Description

Swedish small-cap Enad Global 7 (“EG7”) announced FY23 results on Tuesday: 10% YoY growth with 24% EBITDA margin, and subsequently traded down (19)% to now be priced at 2.0x EV / '23A EBITDA. The market's rationale for the decline, especially in light of positive FCF, a net cash position and company targets for ~50% growth with large margin expansion by 2026E, seems to be based on fear and misinformed short-sightedness. Taking a multi-year viewpoint of this cash generative business, the share price drop has made an appealing opportunity even more appealing.

EG7 has been written up on VIC once previously, in 2022 by Houdini, which provides a good background on the company. Since then there have been a few developments - I hope you enjoy my write-up below.

Summary Thesis:

• EG7 has several strong game brands and has been growing exponentially while generating free cash flow 
• After being over-hyped during the Covid-era speculative craze, EG7’s share became orphaned to short-term speculative interests, driving mispricing
• A disproportionate focus is on the game My Singing Monsters, which was the largest EBITDA contributor in 2023 and is in decline 
• EG7’s other revenue seems to be disregarded as irrelevant indefinitely, despite 2023 representing a temporary trough period due to poor market circumstances
• There are also other mispricing dynamics, including local peer universe contamination, indiscriminate thematic selling, obscurity and size
• Unlike before, management and the Board today comprise highly-experienced profiles
• With sizeable equity stakes 
• Even if this leadership team performs poorly, there is a very sizeable upside
  • At conservative projections far below company announced targets, a DCF shows intrinsic value of 112%+ above current share price 
    • Implied ‘23A EBITDA multiple of 4.3x, ‘24E EBITDA multiple of 5.3x
• There are multiple catalysts for value realization in 2024, including relisting to a better venue and approved capital returns
• With Net Cash of at least 20% of market cap, EG7 presents a highly asymmetric risk-reward opportunity 

ENAD GLOBAL 7

Company Overview

Enad Global 7 (“EG7”) is a Swedish game publisher and developer across PC, console and mobile platforms. The company sells games or in-game features in free-to-play games, does work-for-hire/co-development, provides marketing services and publishes 3rd party games. The company currently manages a portfolio of 10 currently live games with both their own IP and 3rd party IP, and operates through 6 units across Canada, the UK, the US and Sweden. Revenues mostly pertain to games for PCs (54% as of LTM Q2 '23A, last available data), followed by mobile (35%) and the remainder being consoles. Geographically, the majority of revenues are from North America (69% in 2023A), followed by Europe (23%) - Sweden notably only accounted for 1.5% of revenues in 2023A. 

Group Companies

Notes: (1) Excludes group overhead of SEK (34)m; (2) Includes Antimatter, a studio that has been shut down.

Turbulent Company History…

• EG7 was founded in 2013 in Sweden as a co-development studio, before developing its own games
• The company, then called Toadman Interactive, IPO’d on Stockholm’s alternative NGM exchange in 2017. In 2019, the company uplisted to First North - another alternative, small exchange
• The company changed name to Enad Global 7 in 2020
• Parallel to an acquisition spree in 2019-21, EG7’s share became overappreciated as a hot M&A story during the Covid-era speculation craze
• EG7 reported a shockingly disappointing Q2 ’21 report, where the over-pricing of the business became clear
• Any credibility or speculative optimism from previous strong growth was soon lost 
• The CEO-founder subsequently left and the company ceased acquisitions
• The CEO-founder and the former chairman also sold off sizeable parts of their stakes during this time
• EG7 was a big loser in 2021-22 as its former over-pricing corrected and the share became orphaned as the speculative craze turned into fear
• Many locally well-known institutional investors sold off stakes (Stena, Tin Fonder, Skandia fonder, Carnegie fonder and more)
• In 2022-23, EG7’s game My Singing Monsters (“MSM”) exploded online and became a key contributor to growth and EBITDA (see Big Blue Bubble in the group companies overview), but now local brokers cite concerns around its declining growth 
• Following Q4 ’23A results, the EG7 share declined significantly (19%) as MSM’s studio Big Blue Bubble had negative quarter-over-quarter growth
• In summary: EG7 seems to have lost all credibility and is mostly surrounded by speculators with a short-term focus on one of the company’s products
• With some exceptions: hedge fund Alta Fox bought in during early 2023

