CFA Institute 2015
Short Description
The report was dedicated for CFA Research Challenge 2015...
Description
CFA Institute Research Challenge hosted by
Local Challenge CFA Society of Poland J
[IT, Video Game Development, Digital Distribution]
Team J Student Research This report is published for educational purposes only by student competing in CFA Institute Research Challenge
Date 12/02/15
Current Price PLN 16.16
Target price PLN 16.27 (+0.3%) Ticker: (Warsaw SE: CDR)
Recommendation: Hold
Main revenues growth drivers: Market profile On-going triple-A games 26-week price range (PLN) 16.27 releases Average daily volume (last 3M) 128.2 Entrance into the new domain: mobile phone As % of shares outstanding 0.13% games industry Free float 45.1% Steady growth in sales via P/BV 9.38 GOG.com platform. The business is driven by a high Shares outstanding (in mn) 94.95 level of heterogenous Market Cap (PLN bn) 1.54 substitutes. The success of P/E 350.0 the CDP releases relies on the mix of high quality, Earnings per share (in PLN) 0.046 meeting customers’ ROE (2014E) 1.71% requirements, and adjusting to their hardware; GOG which will start selling triple-A games and will introduce its new platform A very good reputation of The Witcher saga. We estimate that the company will have high ability to generate cash and will be selffinanced. Currently, the success of the company is determined by a very good reception of the W2. We do not believe that the company will be capable of sustaining its very dynamic growth in the future and our assumption is that the CDP will suffer from a decrease of its CAGR.; One of CD Projekt's business domains will be sold in 2016 for nearly PLN 20mn (CDP.pl). According to our calculation, the sales of The Witcher 3 and Cyberpunk 2077 will reach 7mn and 6.5 mn, respectively. We estimate that 2016 is going to be the best year in terms of generating cash flows for the company due to the W3 release. The main factors affecting the CDP’s future is currency risk and perception of gamers.
Table 1
20
11/03/2014 The postponement of The W3's release date
18
14
1/03/2011 The publication of an unfavourable quarterly financial report
20/04/2011 The bankruptcy of the daughter company Optibox Sp. z o.o.
The CD Projekt stock price
12 10
16/11/2010 The news about The W2's release date
2/08/2011 The Optimus S.A. transformation into CD Projekt Red S.A.
12
10 5/03/2013 The disclosure about negotiations with PC Factory S.A.
27/03/2012 The GOG.com released issues
8 19/12/2014 The news about the CD Projekt Brands S.A. shares' disposal
6
8 4
6 4 2 0
Volume (in mn)
16
26/11/2014 The CDP.pl shares' disposal
5/02/2013 The announcement about The W3's releasing
2
0
Source: The company's data, The WSE's website
2
Figure 1 Structure of CD Projekt Capital Group
Business Description CD Projekt Capital Group is a Polish company which operates on the global digital entertainment market and is especially known for its video games development department. It was established in 1994, but the contemporary form of the business was adopted due to association with Optimus enterprise. In September 2011 the company has changed its name from Optimus S.A. to CD Projekt Red S.A. The brand became internationally recognized among investors in 2002 thanks to initial public offering at the Warsaw Stock Exchange. The main business domains are:
GOG Ltd.
GOG Poland Sp. z o.o. CD Projekt S.A.
Brand Projekt Sp. z o.o.
CD Projekt Inc.
CD Projekt Brand S.A.
The group is cooperating with 17 worldwide sales partners, what gives it the opportunity to physically distribute on 109 markets (see the Figure 2). The scope of sales is enhanced mainly by distribution through digital platforms such as Steam, PlayStation Network, and Xbox One Marketplace.
Source: The company data. Figure 2 CD Projekt’s sales The Witcher 3:Wild Hunt, 2015
partners
worldwide,
Source: The company data. Figure 3 Gross profit per quarter (in mln)
Global digital distribution of games
30 000 25 000
Distribution and publishing in Poland
20 000
Games development
15 000 10 000
Other activities 5 000 0
Q3 2014
Q2 2014
Q1 2014
Q4 2013
Q3 2013
Q2 2013
Q1 2013
Q4 2012
Q3 2012
Q2 2012
Q1 2012
-5 000
Development and distribution of video games around the world by CD Projekt Red studio, Digital distribution of computer games via GOG.com platform, Delivery of packaged video games, movies, audiobooks, ebooks, and electronic devices by CDP.pl operating in the Polish market.
Consolidation eliminations
Source: The company data. Figure 4 The structure of shareholders Marcin Iwiński Michał Kiciński PKO TFI S.A. MetLife PTE S.A. Piotr Nielubowicz Aviva OFE Aviva BZ WBK Adam Kiciński Free float
Source: The company and the WSE data.
The company’s main product is an action-RPG The Witcher saga based on Andrzej Sapkowski’s novels. The consumer’s perception of the market position of the game is going to be strengthened by titles like Cyberpunk 2077 and The Witcher Battle Arena. Over 200 high-class specialists have got involved in the process of creating adventures of Geralt of Rivia. Not only graphics, programmers and designers, but also musicians and screenwriters have been engaged in the process of game developing. The Witcher saga total sales have reached about 8 million copies worldwide (until the end of 2014). According to pre-order data estimated by VGChartz, almost 240k gamers (a colloquial word for a player) from the U.S. have purchased the newest title (The Witcher 3: Wild Hunt) via 3 game platforms (PS4, XboxOne, and PC). Game has won over 170 international awards before its release, including the biggest global public-voted gaming award - Golden Joystick Award in "Most Wanted" category. On average, 39% of CD Projekt’s total gross profit (as presented in Figure 3) is generated by CD Projekt Red developing video games. Moreover, gross profit from sales of games via GOG.com platform, distribution and publishing in Poland (CDP.pl) constitutes respectively 35% and 30% of the total profit. The company, on average, makes a gross profit on sales in the amount of PLN 16.15mn per quarter. [the above calculation was prepared on the basis of the last 11 quarters] The company’s strategy for the upcoming years can be summed up in the following points: Release of new products - CD Projekt is still working on the two leading-edge releases: The Witcher 3: Wild Hunt and also Cyberpunk 2077: these games are high-budget products, their developers’ primary focus lies in the highest quality of their products (‘tripleA video games’), they employ highly advanced technologies to achieve that aim, Maintenance of the customers’ loyalty - this strategic objective is going to be achieved by supporting their franchise: CD Projekt plans to release two games based on one of their core franchises; although such products are mid-range (circa 20 hours of gameplay), they will also be characterized by the highest quality, Development of innovation - as a digital distribution platform, the company has constantly invested in R&D projects to develop platform’s facilities and also strengthen its position in the global market, Commercialization of proprietary technology - starting to license the game development technology, the REDengine, to third-party developers: the newest version of this multiplatform engine is powering their major releases, Entrance into the new domain - the company assumes that digital and mobile entertainment market is going to rise, so that they are creating new products for users of mobile devices, e.g. The Witcher: Battle Arena. The structure of shareholders by the amount of shares and by the amount of votes at AGM are coincident. During the years 2002-2014, there were several changes in CD Projekt shareholders’ structure. Currently, there are three institutional shareholders (each one holding more than 5% of shares): PKO TFI S.A. (9.48%), MetLife PTE S.A. (5.27%), Aviva OFE Aviva BZ WBK (5.20%). The rest of Company’s equity belongs to the treaty of CD Projekt Red shareholders (35.81%) and to individuals such as ‘Free float’ (44.24%). The majority of votes belongs to business founders and Board Members and is split as follows: Marcin Iwiński (13.28%), Michał Kiciński (12.94%), Piotr Nielubowicz (6.30%), Adam Kiciński (3.29%). CD Projekt’s management is represented by professional and highly devoted people. CD Projekt originated as a small commercial business. Then, after the merger with Optimus, the company evolved into a leading video games developer in the Polish market. Its franchise has started to be internationally recognized after release of the first part of The Witcher saga. Members of CD Projekt S.A. Board are: Adam Kiciński – President and Joint CEO, Marcin Iwiński – co-founder and joint CEO, Piotr Nielubowicz – CFO, Adam Badowski – Studio Head, Michał Nowakowski – SVP Business Development. The company, thanks to its effective management, has taken advantage of many opportunities appearing on the developing Polish market as a grantee of European Regional Development Fund. Since December 2007 it has managed to carry out six projects, amounting to about PLN 155.6k and
3
Figure 5 Projects co-financed by the European Regional Development Fund, 2007-2013
EUR 100k. Currently, CD Projekt is conducting three more projects. One of them is dedicated to the upcoming production The Witcher 3: Wild Hunt.
Corporate Governance 100%
As company listed on WSE CD Projekt is obligated to comply with corporate governance rules stipulated in ‘Good Practice of Companies Listed on Warsaw Stock Exchange’. In connection with that, CD Projekt published on its webpage a list of rules, which are not obeyed by it along with explanation. Main factors having impact on our evaluation of the corporate governance were:
90% 80% 70% 60%
Members of a supervisory board - well-educated and experienced professionals: a solicitor, a Ph.D. in technical sciences, a CFA charterholder, a tax advisor, an IT specialist, lawyer, Shareholder Rights - one-share-one-vote policy, minority shareholders are authorized to revoke shareholder’s resolution, a special procedure for appointing members of the supervisory board which allows minority shareholders to nominate candidates, Audit and Oversight – the whole board of directors creates audit committees, annual reports are audited by PKF Consult a well-experienced consulting company; Compensation - disclosed motivation plan for the board of directors, compensation and benefit scheme was made public. On the basis of our evaluation we claim that CD Projekt follows standards of best practice in corporate governance. Lack of special committees the supporting supervisory board as well as the corporate governance officer arises from facts that both the company’s structure is not extensively developed.
50% 40% 30% 20% 10% 0%
Project Value
EU financing
Source: The company data.
Industry Overview It is estimated that global expenditures on entertainment and media are going to increase from USD 1.56tr in 2013 to USD 2.12tr in 2018, what equals to CAGR of 6.4%. Analysis of the global results reveals that inhabitants of the Asia-Pacific region are world’s top spenders in entertainment and media in comparison to inhabitants of other regions. It is worth noting that Central and Eastern European market growth will be significantly faster than the growth of Western Europe’s markets, although Latin America will be the fastest-growing region over the next four years, with annual growth of 10.9%. Such expenses are strongly correlated with the global economic situation. In countries with a stable economy, society citizens’ wealth has increases and thus spending on entertainment are greater. However, thanks to the Internet and facilities provided by other technologies, people from all over the world have more possibilities to fulfill their needs in the ways they really want. These days lots of traditional methods of distribution have been replaced by digital countertypes/equivalents. For more information, please see the Appendix 9.
