Restructuring, Selective M&A and New Releases Should Help Restart Revenue Growth

Key Takeaways

• Embracer Group AB has recently engaged in an assertive acquisition strategy, primarily driven by financing in a low-interest rate environment. The rise in interest rates has adversely affected the company's finances, causing concern among investors. This issue, combined with a failed deal with one of Embracer's major investors, has led to a 79.89% drop in share price from 2021 to 2024.As a countermeasure, the management has launched a comprehensive restructuring program, including divesting assets and closing studios.
• The company intends to reorganize into three independent publicly traded entities, suggesting a strategic overhaul to enhance its business framework.

Catalysts

Operations:

• Decentralized Operating Model: Embracer Group employs a decentralized model, empowering operative group CEOs and studio heads with creative freedom and financial responsibility, fostering creativity and speed while adhering to governance and compliance frameworks.
• Diversification: The company has grown from 1 to 11 operative groups since 2016, reducing dependency on single titles and creating an attractive risk profile that allows studios to be creatively bold.
• Synergy Realization: While maintaining a decentralized model, Embracer Group encourages synergies between operative groups, including collaboration, best practices, IP, and talent sharing.
• Strategic Acquisitions: The company's history of strategic acquisitions has been managed by integrating new entities into its ecosystem without compromising the group's values or operational independence.

Growth:

• Embracer Group AB has seen a slowdown in growth, seemingly affected by its assertive acquisition strategy. The company's Q2 2023/24 interim report shows robust earnings growth in the PC/Console Games segment, bolstered by strong back catalog sales and new releases. However, the Mobile Games segment is projected to experience mid-to-high single-digit negative organic growth. In spite of these challenges, Embracer Group has reported annual net sales of $1.7 billion and recognizes opportunities in sequels, remakes, spinoffs, and transmedia projects. The company remains committed to its strategy of growth through selective mergers and acquisitions.

Economic Moat:

• Embracer Group's competitive advantage primarily resides in its intangible assets, particularly through the ownership of intellectual properties like "The Lord of the Rings," which commands a significant place in consumer consciousness, akin to iconic brands such as Coca-Cola.

Assumptions

• By 2033, projected revenues are estimated to reach approximately SEK 69,916,431,061.8, driven by moderate growth, consistent demand for key titles, and a stable, non-cyclical consumer market in the entertainment media sector.Projected net earnings for the year 2033 are expected to be around SEK 4,231,518,265.2, based on historical profit margins ranging from 1-5%.Free cash flows are expected to amount to about SEK 3,686,409,202.3 by 2033, due to significant capital expenditures & strategic acquisitions.

Risks

• Market volatility: Embracer Group's stock price can be affected by market trends and economic factors, which may lead to significant price fluctuations. 
• Debt levels: The company carries a notable amount of debt, which could impact its financial stability and ability to respond to market changes.
• Acquisition strategy: While acquisitions can lead to growth, they also come with integration risks and the potential for unforeseen liabilities.
• Industry competition: The gaming industry is highly competitive, with rapid technological advancements and changing consumer preferences.
• Regulatory risks: Changes in regulations, particularly in digital and entertainment sectors, could affect Embracer Group's operations and profitability.
• Dependence on key titles: The company's financial performance may heavily rely on the success of a few key game franchises, which is a concentrated risk.
• Currency exchange risk: As a global company, Embracer Group is exposed to currency exchange fluctuations, which can affect earnings

Valuation

• Revenue is projected to grow between 10-12% in 2024-2025, spurred by significant new releases. Following this, revenue growth is anticipated to stabilize at 8-4% in subsequent years, eventually aligning with the historical average growth rate for entertainment revenue of 0.33% by 2033, due to the company's maturity and limited opportunities for growth.
• Anticipated operating margin of 11.93% in 2024 and a net margin of 8.07%, fueled by heightened efficiency and a decrease in operating expenses (OpEx) and capital expenditures (CapEx), aligning with company objectives. Following this, margins are projected to stabilize at a historical average of 5-10% operating margin and 1-5% net margin in the subsequent years.
• The free cash flow margin, expressed as a percentage of sales, is projected to be 13.78% in 2024, which is consistent with the historical 10-year average. It is expected to decrease gradually to 5.05% by 2033, influenced by high working capital margins and capital expenditure requirements.
• The discount rate is determined using a weighted average cost of capital (WACC) of 7.41%.
• Utilizing a discount rate of 7.41% and a DCF model, the enterprise value net of debt is calculated to be approximately SEK 46,439,304,018.8, resulting in an estimated enterprise value per share of SEK 42.96. Applying a 25% safety margin, the adjusted estimated value per share is SEK 32.22.