…But EG7 Has A Collection Of Great Brands…

Key first-party brands include:

• EverQuest
• Released in 1999. "One of the most iconic fantasy MMO brands in the world"
• H1Z1
• Released in 2015. "The first battle royale game, with 40m+ registrations"
• My Singing Monsters
• Released in 2012. "150m+ registrations on mobile and PC"

Third-party brands include:

• DC Comics Universe Online
• The Lord of the Rings Online
• Dungeons & Dragons Online
• Magic: The Gathering online

…And Sizeable Net Cash On The Balance Sheet…

Notes: (1) As reported without clarification, could be Working Capital related or tax related – included for prudence.

…And New, Competent Leadership Who Own Meaningful Equity…

Board of Directors comprise:

• Jason Epstein, Chairman
• Board member since 2021. Seasoned PE investor with multiple previous and current board assignments
• The single largest shareholder with 10%
• Ji Ham, acting CEO
• Board member since 2023. CEO of subsidiary Daybreak for 6 years, finance background
• Owns 2.3% of all shares
• Ben Braun
• Board member since 2023. Current Managing Director at Liontree, formerly Managing Partner at Liontree and Managing Director at BAML
• Ron Moravek
• Board member since 2023. Extensive experience in the gaming industry in executive roles at Nexon, EA, THQ and more
• Gunnar Lind
• Board member since 2019. Multitude of experience in gaming, not least as CEO of Cherry
• Owns ~0.2% of all shares outstanding
• Marie-Louise Gefwert
• Board member since 2017
• Owns ~0.03% of all shares outstanding

The board is supported by Alta Fox, who are represented on the nomination committee (per Swedish corporate governance structure).

…While Generating Ample Free Cash Flow and Growing

Notes: (1) 2023A lease expense not disclosed in the Q4 ’23 Report, assumed in line with 2022A. Due to be disclosed in the 2023 Annual Report.

How Can EG7 Be Expected To Perform Going Forward?

In September 2023, EG7 hosted a CMD and announced a well-articulated plan for an improved, professionalized business model that should make performance more predictable. EG7 is moving from the typical mid-market game studio approach of VC-like capital allocation and development, to the top-tier gaming names’ model, designed to systematically produce successful outcomes. The strategic shift is not imperative for the thesis, but it reaffirms the competency of the board and management and strengthens my view of the company's long-term cash generation. 

Against this strategic improvement, EG7 has announced targets of

• SEK 1,800m revenue with 22-25% EBITDA margin in 2024E 
• SEK 3,000m revenue with SEK 1,000m EBITDA in 2026E

(confirmed in Q4 ‘23A report), but as is shown below, performance far from this still means significant upside. 

In the central case below:

• Assumptions draw on historical performance and company guidance, but are conservative
• Growth in ’24E ties with company guidance of ~SEK1.8bn sales, thereafter bumper ’25-26E, and converging towards 2% in 2033E
• ’24E EBITDA margin at 22% per low-end company guidance, thereafter EBITDA margin reversion towards 25% in 2027E
• “Up to SEK 500m earmarked for investment 2023-2024”  - growth capex per CMD
• To be on the safe side, projections assume capex ramp-up at 23% of sales in 2024-25E. Cumulatively SEK 510m above the assumed baseline capex of SEK 200m in 2022A
• This ignores the capex visible in 2023A, which should have included the some of the company guidance for growth capex
• Change in NWC average as % of change in sales for 2022-23A, but capped at 0 (no cash generation from NWC), likely higher cash use than normalized
• Leases same as % of sales as in ’22A, likely overstates costs given scalability of game sales
• Tax rate as % of (EBITDA – Capex) assumed at average of 2022A-23A level, but capped at 0 (no cash generation from taxes)

These projections significantly haircut the company targets for 2026E of SEK 3,000m revenue with SEK 1,000m EBITDA

What Is EG7 Likely Worth?