Figure 6 Expected Global Game Market in 2014
Game industry revenue (in bn USD)
40
LATAM
35 30
NAM
25 20
APAC
15
MEA
10 5
EU
0 0
200
400
600
800
1 000
Gamers (in mln)
Source: NewZoo. Figure 7 Total global spending on entertainment by category 300
US $ millions
2012
2013
250 200 150 100 50 0
In-Home Video Entertainment
Audio Entertainment
Cinema
Out-of-Home
Consumer Books
Video Games
Video games development According to Global Games Market Report, worldwide game revenues amounted to USD 75.5 bn in 2013, growing by approximately 14% as compared to the previous year. The top revenuegenerating region is APAC (Asia and Pacific), where the game industry generated 42% of total income. Moreover, revenues of the global games market are expected to increase to USD 102.9bn by 2017. By contrast, on the basis of data from Forecast: Video Game Ecosystem, revenues of the game industry reached USD 93bn in 2013 (Appendix 10 and 13). Sales of games for TV consoles as the most profitable market segment brought USD 23.6bn in revenues (31% of total revenues in 2013). However, revenues from sales of PC/MAC games will grow at 3.3% CAGR over the next six years, while the annual growth rate of games on TV will be four times lower. The total number of video game consoles sold worldwide was about 42m in 2013, twice less than in 2008. The best-selling TV console was Sony’s Playstation 3, reaching the sales of 8.94m units. Please refer to the Appendix 7 and 8. It is expected that the number of gamers exceeded 1.7bn in 2014. 47%, 19% and 13% of them respectively come from regions such as Asia-Pacific, Europe and Middle East-Africa. The profile of an average gamer could be as follows: age 31 and 14 years of video games playing. There are almost as many women as men(who/that are)playing games. Games are the most frequently purchased by 36 years old gamer on average. According to ESA’s estimates of the best-selling video games, nearly one in three gamers choose the action genre and also every fifth sold video game is the shooter. Sales of RPGs constitute more than 12% of computer games and 7% of sold video games units. According to Newzoo‘s data, the Polish games market generated revenues in the amount of USD 280mn and it consisted of 13.4mn players in 2014. They are mainly young men, pupils and students, who spend an average of 21 hours a week playing games. Earnings of nearly half of working Polish gamers amount to or exceed the national average salary. Moreover, the vast majority of Polish gamers plays games via PC platform. The most popular game genres are shooters and role-playing games (Appendix 14).
Source: McKinsey&Company’s, Global Media Report 2014.
4
Figure 8 Global Games Market, 2013-2017
Casula Webgames
100% MMO Games
80% 60%
(Mid)-Core PC/Mac Games
40%
Mobil Phone Games
20%
Tablet Games
Competitive Positioning To understand CD Projekt Red Capital Group competitive position, we should take into consideration the fact that the company consists of three businesses functioning in different market environments. All of them have much in common, but we should remember to analyze each industry very carefully. We want to determine the position of CD Projekt in comparison with its competitors, its future position in the next years. To achieve accurate results, we have analyzed CD Projekt Red Studio, cdp.pl, and GOG.com as compared them to both local and global leaders of their industries, using analytical methods such as Porter’s five forces analysis and SWOT analysis.
Advantage of differentiation of buyers and products’ substitutes
0% 2013 2014 2015 2016 2017
Handheld Games
TV Console Games
Source: NewZoo. Figure 9 Share of total spending on console games (USA) DLC
65% 71% 68%
23%
Pre-owned
65% 66% 64% 80%
14% 9%
77% 75%
21% 27% 22%
20% 23%
12% 9%
Boxed
6%
16% 17% 15% 8% 12% 7% 8%
The modern world of entertainment, performing a part of media industry, has wide perspectives of development, because both customers from developed and emerging markets spend much money on its products: about USD 590mn in 2013, which is 5% growth as compared to 2012 (please refer to Appendix 9). We have analyzed the gaming market from a global perspective. The gaming market is characterized by huge bargaining power of mature and aware buyers with specific expectations. What is more, an easy access to entertainment poses a considerable threat to product substitution. To see more details, please refer to the Porter’s five forces analysis in Appendix 11. Potential buyers are gamers from all over the world and their number is estimated at nearly 2bn people. The majority of purchasers of games are people who consciously choose products: they are aware of their consumer needs and they also know how to meet them. Due to the strong growth of the game industry, high product differentiation and unlimited access to substitutes, bargaining power of buyers is constantly increasing. Another characteristic which has a significant impact on the game industry is wide access to substitute products. Traditional entertainment products such as movies, books, audio books, board games are becoming slightly old-fashioned in the ‘digital age’, but they still have its supporters. According to McKinsey&Company’s Global Media Report 2014, participation of these products in a total global spending on entertainment in 2013 is estimated at 35% compared to 12% spent on video games (Appendix 9). Furthermore, there is clearly noticeable phenomenon in vogue - ‘healthy lifestyle’. It encourages people to do sport instead of spending time in front of a computer screen.
Progressive internationalization and increasing number of competitors Source: NewZoo. Figure 10 Porter’s five forces analysis for CD Projekt Red Studio
Bargaining Power of Suppliers
Threats of New Entrants 5 4 3 2 1 0
Competitio n in the Industry
Source: The team estimate.
Many well-known international brands (like Warner Bros Interactive Entertainment, Namco Bandai Games, Screenlife, 1C, Spike Chunsoft, and Megarom Interactive) have entered into cooperation with CD Projekt, working together on releasing the newest game The Witcher 3: Wild Hunt. Therefore, the operational risk of dependence on the only one publisher decreases. Furthermore, the company does not have to be concerned about promotion and distribution, because it has signed agreements with major local sales partners, what enables CD Projekt Red Studio to distribute its products in 109 countries. Its main product will be physically available in North and South America, Europe, Asia Continental and Pacific, Africa, and Australia. Thanks to that they have guaranteed worldwide sales and improvement of their global performance.
Bargaining Power of Buyers
Threat of Substitute Products
The company is consistently implementing its strategy of internationalization. In accordance with that strategy, it also has sold the majority of shares in cdp.pl, which is functioning only in the Polish market. As a result of the transaction, the company downscaled its shares in cdp.pl to only 8.29% in November 2014. Regardless all those steps cdp.pl still is going to publish The Witcher 3: Wild Hunt on the Polish market, but its cooperation with the Capital Group depends on achieved bottom line. These ‘international’ operations yield positive results, but on the other hand they have a sideeffect in the form of an extremely fast increase of number of potential competitors. One of the most important strategic problem is to choose the best date of the product release. It certainly has a great influence on the future company’s future profits. CD Projekt has changed the date of the premiere a few times. That fact confirms us in our conclusions that main product of CD Projekt Red Studio competes globally.
Mobile Game Segment The mobile game segment is the fastest growing segment of market. We assume that over the following years this trend will continue. In our view, over the next few years there will be following key factors leading to rise in market value: Developed markets – increase of the share of paying players. According to Newzoo 2014, in twoyears time number of paying gamers will rise from 36% to 46% in Western Europe and the US combined. Developing markets – rapid growth in number of smartphones and tablets will make global market larger. It will be an essential trigger of rise in revenues.
5
Hardware innovation – fierce competition among tablet and smartphone manufacturers will drive constant and rapid growth in mobile technology, creating new opportunities for game developers toattract more gamers and improve the quality of games.
Figure 11 Competitive positioning of GOG.com Steam
GOG
Origin
Uplay
Foreign Currency
USD
USD, EUR
Many
Many
Console Game
Limited
NO
NO
YES
Software
YES
NO
NO
NO
Movies
NO
YES
NO
NO
DRM
YES
NO
YES
YES
Demo
Many
No
Few
NO
For You
Special Tools
NO
NO
NO
Optional Voting+Customer Review
YES
YES
NO
NO
Media Gallery with Trailers
YES
YES
NO
NO
Forum for Gamers
YES
YES
NO
NO
In our view, console game producers have a comparative advantage in mobile phone game segment. According to survey the third main reason to start playing a game is, that a certain game is a sequel of games that gamers used to play before. Loyal gamers who play on console are likely to choose the same game on a mobile phone. Well-known console game brands attract gamers. Gamers also stated that a knowledge of a publisher is one of the most important reasons to choose a particular game. Number of games offered on mobile phones is extremely high due to lower cost of production and other factors. The Witcher Battle Arena. CD project is engaged in a process of developing first free-to-play mobile games. We think that the company has a huge potential in this segment. We base our opinion on following facts. Almost all world-renowned console game developers create games for mobile devices. The console game producers have an advantage of well-known game brand which can help them to obtain a high number of downloads. Currently, the company is gaining experience and it's first games will probably not be very profitable. Although, we think that in long term the company will make profit on mobile game segment.
Digital Distribution Direct links to: Discussions/ Guides/News/ Official WebPage
YES
NO
NO
NO
MMO Game
YES
NO
NO
NO
Only Own Brands
NO
NO
YES
NO
Graphics of Webpage (Our Personal View)
Medium
Medium-
High-
High+
Source: The team estimate. Figure 12 Best-Selling Video Games by Units Sold 2013 Strategy Other Games/Complications Action Adventure Arcade Casual Children's Entertainment Family Entertainment Fighting Flight Racing Role-Playing
Source: The 2014 Essential Facts About the Computer and Video Game Industry, ESA. Figure 13 Share of digital distribution and physical copies in selected countries
Belgium Netherlands Italy Spain France Germany UK Europe US
41% 47% 39% 40% 44% 35% 42% 42% 58%
59% 53% 61% 60% 56% 65% 58% 58% 42%
Digital Distribution is growing at two digits number. According to ‘Entertainment Software Association and the NPD Group in 2013, digital distribution accounted for 53% of distribution in comparison to only 29% in 2010. The growth is driven both by the rapid development of the game market for mobile phone and smartphone as well as increase in popularity of digital distribution among gamers. Highly Concentration in Industry. Few market participants monopolize the segment of digital distribution. Leader, Steam accounted for more than half of total revenue. Steam webpage offers the great variety of functionality for the users and is not only a virtual shop but also a platform for communication between gamers. Digital distribution provides a higher profit margin for Developers. Retail distribution in more costly (physical production, transport cost, higher operating cost). Digital distribution offers consumer unlimited access to a great variety of games for people around the world. According to the CDP data, the net receipt from digital distribution of each The Witcher 3 will be about twice higher than in retail distribution. GOG is the leader in digital distribution of older classical games. Based on analysis of revenue structure of GOG, we assume that classical games are mostly attractive for gamers who used to play in those games (developed markets). Global market growth is driven by increase the number of new gamers who could not have a sentiment for older games. Additionally the number of older games, which could attract gamers is limited. We think that in the long run GOG could not grow only by adding additional games to portfolio. Based on the official presentation, we assume that GOG Galaxy will be offering new functionality. Technology gap between Steam and GOG will become smaller. Advantage of GOG is base of loyal customers who support DRM-free policy of platform but the mainstream publisher still relies on DRM and do not want to cooperate with GOG because of lack of DRM protection. We assume GOG Galaxy due to a new technology will be able to limit unauthorized copying without the necessity of internet connection. GOG have loyal customers who support DRM-free policy of platform. We assume that when new titles will be offered by GOG, DRM-free supporters could change platform only because of their personal belief.
SWOT conclusion GOG.com is a digital distribution platform offering a wide range of computer games, especially old titles. A SWOT analysis helps to look at the company’s internal strengths and weaknesses, and also to identify external opportunities and threats. One of its strengths is an international cooperation with publishers and developers from all around the world, which supports product diversification. The GOG’s weakness is the fact that the platform is focusing on the sales of old titles, whose distribution isn’t as profitable as distribution of the newest releases, especially ‘triple-A video games’. Moreover, the fast-growing digital industry offers opportunities for effective development of the business and acquirement of new competitive advantages. However, one of the threats is that Steam will further strengthen its position in the market. Please refer to the Appendix 12 for the SWOT analysis.
Share of Digital Distribution Share of physical copies
Source: The team estimate.
6
Figure 14 Global Games Market 2012-2017
Investment summary 102,9
70,4
12,7
2012
2013
26,3
21,8
17,6
95,2
88,4
81,4
75,5
2014
2015
Sustainable improvement of financial position
30,7
2016
35,4
2017
Total Games Revenues (in bn)
Source: NewZoo. Figure 15 CD Projekt S.A. stock price and WIG20 index performance in the last 5 years CD Projekt
So far, CD Projekt has not paid any dividends to its shareholders. It also do not use long-term loans. The company benefits from such political conditions as e.g. the fact that Polish companies can utilize European Funds as members of EU with developing economies.
