Chit Chat Stocks - Ubisoft (UBI) | Not So Deep Dive

Episode Date: September 6, 2022

Ubisoft publishes video games across the globe, including franchises like Assassin's Creed and Far Cry. The company's games can be played on consoles, PC, smartphones, and tablets. Listen closely as Brett and Ryan go through the history, financials, and future prospects of Ubisoft. Enjoy the show! Is this episode locked? Access our “Not So Deep Dive” episodes by signing up for CCM+. Sign-up directly through Spotify or Apple Podcasts. If you listen on another podcast player, use this link and create a private RSS feed: https://anchor.fm/chitchatmoney/subscribe Need more information? Check-out our launch newsletter: https://chitchatmoney.substack.com/p/welcome-to-chit-chat-money-plus  Want updates on future shows and projects? Follow us on Twitter: https://twitter.com/chitchatmoney Contact us: [e-mail] Timestamps Company Background | (1:58) Industry | (10:38) Management & Ownership | (15:29) Earnings | (22:05) Balance Sheet | (26:50) Valuation | (28:55) Our Analysis | (30:26) Disclosure: Chit Chat Money hosts and guests are not financial advisors, and nothing they say on this show is formal advice or a recommendation. Brett Schafer and Ryan Henderson are general partners and portfolio managers at Arch Capital. Arch Capital and its partners may hold securities discussed on this show. Learn more about your ad choices. Visit megaphone.fm/adchoices

Welcome to Chit Chat Money. On this show, host Ryan Henderson and Brett Schaefer interview industry experts and riff on the world of investing. As a quick reminder, Chit Chat Money is a CCM Media Group podcast. Ryan and Brett are also general partners at Arch Capital, and Arch Capital may have positions in the securities discussed in this podcast. Anything discussed on Chit Chat Money by Ryan or Brett or any other podcast guests is not formal advice or recommendation. Now, please enjoy this episode. Welcome in. This is the Tuesday Not So Deep Dive episode for CCM Plus or Chit Chat Money Plus subscribers. If you're a subscriber, thank you for listening to this episode and supporting

Chit Chat Money. If you are on Apple Podcasts and you want the written reports that we may reference in this and that go in conjunction with these audio or not audio with the podcast email us your email at chitchatmoneypodcast at gmail.com the spelling will be in the show notes i'll say that again if you're on apple podcast and you have not emailed us uh whatever your email would you want to get signed up for the premium research service that goes along with your ccm plus subscription basically just show notes and charts to go along with this episode to help visualize and see all the numbers email us at chit chat money podcast at gmail.com all right ryan today we're talking ubisoft a multinational gaming publisher with a long history and kind of

an exciting one we're hitting our gaming theme this month just to tease it out we're going to be doing ubisoft xbox oh i'm forgetting capcom rovio rovio which is a mobile publisher small one. And then we're going to do an Arch Capital episode on Electronic Arts. Check out the schedule on our Twitter if you want to see that. But let's introduce Ubisoft. Ryan, what do they do? And what is the history of the business? Ubisoft is a digital entertainment company. You kind of already alluded to what they do. It's comprised of dozens of different video game development studios. And there are some that basically work on the same games, but they just do them in different geographies. So there's a lot of overlap with the studios, but they're located all around the globe.

So they have their own little teams. And then Ubisoft is home to several famous franchises that they own themselves. So they do some license work, but then they also have their own franchises. And some of their own franchises include Assassin's Creed. That's probably the one most people are familiar with. Far Cry, Rainbow Six, Tom Clancy. And Tom Clancy has a bunch of different games as well i believe yeah and that's based if you're a reader of his novels that's they they have the agreement with uh we don't need to go into details it's not that important but the the tom clancy novels i believe is is where they're getting that but that's kind of what they they kind of own that stuff um and they do all the tom clancy stuff and then as i mentioned

they do some licensed development on behalf of other companies so um one one uh game that they've been working on lately is mario plus rabbids um if you have a switch you've maybe seen this game before um it kind of includes a lot of the mario characters but it also has these new rabid characters um but it's kind of licensing other companies ip yeah and rabbids are uh ubisoft games so it's like a combo of nintendo stuff plus rabbids um but you know it's on the nintendo switch because that's what nintendo keeps everything you can't mario anywhere else with switch right and then the the company is the largest european game developer but they still generate the bulk of their sales in north america so they sell everywhere but like i said largest

in europe and then despite the company really their origins were kind of in the pc market that's where a lot of their games were first played now it's pretty much all well not all 60 of their revenue comes from consoles and then the second largest is still pc is i think at about 25 and then they've got a tiny mobile business but the majority of this is big like like longer development cycles for big console pc-based games it's not it's not really a mobile driven business although they do have 2048 which is kind of a popular uh mobile game but that's kind of besides the point um and then within its most popular brand assassin's creed the actual game typically costs, once it's first

launched, it's upwards of $60 per game. But then users can also make in-game purchases to improve their character's outfit or the ship that they use in Assassin's Creed. It kind of varies depending on the game and the different story.