DCF

Discounting FCF projections per above with discount rate of 9.0-11.0% and PGR of 2.0% given an EV excl. leases of SEK 2,149 – 2,919m (o/w 53-61% is Terminal Value).

Multiple-Based Valuation

Per CapIQ as of 13-Feb-24. Uses consensus if 2023 actuals are yet to be reported.

• Median multiples for the Mid-Market Game Companies above are applied to EG7’s 2023 actual figures and the projection case figures
• (EBITDA – Capex) multiples applied to EG7's estimated projected EBITDA less Maintenance Capex, estimated at '22A level of SEK 200m
• Lease liabilities per 2023 Q4 report

Valuation Summary

The DCF and multiple-valuations give an EV excl. leases range of SEK 1,069-2,990m: conservative estimates for EG7’s intrinsic value are all far above current share price. 

With net cash of SEK 229m, representing 20% of current market cap (32% if "True Net Cash" per above is used), and 88.6m shares outstanding, intrinsic value per share is estimated at SEK 14.7-36.3, or 16-187% above current share price. The low-end estimate sticks out and comes from the '24E (EBITDA - Capex) multiple valuation, but bear in mind that this is still 16% above current share price and that this is a particularly bad way of valuing the business, as peers' multiples are based on EBITDA growth, as opposed to EG7's projected downturn in 2024. Moreover, the cautious DCF gives intrinsic value per share of 112% above current price, at the low-end. The DCF's projected cash flows, far below company targets, pay off the entire market cap (less SEK 229m net cash) by 2030E. 

But What About My Singing Monsters?

Illustrative maths give credibility to near-term targets despite MSM stabilizing at lower level:

• Revenue 
• Taking out 75% of Big Blue Bubble (MSM’s studio) revenue from the group figure in 2023A leaves “ex-MSM” 2023A revenue at SEK 1,616m
• 2024E guidance of SEK ~1,800m revenue requires incremental SEK 184m, corresponding to 11% growth of 2023A “ex-MSM” revenue
• Note that the 11% growth is against 2023A, which was a year challenged by a poor market environment and product delays
• SEK 184m in incremental revenue seems achievable by 
• Growth of existing game titles and work for hire
• Upcoming releases including DC Universe Online (Q1 ’24) and MechWarrior 5: Clans (H2 ’24)

• EBITDA
• Taking out 75% of Big Blue Bubble’s adjusted EBITDA (only one available FY23 release) from ‘23A reported group EBITDA leaves SEK 229m “ex-MSM” EBITDA (14.2% margin)
• The 2024E low-end target is ~22% EBITDA margin, SEK ~400m EBITDA of the targeted SEK ~1,800m revenue
• At constant 14.2% margin, SEK 184m incremental “ex-MSM” revenue (per above) yields incremental EBITDA of SEK 26m
• Notwithstanding operating leverage / scalability (de-minimis COGS for downloadable content) 
• Closing the remaining SEK 150m gap vs target SEK 400m seems achievable 
• If Toadman’s adjusted EBITDA goes from negative to 0 (CMD guided for this to be achieved in the near term), SEK 29m of the gap is closed
• Taking out extraordinary costs per the Adjusted EBITDA bridge, gives another SEK 25m
• Reversal to’22A margin for Daybreak would have meant incremental SEK 25m on ’23A sales
• Remaining gap of SEK 70m could be closed by increasing the remaining “ex-MSM” margin

• EG7 has a pronounced focus on operational discipline under its new leadership

• ‘23A “ex-MSM” margin was significantly below ’22A. 2023 was a trough year in a business with operating leverage