Possible Investment Risk
Mobile Game Revenues
1600%
The CD Projekt financial situation in short-range forecasts is acceptable for current investors and for those who would like to invest short-term basis, especially among Polish stock companies. CD Projekt is approaching the release of its new valuable product, namely The Witcher 3: Wild Hunt, which seems the most significant driver for the growth of the company’s future value.
WIG20
1400%
Investors should be aware of two risks with the highest impact on the company and its profitability, apart from high fluctuations of exchange rates. The company has to expand its activities, adapt to rapidly changing trends in consumers’ needs and also keep on updating its strategic goals. One of them is perception of developed game risk - if product does not meet gamers expectation, the final sales results will be significantly lower than our estimates. Moreover, the huge impact on the structure of CD Projekt’s revenues has seasonality of the game sales. The rest of investment risks has been identified in Investment Risk section.
Hold the Witcher’s producer
1200%
Our recommendation for CD Projekt S.A. is to Hold stocks with a target price PLN 16.27, which is very similar to its current price of 16.16 (estimated change over the next year is roughly 0.3%). The analysis in terms of attractiveness of the whole industry and prepared valuations confirms strong position of CD Projekt S.A. on the market. CD Projekt has a leading position within the Polish WIG Informatics index and it is the leader on the domestic market as a video game developer and as a provider of different types of entertainment.
1000% 800% 600% 400% 200%
Valuation Methods
0%
Source: The team estimate, Stooq.pl. Data as of January 29, 2015 (Base=100% for January 29, 2010).
Our target price was derived by using the Discounted Free Cash Flow method. The approach was chosen because the company’s sales have significant a seasonal factor. By 6 years period, we captured 2 such periods which lasts 3 years each. Our terminal growth (3%) derives from the strong fundamentals of the Polish economy. We assume that both video game development and digital distribution will still grow but slower while the physical distribution in Poland business will be sold in 2016.
Industry overview and its prospects
Table 2 Total Sales until 2020 forecast for the Witcher 3
The company is operating in a steady growing entertainment industry. Consumers are spending more on entertainment and media YoY – 6.4% of annual increase. The rapid development of new technologies and continuously rising consumer demand are the reasons for which further growth directions have been appearing. Looking at global gaming market, its revenues are expected to increase to over $102bn, with its fastest-growing market segments being mobile phone and tablet games as well, with respectively CARG of 15.2% and 28.2%.
Doubtful long-term increase
Retail Distribution
Digital distribution
The US
1 493 100
614 900
2 108 000
Europe and the rest
3 348 000
1 397 900
4 745 900
According to our calculations nearly 70% of the company’s future assets of the company are going to consist of cash. This fact may lead to a conclusion that the management should implement a well-thought-out strategic plan to guarantee stable long-term prosperity of the company. As the company’s cash generation ability is relatively high, it should use its own funds to create and implement a new investment project. Otherwise, the business is going to be unprofitable.
Sum
4 841 100
2 012 800
6 853 900
Valuation
Sum
Source: The team estimate. Table 3 Total Sales until 2020 forecast for Cyber Punk 2077 Retail Distribution
Digital distribution
The US
1 255 000
598 000
1 853 000
Europe and the rest
2 936 000
1 425 000
4 361 000
Sum
4 191 000
2 023 000
6 214 000
In order to valuate CD Projekt S.A., we used 2 methods – DCF model and ratios model, with weights of 100% and 0%, respectively. The first method consists of the estimated cash flows in the following 5 years (2015-2020, and partially – 2014), with taking into account different scenarios. The ratio analysis has a zero weight because we assume this business too cyclical. Several ratios, such as P/E may be not too accurate because Price discounts expectations of future earnings while Earnings (Net Profit) are strictly accounting-driven measure.
Sum
DCF Model Sales
Source: The team estimate.
Video games development We have estimated Sales according to other AAA games (Table 2, more in Appendix 19). The most convenient video game which is comparable in both production cost and genre is Destiny (Appendix 17). We consider it also as a game heavily based on preorder sales. Additionally, it was released in the middle of 2014. Also counted how does the game sales outside the EU and US (Appendix 26) The next step were estimations of the console base. It is important to notice that The Witcher 2 was released when there had already been dozens of millions of PS3. To estimate how much the fact
7
Figure 16 Estimation of Sales as a percentage of Total Sales of The Witcher 3 and Cyber Punk 2077 in the following years after a game release 60.4% Median Mean
19.2% 5.3%
2.8%
6.6%
1
2
3.4%
3
Our assumption is that a fraction of gamers who will buy the CDP’s product is going to be the same as in the case of Dragon Age 3: Inquisition. We consider the mentioned game as a good indicator as it is also from RPG genre and had a similar budget. To estimate the sales pattern of both The Witcher 3 and CyberPunk 2077, we used the median value of sales for 7 AAA video games (Call of Duty, God of War, Tomb Rider, and others), which was released in the 1st or 2nd quarter of the year. We have omitted the releases during Christmas time (Appendix 24-25).
46.5%
14.9%
of a lower number of consoles affects sales of The Witcher 3, we have used historical data of the new generation consoles in the last months.
4
By calculating the whole pattern of triple-A video games sales, we have assumed that in the first year, The Witcher 3’s sales will equal to over 60% of its lifetime sales (Figure 16). Among other things, in conjunction with very high hardware requirements we decided, however, to flattening of sales to 50% in the first year (Appendix 14). Five independent report results are that video games market is going to grow dynamically with the medium value equals to 8.2% CAGR (Appendix 12). Moreover, Newzoo has published estimations from which we can read that PC/MAC will be growing to 2017 by 3.3% (CAGR) while for TV consoles this rise will equal to 0.8% (Appendix 10.4). Based on the Newzoo data, we calculated how it will shape the relation of sales between consoles and PC and average growth (Appendix 18-19).
Source: The team estimate, VGChartz.com.
The CybePunk77 estimate is performed in the same way as in the case of the W3, however, we believe the total sales will cover only 85% of total sales for the W3. It is due to the fact that The Cyberpunk, as a brand, is relatively unknown outside the U.S (Table 3, more in Appendix 22).
Figure 17 GOG.com Sales Sales
EBITDA
CAGR
350%
70%
300%
60%
250%
50%
200%
40%
150%
30%
100%
20%
50%
89%
38%
39%
38%
35%
33%
0%
10% 0%
2011
2012
2013
2014E 2015E 2016E
Source: The team estimate.
Physical distribution GOG Video game development
100 000
50 000
0 2014F 2015F 2016F 2017F 2018F 2019F
Source: The team estimate. Table 4 Weighted Cost of Capital for CD Projekt S.A. Poland 10Y Bond YIELD (R F rate)
2.29%
Equity Risk Premium
5.07%
Risk for the Polish market SEM
4.92%
Risk for the US market SUS
3.72%
Country risk premium
1.63%
Beta monthly data
1.17
Adjusted monthly beta
1.11
WACC
Source: The team estimate, Stooq.pl.
After 5 years, we assume the stabilization of Sales (low price, much more consoles, more customers in the emerging markets). GOG In the next years, Sales for GOG will increase, however, much slower than as of 2014. It is because there is a limited number of old titles to acquire that can be sold on the GOG platform. We think that the growth in Sales will be partially driven by entering new segments of the market, such as movies and newer titles (from 2010s). Between 2014 and 2016 CAGR in Sales will converge to 6.4% and this value has been a base for estimation for years 2016-2020.
Margins
Figure 18 Net profit breakdown
150 000
In our estimation, total units sold will be divided equally between the U.S. and Europe while the rest of the world share will equal to 16.9%. We have assumed that a factor of growth in total revenues lies in gamers from Asia, Africa, and Latin America. As previously mentioned, though video games market will be growing, this tendency is going to shrink in the developed countries. The expected growth for those 2 regions is weak and equals to nearly 0%-2%.
10.12%
Video games development We have assumed that margins will be lower in case of video games developing and GOG.com. In the first case, it is due to the increasing cost of labour. We believe that salaries of high specified knowledge workers will converge to the Western Europe and North America numbers. Thus, EBITDA margin will decrease. GOG Our expectations are that margins for GOG will decrease. The strategy of acquiring old titles is going to change because of capacity of the old video games market, as mentioned in the previous section. CD Projekt will have to switch to acquisition of newer titles. As a unit cost of more recent video games is higher, we believe it will surely affect margins in a negative way. At this point, GOG is a niche entity and the leading one in its segment. Having a position of a monopsonist helps the company to improve its additional markup. With newer titles, by which we mean video games from 2010s, the entity is going to position itself in a much broader and competitive market.Full graph of EBITDA margin is in Appendix 18. Retail distribution In this segment, margins will remain constant as the company does not consider any changings in the near future, except for eventual selling this part of the business.
WACC In our estimation, calculated Weighted Cost of Capital equals to 10.12%. We have utilized CAPM model by performing regression of CD Projekt’s stock monthly returns against monthly returns of WIG20. Period used for calculations consisted of the last 5 years (period between December 31, 2009 and December 31, 2014). Obtained Beta coefficient equals to 1.17 and this value is justified over the whole forecast period as we believe its core business, which is still game development and digital distribution, will not change anytime soon. We think that diminishing share in revenues from retail distribution will be offset by a greater share of GOG, which operational risk is the similar. The company does not have any debts, as of 2014, and does not wish to have any in the future. Therefore, WACC equals to Cost of Equity.
CAPEX The core business of CD Projekt is not capital intensive. Most of its costs are incurred immediately, e.g. for salaries for its employees. Therefore, we think CAPEX will equals to roughly 1.3mn a year in the analyzed period.
Dividends We assume that the company is going to continue no dividend policy. CD Projekt relies on 100% self-financing, so we assume it wants to have some buffer in the future.
8
Tax We have assumed that tax rate will remain constant over the period of our analysis.
Terminal Value The terminal value was based on the average cash flow in years 2017-2019. This assumption captures the whole cycle for the company – from a year before a game release, through a game release year, to a year after a game release. Additionally, we assumed terminal growth to be 3% as we believe it is the long-term GDP growth in Poland. Table 5 Cash Flow and Terminal Value Forecast mn PLN
2014E
Net Sales
2015E
2016E
2017E
2018E
2019E
159 882
499 659
250 223
251 052
567 195
228 405
EBIT
5 056
146 548
55 235
64 125
150 473
49 968
NOPLAT
5 902
172 633
90 262
77 593
187 383
61 352
676
694
720
749
779
812
6 578
173 326
90 982
78 341
188 162
62 164
+ Depreciation = Net Operating Cash Flow CAPEX
3 848
-1 177
-1 239
-1 305
-1 376
-1 452
Change in NWC
-18 461
63 597
-72 697
242
92 138
-98 738
=Free Cash Flow
28 888
108 553
162 441
76 795
94 648
159 451
=Discounted Cash Flows
28 888
98 581
133 967
57 516
64 376
98 489
PV of Cash Flows
481 816
Discounted Terminal Value
1 063 389
WACC
10.1%
Equity Value
1 545 205
Number of shares (in mln)
94.95
Share price
16.27
Source: The team estimate.
