Media and Games Invest — Focus on ad software platform

MGI is an advertising software platform, built both organically and through M&A, with a strong owned games content offering that delivers it large quantities of first-party data. Its platform is designed to be omnichannel and is currently heavily skewed to the supply side, where it helps publishers and its own games studios to monetise their ad inventory while keeping full control over it through integrating MGI’s software development kit (SDK). The group is now prioritising building out its DSP offering to enable marketers to drive return on their ad spend and reach addressable audiences across all relevant ad formats, channels and devices in a privacy-compliant manner. MGI has a large portfolio of casual and mobile games appealing to a broad demographic, giving it extensive access to first-party data.

The group has a clear strategy for growth: consolidate the market through M&A; integrate the business and realise the synergies; and build and improve to deliver organic progress. The pace of expansion has been rapid, with more than 35 companies bought in the last six years, with the integration process honed along the way. Most purchases have been relatively small, but KingsIsle and Smaato, bought in FY21, were each bought for over €100m. The group has a pipeline of further targets, with a focus on mobile DSP and mobile games assets.

MGI has an impressive revenue CAGR of 45% across FY16–21 and has delivered rising EBITDA margins, reaching 28% in FY21. Mid-term guidance for FY22–25 is for a revenue CAGR in a range of 25–30%, with an EBITDA margin also in the range of 25–30%. For the current year, guidance is for revenue growth of 17–25%, with an EBITDA margin of 28–30%. We have assumed a slightly more cautious growth outlook, given current sentiment around the advertising market, with revenue increasing by 22% in FY22e and by 21% in FY23e.

Leverage is guided to 2.0–3.0x and, following acquisitions in H122, is likely to be running at the high end of this range. Our modelling suggests that this eases through FY23e as the synergistic benefits and the advantages of scale start to come through more strongly. The balance sheet is primarily funded through bonds, rather than by bank debt, with the latest €175m bond issuance in May 2022 oversubscribed.

MGI’s share price has fallen back over the year-to-date by around 50%, more than the average fall in the price of adtech and ad software/content companies and the decline in gaming companies. The timing of the stock market rotation away from high-growth tech stocks and the deterioration of prospects for the consumer economies in major developed markets has coincided with MGI’s re-positioning as an M&A-supported software platform rather than as a games developer and provider. In our view, its shares now trade at an unwarrantedly large discount to peers. If they were to trade at parity across earnings multiples, the share price would be €5.06, over the level at which it started the year, while our DCF suggests a price of €3.92 (9% WACC, 2% terminal growth).

Any M&A-predicated strategy can be derailed through pricing and timing issues. The group’s historical success may not be replicated, particularly if the share price continues to limit the potential for using equity as part of deals. The group has had good success in raising funds through bond issuance; again this may not be repeatable, and the market rates may not be as attractive. MGI is stepping up its standards of corporate governance, relocating from Malta to Sweden and restructuring its board to comply with best practice.

MGI’s origins lie in the games segment, where gamigo was founded in 2000. It was purchased by CEO Remco Westermann out of Axel Springer in 2012 to form the core on which the gaming operation has been built. It was restructured over the next couple of years into a format that was better aligned to grow through M&A and achieve the critical mass needed to attract users and, critically, that data that comes with them. A good variety of high-quality content is an essential element of driving user acquisition at a cost that will enable attractive returns.

Through delivering content attractive to users, MGI has built an extensive pool of first-party data. The value and utility of this resource has risen markedly as concerns over privacy have climbed the agenda both of regulators and of the public over the last few years. With the changes made to Apple’s tracking to an opt-in basis and the forthcoming withdrawal by Google of third-party cookie usage, the traditional model of monetisation through advertising has been compromised.

MGI has over 5k casual and mobile games and over 800 million registered players accumulated over the years. It has assembled its own SDK, bringing together a group of tools that enable the programming of mobile applications, which is now being used within more than 5k direct publisher integrations, which bring together over two billion users globally. It is this degree of global scale that is proving very attractive to publishers and to advertisers.

