Description

The Company

Modern Times Group ("MTG") is a Sweden-based holding company with digital entertainment assets in Esports, mobile and online gaming, and investments in venture capital within the Esports ecosystem. The business generated net revenues of SEK4.0bn ($435m) in FY20 with an EBITDA of SEK0.3bn or an adjusted EBITDA margin of 13%. Around 60% of revenues are in the gaming segment with 40% in the Esports segment. In April 2019, MTG spun-off its Nordic broadcasting business and media assets into Nordic Entertainment Group ("NENT Group"), creating a "new" and smaller MTG (revenues are 5 times smaller than they were previously) while remaining under the same listing.

Within the Esports segment, MTG owns the world's leading Esports brand, Electronic Sports League or ESL. ESL is the biggest league and event operator with around 20% market share of the nascent but rapidly growing Esports industry. As an operator of leagues and events and content producer, ESL generates revenues from a broad range of sources including ticket and merchandise sales, sponsorships and advertising, media rights deals, and fees from publishers. ESL operates its proprietary leagues and events under the ESL brand and co-brands leagues and events alongside publishers. In recent years, ESL has significantly reduced their reliance on the latter, from 49% of total Esports revenues in 2017 to 33% in 2020. Events range from those that are on par with globally recognized sports events drawing in large crowds of attendees and global viewership to national and local leagues and events with attendance between 10-20k. ESL operates through all platforms i.e. console, PC and mobile, over 40 titles and at all levels i.e. amateur to professional. At the amateur level, ESL also operates a free to play platform, ESL Play, whereby players can participate in tournaments from home with a monthly prize pool totalling around EUR45k across a wide range of titles. Over 11m members have played roughly 130,000 tournaments. MTG now owns 91.5% of ESL.

 In addition to ESL and within the Esports ecosystem, MTG owns DreamHack which operates the world's largest grassroots LAN parties and digital festivals across Western Europe and North America. In 2019, Dreamhack hosted 15 such events in 8 countries attracting around 350,000 attendees alongside online viewership. MTG owns 100% of Dreamhack and as a result of a recent strategic review, MTG combined ESL and Dreamhack for efficiency gains (reducing fixed costs through better utilization of production resources such as studios and talent). The two companies will remain as two individual brands.

Within their Gaming segment, MTG now owns 68% of the German-based developer of online and mobile games, InnoGames ("IG"). Their portfolio now includes seven games focusing primarily on mid-core and free to play games i.e. monetized through in-game purchases, within the city-builder and strategy category. Launched in 2007, IG has exhibited consecutive double-digit revenue growth for 13 years and recently surpassed EUR 1bn in lifetime revenue. MTG also owns 100% of a US-based developer and publisher, Kongregate, with over 120,00 games available on their web portal and over 250m mobile installs. However, due to the website's use of Adobe Flash and the subsequent demise of that technology, the company has transitioned from hosting third-party games to first-party mobile games development and a focus on fewer titles.

At the end of last year, MTG acquired 100% of the UK-based racing games developer and publisher, Hutch, with a portfolio of over 13 titles and over 300m downloads across PC and mobile to date. Also, MTG acquired an additional 17% in IG for 10x EBITDA and established a holding company for the gaming assets with MTG owning 77% and the founders of IG with the balance. Both deals were funded with a rights offering, which was just recently concluded, for net proceeds of SEK2.5bn and an increase of shares by 140% (12-for-5). The offering was oversubscribed which saw the share price rise during the subscription period only to see a small sell-off over the last week. The company now has a net cash position of around SEK0.730bn for around 7% of the current market cap.

Finally, MTG has a VC fund with just under $30m invested in early-stage game developers and pure Esports focused companies. Such investments allow MTG to gain exposure to industry leaders within Esports and fuels the development of new games and genres. The company realized their first exit in Q1 2020 when Garena, a subsidiary of Sea Ltd, purchased Phoenix Labs and the creator of Dauntless, for a 1.75x return on invested capital in just over a period of 12 months.