Sensitivity Analysis In this section, we have performed the sensitivity analysis with WACC and Terminal growth as variables. Default values, based on DCF model, were 10.12% and 3%. In the following matrix of results, we have shown the dependence of price on WACC and Terminal growth. The values differ significantly and this is determined by the fact that we have estimated only 31% of value by Discounted Cash Flows in years 2014-2019. The most of variation comes from Terminal growth factor. Due to the fact that we have estimated Terminal Value with Gordon Model, the results are especially sensitive when Terminal growth converges to WACC. Table 6 Sensitivity matrix for CD Projekt stock price WACC
Terminal growth
7%
8%
9%
10%
11%
12%
13%
0%
17.95
15.84
14.19
12.86
11.77
10.86
10.08
1%
20.17
17.46
15.41
13.81
12.52
11.47
10.58
2%
23.29
19.61
16.98
15.00
13.45
12.20
11.18
3%
27.96
22.64
19.08
16.52
14.60
13.10
11.89
4%
35.74
27.17
22.01
18.56
16.08
14.22
12.76
5%
51.30
34.72
26.41
21.41
18.06
15.66
13.85
6%
97.99
49.83
33.74
25.68
20.83
17.58
15.26
Source: The team estimate.
Comparable Valuation We think that comparable valuation approach is not suitable for CD Projekt. First of all, CD Projekt releases one game for every few years. Profits from developing games are the most important drivers of earrings but are very violate due to the fact that roughly 60% of them is generated in the first year. International peers release games every year, their profit are more stable. Secondly, in last quarter’s ,due to lack of release of new games, 47% of CDP gross profit was derived from sales of games via GOG.com platform. The digital distribution segment is not such an important driver of profit for peer’s companies. Steam, the major international competitor in digital distribution, is not a public-listed company and its financial data are not distributed into public and hence could not be used for valuation. We have performed peer group multiples analysis. The group consists of the major international competitors such as Activision Blizzard, Electronics Arts, Ubisoft Entertainment, and other game developers and distributors. Finally, we have excluded Ubisoft Entertainment from comparable valuation because its impact on mean has been too huge due to extremely high P/E in comparison to others.
9
Financial Analysis We have used financial ratio analysis to research the ways in which CD Projekt is currently performing and compare these results with the past performance and financial situation of the company.
Self-financing and cash generation abilities The company mainly uses internally-generated funds to finance and expand its activities. In addition, CD Projekt has effectively utilised grants received from the EU to realise its projects. In our opinion, cash generation ability of the company’s core activities, especially future earnings from sales of The Witcher 3: Wild Hunt and Cyberpunk 2077, and also revenues from distribution via digital platform will be enough to cover expenses in a long-term perspective. The liquidity ratios have confirmed CD Projekt’s ability to meet its obligations without any difficulties (Current Ratio 2012: 2.48 2013: 2.72). We predict such a trend will increase in the estimated period. The amount of the most liquid possessed assets will be 3 times greater than shortterm debts in 2017 (Cash Ratio 2017E: 3.2). For more key financial ratios please see Appendix 4. In previous years, it took the company only 66 days on average to collect account receivables. Payments are being carried out so quickly in view of the most commonly used method – made by credit cards. That’s why, in our opinion, this trend will continue in the projected period. The average inventory days ratio was 97 days during the period between 2011 and 2013, however, the ratio for 2013 amounted to more than 133 days due to ongoing preparation for the huge release. We expect that the ratio will increase to an average of 132 days in the period of forecast due to the work of games development in progress and the physical delivery of future titles.
Profitability Ratios Gross Profit Margin decreased over the years 2011-2013, but it is still over 40%. The changes of margins may depend on the product lifetime. Developing of the main product – video game, which generates the majority of changes in revenues and costs of sales, is a long-term process. After the releases of The Witcher 3: Wild Hunt and Cyberpunk 2077 (2015E – 2018E), Gross Profit Margin is expected to remain above 50%. Other businesses (GOG.com, cdp.pl) are generating a rather sustainable profit YoY. Costs are balanced by revenues. Maintaining constant correlations, the Gross Profit from sales increases while the costs are lower or while the scale of sales expands. In the researched period 2010-2013, the company was still building up their core business – developing of video games. The quality of their products improves so that total costs were constantly growing. We assume that usually the release of a new video game is a reason, which has the main impact on gross profit from sales. The changes are cyclical, but the Gross Profit Margin of CD Projekt Capital Group is rather stable thanks to profits from other businesses. Operating Margin as well as Gross Profit Margin could be analysed in the context of product lifetime and thus Operating Margins is expected to reach the highest rates in years 2015E: 29.3% and 2018E: 26.5%, while the company’s’ main products will be released. To confirm, it is worth noting that the highest ratio in 2011-2013 was recorded while The Witcher 2: Assassins of Kings was released (2011: 20.3%). Calculation of a Net Profit Margin shows us that every PLN of sales allowed to the company earn: 17.6% in 2011, 17.1% in 2012 and 10.5% in 2013. According to our calculation, during the forecasted period, the CD Projekt will be able to cover its operating costs including indirect costs. Return on Assets displays that CD Projekt is able to turn its assets into profit. Even comparing CD Projekt ROA in 2013 (6.8% - the lowest one in 2011-2013) to its global competitors like Ubisoft (5.5% - the highest one in years 2011-2013) or Take-Two Interactive Software Inc (4.8% - the highest one in years 2011-2013) the situation of a Polish company seems to be favourable. CD Projekt has found the way to operate more efficiently against its competitors. We expect future level of return on assets ratios to be an average of 8% in mid-term. However, ROA is estimated to amount only 1% in 2014E due to delays in the process of game development.
Figure 19 Matrix risk for the CD Projekt
Return on Equity forms as follows: 19.4% in 2011, 18.6% in 2012, 8.9% in 2013. In comparison with CD Projekt ROEs, Polish Treasury 10-Y Bonds return was about 6.07%, 5.91%, 3.73% and 4.35% YoY in the analysed period. Our analysis shows that levels of ROE in 2015E-2019E will be attractive for investors, however it should be taken into consideration that a potential for further and stronger growth is highly limited. There is a strong correlation between results of ROE and games’ releases. The company's profits depend on the quality of developed and sold products and therefore the purchasers’ satisfaction.
Investment Risks Concentration of Revenue Among Top Titles ‘Hit’ titles earn a significant portion of total revenue in each segment. According to The NPD Group, in 2013 the Top 10 bestselling titles accounted for 38% of the sales in the industry in the USA in comparison to 30% in 2012. Market participants expect that trend will be continued in the industry. The CDP needs to deliver the best games in each segment. otherwise revenue could significantly drop. (Activision Blizzard Inc. Annual Report 2013, Electronic Arts Annual Report and Proxy Statement 2014). Please be informed that detailed analysis of Investment Risks is presented in Appendix 34, 35 and 36.
Source: The team estimate.
10
Console and Equipment Figure 20 Estimated sales vs Metacritic rating
Introduction of new console system produces additional cost of switching. During transitory period game developer release titles on both console, what is costly. Constant improvement in game quality is the effect of increasing computing power of hardware. The CDP success will depend on ability to develop the best game on upcoming platforms.
Piracy Risk Entertainment software industry is highly affected by data piracy laws and consumer attitude to piracy. Intellectual protection on the internet is the key issue for the whole entertainment industry. Percentages of illegal software used by consumer differ significantly across countries. According to Business Software Alliance Survey, the global rate at which PC software was installed without proper licensing was 43% in 2013 in comparison to 42% in 2011.
Perception Of Game Source: Ars Technica. Green dots represent the median sales performer at every individual Metacritic score. Figure 21 Monthly salaries across industries in Poland and USA
USA
Poland
18 16 14 12 10 8 6 4 2 0
Perception of Game is the key point to success in the game industry. As a result of one game under consumer’s expectation, perception of a whole franchise may be harmed. The CDP could incur substantial costs and also lose both customers and revenues.
Channel Partners Risk Video games are sold to customers through channel partners as Sony, Microsoft. They have a freedom to set rates that the CDP must pay to provide games via online channels. Channel partners could change fee structures for online channels. It could adversely impact costs, which led to a loss in profitability and margins. In comparison to PC producer, Sony and Microsoft need to accept a game before release. According to ‘PWC Global entertainment & media outlook 2014-2018’ Hong Kong total game consumer spending on PC games will decrease 13% from 2013 to 2018 but spending on console game grows 22% from 2013 to 2018. It is highly probable bargaining power of console producers will increase.
Personnel Risk In this industry, human resources are essential. Good reception of CD Projekt-produced games opens their personnel opportunities to work for other companies. Salaries offered by top entertainment software producer located in the USA are greater than these offered by the CDP. Thus, this brain drainage is highly possible.
Risk of Change in Public Taste and Preferences
Source: Bankier.pl. All values on vertical axis in PLN. Figure 22 EURPLN and USDPLN exchange rates
Video games are a substitute for watching TV, going to the cinema and watching movies. According to Entertainment Software association, about 45% gamers who play more video games than they did three years ago are spending less time watching TV, going to the cinema and watching movies. Change in public preferences connected with spending a leisure time could have a negative impact on the industry.
European Union Funding CD Project use conditional funds form European Union. The company need to fulfill all provisions of agreement in other case will be obligated to return all money. The extension. The scope of EU funding show Figure 5
Risk of Change in primary devices used to play video games Constant and rapid development of personal devices like tablets and smartphone could change public preferences. Improvement of hardware system could lead to switching game player from PC and console to tablets and smartphone. According to ‘Newzoo Global Games Market Report’ global mobile games revenue is forecast to rise at CAGR of 19.1% in comparison to total game industry growing at CAGR of 8.1%. Main drivers of growth will be rising smartphone ownership which will lead to increasing access to mobile phone games.
Risk of Seasonality Video Games business is seasonal with the highest quantity of sales in the 4th quarter due to Christmas time. All delays in production could adversely impact revenue if a game would be not finished on time.
Currency Risk The CDP operates in Poland but most revenue, approximately 80%, earns in foreign currencies (U.S. dollar and Euro). Hedging position is possible only in short-time and generates costs. Change in exchange rates could adversely impact company profitability and margins. As it is shown on Figure 7, the market volatility for those quotations were especially high during the crisis. If it occurs the next time, CD Projekt will suffer from it with a high probability.
Source: The team estimate, stooq.pl. Left axis contains values for exchange rates, right axis contains 60 days standard deviations of log returns for quotations.