Over the last three years, the group’s revenue has transitioned more towards software, as demonstrated in Exhibit 1, above. ‘Consumer’ here relates specifically to subscriptions and in-game purchases, with revenues from in-game advertising captured within the ad software numbers. The quarterly progression in the number of ad impressions is also shown here, demonstrating the organic growth and the scale of the impact of the acquisitions to date. It should be noted that there is a natural seasonal bias within the sector to Q4 each year, with Q1 being the weakest reporting period.

MGI’s SSP helps publishers and its own games studios to monetise their ad inventory/ad spaces while keeping full control over it. Publishers connect to the SSP by integrating MGI’s SDKs into their content. Publishers sell their ad inventory to advertisers using real-time bidding techniques. The group’s Verve data enrichment engine enables users of apps to segment audiences in a privacy-compliant manner and allow advertisers to bid for the most attractive audiences. Clients on the supply side are primarily publishers and app developers that allow direct integration with their apps, maximising automation and sales efficiency of ad inventory. The SSP segment also includes MGI’s own games studios, which provide first-party data and in-game advertising spaces. Most SSP revenues are generated by usage-based platform fees based on a percentage of a client’s total supply revenues.

MGI’s DSP enables advertisers to drive user acquisition campaigns across the open internet. Through the group’s self-service, cloud-based platform, advertisers can create, manage and optimise data-driven digital advertising campaigns across all relevant ad formats and channels (including for example display, native and video) and devices (mobile, desktop, digital out-of-home and connected TV). Clients on the demand side are primarily large brands from Fortune 500 companies as well as agencies such as WPP or Mediacom, which manage the budgets of large advertisers. MGI’s DSP generates revenue by charging usage-based fees based on a percentage of a client’s total spend on advertising.

MGI refers to its software platform under the brand of Verve, which covers the full stack from the DSP to data to the SSP, as illustrated in the exhibit below. The SSP dominates in the mix (93% of FY21 revenues), with the revenues being majority-derived from mobile at 57%, with desktop contributing 29%, connected TV 14% and digital out-of-home the small balance.

The group has a large and growing number of substantial clients, defined as contributing over $100k of revenue. The number falling into this bracket was 479 in Q122, up 15% on Q421. 69% of these substantial clients are in the entertainment or games sectors.

Third-party cookies and other mobile identifiers made life comparatively easy for advertisers to track and target the individuals that they wanted to reach. A growing understanding of the balance of the value in that relationship and with it a greater concern for privacy is fundamentally shifting the economics behind the web and access to content.

MGI has been developing methodologies to help bridge the requirements of users, publishers and advertisers:

To date, ATOM has been achieving 15% higher CPM (cost per mille, the standard industry measure for advertising pricing) and 28% higher click-through rates (CTR) than cookie-based advertising.

Management states that Moments.AI has been achieving CTR up to 200% higher, and with 50% higher viewability, than traditional methods.

Verve’s success at positioning itself as a specialist games adtech platform can be judged by the clients it is attracting and retaining, with the likes of AppLovin and IronSource now clients, together with games publishers such as Zynga (Take-Two), King.com (EA), Loop Games and ILoveLOL.

MGI’s games business was built around its games platform, gamigo, and includes c 10 massively multiplayer online games (MMOs) as well as over 5,000 casual games, across the role-playing game (RPG), fantasy and strategy genres with over 100 million registered players. Titles include Trove, Aura Kingdom, Desert Operations, Grand Fantasia, Fiesta Online, as well as Pirate101 and Wizard101, acquired through the KingsIsle transaction in January 2021. Games are typically licensed worldwide or exclusively for specific regions or territories. Gamigo delivers a monthly average revenue per paying user (ARPU) of €61.

