Description

Thesis Summary: Enad Global 7 (“EG7” SS) is a small-cap, Swedish-listed video game company. The core business is reasonably diversified, grows revenue modestly, generates meaningful free cash flow, and currently trades at ~5x NTM consensus EBITDA (which is far too low).

There are two reasons we believe the stock can double over the next 6-12 months.

1. The company is the sole owner of the “My Singing Monsters” IP, which has catapulted over competing gaming apps to become one of the top 15 mobile gaming apps on the app store in the last 3 months. This is due to viral marketing on TikTok and other social media. As we outline the write-up, we believe My Singing Monsters could generate more EBITDA in FY 2023 than the entire core business generated in 2022! The sell-side has not started to wake up to this reality. As a result, our conservative base case EBITDA estimate for 2023 is 50% higher than consensus, entirely driven by our expectations for My Singing Monsters.
   
   
2. The company’s management and Board has seen a significant upgrade over the last 18 months. EG7 now has a very sophisticated management team and Board that is highly incentivized to drive equity value per share meaningfully higher.

We see ~100% upside in the stock price and at least 50% upside vs consensus EBITDA in FY23 with the potentail for a 100%+ beat).

The Setup:

The former CEO of EG7 was a gaming enthusiast with little poor financial discipline. He grew the business through equity-financed M&A, overselling investors on growth expectations along the way. Once it became clear those expectations were unachievable, investors lost confidence in management and the stock price collapsed. The former CEO was let go and replaced by a top-tier management team & board that is very focused on growing the business organically. The new CEO has done a good job resetting expectations and rebuilding confidence with investors. Then in October, the dream scenario manifested – one of EG7’s portfolio assets, My Singing Monsters, went viral on social media and player engagement has been climbing ever since. We believe that IP is on track to double (or triple) EG7’s consolidated EBITDA in FY23 which will result in >50% upside vs consensus estimates.

For more details on EG7’s background, please see the background summary in the appendix.

Thesis Points:

1. EG7 owns a collection of secular growth gaming assets that generate significant FCFE. We believe “core EG7” (excludes My Singing Monsters) is growing revenue and EBITDA at a ~HSD % per year and is worth ~29 SEK/share at 6x EBITDA.
   1. Daybreak Games (see Appendix for more details on portfolio)
      1. Operates a collection of owned and 3P evergreen MMO/free-to-play titles (each IP has been around for at least 10 years if not 20+ years). If a studio no longer wants to operate its own free-to-play PC-focused title, Daybreak has carved out a niche as the premiere outsourced operator for that game.
      2. The business was formerly run by gamers within Sony who were perpetually unable to make a profit. Jason Epstein bought the business from Sony in 2015 for an undisclosed sum. Jason and Ji went to work restructuring the P&L to get the asset to profitability and made several “bolt-on acquisitions” for pennies on the dollar along the way.
         1. https://www.cnbc.com/2015/02/02/investment-firm-buys-sonys-online-gaming-division.html
   2. Big Blue Bubble
      1. My Singing Monsters (owned IP) represents essentially all of Big Blue Bubble’s earnings power. The game launched in 2012 and from 2017-2019 was a relatively sleepy title. This allowed EG7 to purchase the studio for a bargain price in 2020.
      2. The game has been continuously building steam since 2020. Following executive leadership changes at EG7 in 2021 that encouraged Big Blue Bubble to better utilize social media channels and launch a 10-year anniversary campaign, interest in the game has skyrocketed to all-time highs.

Source: Socialblade for MySingingMonster’s Tiktok Channel

https://socialblade.com/tiktok/user/mysingingmonsters/monthly

3. 3. Petrol & Fireshine
      1. High-quality marketing & publishing agencies respectively.
   4. Piranha
      1. Indie game developer known for the Mechwarrior franchise.
   5. Antimatter & Toadman
      1. Subscale indie game development studios working on several new IPs yet to launch.
         