11
APPENDIX Appendix 1 Comprehensive balance sheet in years 2011-2019 ASSETS
2018E
2019E
94 964
108 690
122 588
194 413
442 647
479 997
557 208
810 400
799 950
9 819
26 866
39 684
68 572
177 124
339 565
416 360
511 008
670 459
Receivables
32 757
35 882
20 920
29 759
84 078
42 105
42 245
95 442
38 434
Inventories
31 112
33 367
51 966
85 626
166 498
83 380
83 657
189 003
76 110
Other current assets
21 276
12 575
10 018
10 456
14 947
14 947
14 947
14 947
14 947
Fixed assets
90 762
94 202
95 047
94 206
96 644
100 339
104 305
108 564
113 136
Current assets Cash and cash equivalents
PPE Intangible assets
2011
2012
2013
2014E
2015E
2016E
2017E
9 924
10 755
11 187
6 663
7 146
7 665
8 221
8 817
9 457
77 923
34 801
36 403
40 122
43 080
46 257
49 668
53 330
57 262
2 002
46 417
46 417
46 417
46 417
46 417
46 417
46 417
46 417
913
2 229
1 040
1 004
Long-term investments Goodwill Other non-current assets Total assets LIABILITIES Current liabilities
185 726 2011
202 892 2012
217 635 2013
288 619 2014E
539 291 2015E
580 336 2016E
661 513 2017E 130 255
918 964
913 085
2018E
2019E
196 661
125 498
54 327
43 758
44 991
106 390
182 475
130 081
Payables
28 869
104 954
52 559
52 734
119 140
47 977
9 583
Other current liabilities
25 458
61 196
7 568
53 657
63 335
82 104
120 672
196 661
125 498
Long-term liabilities
7 590
7 604
5 276
6 651
6 651
6 651
6 651
6 651
6 651
Short-term borrowing
Long-term liabilities Other non-current liabilities Equity
Retain earnings
7 590
7 604
5 276
6 651
6 651
6 651
6 651
6 651
6 651
123 809
151 530
167 368
175 578
350 165
443 604
524 607
715 652
780 937
201 655
200 150
208 256
220 834
220 834
220 834
220 834
220 834
220 834
101 530
76 459
55 987
54 133
51 182
62 340
111 530
161 748
274 274
278
286
199
5 926
Other equity components Net income Total liabilities and equity
23 962
28 125
14 900
2 951
113 522
49 190
50 218
112 526
40 420
185 726
202 892
217 635
288 619
539 291
580 336
661 513
918 964
913 085
Source: The team estimate, CD Projekt data. Appendix 2 Profit and loss statement in years 2011-2019 P&L STATEMENT
2018E
2019E
136 210
164 040
142 172
159 882
499 659
250 223
251 052
567 195
228 405
COGS
54 504
89 618
83 186
114 214
215 619
112 426
117 567
239 636
118 207
Gross profit (loss) from sales
81 706
74 422
58 986
45 668
284 040
137 797
133 485
327 559
110 198
SG&A
49 567
38 306
40 874
41 344
138 044
85 139
70 075
180 679
60 871
4 517
7 749
3 238
732
552
2 577
716
3 593
641
27 622
28 367
14 874
5 056
146 548
55 235
64 125
150 473
49 968
Sales revenues
Other net expenses EBIT Net Financial Revenues
2011
2012
2013
2014E
2015E
2016E
2017E
393
80
2 316
4 958
2 803
6 842
2 429
10 204
2 092
EBT
28 015
28 447
12 558
10 014
149 351
62 077
66 554
160 677
52 060
Tax Expense Profit from continued operations Profit from discontinued operations
3 267
162
2 339
5 487
23 282
9 058
11 038
26 706
9 292
24 748
28 285
10 219
4 527
172 633
71 135
77 593
187 383
61 352
Net Profit
24 748
28 285
10 219
4 527
172 633
77 593
187 383
61 352
19 127 90 262
Source: The team estimate, CD Projekt data.
12
Appendix 3 Cash flow statement in years 2011-2019 CASH FLOW STATEMENT Net Profit
2011
2012
2013
2014E
2015E
2016E
2017E
2018E
2019E
27 229
28 125
14 851
4 527
172 633
90 262
77 593
187 383
1 536
1 978
2 617
676
694
720
749
779
812
Change in NWC
14 427
5 920
4 506
18 461
63 597
72 697
242
92 138
98 738
Change in long-term liabilities
10 517
2 436
4 990
Change in other equities
14 595
1 711
6 231
Total Operating Cash Flow
10 774
23 458
24 183
23 665
109 730
163 679
78 099
96 024
160 902
CAPEX
2 634
3 939
4 108
3 848
1 177
1 239
1 305
1 376
1 452
Change in Financial Asset
3 865
3 512
143
1 177
1 239
1 305
1 376
1 452
Depreciation
Investment Activities Total cash from investing Cash flow from financing
61 352
260
302
162
6 239
125
4 127
3 848
263
9 523
5 109
1 375
263
(9 523)
(5 109)
1 375
-
-
-
-
-
5 791
17 047
12 818
28 888
108 553
162 441
76 795
94 648
159 451
15 610
9 819
26 866
39 684
68 572
177 124
339 565
416 360
511 008
9 819
26 866
39 684
68 572
177 124
339 565
416 360
511 008
670 459
Dividend paid Total cash flow financing Net change in cash Beginning cash Ending cash
Source: The team estimate, CD Projekt data. Appendix 4 Ratios in years 2011-2019E RATIOS
2011
2012
2013
2014E
2015E
2016E
2017E
2018E
2019E
Gross Profit Margin
60.0%
45.4%
41.5%
28.6%
56.8%
55.1%
53.2%
57.8%
48.2%
Operating Margin
20.3%
17.3%
10.5%
3.2%
29.3%
22.1%
25.5%
26.5%
21.9%
Net Profit Margin
17.6%
17.1%
10.5%
1.8%
22.7%
19.7%
20.0%
19.8%
17.7%
Return on Assets
12.9%
13.9%
6.8%
1.0%
21.1%
8.5%
7.6%
12.2%
4.4%
Return on Equity
19.4%
18.6%
8.9%
1.7%
40.1%
14.8%
13.1%
22.7%
7.5%
Current Ratio
1.75
2.48
2.72
1.80
2.43
3.69
4.28
4.12
6.37
Quick Ratio
1.18
1.72
1.57
1.00
1.51
3.05
3.64
3.16
5.77
Cash Ratio
0.18
0.61
0.88
0.64
0.97
2.61
3.20
2.60
5.34
66.6%
57.4%
66.9%
58.9%
19.3%
40.1%
41.5%
19.1%
49.5%
NWC Turnover
0.22
0.32
0.36
0.30
0.48
0.60
0.65
0.67
0.74
ACC Receivable Turnover
4.3
5.2
8.3
7.6
5.9
5.9
5.9
5.9
5.9
Days of Sales Outstanding
84.5
69.5
43.8
47.8
61.4
61.4
61.4
61.4
61.4
Inventory Turnover
4.38
4.92
2.74
1.87
3.00
3.00
3.00
3.00
3.00
Days of Inventory on Hand
83.4
74.2
133.4
195.5
121.6
121.6
121.6
121.6
121.6
Payables Turnover
2.51
3.75
3.16
1.50
2.74
1.92
1.93
2.88
1.82
Number of days of payables
145.6
97.4
115.5
242.9
133.3
189.7
189.4
126.6
200.6
Cash Conversion Cycle
22.3
46.4
61.7
0.4
49.7
-6.7
-6.3
56.5
-17.5
Long-Term Debt to Assets
0.04
0.04
0.02
0.02
0.01
0.01
0.01
0.01
0.01
Debt Ratio
0.33
0.25
0.23
0.40
0.35
0.24
0.21
0.22
0.14
Financial Leverage
1.50
1.34
1.30
1.65
1.90
1.75
1.73
1.86
1.71
0.25
0.30
0.16
0.03
1.20
0.52
0.53
1.19
0.43
Profitability Ratios
Liquidity Ratios
Efficiency Ratios Fixed Asset Turnover
Solvency Ratios
Shareholder Ratios Earnings Per Share
Source: The team estimate, CD Projekt data.
13
Appendix 5 Average margins and physical and digital share in distribution for The Witcher 3 and Cybyrpunk 2077 in years 2014-2019
Timeline
Average margin
2014
43.4% 43.4% 43.3% 43.5% 44.4% 44.7%
2015 2016 2017 2018 2019 Distribution
2014E
2015E
2016E
2017E
2018E
2019E
Physical
74.00%
72.57%
71.06%
69.47%
67.79%
66.02%
Digital
26.00%
27.43%
28.94%
30.53%
32.21%
33.98%
CAGR
5.50%
Source: The team estimate. Appendix 6 CD Projekt and its competition’ financials Company
PL JPY JPY JPY JPY JPY JPY
Stock Exchange WSE NIKKEI 225 NIKKEI 225 NIKKEI 225 NIKKEI 225 NIKKEI 225 NIKKEI 225
USD USD USD USD USD
NASDAQ NASDAQ NASDAQ NASDAQ NASDAQ
KARW EURO GBP
KRX EPA LON
Market Cap in B 1.56 126.36 159.49 460.08 315.35 524.58 310.07
EV/EBITDA
ROA
ROE
719.1 74.4 18.0 7.4 31.1 19.4 59.9 35.0 24.0 49.0 14.2 N/A 10.4 24.4 20.2 241.8 17.8 45
445.2
1% 3% 7% 72% 3% 6% 1% 16% 7% 0% 24% -2% 7% 7% 11% -5% 53% 13%
1% 5% 8% 120% 5% 10% 2% 25% 11% 0% 46% -2% 10% 13% 15% -8% 68% 21%
All Peers Mean (excluded Ubisoft)
29
6
CDP Projekt premium versu video games peers (exclude Ubisoft)
25
78
0.66PLN
0.29PLN
CD Projekt Capcom Tecmo Koei Holdings GungHo Online Entertainment Square Enix Holdings Namco Bandai Holdings Konami NIKKEI Peers Average Activision Blizzard Electronic Arts Take-Two Interactive Software Zynga Perfect World NASDAQ Peers Average NCSoft UBISOFT Entertainment PlayTech All Peers Mean
Currency
CD project value based on the comparables
14.80 15.17 2.48 2.39 0.95 4.77 1.81 2.01
P/E
13.8 20.2 4.0 20.0 5.7 4.7 10.4 5.3 6
Operating Margin 1% 5% 18% 56% 5% 8% 4% 16% 30% 1% 17% -8% 11% 10% 25% -10% 34% 14%
Data on 2014 2014 2014 2013 2014 2014 2014 2013 2014 2014 2013 2013 2013 2014 2013
Source: The team estimate, Yahoo! Finance.
14
Appendix 7 Game consoles sold worldwide (in millions of units)
Please be informed that the following data show the quantitative trends in cumulated and annual sales of video game consoles. These information help to indentify users and to estimate future directions in development of selected game platforms worldwide. The 20 best-selling game platforms No.
Platform
North America
Europe
Japan
Rest of the World
Global
1 2 3 4 5 6 7 8
PlayStation 2 Nintendo DS Game Boy PlayStation Wii PlayStation 3 Xbox 360 Game Boy Advance
53.65 57.37 43.18 38.94 45.37 29.00 48.26 40.39
55.28 52.07 40.05 36.91 33.75 33.45 25.57 21.31
23.18 33.01 32.47 19.36 12.77 10.21 1.66 16.96
25.57 12.43 2.99 9.04 9.28 12.07 8.99 2.85
157.68 154.88 118.69 104.25 101.17 84.73 84.48 81.51
9 10 11 12
PlayStation Portable Nintendo ES Nintendo 3DS Super Nintendo ES
21.41
24.14 8.30 13.37 8.15
20.01 19.35 18.12 17.17
15.26 0.77 3.10 0.90
80.82 61.91 50.45 49.10
13 14 15 16 17 18 19
Nintendo 64 Sega Genesis Atari 2600 Xbox Game Cube PlayStation 4 Xbox One
20.11 16.98 23.54 15.77 12.55 7.51 6.87
6.35 8.39 3.35 7.17 4.44 7.39 2.91
5.54 3.58 0.53 4.04 1.01 0.05
0.93 0.59 0.75 1.18 0.71 2.69 1.27
32.93 29.54 27.64 24.65 21.74 18.60 11.10
20
Game Gear
5.40
3.23
1.78
0.21
10.62
33.49 15.86 22.88
Source: VGChartz. Appendix 8 Global unit sales of current generation video game consoles from 2008 to 2012 (in million units)
Unit sales of current generation video game consoles Video game console
2008
2009
2010
2011
2012
2013
Sony Playstation 3
10.2
13
14.18
15.09
12.98
8.94
Sony PSP
14.05
9.86
9.61
7.71
4.5
3.08
3.77
3.12
Sony Playstation Vita Xbox 360
10.91
10.16
13.53
14.07
11.33
6.11
Nintetndo Wii
24.19
21.3
17.68
11.83
5.36
2.06
2.37
3.09
8.86
3.05
0.82
13.72
14.91
14.74
Nintetndo Wii U Nintendo DS Nintendo 3DS
29.66
27.57
20.97
Source: Statista
15
Appendix 9 Global trends: Expenditures on media and entertainment 1.