MGI’s core MMOs are all established games operating a games-as-a-service model, with games supported with regular content to maintain active communities, encourage user retention and add new players. This model extends the games’ lifespan over multiple years and keeps players engaged and entertained.

MGI’s casual games are mostly single-player games, playable on multiple platforms and devices (PC, mobile, console), with all the games on a portal typically accessed by way of a monthly subscription. MGI’s casual games portfolio also includes Facebook titles as well as mobile titles. For all casual titles (in contrast to premium titles paid for upfront), a portion of MGI’s revenues come from advertising and promotional videos.

MGI’s games platform, gamigo is PC-led, but intent on growing its mobile capability.

MGI regularly launches new games, with 370 games launched in FY21. This means that, on average, MGI published 30+ casual games every month in FY21, with major releases weighted towards Q4, to drive engagement and monetisation in the high advertising season.

Free-to-play MMOs account for the largest share of MGI’s revenues. Free-to-play means users can play for free (with low-level ad-funding), but also have the option of purchasing in-game items at a range of prices. The business model requires funding to develop the game and related content, working in close collaboration with the playing community. In addition to regular events and competitions, new items (eg costumes, skins, weapons) and content (new functions, levels and opponents) are released on a regular basis to enhance the game and maintain a fresh playing experience for the committed community.

With appropriate support, users can remain loyal to the game for many years, playing for free or investing money in the game over the player lifetime. For established games, over 50% of revenues can be generated by players who have been active for more than five years. For paying users, monthly investment of €50–80 is not uncommon and over the full lifetime of a game (sometimes 10 years or more), superfans may choose to invest thousands or even tens of thousands of euros to maintain their playing experience. To highlight this longevity, set out below are the player age groupings for certain of MGI’s games portfolio.

MGI’s core demographic are male and female gamers aged 20–34, playing for an average of 10–15 hours per week. On a cost per hour basis, as gamers can spend multiple hours per week over several years, MGI’s games offer a very cost-effective form of community-based entertainment, typically under €1 per hour, even to higher spenders.

Launching new games on the market is a major risk for games companies, since there are already many games with a long-term loyal player base, as well as large numbers of new games launched every month. To manage this risk, MGI prefers to acquire mature game licences by taking over companies with established titles, rather than developing original IP.

The group is now also launching games based on existing licences (fractured, fantasy town etc).

In Q222, MGI announced the acquisition of AxesInMotion, a Spanish free-to-play mobile games developer of racing games for €55m in cash up-front, plus a potential earn-out of up to €110m over three years. This represents the group’s first major acquisition in the mobile games space and also a change in risk profile as, rather than buying an established title, the group is investing in a studio with proven development capabilities ahead of the launch of future titles in an established niche.

AxesInMotion is a 30-person studio, based in Seville. Its key titles are Extreme Car Driving Simulator, Mega Ramps and Extreme SUV Driving Simulator, with two new titles planned. Its games have been downloaded more than 700m times since 2014, generating FY21 revenues of €7.9m and adjusted EBITDA of €5.1m (64% margin). For FY22, management expects revenues of €9.2m with adjusted EBITDA of €6.0m (65% margin). The company has delivered a three-year revenue CAGR FY18–21 of 36%. In total, 33% of revenues derive from the US, with 87% from in-game advertising.

As well as building out MGI’s mobile games development capability in the racing genre, the acquisition of AxesInMotion will also benefit MGI’s adtech business, increasing its first-party audience data to support the group’s ad-targeting capability (independent of identifiers and third-party data). Management’s expected mid-term synergies include 100% revenue retention, better ad-monetisation, more efficient user acquisition, as well as the benefit to Verve of increased first-party data. Based on these medium-term synergy assumptions, management has calculated that the acquisition could deliver mid-term revenues of €24m, with €17m of EBITDA (71% margin).

Management identifies four pillars of its strategy:

These targets were identified in the Q122 presentation, with the first box already ticked with the purchase of AxesInMotion, described above. From the description, Dataseat would appear to be the target listed here at number three (revenues in mid-single-digit £m).