Industry Landscape

Esports

The Esports industry is in its infancy yet rapidly growing with total revenues up from $325m in 2015 to just shy of $1bn in 2020. Such revenue expansion has been driven by the increasing popularity of video games which in turn has led to competition gaming i.e. Esports. The video gaming industry itself generated just shy of $160bn in 2020. Of the $1bn to be generated this year, the lion share comes from sponsorships and advertising at around 60% of the total. This source coupled with the rapid growth of media rights suggests that as the global audience continues to expand, advertisers will continue to direct their spending toward both content producers such as ESL and streaming platforms such as Twitch and YouTube Gaming. The Esports audience is slated to reach just under 500m in 2020 with around 45% defined as enthusiasts therein frequent viewers and 55% defined as occasional viewers. Esports fans are very young compared to any other global sport with 68% of fans between the ages of 16 and 34 and so highly sought-after. In addition, China has become the largest region in terms of revenue generation, expecting to generate revenues of $380m this year as compared to North America's $250m. All in all, we see that the Esports industry is expanding rapidly on a global basis and monetization opportunities continue to emerge.

To further illustrate how the industry has evolved we can look to how the composition of advertisers has evolved from brands largely in the gaming and computer space i.e. AMD, Benq, Nvidia etc., to companies to such as Mercedes, DHL, Louis Vuitton etc. While measurement is difficult such brands now account for around 35% of the total ad spend in the industry. Media rights have also evolved to include national and linear TV providers such as BBC and Sky Sports in the UK, ESPN in the US, ProSieben in Germany etc. Partnerships such as the one between Louis Vuitton and Riot Games, to both design and sell in-game skins and a League of Legend ("LoL") collection of clothes and a custom trophy, suggest a sign of things to come. That is, similar brands will flock to Esports to avail of the younger and digitally native fans who will become prime-age consumers over the next decade or so. However, concerns remain about the ability to monetize the average Esports fan with an age of 25 and whether Louis Vuitton's partnership makes sense of them specifically due to LoL's following in China. The challenge for the industry's growth will be dictated to the extent to which the younger consumers and fans in their 20s today go on to watch Esports in their 30s and 40s. The risk is that screen time shifts away from Esports as fans get older. It's worth noting that the average age of a gamer in Europe and the US is in their early 30s and so as gaming itself becomes more mainstream (out of the basement and into the living rooms of millennials and Gen Z) that in turn Esports viewership will also.

As the industry continues to evolve, significant developments have unfolded in a short period of time. One notable development has been the advent of franchising between the publishers and the teams and players. In 2018, Riot Games introduced a model of franchising for LoL whereby teams could purchase a slot within different regions. It was thought this would bring stability to the teams from an investment perspective. Teams' owners, without the fear of relegation, could take a long-term view of their team within LoL and so receive a revenue share from Riot. In doing so, Riot Games took event management in-house which at the time spurred ESL to move away from hosting third party events rather focus on their proprietary leagues and events. Around the same time, Activision Blizzard followed suit and franchised their Overwatch League making a clear distinction between this closed ecosystem whereby the publisher owns and runs the game's league compared to the open ecosystem whereby league operators such as ESL work in partnership with publishers such as Valve. In the meantime, Riot Games and Activision Blizzard continue to work with ESL to avail of their brand league offerings.

Turning to the possibilities for monetization, today Esports generates $5 revenue per fan whereas traditional sports generate around $33 to $91. This assumes around 200,000 viewers in the denominator so the narrower definition. This viewership is comparable to that of the MLB and NHL, yet these sports generate revenues many times that of Esports today. The monetization gap is set to close over time as revenues are expected to grow faster than audience growth. Total industry revenues are expected to grow at around 15% through 2023 with audience growth at 10%. As a result, the revenue per fan would be just under $6 by 2023 thus remaining far below level that of established sports. This suggests that if the growth of both the gaming industry and Esports continues that this monetization will close over time.

Revenue per fan

Gaming 

The video game industry was worth just under $160bn in 2020 representing an increase of 9% to 2019. Just under half of these revenues are in mobile games which is the fastest growing segment at 13%. Console and PC games make up the rest of the revenues and are expected to be up 7%. By regions, APAC is the largest market accounting for just under 50% of total revenues with North America and Europe as the second and third largest. The shift to mobile has been met with the proliferation of free to play ("F2P") whereby the games are monetized through in-app purchases and to a lesser extent, advertising.