Total spending by region from 2013 to 2018 Total spending on entertainment and media by region (in mn USD) Region
2013
2014
2015
2016
2017
2018
2013-2018 CAGR
North America
448 930
476 142
497 816
527 166
552 123
584 809
5.4%
Western Europe
396 362
406 626
419 349
434 316
450 186
467 433
3.4%
Central and Eastern Europe
56 715
61 425
66 936
72 735
78 935
85 462
8.5%
Middle East-Africa
35 012
39 871
44 727
50 977
57 722
65 203
13.2%
EMEA total
488 089
507 922
531 012
558 028
586 843
618 098
4.8%
Asia-Pacific
506 855
547 672
591 305
637 993
685 338
734 395
7.7%
Latin-America Total
111 477
125 360
137 802
154 536
169 760
187 153
10.9%
1 555 351
1 657 096
1 757 935
1 877 723
1 994 064
2 124 455
6.4%
Source: Global Media Report 2014, McKinsey&Company 2.
Spending by digital and non-digital status worldwide from 2013 to 2018 Global spending by digital/non-digital status (in mn USD) Status
Digital* Non-digital Total
2013
2014
2015
2016
2017
2018
624 058 931 293 1 555 351
704 940 952 156 1 657 096
787 642 970 293 1 757 935
877 022 1 000 701 1 877 723
971 163 1 022 901 1 994 064
1 069 251 1 055 204 2 124 455
2013-2018 CAGR 11.4% 2.5% 6.4%
Source: Global Media Report 2014, McKinsey&Company * Digital consists of spending on broadband, transactional video-on-demand through TV subscription providers, OTT transactional digital video, OTT subscription digital video, digital recorded music downloads, digital recorded music-streaming subscriptions, consumer magazine digital circulation, daily newspaper digital circulation, electronic consumer books, digital learning materials, online video games, and mobile video games 3.
Total global spending on entertainment by category Total global spending on entertainment by category (in mn USD) Category
2012
2013
2014
2015
2016
2017
2018
In-Home Video Entertainment
270.59
283.084
296.49
311.168
325.943
340.694
355.112
Audio Entertainment
93.567
96.544
96.376
98.009
100.337
102.965
106.049
Cinema
35.914
37.223
39.184
41.226
43.383
45.629
47.901
Out-of-Home
30.27
31.822
33.604
35.496
37.713
39.997
42.388
Consumer Books
70.574
71.454
71.958
72.532
73.13
73.635
74.084
Video Games
63.698
70.028
77.455
85.284
93.285
101.308
109.31
Source: Global Media Report 2014, McKinsey&Company
16
Appendix 10 Global Trends of Game Market
1.
Gamers and revenue in 2014E
2.
2013-2017 Global Games Market
Global Game Market 2013-2017, in %
Global Game Market in 2014E by gamers and revenue Region
Gamers
Revenue (in bn)
Market Segment
Total
1 775 489 000
81.4
TV Console Games
LATAM
185 180 000
3.3
NAM
195 016 000
22.2
APAC
826 544 000
36.8
MEA
230 435 000
1.4
EU
338 314 000
17.7
2013 2014 2015 2016 2017 31 6 6 17 10 20 10
29 4 8 19 9 22 9
27 3 10 20 9 22 9
25 3 11 21 8 23 9
24 2 12 22 8 23 9
0.8 -14.7 28.2 15.2 3.3 11.2 5.8
75.6
81.5
88
95.2
102
8.1
Handheld Games Tablet Games Mobil Phone Games (Mid)-Core PC/Mac Games MMO Games Casual Webgames Total Revenue in bn USD
CAGR in %
Source: NewZoo Source: NewZoo
3.
Global video game markets, segmented by forecast rate of growth and scale, 2013-2018
Lower-growth, larger-scale Markets worth more than 750mn USD in 2018 but less than 7% CAGR to 2018
Higher-growth, larger-scale Markets worth more than US 750mn USD in 2018 and 7% or more CAGR to 2018
North America: Canada, US APAC: Australia, China, Japan, South Korea EMEA: France, Germany, Italy, Netherlands, Spain, UK
APAC: India EMEA: Russia Latin America: Brazil, Mexico
Lower-growth, smaller-scale Markets worth less than 750mn USD in 2018 and less than 7% CAGR to 2018 APAC: Hong Kong, Malaysia, New Zealand, Pakistan, Taiwan EMEA: Austria, Belgium, Denmark, Finland, Greece, Ireland, Norway, Portugal, Sweden, Switzerland, Israel, Romania, Rest of MEN
Higher-growth, smaller-scale Markets worth less than 750mn USD in 2018 and 7% or more CAGR to 2018 APAC: Indonesia, Philippines, Singapore, Thailand, Vietnam EMEA: Czech Republic, Hungary, Poland, Turkey, Egypt, Saudi Arabia, UAE, Kenya, Nigeria, South Africa Latin America: Argentina, Chile, Colombia, Peru, Venezuela
Source: Global entertainment and media outlook 2014–2018, PwC. 4.
Estimated CAGR of global game market segment
CAGR in 2013-2018 of game market segments Casual Webgames
5.8%
MMO Games
11.2%
(MID) - Core Games
3.3%
Mobile Phone Games
15.2%
Tablet Games
28.2%
Handheld Games
-14.7%
TV/Console Games
0.8%
Source: Newzoo
17
Appendix 11 Porter’s five forces analysis for CD Projekt RED Studio Threats of New Entrants
5 4 3 Bargaining Power of Suppliers
2 1
Bargaining Power of Buyers
0
Threat of Substitute Products
Competition in the Industry
Final rating: 3.8 1.
Threat of New Entrants a. low legal barriers to do business b. high operating expenditures are needed, although low registered capital is necessary c. fast-growing video game market d. difficulties with gaining publishers’ and distributors’ trust e. growing digital market attractiveness for new independent developers
2.
Bargaining Power of Buyers a. great number of potential buyers worldwide b. huge product differentiation c. aware and mature gamers with defined expectations d. high diversification of video game buyers e. unlimited availability of substitutes
3.
Threat of Substitute Products a. easier, wider and cheaper access to traditional entertainment like movies, books, audiobooks, board games b. fast-growing digital entertainment market, especially apps and games for portable devices c. growing use of tablets and smartphones due to social changes and necessity to commute d. spending leisure time in an active way as a result of healthy lifestyle trends
4.
Competition in the Industry a. a few leading developers heavily competing on a global market b. high growth rate of game industry c. huge involvement of fixed costs in game development d. high level of product differentiation because of original character of each product
5.
Bargaining Power of Suppliers a. lack or marginal role of external suppliers cooperating in a process of developing a game b. necessity of hiring highly qualified professionals - suppliers of know-how c. medium-concentrated market of publishers d. advantage with forward integration – publishers becoming competitors for developers
18
Appendix 12 SWOT Analysis for GOG.com
S
• international cooperation with publishers and developers (more than 200 partners worldwide), • synergy effect of capital group - support by distribution of games developed by CD Projekt RED Studio and loaning money within the group, • high quality of customer service: consumer loyalty programs, in-home supportive service, bonuses and other conveniences such as ”30 days Money Back Guarantee” • acceptance of payment in different currencies (USD, EUR, GBP, AUD and Rubles), • auto-updating platform GOG Galaxy, which could enhance usage of GOG.com as a link between gamers from GOG.com and STEAM;
W
• lack of DRM system - no protection against unauthorized users and illegal copying, • focus on sales of old titles - smaller scale of operation and thereby lower revenues, • lack of A-triple video games in sales offer (apart from The Witcher 3: Wild Hunt), • limited range of marketing activities, • offer addressed to PC owners, who enjoy doing online shopping, not meeting the needs of gamers who prefer to have a traditional ‘box’-edition;
O
• changes of customers’ habits - traditional methods of distribution replaced by digital methods • suceeding proccess of game development by partners, • further development of new technologies, • wider access to the Internet, • decreasing viability of physical distribution of classical games (costs of transport, packaging);
T
• high concentration in the digital distribution market, • deepening problem of illegal online activities, • further development of the market leader (Steam) at the expense of smaller, independent distributors, • changes in customers’ attitude towards a digital sales channel, • risk that offered games may not meet customers’ expectations;
Source: The team’s estimation.
19
Appendix 13 The profile of a gamer, based on The 2014 Essential Facts About the Computer and Video Game Industry, ESA
The following data show characteristics such as age, gender, types of game spending and needs of world game-population. Selected facts inform about interesting trends in the game industry. It’s worth mentioning that that the group representing the majority of players is potential purchasers of game developed by CD Projekt Red Studio. The company’s products are targeted to mature and aware gamers appreciating high quality. 1.
Age of game players
2.
Gender of game players
29% 39% 48%
52%
32%
under 18 years 3.
18-35 years
36+ years
male
female
Total Consumer Spend on Games Industry 2013 18 16 14 12 10 8 6 4 2 0 Content
4.
Hardware
Accessories
Best-Selling Computer Games by Units Sold in 2013 Strategy Other Games/Complications Action Adventure Arcade Casual Children's Entertainment Family Entertainment Flight Racing Role-Playing Shooter
Facts: “Adult gamers have been playing for an average of 16 years, with adult men averaging 18 years and adult women averaging 13 years.” “The number of female gamers age 50 and older increased by 32% from 2012 to 2013.” " Smartphone and wireless device use increased by 22% and 37%, respectively, over 2012.”
20
Appendix 14 – The profile of an average Polish gamer 1.
Frequency of playing games* 3%
2.
Time spent playing games* (a week)
1%
to 10 hours Everyday
18%
8%
25 hours and more
11%
2-3 times a week once a week
36%
20-24 hours
15%
15-19 hours
occasionally
78%
10-14 hours
30%
3.
Devices used to play games*
Net salary working gamers (in PLN)
92% lack of information more than 3200
50%
2401-3200
36% 1601-2400
12%
801-1600 to 800
Computer
Mobile Phone or Tablet
Console
Handheld console
0%
10%
20%
30%
40%
Source: Jestem graczem, Ipsos 2014 Appendix 15 Expectation of CAGR for global games markets
PwC IDC Gartner DFC Newzoo
Average
7.2% 9.3% 10.5% 6.0% 8.1% 8.2%
Source: Global Games Market Newzoo Note: Compound annual growth rates cover different periods: PwC (2012-16), IDC (2011-16), Gartner (2011-2015), DFC(2012-17), Newzoo (2012-2016).
