Description

Endor was written up as a long by cosecant95 in June 2020, which provides helpful background on the Company and the industry. The thesis has largely played out as expected, yet the stock price is unchanged (adjusted for an 8 for 1 stock split). This writeup outlines a number of incrementally positive developments that have transpired since then which give me increased confidence in the upside case for Endor. I see a path to a >4x return over the next 3-5 years. 

INDUSTRY & BUSINESS DEVELOPMENTS

Motorsport gaining popularity - Motorsport racing has enjoyed a surge in popularity, most visibility in Formula 1 but across other series as well. INDYCAR is reportedly seeing the highest viewership in 19 years, up 34% from 2021 so far this year. Even NASCAR, which has been in decline since 2005, has drawn the largest audience in five years. Notably, motorsport is bringing in younger audiences. So far in 2022, NASCAR viewership is up 61% among 18-24 year olds, with Formula 1 and INDYCAR also reporting stand-out gains with younger viewers. The growth of motorsport broadly and with young people in particular serves as a funnel into simracing. According to a survey commissioned by INDYCAR and conducted by Nielsen, “esports are increasingly relevant to INDYCAR fans, with nearly half partaking in gaming weekly. This number rises to 85% among 16- to 24-year-olds and 70% among 25- to 34-year-olds”. 

Other data points to support the rising popularly of simracing more directly since June 2020 include the simracing game iRacing growing from 160k active customers to 215k today, leading simracing YouTube channel Boosted Media growing from 63k subscribers to 225k, and Fanatec’s own Instagram account growing from 75k in to 180k. 

Blurring the lines between real and virtual racing - For many years, founder Thomas Jackermeier’s vision has been a world where real-world and virtual racing converge and complement each other. Increasingly, this vision is coming to life. 

• In 2021 the Fanatec GT World Challenge Powered by AWS was launched to include an integrated simracing component with points that contributed to the outcome of the championship. Other events have followed and this is likely to be an ongoing trend going forward. 

• While there is a history of motorsport racers practicing their craft on simracing rigs, simracing is increasingly a training ground for aspiring real racers. Most recently, F1 simracer Cem Bolubasi became the first ever esports driver to make the Formula 2 cut. 

• Fanatec has now launched three wheels that are interchangeable between sim-rigs and real race cars. They are not replicas; they are the real thing. These wheels carry very high price points and are produced in low volumes, but impart an important halo effect around the Fanatec brand. Simracers seek to replicate the real thing, and there is nothing more real than this. 

Launch of entry-level direct drive - On April 1, 2021 Endor CEO Thomas Jackermeier released a blog post teasing a product that was, well, too good to be true. Because of the date and use of terms like FluxBarrier Technology, it was dismissed as just another corporate April Fools joke. Yet a few weeks later, another post revealed the product to be real. The product was the CSL DD, a direct-drive wheelbase at an entry-level price of $350. For context, the wheelbase is what the wheel plugs into, houses the mechanism that controls feeling and fidelity of the experience, and generally serves as the central hub of a simracing rig. At the low end, a wheelbase uses rubber brands as the mechanism which is obviously far removed from what it feels like to drive a real car. Higher up the range, wheelbases use belts and pulleys which are much improved over rubber bands but still leave something to be desired. At the top is direct drive, whereby the wheel plugs directly into the motor and provides incredible responsiveness, torque, and tactile fidelity that comes remarkably close to the actual experience of racing. Fanatec is the leader in direct drive, and historically their Podium DD1 and DD2 wheelbases have sold for $1,200 and $1,500 respectively; prices that put them out of reach for many simracers. 

The CSL DD was launched at a $350 price point, and offers an experience that has been described as nearly indistinguishable from the higher-end offerings albeit with a lower torque capacity (which many do not make full use of anyway). At $350, the CSL DD is priced similarly to belt-driven options from competitors like Thrustmaster but with far superior performance. As one review put it, it’s like getting an 8-cylinder engine for the price of a 4-cylinder. This has set the new standard in simracing and unlocked new customers who would previously have gone with lower-priced competitors. 

