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Steven Chen
Steven Chen
Articles (184)  | Author's Website |

A Total Return Analysis on Team17

Given a 15% to 20% medium-term growth rate, a high price multiple should not discourage buy-and-hold investors with a low-to-mid-teens hurdle rate

June 30, 2020 | About:

Overview

Team17 Group PLC (LSE:TM17) is the U.K.-based video game label and creative partner behind some well-known titles, including "Worms," "Overcooked" and "The Escapists." As described in our previous article, the company, which went public in May 2018, employs a unique business model with a proven financial track record, is founder-led and has a strong balance sheet. We went on to estimate the total equity return of this predictable business.

Looking into the future, we believe that a sustainable high-teens growth rate at Team17 can be possible, driven by new products, the industry tailwind and targeted acquisitions. The positive near-term momentum and decent long-term prospect of the business should make the high price multiple of the shares less relevant when it comes to the calculation of the future returns. A high-teens total return or more looks achievable to us.

Financials

Team17 possesses a robust back catalog, which comprises more than 100 titles released in previous years, including the highly-successful "Worms" franchise, and the correspondent over 300 digital revenue lines. Sales form this significant portfolio are recurring to the degree depending on individual product lifecycles. Over the last three fiscal years, the back-catalog portion respectively accounted for 53%, 52% and 71% of total revenue, representing an increasingly important growth driver for the business.

The label partnership and the associated revenue share model significantly differentiate Team17 from a traditional online gaming business. As of fiscal 2019, more than 80% of the total revenue came from third-party intellectual property, while over 80% of the third-party-IP sales involved co-development from Team17.

In 2019, the company improved its return on assets to almost 20%, up from 11% in the previous year, thanks to the increase in asset turnover. The operating and free cash flow margins have both been maintained at a superior 30% level. Normally, management spent less than 10% of total sales as capital expenditures, mainly on development costs, new studios and acquisitions. The company currently has a highly liquid balance sheet (i.e., a 4.5 times current ratio) with no debt.

Team17 delivered an astonishing top-line compounded annual growth rate of 56% for the last five years. The growth did slow down in recent years, but not too much. The revenue grew by 43% and 46%, respectively, over the past two years. Both the back catalog and new titles contributed here. Twelve new titles were launched in 2018, and another seven in 2019. The company claims to have a solid pipeline of 10 games to be launched this year.

Momentum

According to the management's recent trading update, the business momentum is "strong" with "above-expected demand" underpinned by the Covid-19 pandemic and subsequent lockdown. Although not putting ourselves into the game of predicting the rapid development of the pandemic, we think Team17's socially-orientated and local co-op scenes of its games that symbolize "together-ness" and harmonize the community would position the stock particularly well to benefit from any stay-at-home trade.

The company also mentioned that its proprietary "green-light process," which appraises third-party IP, has "thrived" with more games in later-stage discussion and more games in the development pipeline than any other time in its history. A market downturn tends to wipe out the weak. We believe the current economically adverse situation around the globe may continue to benefit Team17's resilient partnership approach and boost the company's near-term sales.

Prospect

Over the longer term, we believe Team17 can grow sustainably by enhancing its capacity to capitalize further on the back catalog as well as to launch new releases from both first-party and third-party IP. This is achievable via the company's scalable green-light process as well as team expansion. At the same time, management expects the industry to grow at a high single-digit CAGR through 2022.

Management also expressed its interest in "selective acquisitions that align with the strategy and values." As long-term, buy-and-hold investors, we always feel cautious about any acquisition-driven growth. However, it seems to us that CEO Debbie Bestwick understands the challenge behind the approach and the high costs associated with poor execution. She told GamesIndustry.biz last year:

"We will do what we believe is right. It's really easy to spend money. Acquisitions are really easy, but good acquisitions are much harder. I grew up during the era of Infogrames and I saw a lot of bad acquisitions. What's important is the right acquisitions that suit our business.

We are building the business that we want long term. What is important for us is additional resources. We have a target list, and we're looking at them in terms of studio acquisitions. Where it is quite interesting from that side is that they're not just going to be on work-for-hire projects, but they'll be working on new IP. We are investing in our internal new IP as well.

...

Everyone is expecting us to go out there and buy lots of studios and to do this merger or that acquisition. The biggest job I have is managing everyone's expectations. Why would we change what we're doing when it's delivering such great growth? We will acquire more IP - existing and new IPs - as we're going through things, but it must be right for our partners, for people out there in the world, and ourselves. We are not huge about taking over people's IPs. It is not the most important thing for me. But we are interested in exploring discussions where it makes sense.

The other area people often ask is if we plan to add more development capacity. We do, but we prefer to do it organically. We've doubled our headcount in the last couple of years. We have a great culture, so it needs to be right. How many M&A businesses do you see fail? You have to find the right cultural fit."

Total return

According to our calculations, Team17 generated a 26% return on retained earnings over the last five years, a 19% incremental return on equity for the past three years and an average 22% return on equity post the initial public offering. The company has not paid a dividend nor repurchased any shares since the IPO. Instead, it reinvested roughly 40% of its earnings into the business and kept the remainder on the balance sheet for later deployment over the last two years.

We believe that the low-risk, niche-focused model, a disciplined acquisition approach and the industry tailwind should leave the company with few problems in finding plenty of areas to deploy its retained capital at a high rate of return, at least for the medium term. For now, we are confident with our assumption of a 15% to 20% sustainable growth rate at Team17. Taking into consideration the current price multiple of 43 times earnings or 40 times free cash flow, our valuation metric (i.e., current yield plus sustainable growth rate) points to an estimated total return in the range between 17% and 22% of the stock.

Disclosure: The mention of any security in this article does not constitute an investment recommendation. Investors should always conduct careful analysis themselves or consult with their investment advisors before acting in the stock market. We own shares of Team17.

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About the author:

Steven Chen
Steven CHEN is a quality-focused investor (with bottom-up opportunistic approaches), an ex-hedge fund analyst on Wall Street, a serial entrepreneur, computer scientist, and free-market capitalist.

Steven is the Managing Partner of Urbem Partnership, a value/quality-focused investment partnership fund (www.urbem.capital), and Urbem Capital, the research boutique that focuses on the highest-quality 0.1% of all public companies worldwide.

Steven can be reached at [email protected] or through LinkedIn.

Visit Steven Chen's Website


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