F2P games are now some of the highest grossing games by revenues including Fortnite, PUBG, and LoL. According to Superdata, F2P games generated around $87bn in revenues in 2019, accounting for 60% of the industry's total revenues. This model is dominant in mobile gaming with over 80% of the mobile revenues and an important model for PC with 57% of total PC revenues. F2P penetration within the console segment remains low at less than 5% but has grown in recent years due to games such as Fortnite and Apex Legends from Electronics Arts. The growth of both mobile and F2P games has been aided by the advancements in screen sizes, processing power, and internet speed allowing for faster download and uploads and less latency driving more frames per second. This has helped move the mobile and F2P games away from puzzle and arcade games and toward games such as battle royale games i.e. Fortnite and PUBG, and strategy games such as those offered by MTG's IG.

The revenue model of F2P games rests on converting free users into paying customers who purchase in-game items i.e. skins and or upselling them on a premium version of the game e.g. unique maps or levels. Compared to the premium revenue model whereby a price of $60 is paid upfront to the game publisher, the F2P revenue model pushes out a game's breakeven and restricts profitability compared to the former. In terms of the percentage of paying customers, the conversion rate ranges from 1-10% and so it requires a very large audience of which a small percentage of users are highly engaged and willing to purchase in-game goods. The removal of an upfront price removes a barrier to entry for user adoption and so it helps to drive significant user growth early in the game's lifecycle. However, this is offset by the need to retain customers. The removal of this barrier to entry has resulted in extreme competition within the segment and especially on mobile. Apple's iOS app store alone lists over 800,000 games accounting for around 25% of all active apps on the store with more than 2,000-3,000 games released per month. Discoverability has become an increasing challenge for publishers as only the top games and those listed on the first 3-5 pages within their genre achieve meaningful reach. As a result of such competition, the cost of acquisition has risen over time. Another challenge is achieving the necessary conversion and monetization to generate attractive unit economics not least a breakeven. Then with retention, on average, only 7% of the game's monthly users play daily so regular engagement is low. Not surprisingly, there is a large ARPU gap between the top and bottom games with the top 25% of all games pulling in a monthly ARPU of around $12 and the top 25% of RPG, strategy and simulation games generating closer to $25. 

Overview of operations and value drivers

 Esports

ESL and Dreamhack together command around 20% of total Esports revenues, as defined by Newzoo. More importantly, however is the change in the composition of revenues in recent years. Looking at it from the perspective of owned and operated ("O&O") events (and leagues) and third party hosted ("ESS" for Esports Services) events, the revenues in the latter declined at a CAGR of -8% to 2019 compared to +28% for O&O revenues and +12% for MTG's total Esports revenues from 2017 to 2019. Over the same period, total industry revenue grew at a CAGR of 20%, resulting in MTG losing market share since 2017. To understand why management took this path, we must first look at MTG's change in revenues by revenue type.

From the chart above we see that MTG exhibited significant growth in revenues from sponsorships and media rights from 2017 to 2019. These increases saw sponsorships accounting for 29% (18%) of total Esports revenues in 2019 (2017) and media rights at 19% (15%). Meanwhile, advertising revenues declined to 6% from 10% in 2017. Finally, revenues from publishers declined slightly to 33% from 35% reflecting the fees publishers pay ESL and Dreamhack to avail of their O&O branded events and offset by the loss ESS related fees. Advertising, as compared to sponsorship revenues, have declined as a greater percentage of these revenues go to the streaming platforms and to an extent, teams. On the other hand, sponsorships are when brands such as Mercedes or DHL partner with a premium ESL league both for live events and broadcasting i.e. on-screen throughout include during play and in studio.

O&O tournaments generate higher profits however not immediately. Under the ESS model, MTG is merely the white label tournament organizer receiving a fixed fee thus margin. The upside of this approach is a guaranteed income on a low risk investment and the downside is the fixed fee thus a small slice of the overall tournament revenues. Under the O&O model, ESL controls the commercial rights i.e. sponsorships, media rights, B2C revenues etc., and stands to generate scalable profits. The downside of this approach is that scalability is not guaranteed nor is a return. However, sponsorships and media rights are both high margin and key drivers behind O&O events and so the significant increase in both is a positive development. Management has noted the typical event breaks even in the third year as viewership scales faster as the event itself becomes established and sponsorships, media right, and ticket and merchandise sales follow suit. Therefore, as the company moves away from hosting ESS tournaments and creates more O&O tournaments then the gestation period of the latter will create a short to medium term drag on profitability. This is exactly what the segment's profitability shows, from 2017 to 2019, EBITDA losses expanded as the company went from 81 such tournaments in 2017, to 94 in 2018, and 108 in 2019.

