VIDEO GAME STUDIOS: VALUATIONS ARE “KICKING ASS AND CHEWING BUBBLEGUM” IN THE ERA OF COVID-19
Valuations in video game studios have increased significantly, but why? Here is a quick peek at the possible value drivers and where most of the increase in valuations have been observed. I was inspired to take a look this industry after speaking to some folks who started their own game studio, as well as listening in on an RSM/Media Financial Management Association webinar on the broad video game industry (great stuff!). Understanding that there are some significant limitations in the application of public capital market data to a start-up game studio, I thought that some high-level valuation insight into the recent trends might be helpful.
This article also posted in the ValuInsights Industry Blog. Visit us for more valuation insights and resources and follow me on LinkedIn!
Important notes: This article briefly investigates what may be driving valuations in the industry from a financial statement perspective. An actual valuation of a company requires an in-depth analysis of the business operations and associated risk factors that cannot always be directly considered through the data on the financial statements. Also, in order to keep the length manageable, this article will focus on what I interpreted to be the primary value drivers and will not touch on every observation in the data. For a quick read on the basic concepts of risk and return and how they apply in the context of this article, please visit: What is Value and Risk and Return in the Market Approach.
The industry constituents for this analysis are listed below. Given the number of players in the industry, it made sense to analyze the industry in two groups: large-sized companies having a market capitalization of $1 billion or greater as of December 18, 2020, and small to medium-sized companies having a market capitalization of less than $1 billion. I focused on companies in developed countries, traded on major exchanges, and with a stock price equivalent of $1 or more.
Each group’s median enterprise value (“TEV”), median revenues, and median EBITDA are summarized in the following charts. EBITDA trends were excluded from the small to medium-sized companies chart due to the number of unprofitable companies, which limits comparability. The focus of this article will be on revenue multiples to allow for a meaningful comparison between large and small to medium-sized companies in the industry.
The larger companies experienced a substantial increase in their TEV (80% from the latest fiscal year to the latest 12-month, or “LTM”, period) relative to their most recent revenue and EBITDA growth. Small to medium-sized companies experienced a comparatively lower increase in TEV (30% from the latest fiscal year to the LTM period) relative to their recent revenue growth.
The discrepancy between financial metric growth and TEV growth means that multiples increased during 2020. This is evident in the trend in revenue multiples among the large and small to medium-sized companies below (see the uptick in the latest period for both large and small to medium-sized companies).
The Growth Story
Growth often has a strong influence on how multiples differ among companies in an industry and the multiples in game studios appear to generally follow the same trend. The following charts summarize how consensus forecasts changed for the large and small to medium-sized companies over the last year (note that the current year appears in blue, “LFY” means latest fiscal year and “NFY” means next fiscal year):
The growth expectations for both large and small to medium-sized companies improved as of December 18, 2020 vs. the same time last year. This is likely to have contributed to higher valuation multiples. However, the larger companies in this space appear to have enjoyed a much larger increase in their multiples as compared to their smaller counterparts, despite having less overall growth projected over the next five fiscal years.
The Size Story
One possible explanation to the trend noted above is that, while investors currently view the industry favorably, they remain focused on managing risk given the uncertain economic environment caused by the ongoing pandemic. Larger companies are generally perceived to have lower levels of risk relative to smaller companies due to improved product or geographic diversification, deeper management teams, access to more distribution channels, and better availability of capital, among other factors. In this case, the larger companies presumably have strong pipelines of new games that would support future growth. The chart below compares the TEV of each company relative to its LTM revenue multiple.
While a consistent trend is not observed among each of the individual data points (as is typically the case), the larger companies appear to consistently trade at or above 4.0x LTM revenue, while smaller companies generally trade below 4.0x. Although not shown here, I did hone in on the cluster of the smallest companies trading at 4.0x LTM revenue multiples or lower. There did not appear to be a correlation between size and revenue multiples nor between projected growth and multiples. It is entirely possible that, at the smaller sizes, the story around ongoing operations, success of individual releases, depth of (or lack thereof) pipeline products in development, brand recognition among consumers, or some other company-specific factor influences the behavior of the multiples.
There are six companies with less than $10 billion in TEV trading at revenue multiples at or above approximately 8.0x LTM revenue, and all are expected to generate substantial revenue growth in the NFY. This suggests that strong growth may, in some cases, trump the impact of small size.
The Profitability Story
Revenue multiples are typically heavily influenced by profitability, as higher profit margins means that a company is able to generate more return per dollar of revenue for its stakeholders. Since investors view higher margins favorably, they are usually willing to pay more per dollar of revenue and, therein, higher multiples. Below we summarize the relationship between LTM revenue multiples and LTM EBITDA margins:
In this case, there appears to be some (very) loose correlation between multiples and margins in the data, but nothing that is consistently observed across the 32 companies in the public group. While margins may possibly have some influence on multiples (mostly among the most profitable of the group), they do not appear to be a primary driver in how investors are pricing game studios in the public markets.
The trends observed above would tend to suggest that the industry has garnered strong investor interest in the midst of one of the worst economic declines since the Great Depression. This makes sense, as the much higher number of people now working, eating, and playing at home would intuitively drive additional demand for the broad gaming industry. As is the case in many other industries, the largest companies appear to be favored by investors via higher valuation multiples as compared to their smaller peers due to a perceived difference in risk. However, strong growth expectations can (and typically do) drive up multiples among smaller operators. Investors do love a growth story at the end of the day.
This article pointed out some potential value drivers for the game studio industry based primarily on the observed and projected financial metrics in the publicly-traded companies. What are some of the more qualitative considerations impacting valuations in this industry? Any and all input, feedback, suggestions, and questions (including disagreements with my high-level analysis) are welcome!
Companies in this space are complex organizations with numerous value drivers. The valuation of a video game studio requires an understanding of the risks associated with the company and industry and the proper interpretation of capital market evidence. Helios Consulting, Inc. is a full-service valuation services provider with the experience needed to guide you through your valuation requirements.
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