's been successfully operating now for 23 years, there's always been hit games. And as hit games come out, there's a significant uptick in those numbers for those titles. But we always get our players back because our players are dedicated to and the committee that are dedicated to the titles that they'd fallen love with our existing MMOs and live games portfolio.

So yes, there's going to be some fluctuations. There will always be great hits that come up from time to time. But we do believe that you have this -- we have this unique, sticky, highly predictable portfolio of live games that's been proving itself year-over-year, now going on 24 years for Daybreak and 10 years for Big Blue Bubble with My Singing Monsters as well.

[Ludvig Andersson, executive]

Thank you. How did you calculated the value of Innova?

[Ji Ham, executive]

Yes. It's very much an extraordinary circumstance. So it was not some easy sort of -- and clear way of being able to ascribe a fair value on the transaction at this time. But we were able to look at performance last year and projected performance going forward for this year and be able to come to an agreement with the management team at Innova. That SEK 330 million of value, which represents about 3x multiple on 2021 EBITDA, would be a fair value that we could agree to today.

[Ludvig Andersson, executive]

Thank you very much. I'm afraid that's all we have time for today. Thank you, everyone, for tuning in. And we wish you a great day. Thank you very much.

[Ji Ham, executive]

Great. Thank you, everyone.

[Fredrik Ruden, executive]

Thank you.