Virtuous Circle

As the company focuses on building their own branded offerings in ESL and Dreamhack they begin to benefit from a virtuous circle whereby the growing scalability of O&O events attracts teams and fans thus growing the audience resulting in sponsorships and media rights deals. Which in turns drives higher prize pools for teams and attracts more publisher partnerships resulting in new O&O events and turning ESL and Dreamhack into go-to brands within the Esports ecosystem.

Impact of the COVID-19 pandemic

The obvious impact to MTG and the industry was the inability to host live events resulting in a loss of revenues from ticket and merchandise sales. This was partially offset by events moving online with teams competing out of team offices, MTG carrying out the production through central studios and fans watching the games online. As a result, MTG Esports revenues declined 23% y/y and EBITDA losses narrowed to -SEK220m compared to -SEK351m in 2019. MTG was negatively impacted in Q1 2020 as attendance declined while bearing the full cost to run the in-person events. As the pandemic rolled on and it was clear that live events would be postponed, MTG pivoted to online events and so losing the ticket sales offset by shedding costs related to hosting events including personnel. Viewership on both Twitch and YouTube Gaming are both up around 2x compared to pre-pandemic levels. While as of Q1 MTG were already breaking year-on-year records for online viewership growth. In Q3, ESL's Pro League for CS:GO delivered record breaking viewership and was the most online watched match of CS:GO in history (ESL's league for this game was also the third most watched of the year out of all games/formats). This significant increase in online viewership can be viewed as an accelerant, helping to expand the reach and overall awareness of Esports and stands to complement live events once they resume. Indeed, various surveys point to such a return to live audiences. A recent survey of 2,200 gamers in North America found that 77% are interested in attending an in-person event yet only 17% of those surveyed had previously done so.

ESL Pro League seasonal CS:GO viewership stats.

As a result of the shift to this hybrid of online and in-person events, the company recently combined ESL and Dreamhack bringing the two companies closer together to reap synergies. The two will remain as two individual brands but under one management team. More important has been the unprecedented volume of media rights deals and publishers partnerships that have been struck over 2020 including, but not limited to:

Media rights deals

• Three-year deal with Twitch to become the exclusive English language streaming platform for the majority of ESL and Dreamhack's content

• One-year deals with both Huya and DouYu to become the exclusive Chinese language streaming platforms for ESL and Dreamhack's branded leagues for CS:GO and Dota 2 (Huya) and Starcraft II and Warcraft III (DouYu)

• Various deals with mainstream broadcasters such as Globo in Brazil, TV 2 in Denmark, Prosiebensat1 in Germany, DMAX in Turkey, Esport1 in Hungary, BBC Sport in the UK etc.

 Publisher partnerships

• With Blizzard Entertainment to create new ESL Pro Tour formats for StarCraft II and Warcraft III

• PUBG MOBILE to build a mobile tournament

• Riot Games to create a league around LoL in both the UK and Nordic regions with BBC Sport as the UK broadcaster

• Epic Games to build a new Fortnite open tournament series

• Additional partnerships struck with Riot Games and NetEase to run mobile leagues in Southeast Asia

 Sponsorships

• With Mastercard and Barclays as the main sponsors for the LoL league in the UK. Pringles, Bitburger 0.0%, Mercedes, DHL, Kappa etc., for various leagues, some of which were renewal deals

More recently, the company partnered with DDB Worldwide, an Omnicom company, to develop a brand and advertising strategy to elevate their Esports brands. This follows a similar partnership that was made with Nielsen at the end of 2019 to develop metrics and reporting to understand media value, standardized industry metrics and fans in turn driving commercial professionalization of the industry. The combination of these partnerships coupled with media rights deals with leading streaming platforms should enhance the product offering for sponsors with a more accurate understanding of return on ad spend. Meanwhile and into the medium term, the volume of media rights deals and publisher partnerships suggest that sponsorships will follow as both leagues scale and in-person events return. In addition, the company's gains in mobile through their ESL Mobile Open franchise and with leading publishers in Riot and NetEase should pay dividends as mobile becomes more important in Esports, especially in emerging markets.