Appendix 16 The Witcher 3: Wild Hunt PC system requirements
Minimum System Requirements Intel CPU Core i5-2500K 3.3GHz AMD CPU Phenom II X4 940 Nvidia GPU GeForce GTX 660 AMD GPU Radeon HD 7870 RAM 6GB OS 64-bit Windows 7 or 64-bit Windows 8 (8.1) DirectX 11 HDD Space 40 GB
Recommended System Requirements Intel CPU Core i7 3770 3.4 GHz AMD CPU AMD FX-8350 4 GHz Nvidia GPU GeForce GTX 770 AMD GPU Radeon R9 290 RAM 8GB OS 64-bit Windows 7 or 64-bit Windows 8 (8.1) DirectX 11 HDD Space 40 GB
Source: The company data
21
Appendix 17 Cumulated preorders upon the Destiny release. Weeks to the game release 26 25 24 23 22 21 20 19 18 17 16 15 14 13 12 11 10 9 8 7 6 5 4 3 2 1 2 1
PS4
Xbox One
PS3
Xbox 360
326 576 331 252 338 146 344 189 349 799 353 898 363 493 376 158 387 325 395 248 402 202 410 132 417 058 446 458 502 794 542 618 586 279 644 139 700 200 754 233 782 701 820 567 852 977 874 856 902 879 935 999 902 879 935 999
284 131 288 004 293 022 298 295 302 951 306 902 321 254 330 548 337 242 344 278 350 016 356 998 364 454 374 829 397 012 419 299 443 884 495 289 536 169 592 676 642 101 673 053 695 467 710 041 726 522 750 052 726 522 750 052
60 792 61 497 62 407 63 988 64 920 65 963 68 484 70 772 72 740 74 059 76 039 78 093 79 987 81 476 83 967 85 766 88 463 96 301 106 341 121 089 130 404 133 984 137 067 137 867 140 436 144 854 140 436 144 854
132 823 134 009 135 622 137 642 139 374 141 285 145 272 148 727 152 308 155 137 157 406 159 610 162 610 165 537 169 644 173 886 178 958 196 857 213 905 245 025 266 834 282 905 289 117 293 753 303 575 326 573 303 575 326 573
Source: VGChartz. Sales of the Destiny prior to the game release helped in estimating Sales for the W3. Appendix 18 GOG Sales and EBITDA margin
Sales
EBITDA
CAGR
120 000
70%
100 000
60% 50%
80 000
40% 60 000 30% 40 000
20%
20 000
89%
39%
38%
38%
35%
33%
32%
32%
32%
32%
2014E
2015E
2016E
2017E
2018E
2019E
2020E
0
10% 0%
2011
2012
2013
Source: The team estimate, the CDP data. Values for CAGR series are on the right axis. Values on the left axis are in th PLN.
22
Appendix 19 Sales forecast for The Witcher 3 PC All values in USD the US
Timeline
Classical retail distribution
Europe and the rest
2015 10w 2015 6m
59.99 49.99
67.79 56.49
2016 2017 2018 2019
42.49 29.99 24.99 19.99
48.01 33.89 28.24 22.59
232 005 65 497 37 158 25 605
2015 10w 2015 6m 2016 2017
59.99 49.99 42.49 29.99
67.79 56.49 45.19 33.89
2018
24.99
2019
19.99
Average price Europe and the rest
the US
Sales
Unit sales Europe and rest
Unit sales in the US
Total Revenues
Sales
17 319 853 1 791 667
59.99 49.99
79.09 67.79
1 210 940 148 119
523 569 66 912
42 802 056 4 508 627
60 121 909 6 300 294
105 749 29 851 16 953 11 768
7 177 951 1 430 210 676 369 373 768
42.49 29.99 24.99 19.99
59.31 45.19 28.24 22.59
725 015 196 490 108 778 73 143
330 465 89 553 49 629 33 616
19 193 752 3 875 934 1 467 799 791 492
26 371 703 5 306 144 2 144 168 1 165 260
813 285 164 379 20 106 94 480 28 784
361 148 71 072 9 083 43 065 13 119
28 769 818 9 224 621 953 881 3 671 761 821 662
59.99 49.99 42.49 29.99
79.09 67.79 56.49 45.19
2 462 485 493 137 60 319 295 251 86 353
1 093 745 213 215 27 249 134 577 39 357
72 639 660 30 794 434 3 243 344 13 342 601 3 011 425
101 409 478 40 019 055 4 197 225 17 014 362 3 833 087
28.24
17 655
8 055
420 099
24.99
28.24
51 684
23 580
1 229 796
1 649 895
22.59
13 180
6 057
251 475
19.99
22.59
37 648
17 303
718 349
969 825
338 585
150 451
15 343 498
1 024 392
455 281
52 339 950
67 683 449
Sum
Digital distribution
Video game consoles
Average price Unit sales Unit Europe sales in and the the US rest 403 647 174 523 49 373 22 304
Sum
Source: The team estimate. Appendix 20 Sales forecast for CyberPunk 2077 PC
All values in USD
the US average price
Timeline
Classical retail distribution
Unit sales Europe and rest
Unit sales in the US
Sales
the US average price
Europe and the rest average price
Unit sales Europe and the rest
Unit sales inthe US
Sales
Total Revenues
2018
59.99
67.79
540 000
230 000
23 055 891
59.99
79.09
1 570 000
660 000
55 032 969
78 088 860
2019
49.99
56.49
170 000
71 000
6 009 740
49.99
67.79
480 000
200 000
14 267 409
20 277 149
710 000
301 000
29 065 631
2 050 000,00
860 000
69 300 378
98 366 010
2018
59.99
67.79
250 000
110 000
14 109 648
59.99
79.09
740 000
310 000
45 792 187
59 901 835
2019
49.99
56.49
87 000
37 000
4 046 870
49.99
67.79
250 000
100 000
12 989 718
17 036 588
337 000
147 000
18 156 518
990 000
410 000
58 781 905
76 938 424
Sum
Digital distribution
Video game consoles
Europe and the rest average price
Sum
Source: The team estimate. Appendix 21 Average fraction of SGP received by the CDP
Europe
North America
XBOX ONE / Playstation 4
PC
XBOX ONE / Playstation 4
PC
Classical retail distribution
42%
31%
55%
41%
Digital distribution
56%
56%
70%
70%
Source: The team estimate, the company data. Appendix 22 Platforms share in the next years
2013
2014
2015
2016
2017
2018
2019
2020
PC/Mac
10
9
9
8
8
8
8
8
TV consoles
31
29
27
25
24
24
24
24
PC/Mac share
24.4%
23.7%
25.0%
24.2%
25.0%
25.0%
25.0%
25.0%
TV consoles share
75.6%
76.3%
75.0%
75.8%
75.0%
75.0%
75.0%
75.0%
Source: Newzoo,the team estimate.
23
Appendix 23 Suggested and estimated retail price for the Witcher series games
$70
The Witcher
$60 $50
The Witcher 2
$40
The Witcher 3 rational
$30 $20 $10 $0 day m4 one
m8 m12 m16 m20 m24 m28 m32 m36 m40 m44 m48 m52 m56 m60 m64 m68 m72
Source: Steam, the team estimate.
Appendix 24 Sales in the first 10 weeks.
Game
Call of Duty: Modern Warfare 3 God of War: Ascension Tomb Rider
Platform
Appendix 25 Sales in the first year.
Sales in the first week
Sales in the first 10 weeks
Quotient
Game
Platform
Sales in the first 10 weeks
Sales till the first year
Quotient
PS3
5 091 237
10 213 861
201%
God of War: Ascension
PS3
1 169 381
1 765 174
66.25%
PS3
676 538
1 169 381
173%
Tomb Rider
PS3
1 433 701
2 130 650
67.29%
The Last of Us
PS3
3 131 268
4 374 477
71.58%
Middle Earth: Shadow of Mordor
PS4
1 579 436
1 969 566
80.19%
InFAMOUS: Second Son
PS4
1 522 589
2 172 439
70.09%
Watch Dogs
PS4
2 940 880
3 662 514
80.30%
PS3
653 396
1 433 701
219%
The Last of Us
PS3
1 319 206
3 131 268
237%
Middle Earth: Shadow of Mordor
PS4
565 699
1 579 436
279%
Watch Dogs
PS4
1 970 969
2 940 880
149%
Destiny
PS4
3 657 685
4 548 845
80.41%
Destiny
PS4
2 260 312
3 657 685
162%
Mass Effect 3
Xbox360
2 101 128
2 569 500
81.77%
Call of Duty: Modern Warfare 3
Xbox360
6 667 933
10 803 622
162%
Average
74.7%
Median
75.9%
Average Median
197.8% 186.7%
Source: VGChartz. Quotient is calculated as a division of Sales in the first 10 week by Sales in the first week.
Source: VGChartz; Quotient is calculated as a division of Sales in the first 10 week by Sales in the first week.
24
Appendix 26 Sales outside the US & the EU (in %)
Game
Platform
Call of Duty: Advanced Warfare Destiny FIFA 15 Titanfall InFAMOUS: Second son Middle Earth: Shadow of Mordor Watch Dogs The Last of Us Tomb Raider Diablo III Sims 4 StarCraft II: Heart of the Swarm Average
XboxOne XboxOne XboxOne XboxOne PS4 PS4 PS4 PS4 PC PC PC PC
Sales outside the US & the EU (in %)
8.1 7.9 11.2 7.1 23.2 24.9 26.4 24 30.1 12.8 14.2 12.5 17.6
Source: VGChartz.
25
Appendix 27 Average Rate of Unlicensed Software Use
Appendix 34 Piracy and unauthorized copying
70% 60% 50% 40% 30% 20% 10% 0%
Source: Business Software Alliance (BSA). Appendix 28 Global Self-Reported Piracy- "How often do you acquire pirated software or software that is not fully licensed?"
Always Mostly Occasionally Rarely Never Refuse
Source: Ninth annual BSA Global Software Piracy Study 2011. Appendix 29 Most Pirated Games on Web in 2010 (in millions)
Piracy and unauthorized copying is a persistent problem in an entertainment industry. The biggest risk of unauthorized copying is connected with game developed on PC. Downloading and installation of unlicensed console game from technical point of view is much harder and almost impossible in wider scale. So far, the effort to control piracy is unsuccessful. Companies in the industry take technical steps to make the piracy more difficult. Insufficient legal protection with the enforcement of intellectual property rights could be costly and time consuming, especially in countries where protection of this kind of rights is limited. Society of developing countries benefit from a less protective law because software are mostly developed by other countries. Governments do not have an motivation to enforce strive intellectual property rights. According to “Go-Gulf Online Piracy in Numbers 2010” more than 75% of PC have installed at least 1 illegal software and about 95% of music downloaded online is illegal. Finally, website with non-copyrighted content receive more than 146 Million visitors per day. According to „Ninth annual BSA Global Software Piracy Study 2011” the biggest drivers of software piracy are emerging economies. Developing countries are responsible for 56% of the world’s new PC shipments in 2011. In those countries, the rate of unauthorized software is the highest. We assume that main factors having impact on piracy are: Public Education and Attitude to Intellectual Property – Physical and Intellectual Property are treated differently in relation to theft. According to “Go-Gulf Online Piracy in Numbers 2010” 70% online users find nothing wrong in online piracy. Social welfare and Country Development – Average rate of unlicensed software is very different among countries. Correlation between economics development and piracy is observed. On the other hand, differences between countries on similar stage of development are significant. The rate of unlicensed PC software installations in Poland is 51%, in comparison to 37% in Slovakia and 34% in the Czech Republic. Effective Law – Legal frameworks are a key point in IP protection. Companies need to enforce their rights in a quick and inexpensive proceedings. IP Protection Policy – Countries governments need to support IP protection to make it effective. We believe that in many countries, especially in developing ones, governments do not have an incentive to provide effective IP protection because most of application are delivered by foreign companies.