Notably, despite the CSL DD being a very disruptive product that has driven explosive growth for Fanatec, competitors Thrustmaster (owned by Guillemot) and Logitech have continued to see strong sales of simracing gear which is testament to the health of the overall industry. 

Fanatec’s entry-level direct drive has been a game changer for the industry, and you would think that the competition would be eager to follow suit. But more than a year after the announcement of the CSL DD, Thrustmaster and Logitech have yet to release their own direct drives. This is likely due to channel conflict at these competitors. Fanatec sells directly to customers online, which allows them to capture the full margin without the retailer’s cut. The CSL DD was margin dilutive, but given how high margins were to begin with there was plenty of room in the P&L to support the product. This isn’t the case with Thrustmaster and Logitech, who rely heavily on the wholesale channel. If Thrustmaster wants to sell an entry-level direct drive, their options are 1) accept a much lower margin via their wholesale channel which jeopardizes their profitability, or 2) sell the product directly which risks alienating their primary distribution partners. Neither option is particularly appealing. 

Gran Turismo 7 tie-in - With a new entry-level direct drive wheelbase, Fanatec was chosen as the official partner of Gran Turismo 7, the wildly popular racing game launched March 2022. Thrustmaster had previously held this position, but was no match for Fanatec’s offering. In collaboration with Gran Turismo’s publisher Polyphony, Fanatec launched the Gran Turismo DD Pro which bundled the CSL DD, a custom Gran Turismo wheel, and pedal set. 

According to NPD Group, Gran Turismo 7 had the strongest launch month (March 2022) of any title in the history of the franchise. Gran Turismo 5 (2010) and Gran Turismo Sport (2017) went on to sell 12 million and 8 million copies respectively, with total franchise sales of over 85 million. 

An important dynamic I’ve come to appreciate about simracing as a hobby is the nature of the purchase cycle. A full rig, particularly a Fanatec rig, is expensive and typically not purchased all at once. Instead, upgrading the rig happens over time and is a perpetual work in progress for most people. The purchase cycle looks something like this: a console player buys a racing game like Gran Turismo (PlayStation) or Forza (Xbox) to play with the standard controller. Wanting to upgrade the experience, they purchase an entry-level wheel and pedal setup from Logitech. While better than a controller, Logitech’s offerings are plastic toys that don’t feel very realistic and the player will come to learn that better offerings exist from Thrustmaster in the middle and Fanatec as the top of the line. With the introduction of entry-level direct drive, more players are likely jumping straight from Logitech to Fanatec. Once in “the Fanatec ecosystem”, where products are exclusively compatible with each other and can be layered on modularly, simracers begin building their dream rigs and adding new wheels and other accessories. At some point, many will “graduate” from console games to PC games like iRacing where the most hardcore simracers operate. 

I outline this purchase cycle to highlight how important Gran Turismo 7 could be for Fanatec longer-term. While the launch has provided an immediate boost to the business, the benefits are likely to be much longer lived as gamers progress through this cycle. If Gran Turismo 7 sells ten million copies and 2% of those spend $500 on Fanatec gear, that is $100 million of revenue over time. 

“Growing up” the organization - The startup mentality has served Endor well over the years. They’ve been scrappy, innovative, and entrepreneurial as the business scaled from humble beginnings to what is now a highly impressive enterprise. But larger scale has come with its own set of challenges. Customer service has suffered as sales surged 5x in five years. Product development delays crept in as the number of product launches multiplied (44 launches over the past three years vs. just 12 in the prior three). And of course, recent supply chain constraints exposed any weakness in sourcing capabilities which has been particularly problematic for Endor. To set the stage for the next leg of growth, Thomas Jackermeier has made a concerted effort to “grow up” the organization. As he put it to me, “we don’t want to have a chaotic startup philosophy anymore. We made a lot of avoidable mistakes. But we don’t want to build a bureaucracy either. I still want people thinking outside the box. I want us to grow up but still be cool.” 