Gaming

MTG's gaming assets are developers and publishers of mobile and internet F2P games with annual sales of SEK2.7bn or ($290m) in FY20 with EBITDA of SEK.660bn for a 25% margin. Around 80% of revenues are derived from IG and 20% from Kongregate (Hutch was acquired in late December). Revenues have grown organically at a CAGR of 8% from 2018 to 2020 with revenues up 6% y/y. 51% of total revenues are in Europe, 43% in North America, 4% in APAC and 1% in the rest of the world. This composition has been consistent over the last four years.

IG

Based in Hamburg and founder led (minority owners), IG focuses on a three-pillar strategy of expanding existing titles, first party development of new titles and to a more recent extent, bolt on acquisitions of smaller studios. Founded in 2007, IG manages a narrow portfolio of seven titles but with depth. Their first game, launched in 2003 (by the founders and before incorporating), continues to pull in revenues and four of the seven games have lifetime revenues in excess of EUR100m. One game, Forge of Empires ("FOE"), has lifetime revenues in excess of EUR500m while another game, launched in 2015, has quickly scaled to lifetime revenues in excess of EUR100m. The advent of mobile while initially a threat for the company turned into a blessing in disguise as the company began to adapt its games for mobile use as early as 2011 and to coincide with the launch of FOE. As a result, mobile has been a significant driver for growth while browser or PC revenues continue to grow also. From a monetization perspective, the conversion rate of paying users is around 9% compared to an industry average of less than 5%. To understand player stickiness, we can look at daily active users over monthly active users therein the average rate of monthly users playing on a daily basis, this ratio has averaged 42%. Meaning that 4 in 10 monthly active users play daily which is best in class for gaming with the top 25% mobile games at an average of 13%. Then looking at the average revenue per paying user (ARPPU), IG is generating EUR46 in monthly ARPPU (ARPMPU) which compares to $25 for the top 25% RPG and strategy games. These core drivers reconcile to 2019 revenues as follows; MAU x conversion rate x ARPMPU x 12 months for 4m x 9% x 46 x 12 = EUR190m. Where the high retention comes into play is allowing the company to rely on a lower number of MAU or lower monetization, holding the conversion rate constant, to achieve the same revenues i.e. MAU x retention rate = DAU and annual revenues = DAU x conversion rate x ARPDPU x 365 = annual revenues. For example, if the conversion rate was closer to the average of the top 25% of games at 13% then MAU or ARPDPU would need to be 3x higher. Consistency in these drivers allows for higher accuracy when predicting future growth while also allowing the company to focus on creating and nurturing its portfolio of games for long term sustainability.

Lifetime revenue by game, as of March 2019

Such sustainability has been achieved through a focus on long-lifecycle games that provide social and challenging gameplay that engender user devotion and engagement over the long term. This is aided by live operations where new content comes live every two weeks, therefore, bringing newness to the game in the form of fun e.g. in-game live events and ensuring that players become neither too bored nor frustrated i.e. too difficult. This is achieved through an iterative process of A/B testing to ensure that deployment leads to the desired action i.e. engagement and monetization.

Kongregate

Accounting for around 20% of MTG's gaming revenues is both smaller and different to IG in many ways. As previously mentioned, Kongregate's original business model has centred around in browser and Adobe flashed enable games. However, due to the sunsetting of this technology, Kongregate pivoted toward mobile publishing and first party development. In contrast to IG's narrow portfolio, Kongregate has over 30 games live on app stores today. Less than 10 of these were developed by Kongregate with the rest developed third parties and published by Kongregate. Recently, focus has been put toward first party development with the bolt on acquisitions of small studios (teams of less than 10 people) as Kongregate was purely a publishing business prior to this turnaround. While data is limited, one such success has been the expansion of a title that now accounts for 10-15% of MTG's total gaming revenues and so 70% of Kongregate's. Kongregate monetizes the mobile games with around 70% in-games purchases and 30% ad revenues.

As a result of this shift in the business model, total users have been declining as the web portal is slowly shut down and developers pull their games. At the same time, rates of user monetization are increasing as low yielding users leave the web portal and the mobile games ramp up. The net of these effects is flat to low single declining revenues. Moving forward, Kongregate will focus on launching 6-8 games per year with an even mix coming from first- and third-party developers. The performance of games released in the last 18 months suggests metrics are moving in the right decision. In addition, the former CFO of IG is now the CEO.