Overall, the set–up for EG7 is strong despite declining MSM

In broad strokes, looking at EG7 besides MSM, the robust game pipeline with DC Universe Online and MechWarrior 5: Clans due for release in 2024, a new Cold Iron title in 2025 and more releases planned later, gives credibility to near-term performance. The strategy improvement also seems very well thought-out and should drive margin expansion and growth over time as commercially-viable franchise expansions or new titles become the disciplined focus. Management and the Board certainly seem to think improved performance is feasible given their announced targets and continued sizeable ownership. It is also worth noting that both the CFO and the IR manager bought shares post the FY23 report sell-off.

But even a blatant failure “ex-MSM” implies intrinsic value above current price

Assuming

• Lower than industry growth for revenue “ex-MSM”
• Margin far below peers 
• Capex as in the DCF for ’24-25E (likely too much)
• Change in NWC average as % of change in sales for ‘22-23A, but capped at 0 (no cash generation from NWC), likely higher cash use than normalized
• Leases same as % of sales as in ’22A
• Tax rate as % of (EBITDA – Capex) assumed at average of 2022A-23A level, but capped at 0

still gives a low-end DCF EV excl. leases of SEK 996m (11% discount rate, 2% PGR), corresponding to SEK 13.82 intrinsic value per share.

Why Does This Opportunity Exist?

Obscurity and Size 

Size and a relatively obscure listing venue inhibits investor discovery. EG7 is a small company with a SEK ~1.1bn market cap (~US$107m), listed on First North, which is an alternative exchange for growth companies, and as such the investor universe is limited. The local and limited research coverage does not help educate investors and exacerbates the problem.

Orphaned Equity Story and Contaminated Peer Universe

Arguably, EG7’s reputation as a shoddy small cap persists. Numerous Swedish institutional investors abandoned the stock as its former extreme over-pricing corrected, but speculative interest still surrounds the company and takes a too short-term view of EG7’s prospects. Moreover, some local peers (e.g. Embracer and G5 Entertainment) are facing intrinsic issues, which taints the sector. Trouble at these companies likely contributes to indiscriminate selling in EG7 by top-down / thematic sellers. Given its history, EG7 is listed in Sweden and priced relative to lower quality local peers, but it is by majority of revenues a North American business.

Previous Disappointments and Complexity

EG7 previously reported disappointing results vs. overly hyped-up expectations and it is difficult to understand growth and normalized cash generation, not least as declining My Singing Monsters is a large contributor to EBITDA. Given the prior disappointments and continued complexity, fear-driven indiscriminate selling prevails in EG7, driving a mispricing below even very pessimistic expectations for cash generation.

How Will The Value Become Available?

Change of Listing Venue

EG7 is working to relist to a larger exchange in Sweden or abroad, with advisors engaged and on-track for 2024 per Q4 earnings call. This should address several reasons for the current mispricing, by allowing for a larger, more sophisticated investor universe and potentially moving the company further away from lower quality local peers.

Capital Returns

EG7's first-ever dividend is underway for this spring and buybacks are due to come once the relisting is complete (to avoid complications).

Investor Discovery and Education

The company is clearly improving investor communications with better report commentary and clearer guidance, as exemplified by the CMD in September. Improved communications should aid in revitalizing the equity story and in investor discovery.

Cash Generation

While the market currently ignores EG7’s results and financial targets, continued cash generation should prevail over time and converge price with intrinsic value.

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SHOULD NOT BE CONSIDERED INVESTMENT ADVICE. MAY CONTAIN ERRORS AND INCLUDES SUBJECTIVE VIEWS. 

Sources used: CapIQ, company filings, company presentations, news articles, company websites.

Catalyst

1. Cash generation
2. Investor discovery and education
3. Change of listing venue (on track for 2024, advisors engaged)
4. Capital returns: first-ever dividend to come, buybacks approved by EGM