Piracy and unauthorized copying of The Witcher 2
The unauthorized copying PC version of the Witcher and the Witcher 2 negatively affected the company revenue. According to the Company estimation about 4.5 million of unauthorized copy Prototype of the Witcher 2 was downloaded via BitTorrent. CDP take some legal actions against users who Starcraft 2 are suspected to illegally download game. the Company DRM-free policy could be questionable. Sims 3 CDP claim that don not want to punish legal customers and introduce advanced copy protection Mass Effect 2 systems. The main competitors use DRM tools to protect their games from unlicensed copying. Mafia 2 This policy create some doubts among gamers and could negatively affected CDP perception. In Battlefield: Bad Company 2 our view, for gamers quality of game and price are the most important factors which influence Call Of Duty: Modern Warfare 2 decision about purchase and introduction of DRM will not damages trust to CDP. Call Of Duty: Black Ops RPG games have a bigger share in PC game market than in console game market, 12% in comparison to 6%. We think that this proportion should be stable over time, in shooter or action 0 1 2 3 4 5 games, suitability of keyboard as playing device is limit, in other game type like strategy gamers prefer PC. In our view, company could improve their revenue by introduction additional IP Source: Go-Gulf Online Piracy in Numbers 2010. protection. According to official announcement CDP is currently working on The GOG Galaxy Appendix 30 Most Pirated Movies on Web in 2010 (in which we assume could limited problem of unlicensed copying. Street Fighter IV
Need for Speed: Shift
millions)
Our forecast of future global trend in piracy
Salt The Hurt Locker
Sherlock Holmes Green Zone Clash of Titans
Iron Man 2 Shutter Island Inception Kick-Ass
Avatar
0
5
10
15
We think that in long run piracy in the game industry will have trend downward but in short run percentage of unlicensed copy could increase. Fast developing country from Asia will become important game market as well as software producer. They will need to improve IP protection in order to stimulate domestic software producer market. Global growth will lead to limitation of piracy. Games will become more interactive with wider usage of move controllers which force gamers to play on consoles which are not negatively affected by piracy problem In short run new PC shipments in developing countries could have negative impact on percentages of unauthorized copying of game.
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Source: Go-Gulf Online Piracy in Numbers 2010.
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Appendix 31 Game Developer Salary
Appendix 35 IT trends in Poland Game Developer Average Annual Salary (in dollars) USA
83 060
Europe
46 232
Canada
71 445
Source: Game Developer Salary Survey 2014.
According to the Report Central and Eastern European IT market – Trends and Forecast Pmrpublications.com, IT market in Central and Eastern Europe (CEE) will increase by 4.5 % annually in 2014-2018%. The CEE countries seem to be quite homogenous when it comes to the IT market trends and tendencies. We assume that it could have an impact on salary in whole IT industries. Increase in salary could negatively affect CDP but we believe that cost of labor in IT industries will be increasing also in other countries/However we presume that finally the term of trade will stay at the same level. Forecasts for Polish IT labour market
Survey of International IT Companies Located in Poland Appendix 32 Salaries in IT sector
Competitive Advantages of Polish IT Markets Average Annual Salary (in dollars)
1. 2. 3. 4. 5.
Lower cost of labor Highly qualified workforce Highly motivated staff (IT is a hobby for many workers) Similar culture Geographic location of Poland in the middle Europe
Programming
92 962
Art and Animation
75 780
Game design
73 386
Polish IT labour market
Production
85 687
Audio
83 182
Quality assurance
47 910
Business
102 160
In Poland, every year, about 14 000 students graduate from Information Technology Department with IT specialist diploma. In recent years number of students graduated from IT department is declining. During last year number of students who found a job during studies and therefore have not completed it, was growing.It was one of the reasons which have negative impact on number of graduate with diploma. In order to change this trend Polish Ministry of Science and Higher Education set a special program to increase number of IT students. Both public and private schools could get additional funds from ministry, for each IT student.. Obtaining scholarship for IT studentsis much easier. We assume that this policy should have positive impact on number of IT student in long term. According to GUS data, in 2012 number of students of IT department stopped declining.
Source: Game Developer Salary Survey 2014.
Appendix 33 Salaries in IT industry in Poland Median of Gross Salary in PLN
Competitive Advantages of the CDP Monthly
Annual
CEO of IT department Manger of IT department
14 500
174 000
8 950
107 400
IT Consultant
7 000
84 000
SAP Consultant
6 550
78 600
WebMaster
3 550
42 600
Game graphics
3 000
36 000
The cost of labour in game developing industries are much lower in Poland in comparison to costs inEurope and especially on the USA Market. In our view, game developers who want to work on world-renowned games in Poland, need to work in CDP.Other Polish studios create games in much lower quality and their titles are not as well-known as the Witcher. According to Polish Information and Foreign Investment Agency 44% of graduates declare that they do not consider working abroad. In our view, in next year’s lower labour costs will be constant competitive advantage of CDP in comparison to game developers located in the USA. According to the Survey of International IT Companies Located in Poland - workforce in Poland is well-qualified and highly motivated. Polish students get an excellent results in international competitions.
List of Polish students successes in international competition
Source: Pracodawcy IT Computerworld, 2013
University of Wroclaw Final of International Collegiate Programming Contest 2014 University of Warsaw 1st place in Google Code Jam 2012 2nd place in International Collegiate Programming Contest 2012 1st place in International Collegiate Programming Contest 2007 Poznan University of Technology 1st place (twice), once 2nd and 3rd place in the IEEE Computer Society Annual International Design Competition- during the years 2000-2005 1st place in Imagine Cup organized by Microsoft in the years 2005, 2006, 2009 2nd place in Imagine Cup in 2007 3rdplace in Imagine Cup world finals – 2008 and 2010 1st place in Imagine Cup Innovation Accelerator in 2008 2nd place in Imagine Cup in 2007 5th place in International Collegiate Programming Contest in 1999 1st place in International Collegiate Programming Contest in 1998
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Appendix 36 Company strategy versus market trends We highly grade the company’s management and strategy. In our view, CDP effectively anticipated to previous and current market trends. We assume that the key trend are: According to the Report Central and Eastern European IT market – Trends and Forecast Pmrpublications.com, IT market in Central and Eastern Europe (CEE) will increase by 4.5 % annually in 2014-2018%. The CEE countries seem to be quite homogenous when it comes to the IT market trends and tendencies. We assume that it could have an impact on salary in whole IT industries. Increase in salary could negatively affect CDP but we believe that cost of labor in IT industries will be increasing also in other countries/However we presume that finally the term of trade will stay at the same level. Forecasts for Polish IT labour market
Survey of International IT Companies Located in Poland Competitive Advantages of Polish IT Markets 1. 2. 3. 4. 5.
Lower cost of labor Highly qualified workforce Highly motivated staff (IT is a hobby for many workers) Similar culture Geographic location of Poland in the middle Europe
Polish IT labour market In Poland, every year, about 14 000 students graduate from Information Technology Department with IT specialist diploma. In recent years number of students graduated from IT department is declining. During last year number of students who found a job during studies and therefore have not completed it, was growing.It was one of the reasons which have negative impact on number of graduate with diploma. In order to change this trend Polish Ministry of Science and Higher Education set a special program to increase number of IT students. Both public and private schools could get additional funds from ministry, for each IT student.. Obtaining scholarship for IT studentsis much easier. We assume that this policy should have positive impact on number of IT student in long term. According to GUS data, in 2012 number of students of IT department stopped declining.
Competitive Advantages of the CDP The cost of labour in game developing industries are much lower in Poland in comparison to costs inEurope and especially on the USA Market. In our view, game developers who want to work on world-renowned games in Poland, need to work in CDP.Other Polish studios create games in much lower quality and their titles are not as well-known as the Witcher. According to Polish Information and Foreign Investment Agency 44% of graduates declare that they do not consider working abroad. In our view, in next year’s lower labour costs will be constant competitive advantage of CDP in comparison to game developers located in the USA. According to the Survey of International IT Companies Located in Poland - workforce in Poland is well-qualified and highly motivated. Polish students get an excellent results in international competitions.
List of Polish students successes in international competition University of Wroclaw Final of International Collegiate Programming Contest 2014 University of Warsaw 1st place in Google Code Jam 2012 2nd place in International Collegiate Programming Contest 2012 1st place in International Collegiate Programming Contest 2007 Poznan University of Technology 1st place (twice), once 2nd and 3rd place in the IEEE Computer Society Annual International Design Competition- during the years 2000-2005 1st place in Imagine Cup organized by Microsoft in the years 2005, 2006, 2009 2nd place in Imagine Cup in 2007 3rdplace in Imagine Cup world finals – 2008 and 2010 1st place in Imagine Cup Innovation Accelerator in 2008 2nd place in Imagine Cup in 2007 5th place in International Collegiate Programming Contest in 1999 1st place in International Collegiate Programming Contest in 1998
Concentration of Revenue Among Top Titles ‘Hit’ titles earn a significant portion of total revenue in each segment. According to The NPD Group, in 2013 the Top 10 bestselling titles accounted for 38% of total sales in the industry in the USA in comparison to 30% in 2012. Double-digit growth in digital distribution segment Recently, Digital Distribution is growing at two digits number. According to ‘Entertainment Software Association and the NPD Group/Retail Tracking Service’ in 2013, total digital distribution accounted for 53% of total distribution in comparison to 29% in 2010. The highest number of sales are reported by franchise The world-renowned game developer create franchise. It built loyalty to brand and minimized costs of advertising as well as had a significant impact on game sales. Gamers who were satisfied by previous game are more likely to buy a new one for higher prices. Quality of game is less crucial in case of franchise than when it comes to a new title.
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Rapid growth in mobile phone game market According to “Global Game Market 2013-2017 Report” by Newzoo mobile phone game market will be growing at CAGR 15.1% to 2017. In our view, CDP is very flexible and easily adapts to market trends. Moreover the company has forecasted correctly future trends and it tries to take advantage of upcoming market opportunities. Company strategy Worldwide digital distribution of videogames via the GOG.com platform which currently ranks as the second most popular independent distribution platform in the PC and Mac segments. The GOG was established in 2008. Triple-A Video Games Development and distribution of “triple-A videogames”, with an extensive development budget, top-of-the-line production values and excellent marketing potential. Cyberpunk 2077 Role-playing game targeted for the PC and consoles. Based on Mike Pondsmith’s Cyberpunk® cult classic game, with over 5 millions of fans, 70% of whom live in the USA. The Cyberpunk 2077 will be a new franchise of CDP but in order to obtain “saga effect” the company got the right to use old “Cyberpunk” trademark The Witcher Battle Arena Company is currently developing a game designed for mobile phones. In our view, CDP is testing the market. We assume that over following years company’s leading game segment will remain developing triple-A game.
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Disclosures: Ownership and material conflicts of interest: The author(s), or a member of their household, of this report does not hold a financial interest in the securities of this company. The author(s), or a member of their household, of this report does not know of the existence of any conflicts of interest that might bias the content or publication of this report.
Receipt of compensation: Compensation of the author(s) of this report is not based on investment banking revenue.
Position as a officer or director: The author(s), or a member of their household, does not serve as an officer, director or advisory board member of the subject company. Market making: The author(s) does not act as a market maker in the subject company’s securities. Disclaimer: The information set forth herein has been obtained or derived from sources generally available to the public and believed by the author(s) to be reliable, but the author(s) does not make any representation or warranty, express or implied, as to its accuracy or completeness. The information is not intended to be used as the basis of any investment decisions by any person or entity. This information does not constitute investment advice, nor is it an offer or a solicitation of an offer to buy or sell any security. This report should not be considered to be a recommendation by any individual affiliated with CFA Society Poland, CFA Institute or the CFA Institute Research Challenge with regard to this company’s stock
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