Impact of the COVID-19 pandemic

While users declined overall due to the turnaround ongoing at Kongregate, user engagement reached record highs at IG in the first and second quarters. This has resulted in record high ARPUs throughout the year as low yielding DAUs leave Kongregate and higher engagement is seen at IG. Both sales and profits were helped with a falling cost of marketing that has benefited the industry as lower advertising demand was seen from non-gaming industries. For MTG, this resulted in a lower cost per install driving user acquisition and engagement was helped by in-game feature improvements. Marketing investments were normalized in the second half which combined with strong user engagement delivered record high profits with an EBITDA margin of 30%. Kongregate successfully launched a game in Q3 as planned and to strong reviews and engagement.

Hutch was acquired with F9M revenues of $56m and an EBIT margin of 25%. Revenues for the F9M were up 160% as newly released titles gain traction. The success of three titles, from a total portfolio of thirteen, has seen Hutch's sales and profits grow significantly in recent years following a period of lacklustre growth. On an EV basis and including the expected earn-outs, implied multiples are around 5 and 20 times 2020E sales and EBITDA.

Other recent events and why this opportunity exists?

MTG's predecessor company, Modern Times Group AB ("Old MTG"), was majority owned by the listed Swedish investment vehicle, Kinnevik AB. To gain regulatory approval, the Old MTG was spun out to shareholders in late 2018. Kinnevik was forced to do so by the regulator to gain approval for the merger of its majority-controlled telecom operator (Tele2) with the largest cable TV operator in Sweden (ComHem). Then on April 1, 2019, the Old MTG split into two separately listed companies; NENT Group (the broadcasting and media businesses) and the new MTG discussed here. The new MTG retained the legacy company name.

Since then various changes have happened at the board, management and investor level. With the latter, two activist investors have entered the fray, one stemming from an initial stake in the Old MTG, Evermore Global Advisors, and a new investor last year, Active Ownership Capital. Combined in the two have amassed a 12% stake and hold seats on the nomination committee (2 of 3 along with the chairman of the board). The primary role of the committee is to allow shareholders to play an integral role in the board's selection process. Such shareholder involvement saw the board expand over the last year, losing one member and gaining three new. The three new board members come from former roles such as the CMO of the NFL (Dawn Hudson) and the CFO of the LEGO Group (Marjorie Lao). Also, the CEO stepped down to be replaced by the CFO and recently, the chairman stated he does not intend to stand for reelection.

Finally, a quick note on the management of the underlying verticals. Both ESL and IG remain under the day to day management of their founders, Hendrik Klindworth at IG and Ralf Reichert at ESL (alongside Co-CEO, Craig Levine, who has spent over 20 years in the Esports and gaming industries). Both continue to hold a minority stake in their business thus having skin in the game.

Investment thesis

1. In both verticals, MTG has an attractive set of assets that the market is undervaluing

1. The Esports business and its league offerings are in a market leading position. The media rights and publisher deals signed, almost weekly, provide future growth alongside the resumption of existing events. The latter should see higher monetization as the key deals with Twitch, Huya and DouYa and the many national broadcasters will drive up viewership which in turn will draw in sponsors, drive higher prize pools etc. This in turn spurs new tournaments and so the flywheel continues to spin. This opportunity combined with a low capex intensity (2% of sales) should deliver significant cash flows as the business scales

2. The gaming business having already established consistent revenue growth is expected to continue to do so with a combination of organic and inorganic growth. With the former driven by the continued growth of existing titles, new games, and any synergies relating to user acquisition and marketing. Inorganic growth will be achieved through select M&A in the casual to mid-core segment

1. Earlier this year, the company announced they had an LOI to acquire a company for around $140m at 8x EBITDA which is yet to be confirmed

2. There are numerous ways to unlock value

1. A separation of verticals is not off the cards rather more a "wait and see" moment as MTG moves to strengthen the gaming vertical through strategic acquisitions to diversify and to build critical mass

2. Such clear intentions of unlocking value speak to shareholder-friendly management supported by MTG's shareholder base and the various changes that have occurred at the board level

3. Potential listing of the Esports business (pure play)

4. Both verticals are attractive M&A candidates as consolidation sweeps through the industry

Valuation

Quantifying the above thesis is best suited to a SOTP valuation. Adding the full year revenues of Hutch to the gaming vertical, we get revenues of SEK3.3bn and EBITDA of SEK0.8bn (25% margin) in 2020. Assuming Hutch can grow at 50% (from 160% F9M 2020) and IG and Kongregate at 8% (considering the launch of new games), total revenue growth is 17% for SEK3.9bn in 2021. Combined all three companies should generate an EBITDA margin of 24% (allowing for some compression for the launch of new games) for SEK0.9bn. Looking at peer valuations and recent deals, peers are broadly trading around 16x NTM EBITDA.