6. 6. >100% of EG7’s stock price is fully covered by using a reasonable valuation multiple on core EBITDA and adding back net cash/share. 6.0x is in-line with the median of European gaming comps (and well below the average) and a >50% discount to high-quality US comps.

*Note that DC Universe Online, Everquest 1&2, LOTRO, Planetside 2, D&D Online, and MTGO are all Daybreak titles.

2. Prior management’s legacy of investor misalignment has obscured the internal transition to an excellent new management team with strong alignment (Chairman/CEO own ~11% of the company).
   1. Jason Epstein and Ji Ham are not the typical European gaming management team. They are US-based, have a US-centric attitude towards capital allocation where every $ matters, and have significant PE experience in the gaming sector (including a successful investment in Harmonix from 2010-2021, owner of Rockband/Dance Central/Guitar Hero which Epstein sold to Epic Games in November 2021). The team is relentlessly focused on the bottom-line and the ROI every investment will generate. This attitude could not be more different from the majority of Europe’s gaming conglomerates (including EG7’s prior management team) that seem to only be able to successfully drive growth through acquisition.
   2. EG7’s multiple has de-rated alongside larger Swedish gaming peers that rely on M&A to drive growth (Embracer and Stillfront are the two primary examples) despite M&A being non-core to EG7’s strategy or growth thesis. We believe there is a significant opportunity for multiple expansion in EG7 to somewhere in-between US-peer levels and European-peer levels (~8x EBITDA seems fair to us).
   3. Their management style has already begun to pay dividends:
      1. Ji Ham reset sell-side margin expectations to trough levels in Q2 22 – one quarter later his outlook proved to be too conservative, and EG7’s stock price galloped higher on the back of renewed confidence in management and fundamentals.
      2. Core to Daybreak’s strategy is utilizing social media (including email marketing) to retain, reacquire, and acquire new players. This was non-core for Big Blue Bubble prior to Ham and Epstein taking the reigns at EG7. We think it is no coincidence that under Ham’s leadership, My Singing Monsters has become a top mobile game globally.

2. My Singing Monsters is the upside kicker. We believe the exceptional performance in EG7’s My Singing Monsters game could provide 50-150% upside to FY23 EBITDA numbers, implying EG7 is likely trading for ~3x EBITDA.
   1. Below we show several charts that compare consumer engagement in My Singing Monsters to that of Zynga’s top portfolio games. The conclusion one should take is that My Singing Monsters has been performing in-line with Zynga’s top portfolio titles since the end of October 2022.
      1. For reference, as of FY21, each of Zynga’s top 3 games was doing $352M a year in revenues.
   2. Despite My Singing Monsters performing in-line with Zynga’s top games today, out of an abundance of conservatism, we assume that the comparable period for My Singing Monsters’ CURRENT performance is a pre-covid average of Zynga’s 2018 ($100M/top 3 game) & 2019 ($167M/top 3 game) revenue/top 3 game. That is how we derive our run-rate sales estimate of 1,402M SEK ($134M USD). Holding EBITDA margins ~flat at 60% implies 841M SEK in run-rate EBITDA ($80M USD) from My Singing Monsters.

Source: ZNGA 10-ks
*Note that there is a legitimate chance that My Singing Monsters is actually run-rating closer to FY20-FY21 rev/avg game levels (~$300M USD) given its player engagement metrics.