These objectives are designed to achieve the following mid-term targets (by FY25):

The senior management team is headed up by Remco Westermann, who has been CEO and chairman 2018. He has extensive experience in the mobile and online entertainment industry. He founded Bob Mobile (later CLIQ Digital, a client of Edison Investment Research) and helped build the mobile media company Sonera Zed, managing its German subsidiary as CEO. Previously, Remco was a manager at leading companies such as Balance Point and a consultant at Rost & Co. In the dynamic, highly competitive and fast-growing games market, Remco has built up a leading and fast-growing online games company through a successful M&A strategy following the acquisition and repositioning of gamigo in 2012. In 2018, MGI came about via a reverse merger when Westermann acquired a majority stake in the publicly listed Solidare Real Estate Holding and was appointed CEO and executive director of the board. gamigo was acquired and integrated and all real estate assets were subsequently, with the business model changed to ‘buy, integrate, build and improve’ in the gaming and media sectors. He has an indirect holding of 41.7m shares and an option for 15.0m running through to FY30 at €2.60 per share. This option was granted to enable an ESOP phantom share programme for employees of the MGI group. It is contractually secured that these 15 million options can only be used for such ESOP programmes and that Bodhivas shall, in the case of profits, transfer such profits to the capital of MGI without retaining any profits for Bodhivas.

Paul Echt has been group CFO since 2018, prior to which he gained more than 10 years’ experience in the tech and finance industry as a finance manager. He previously held positions at UniCredit Bank in Berlin, Munich and New York and Shopgate in San Francisco. Paul holds 1.7m of phantom stock and 45,320 shares in the company.

COO Jens Knauber joined in 2018 with more than 10 years’ experience as a manager in the gaming industry, with over 300 published games. He held a series of leadership positions at Hamburg publisher dtp entertainment and has a strong background in games publishing with a wide global network in the gaming industry. He is responsible for gamigo. Jens holds 2.55m of phantom stock but no shares. The C-suite is completed by the more recent appointment of CIO Sonja Lilienthal. Her background is in investment banking and, in particular, M&A. Before joining MGI in Q122, Sonja had worked for Rothschild & Co since 2007, most recently as managing director. She holds 0.3m of phantom stock.

MGI is going through a process of raising the standards of its corporate governance. Following the listing of the shares in Sweden on the Nasdaq Stockholm First North Premier Growth Market in 2020, management has reappraised the group’s governance structure to make sure that it has better access to capital markets, with fewer barriers to investment by potential shareholders who would otherwise be interested. The impetus behind this process was increased by the grey listing of Malta by the Financial Action Task Force in mid-2021.

This involves:

These changes will bring the group into line with Swedish laws and the Swedish Corporate Governance Code.

There are a number of factors that investors should bear in mind when investing in MGI:

MGI operates across stock market subsectors, with its adtech earnings becoming increasingly important but no longer truly distinguishable from the revenues it generates from games. Historically, it may have made sense to appraise the valuation against other games stocks, but this no longer seems appropriate and any ‘sum-of-the-parts’ approach fails through the aggregation in the reporting.

We have therefore looked at the valuation when compared to three sets of peers; (relatively) pure adtech, ad software combined with content (games or other) and (relatively) pure gaming. Although this leads to a cumbersome peer table, it allows us to see the slightly different dynamics. The gaming companies are being accorded slightly higher ratings on a current year EV/Sales and EV/EBITDA basis, but at a discount on P/E. On FY23 numbers, there is less differential.

It is notable, however, that this follows a difficult period for high-growth stocks on global markets in FY22. The gaming stocks have not been such a primary target for the bears, with their share prices retreating on average by 16% year to date, compared to falls of 47% in the adtech and 56% in the ad software and content group. MGI’s share price has retreated by 52% over the same period, with a notable further step down over the last few weeks from €3.30 at the time of the bond placing on 9 June on comparatively thin volumes.