Using an EBITDA multiple of 15x on MTG's gaming combined EBITDA expected for 2021 of SEK0.9bn, the EV based on 100% ownership of the holdco is SEK13.9bn. Netting this number at 77% and deducting the contingent payout relating to the acquisition of Hutch, brings the net fair value of SEK10.1bn to MTG.

Plugging this number into a SOTP valuation we can understand what the market is pricing the Esports business at today and consider whether this is a fair value. Based on the gaming business being worth SEK10.1bn, for the equity value to tie to the market capitalization of SEK11.04bn, it implies a value of SEK1.3bn (at 100%) or $150m for the Esports business.

Towards the end of 2019, ESL and Huya had agreed to form a JV in China that would roll out tournaments across China with Huya becoming an investor in ESL with a 30% stake. This deal valued ESL at an EV of $425m or SEK4bn. In the end, the deal fell through. However, what we have to ask ourselves is what was management willing to give away to access this lucrative market in addition to partners in Huya (and Tencent). The implied EV for the Esports business is worth SEK1.3bn at 100% indicating that the market is significantly undervaluing the business. Using 91.5% of Huya's EV of $425m, there is a +20% upside to the current share price.

A DCF valuation based on the Esports business (9% cost of equity, 3% terminal growth rate) being able to secure 18% of market share and achieve MSD-HSD EBIT margins (by 2023 onwards) yields an EV of SEK4.3bn, which at 91.5% results in a share price of SEK144 for a +25% upside. For MTG to own 18% of the industry in the long run, this is around what they own today but live events were significantly impacted over the last year and 18% is less than what they owned in prior years.

It's still very early

Based on the TAM and audience growth of 15% and 10%, respectively, this leaves revenue per fan similar to what it is today at around $6 per fan (enthusiasts). However, a lot is unknown as to how far Esports pushes into the mainstream and ultimately what growth for the industry is in the long term. This lack of monetization at the customer/fan level plus the land grab at hand renders valuations less than ideal. That said, there are still a lot of remaining questions to be answered.

Key risks/questions

Will ESL/Dreamhack remain the leading Esports league and event operator/brand?

The extent to which the industry moves towards one of a closed or open ecosystem remains unclear. Might it be the case that the publishers hold on to their best performing titles, managing these internally and leaving only the new and geographically specific titles to ESL to manage? Or might it be that publishers require the ESL brands to get titles off the ground, expand into new markets and grow awareness? Recent deals would suggest more of the latter with ESL striking deals with popular titles such as PUBG Mobile, StarCraft II and Warcraft III, Fortnite etc. Overall, there remain many unanswered questions, yet it appears unlikely that ESL would be supplanted as the leading league and event operator due to both their growing brand strength and the scale advantages of producing 140+ on and offline events annually (their closest competitors, Riot Games and Activision Blizzard produce less 90 on average as they are restricted to their game portfolios). Scale advantages are realized through the ability to spread fixed costs relating to studios rental, production talent, equipment for both events and studios etc.

ESL’s global footprint

Are our expectations for value creation unrealistic?

As we look at the intrinsic value of an investment in MTG today, there are a lot of assumptions around how this value will be realized. There is a risk that many of the ways of unlocking this value may not come about i.e. that the gaming business is not re-rated. The two businesses could also remain as one under MTG thereby shouldering a holding company like discount as investors will want to own one or the other business, not both, given their differing appetites for risk (and reward). That said we can take comfort in the fact that two of the largest shareholders are activists and sit on the nomination committee and so are aligned to the unlocking of value.

Catalyst

Separation of the verticals

Resumption of live events 

Gaming vertical continues to build critical mass through bolt-on acquisitions