Endor has been building out the management team with proper team-leads including COO, commercial director, financial director, R&D leader, and a customer service lead from Apple. These team leads are directly addressing the primary pain points of customer service, product development, and supply chain management. 

• New COO Michael Op De Hipt spent 7 years as CEO of Diametal, a Swiss cutting tool business and brings extensive supply chain and operational expertise. At Endor, his efforts are primarily focused on improving supply chain management, specifically the semiconductor shortage. Michael and Thomas are working to personally develop relationships with suppliers, and have agreed to move to a new kind of chip in exchange for guaranteed supply. Supply allocation often comes down to personal relationships; something Endor had not previously nurtured. 

• The R&D leader is working to streamline product development by standardizing both hardware and software to make each new product more modular. Previously, each new product was developed from scratch, with little carrying over from existing products. They are now working to build every new product off a standardized set of hardware and software which should dramatically improve development time. 

• Lutz von Stengel joined Endor in February 2022 as Customer Care team leader, and spent 4 years at Apple as Sr. Manager of Apple Care. Lutz is working to develop more advanced self-help systems so that customers can do their own repairs more often, while working with the development team to design products with self-repair in mind. They have also hired more customer service representatives and opened a call center in the US. American customers are quite demanding when it comes to service and want native speakers working during American business hours. 

Demonstrated margin potential - A critical element of the thesis is that this is a high-margin business at scale, enabled by a direct-to-consumer distribution model generating mid-50s gross margins. This is not just a theoretical exercise either. In 2015, the business earned a 16.6% operating margin on just €11 million of revenue. In 2019 they earned a 17.4% margin on €39 million of revenue, and in 2020 the margin expanded to 22.9% on €90.2 million of revenue. Endor has a history of demonstrating the margin capacity of the business, before investing for growth through the P&L which takes time to grow into. For example, after realizing the 16.6% operating margin in 2015, the margin compressed down to only 5.8% in 2018 as new licensing agreements took time to digest. Of course, as those licensing agreements drove the top line in subsequent years, the margin exceeded the 2016 peak and expanded to the 22.9% realized in 2020 (on >8x the revenue!). 2021 was another investment year, as Endor spent heavily to “grow up” the operational infrastructure of the organization, but we’re off to the races again in 2022. In fact, in 1Q22 Endor realized an operating margin of 25.8%, the highest in the Company’s history. Now, the quarter was boosted by the launch of Gran Turismo 7 which means the margin should not be extrapolated for the full year, but it does demonstrate the margin potential of this business at scale. In other words, the quarter demonstrated that there are enough fixed costs in the business that if they sell enough product, margins can exceed 25%. There are other businesses that promise attractive margins at scale, yet as they grow show no progress toward those promises. This is not one of those businesses. 

I estimate that Endor can achieve >25% operating margins on an annual basis with revenues of approximately €180 million. Guidance for 2022 is for “low triple-digit millions” and management thinks they could have achieved >€150 million this year absent inventory constraints, so it’s not far off. Leverage primarily comes from personnel expenses and the fixed-components of Other Opex which is a catch-all line that I have worked with management to better understand. I estimate that Endor can realize almost 10-points of leverage from Other Opex relative to 2021 at a €180 million sales level. 

STOCK DEVELOPMENTS

• In January 2021 founder Thomas Jackermeier purchased an additional 3% of the shares on the open market for €7.725 million or €16.61/share, increasing his ownership to 50%. Commenting on the purchase, he said “I am convinced that we will also benefit greatly from the future growth of our industry, especially in simracing. Therefore, it was very important to me personally to further expand my shareholding”. 

• Endor began reporting in English in 2021, in parallel with their German reports.

