CI Games — Smooth operator

With no new releases in 2022, revenue during the year has been driven by the group’s back catalogue (principally previous iterations of the Sniper Ghost Warrior franchise), resulting in significant revenue declines year-on-year that have accelerated as the year has progressed. The rise in gross margin in the first nine months of 2022 reflects the increased share of digital sales over 2021, largely due to the lack of any new releases and the associated physical box sales that typically accompany new releases, together with reduced amortisation costs.

However, on a quarterly basis the gross margin fell by 17.1pp q-o-q, mainly relating to the marketing campaign for TlotF, which started in August 2022. The same marketing drive also led to an adjusted EBITDA loss of PLN2.5m in Q322. We note that CI Games splits its marketing spend between COGS and opex.

Despite falling into an operating loss in Q322, CI Games remained in a net cash position, of PLN6.8m (PLN2.3m including financial leases), at end Q322. We expect that a successful marketing campaign in H222 could be accretive to FY23 margins, as it should drive sales growth without the need to elevate costs correspondingly. Our FY23 forecasts suggest that CI Games will expand its net cash position to PLN79.3m by year end.

We raise our gross profit estimate to PLN42m from PLN27m in FY22, at a margin of 70%, reflecting the group’s higher-margin product mix (digital sales), which should offset an expected increase in H222 marketing costs. Given the positive momentum around TLotF, we believe management may want to push higher marketing spend towards the end of the year. This margin compression is in line with its Q3 results.

CI Games maintained adjusted EBITDA margins between 50% and 60% in FY21 and H122, with margins rising from 50% in Q122 to 54% in Q222 (Exhibit 2). We expect this to fall to 28% for the full year, driven by an end-of-year marketing push for the FY23 game releases. TLotF’s release will drive sales growth in FY23, while the operational leverage built in H222 should benefit margins; we have raised our FY23 EBITDA margin forecast by 25.3pp to 76.6%. We also note that gross margins in FY23 could be affected by a higher volume of physical sales relating to the release of TLotF.

Previously we had overestimated the levels of depreciation for FY22, not recognising that depreciation would reduce materially now that Sniper Ghost Warrior Contracts is fully depreciated. Lower levels of depreciation mitigate the impacts of heightened selling costs on our FY22 pre-tax profit forecast.

It is worth highlighting that we forecast sales revenues in US dollars, which means that the strength of the US dollar also has a material impact our forecasts; with CI Games reporting in Polish zloty this has caused our FY22 forecasts to rise by over 10%. The strong US dollar drives our FY23 estimates 9–12% higher due to CI Games’ dollar-based sales and its zloty and euro cost base. Management has recently entered into a series of currency forward contracts to hedge against future foreign currency changes.

The anticipated performance of TLotF, CI Games’ most expensive title to date, underpins our forecasts for FY23. Our base case estimates c PLN201m in sales for TLotF in FY23 (74% of sales), based on c 2m units sold at $21 using a current exchange rate of PLN4.78/US$. The other potential major release is an ‘early access’ release for Project Survive, together with potentially two United Label titles, neither of which yet has been named nor had release dates confirmed: firstly, a sci-fi game with a Chicago-based studio; and a second title by Odd Bug Studios (developer of Tails of Iron).

The marketing campaign for TLotF kicked off in August 2022, with the launch of the official trailer at Gamescom, one of the largest European games events. Management has stated that the game is expected to be substantially complete by year end, before an extended period of polishing ahead of its launch in FY23. The title appears to have captured players’ attention at Gamescom and is already in the top 40 of Steam’s wish list rankings.

CI Games has established itself as a Pan-European games developer and publisher that specialises in first-person shooter and action-driven role-playing games. Over the years the company has become a global player, with offices in Poland (headquarters), the UK, the United States, Spain and Romania, with its games selling worldwide. Management believes it is unlikely that the previously announced dual listing of its shares in London (alongside Warsaw) will happen in 2022, but instead expects it in early 2023; the listing should help further internationalise the story.

In its strategic roadmap for games releases for FY23–27, announced on 24 October 2022, management stated that it expects to raise the frequency of new releases, increasing its current four pillars to seven, to provide greater consistency of performance year-on-year.

Management has previously identified four pillars underpinning CI Games’ future growth:

To these four pillars, three further pillars have been added to sustain and build future growth:

CI Games’ strategic review, first announced in August 2021, continues. Ci Games’ adviser, Drakestar, has accelerated the process following the release of the TLotF cinematic trailer and players’ warm reception to the title. Management confirmed it is considering both minority and majority investors and progress will be reported when appropriate. Management also stated that a dual listing in London was now unlikely to happen in 2022, with early 2023 seeming more likely and it has no intention to raise funds on listing. The slight delay in timing to FY23 reflects the challenging macroeconomic climate and affords the benefit of allowing additional time for strategic conversations around TLotF to mature.

Over the next five years, CI Games wants to build on its presence as one of Europe’s major games developers and publishers, building its existing franchises and launching new games on a more regular basis as set out in the FY23–27 strategic plan. FY22 has been a fallow year for major new games releases, with FY23 seeing the release of TLotF as the first in the line of new games. If momentum continues and TlotF is well received by gamers, then its success should be the start of a transformation in the group’s profitability (Exhibit 6).

Given this dynamic, our valuation focuses on FY23. A group of pan-European peers, which we believe most closely resembles CI Games, is trading on a mean EV/EBITDA of c 30.2x in FY22, falling to 12.1x in FY23. This compares with CI Games, on 30.0x our FY22 EV/EBITDA and 2.4x in FY23. Similarly, for P/E multiples, the peer group trades on 41.3x consensus FY22 earnings and 21.2x FY23. This compares to CI Games on 69.2x FY22 and then 4.8x FY23e.

Looking at our FY23 forecasts, the peer group valuation suggests there could be material upside as CI Games’ valuation normalises towards the mean of the select and wider European peer group, with the forthcoming dual listing an obvious trigger point for a re-evaluation of the story, together with the potential for strategic newsflow, as well as positive game-related announcements as we move towards the launch of TLotF. In addition to Frontier Developments and Remedy Entertainment, we also note that CI Games is one of few peers in the group that conducts its own in-house game development and can build on games franchises using its own IP.