Source: Google Trends

Source: Sensor Tower

3. 3. In a very conservative base case, we assume that My Singing Monsters’ EBITDA quickly falls from its Q4 peak and will double, rather than triple, EG7 EBITDA in FY22. We also assume that EG7 sees no multiple expansion from its currently depressed levels. This implies a 45/share stock price of 60% upside from current levels.
      1. It’s hard to value My Singing Monsters but demand is off the charts. It is a highly addicting game that has reacquired many lapsed players during its debut on mainstream social media in Q4 2022. The history of mobile games suggests that they are much stickier than people think (Zynga’s top-earning games have all been top earners for the last 6+ years).
      2. We assume the game loses popularity over time but given the success Zynga has seen in sustaining demand for its top mobile games, we believe it is highly unlikely that earnings power for My Singing Monsters returns close to 2021 levels in the foreseeable future.
   4. In a bull scenario that assumes EG7 gets a fair (but not expensive) EBITDA multiple of 8x and that current run-rate earnings power for My Singing Monsters is sustainable (we assume a slight moderation), we have My Singing Monsters tripling core EBITDA and EG7 worth >100 SEK/share.
   5. In a bear case, we have My Singing Monsters giving back the entire move by year-end FY23 and assume EG7 de-rates by 1x to 4x EBITDA – even in that extremely punitive scenario, we believe there is minimal downside from current prices.
   6. When probability weighting each case, we arrive at a price target of 54 SEK or nearly 100% upside from current levels.

*Note that our FY22 My Singing Monsters EBITDA assumption run-rates Q3 EBITDA in Q4 to demonstrate what “normalized” earnings power looked like prior to the game going viral. 

SOTP Sanity check:

7. 7. Lastly, we believe that the success of My Singing Monsters makes EG7 an even more attractive acquisition candidate.
      1. #1 EG7 is cheaper at 28 SEK than it was at 16 SEK following its exponential increase in earnings power.
      2. #2 Mobile assets that have stood the test of time and show staying power are rare to find and highly desirable (especially those that are not social casino games). To exemplify the quality of the game, we look to its margin profile: EBITDA margins for My Singing Monsters were 63% in Q3 22.  
      3. We believe that EG7 could fit very well into a number of video game portfolios including Take-Two’s portfolio (My Singing Monsters is a great fit for Zynga and Take-Two could do wonders with EG7’s MMORPG titles) and Embracer’s portfolio (owns the rights to Middle Earth and has the resources and alignment to invest aggressively into modernizing LOTRO).
         

Risks:

• Continued industry multiple compression.
• Our analysis regarding the range of My Singing Monsters’ earnings power proves incorrect.
• My Singing Monsters’ popularity collapses near-term to below Q3 21 levels.
  • A TikTok ban could catalyze this.
• Large non-insider legacy holders (M8G/Settecento) use rallies in the stock as an opportunity to sell positions and weigh on the stock price.

Conclusion: EG7 is a unique and very attractive risk/reward setup. The core business offers significant downside protection with its stable cash flows and MSD-HSD growth profile, while My Singing Monsters will catalyze earnings power in the quarters to come and result in significant sell-side upgrades to #s. With the business trading at 3x our FY23 base case EBITDA estimate and >50% EBITDA upside vs consensus in a base case (with 150% upside in the bull case), we believe it is likely that investors are rewarded in the near-term.

Catalysts

• Q4 22 earnings / Q1 23 earnings
  1. Note while EG7 has not disclosed My Singing Monsters’ revenue recognition policy, we believe that it is deferred over a finite period (likely ~3-6 months). Therefore, it is possible that some revenues earned in Q4 are pushed to Q1 and it will not be until Q1 23 that we realize the full force of My Singing Monster’s new earnings power.
• EG7 acquired by a strategic buyer
• Potential uplisting to UK exchange
• New sell-side coverage as EG7’s scale rapidly increases
  1. Kepler Cheuvreux, Redeye, and Svenska Handelsbanken are the only analysts who cover the stock.
• IP deal w/ larger 3^rd party to co-invest into EG7’s existing IP
  1. i.e. LOTRO JV investment from Amazon or Embracer
• Meaningful success converting loss-making studios to work-for-hire B2B game development operations which could represent an incremental $50M SEK (~$5M USD) EBITDA opportunity.