• In an effort to improve liquidity, they implemented an 8:1 stock split in 2021. It didn’t work, and the shares remain illiquid. But they tried. 

• After earning record profits in 2020, Endor paid a €0.50 (split adjusted) dividend which represents a healthy 3.4% yield on today’s share price. The dividend will not be repeated this year after discretionary investments and supply chain disruption compressed profits in 2021, but the payment demonstrated shareholder friendliness and is likely to be continued in the future. 

• Endor shares remain highly illiquid and difficult to purchase. The float is low (50% owned by the founder and another 9% owned by the CFO and board), and it is difficult to get access to the few shares that do trade. The shares currently trade on the Munich exchange which most brokers do not have access to. After being told by our prime (Goldman) that they could not access the exchange, our fund had to establish a new brokerage relationship with Interactive Brokers to buy Endor shares. While this friction has put a lid on the shares for now, access is likely to be much improved in the future. Endor has confirmed that they are actively working on uplisting to the main Frankfurt exchange while also evaluating a potential Nasdaq listing. This is taking some time because the uplisting requires a transition from German GAAP to IFRS. The process is underway, as revealed by job postings for financial managers with IFRS reporting experience. Exchange uplistings have a good record of catalyzing value realizations.   

VALUATION & POTENTIAL RETURN

With 15.5 million shares outstanding, Endor is selling for a market capitalization of €225 million at today’s share price of €14.50. There is de minimis net debt on the balance sheet.  In 2020, Endor earned operating income of €20.7 million, for a multiple of 11x. While earnings declined in 2021 as they refreshed the product line and were out of stock for much of the year while also making significant investments, I do not think earnings power was diminished as evidenced by the strong rebound so far in 2022. The stock is cheap on current results, and offers substantial upside if the business develops as I expect over the coming years. To sketch out the potential upside, I see a path to €250 million in sales and a 25% operating margin which would imply EBIT of €62.5 million. Pick your multiple, but post uplisting I could easily see Endor selling for 16x which would imply an enterprise value of €1 billion or more than a 4x return from today’s price. 

Again, sales guidance for 2022 is “low-triple-digit millions” and without supply constraints management thinks they could have done €150 million this year. I calculate that the business can achieve 25% operating margins at around €180 million of annual sales absent further discretionary investments, so my margin target at a €250 million sales level could prove conservative. But if my sales or margin targets prove too optimistic, at 11x 2020 EBIT there is room for error. 

Also of note, management acknowledged that there have been potential acquirers interested in Endor. 

RISKS

Limited addressable market - this is a very niche industry with expensive gear that requires a certain level of skill to operate. There is risk that simracing simply runs out of runway. At this point, I see no indication of that anytime soon. Further, the continuation of growth post-pandemic when virtually every other “COVID-beneficiary” has experienced a hangover suggests real underlying growth drivers. Still, I am cognizant of this risk and monitor industry growth markers like social media engagement and player counts for popular simracing games closely. 

Competition - Thrustmaster and Logitech are Fanatec’s two primary competitors in the industry. Both operate at the low-mid end of the market and lack direct-drive capabilities, but due to marketing and distribution maintain significant market shares. At the high end, there are several competitors such as Simucube that make quality gear at very high price points but remain fairly inconsequential in terms of scale. More recently, there have been small entrants to the scene from Chinese competitors such as Moza that offer direct drive at affordable price points. I’m monitoring these closely, but at present they offer limited product ecosystems relative to Fanatec and customer service is questionable. Fanatec’s out of stocks last year did push some customers to these competitors.

Execution - Fanatec is executing well at driving innovation and adoption in the simracing industry, winning the hearts and minds of customers. But Endor remains a work in progress organizationally. While they are making encouraging strides in this area, it remains to be seen whether the organization is capable of unlocking its business potential.  

Catalyst

• Uplisting to Frankfurt/NASDAQ 

• Continued revenue and earnings growth

• Greater investor awareness