MGI’s shares are trading at a discount across EV/Sales, EV/EBITDA and P/E for FY21, FY22e and FY23e. Were they to trade at parity to the averages of these peers across the three years, MGI’s share price would be €5.06, above the level at which they started the year.

We have also looked at a DCF based on revenues continuing to grow at the 25% indicated by management in its medium-term guidance through to FY25 and then increasing at a reducing pace through to a terminal growth rate of between zero and 4.0%. In this broad-brush modelling, we have also assumed that the achievable margin starts to drift off a little towards a long-term rate of 25% post FY25, although it is arguable that if capex and marketing spend were to be curtailed, then that margin would lift – at least for a couple of years before the top line would start to sag.

As ever, we caution that the output of a DCF is crucially dependent on the inputs and that erroneous assumptions become compounded. As described, our modelling generates a value per share of €3.92 using a WACC of 9.0% and terminal growth of 2%, which is reasonably close to the valuation derived from the peer analysis.

While we have commented on the financial performance of the company in our previous notes, we have now built out a model and introduce our own forecasts, rather than relying on market consensus.

MGI has achieved annual revenue growth of more than 67% y-o-y for each of the last three years, contributing to a five-year revenue CAGR in FY16–21 of 45%. In FY20 and FY21, management has developed an attractive habit of beating guidance:

Management guidance for FY22 is:

Our FY22 revenue projection is towards the higher end of the guided range, with 21% further progress modelled for FY23. This is lower than the mid-term guidance for revenue growth, which reflects a degree of caution from us on overall advertising market sentiment, given the economic backdrop of major developed economies. The figure does not build in any additional M&A but gives a full-year benefit from those acquisitions carried out in FY22 to date. Given management’s expansionary strategy, we would be surprised (and possibly disappointed) if the group’s configuration was to look the same by that stage.

Management’s margin assumptions are set building in continuing investment in people and products that will drive future growth. Dialling the investment down could deliver adjusted EBITDA margins of 30–35% which, in our opinion, would signal migration into a more mature development phase with a slower top-line trajectory.

Our modelling therefore assumes that EBITDA margins stay in the high 20s to 30%.

The largest element of operating expenses is purchased services, at 55% of revenue in FY21 (and FY20). We would expect this proportion to go down as the group builds its own DSP and brings more of the offering in house. Labour costs represented another 22% (FY20: 28%), again with further opportunity to reduce this proportion as the business scales.

The longer-term record shows clearly the increased pace of expansion, buoyed by the M&A.

The group actively manages its leverage, with regular raising of both equity and debt. The underlying cash characteristics of the group are strong, with little requirement for major capital expenditure programmes and comparatively little tied up in terms of working capital.

Management’s guidance for leverage is that it should fall in a range of 2.0–3.0x across the three years to FY25. Our modelling implies a current year of 2.9x but moving back more comfortably inside for FY23e and FY24e. Of course, the high level of corporate activity at the company means that this calculation will most likely need to be recalibrated on a regular basis.

Maintenance capex requirements are relatively modest, running at €10m in FY21, and primarily directed towards investment in games content and updates. The bulk of capex is directed towards projects to expand the group’s base. In FY21, MGI spent €22m on ad software and €2m on games licences. The ad software platform projects included investments in the publisher SDK, ATOM and Moments.AI as described above.

M&A spend in FY21 added up to €261m, the bulk of which was attributable to the purchases of Smaato and KingsIsle. The latest acquisition, UK-based Dataseat, is being bought at an undisclosed price, which is in the high single-digit million pounds for FY22 revenues in the mid-single digit million pounds (and likely to be break-even at the EBITDA level), with a deferred component linked to the vendors staying in the business and an earnout within three years. This represents a modest upfront outlay, to be paid in cash, with the deferred element either in cash or in shares. Cash payments would be made earlier, within 18 months of closing the deal, whereas a share-based deal will settle in three years.