Appendix:

EG7 Background Details:

• EG7 was founded by gaming enthusiasts with little business acumen. The business plan was to essentially to create “Embracer 2.0” (video gaming conglomorate with service and game development synergies in-house. Following EG7’s buying spree from 2019-2021, CEO Robin Flodin wanted to continue to do M&A while the Board wanted him to pause and focus on integrating the assets he had (to date EG7 had spent >$600M USD on acquisitions). The parties were unable to work out a compromise and Flodin began to look for the exits. He and the former Chairman then proceeded to sell ~25% of their shares near all-time-high stock prices (low 90s SEK/share). EG7 then reported a disastrous Q2 21 where it became clear that sell-side forecasts were far too high for the business and the growth rates EG7’s portfolio companies experienced during 2020 were not sustainable. Flodin was out of the CEO job a few days later.
• In came Ji Ham to the interim CEO role at EG7, a highly seasoned PE executive with extreme discipline towards capital allocation who has also been the CEO of EG7’s largest portfolio company (Daybreak Games) since 2015. On 6/21/22, EG7’s former Chairman stepped down and Jason Epstein (the owner of Daybreak Games who sold to EG7, former PE partner of Ham, and 9% shareholder of EG7) became the new Chairman. New management expressed a strong desire to grow organically and de-prioritize M&A.
• On 5/30/22, in anticipation of becoming Chairman and to capitalize on a great buying opportunity, Jason Epstein, Ji Ham, and the former Chairman of EG7 (who is still on the Board) bought out Robin Flodin’s remaining stake representing 2.8% of EG7 at 16.25 SEK/share ($4M USD transaction value).
  • Following the transaction, the Chairman (Epstein) & CEO (Ham) of EG7 (both from Daybreak Games) together own ~11% of the company.
• On 11/17, stronger-than-expected Q3 22 results and EG7’s first meaningful guidance upgrade since early 2021 (increasing revenue forecasts from 1.6-1.7B to 1.8B) sent EG7’s stock price from 18 SEK to 26 SEK.
• On 11/25 in a significantly underappreciated press release, EG7 announced that My Singing Monsters had surpassed >1 billion hashtags on Tiktok and moved to a top 10 iOS app store game in over 100 countries including the #1 spot in more than 15 countries. Notably, the press release made no mention of run-rate revenue/EBITDA for the game.
  • Our own analysis suggests that at current levels of player engagement, My Singing Monsters is likely run rating ~$840M SEK ($80M USD) in EBITDA by itself.
  • My Singing Monsters could be worth more than all of EG7’s other assets combined. Its success is happening in real-time and can be reasonably tracked and quantified. The sell-side has not woken up to this as management has not quantified the impact the game’s ongoing success will have on Q4 results.
  • My Singing Monsters’ exponential growth will become evident by Q4 22 results where we expect EG7 to significantly beat expectations.

Daybreak Games Details:

• Owned IP:
  • Everquest 1 & 2
  • Planetside 2
• 3P IP
  • LOTRO – acquired by Daybreak in 2016
  • DCUO – legacy daybreak title
  • D&D Online – acquired by Daybreak in 2016
  • MTGO – acquired by Daybreak Dec 2021 for ~$0 and a promise to reinvest in the asset      
  • 3P contracts are long-term in nature where EG7 owns the right to the technology which increases switching costs for their IP partners.
    • For example, if Embracer (who now owns the Middle Earth rights) wanted to launch a new Lord of the Rings MMORPG, they would not be able to leverage LOTRO’s existing infrastructure unless Embracer and EG7 mutually agreed on a deal.
• Despite the dated graphics of the games in Daybreak’s portfolio, the games continue to grow revenues and EBITDA over time through savvy reinvestment into new services and secular player growth. Daybreak has not been able to make more meaningful investments into its legacy titles due to capital constraints. However, on the heels of the cash flow windfall My Singing Monsters is currently producing, we believe this will give EG7 the flexibility to finally make long-awaited investments in legacy titles including potentially upgrading graphics enabling much lower customer acquisition costs for games like LOTRO and Everquest causing Daybreak’s revenue growth to accelerate.

Catalyst

-next qtrly earnings release/FY 2023 guidance

-greater awareness of My Singing Monsters and the resulting financial impact on EG7