However, Ubisoft doesn't actually break out what percentage of its sales come from microtransactions versus actual game purchases. It seems that But Ubisoft generates more, they are more tied to the actual game cycle. So it's not quite as driven by microtransactions as some other game developers.

And that's kind of just the nature of their games. A lot of these are very, they're story-based games. You're kind of fulfilling this, you're following this arc with the character. There isn't as much need for like that live services component. although the gamers are still very upset that they had the micro transactions uh so i guess they get the they can't have uh yeah they're not benefiting from as much as maybe a you know a grand theft auto or a fifa but they're still you know they still get the complaints and what's interesting is assassins creed games were coming out at a much quicker pace than say some of the

other you know premium story mode games i think like almost once a year at one point which we can discuss the benefits or positives that later in the show or what do you think the right strategy is but that was kind of you know instead of buying one game playing it for five years there's all these new games coming out that you'd maybe spend 60 on although they haven't had a game i don't know the exact schedule now they haven't had a game for a while and they're kind of maybe seeing the success of some of those other companies that release one you know large game every five years and maybe they're trying to transition to that right and these are this these are brands that have been around for a long time and they've just basically done new iterations i think some of

these have been around 20 plus years far cry is now on far cry 6 it has the character from breaking bad um and the new one yeah antagonist i don't know if it yeah it's the same they they got that actor i don't know i can't remember if it was the exact same like character from breaking bad but it's the same actor who was kind of in the game as the as the bad evil boss although it's a similar character i think there's it's sort of this drug lord in a south american the commercials look good yeah i never played the commercials look great um and assassin's creed i think just celebrated its 15th year anniversary so fairly old but not as old as some of the older franchises right and then as far as history goes the ubisoft was actually started as a family business that

belonged and we're going to talk about these this family a little bit to the guillemots guillemots it's a it's a french family um and basically the business was just selling parts to farmers in the brittany province of france however it was run by the parents initially and then once the sons their five sons graduated college they went kind of worked for the the family business and around the 1980s they began to expand into other products so they began selling computer and hardware and software. And then basically buying computer hardware or software was much more expensive in France than it was in the US. So they were basically just being a distributor of US computer hardware and software in France. And they do mail orders for that. And then they

started around that 85, 84 timeframe, gaming was becoming really popular. And they said, all right, we can do the same thing around the gaming market. And so they tried to capitalize on that. And they were able to kind of replicate that computer hardware software for the video game market, because they already had the distribution points and the distribution business and understanding around Europe. And so they actually started their own company. The mom said, if you guys want to do this, you can start your own company. I believe it was called, let me get it right the guillemot informatic uh was the was the name of the company at the time but once they moved into games they actually changed the name to it was two words ubi and soft

i forget what the origins of that were for i think part of it was they just liked the name um but they moved into this chateau in sort of a outside of paris so it wasn't in like the downtown market and part of the allure or the the goal with moving into the chateau was to attract developers to like this really nice place to work um and that actually worked fairly well and i kind of springboarded them into the video game development market at the time it was kind of a combination of partnerships to distribute games outside of the u.s while also internally trying to develop their own games um and then there's this podcast and uh we're gonna we have it in our links to to go listen to but that goes through its whole history um but basically they

acquired a bunch of different studios smaller studios all around the globe and those those different studios had huge hits um and basically struck gold with some of the franchises that we've already mentioned am i you've listened to that podcast as well am i missing any big parts of the history yeah i don't think i don't think so they have acquired a lot of you know studios for the ip and stuff they made a lot of deals and just throughout the years they've had some hits and like a lot of other gaming publishers they found the ones that have a sticky fan base that gamers like and they've kept investing in them we'll talk about the future game development because they're in a bit of a weird spot right now but that that's for the second half of the

showing yes the links to that podcast if you're interested which kind of goes through a three-part series about two hours in total about the history of ubisoft yeah we'll have that in the newsletter um all right i'll hit industry and competition fairly simple for the video game industry it's quite large and quite diverse um it's estimated that this industry did about 178 billion dollars in usd in revenue in 2021 that is really expected to grow to about 250 billion dollars by 2025. However, in 2022, the industry is expected to actually contract slightly as of this writing due to the COVID-19 consumer spending hangover. A lot of people spent money on games when they were locked inside. But the industry is expected to get back on track in 2023. So

from an industry level perspective, there'll be a lot of reports out there about that. Kind of something to track. It's not the best indicator for looking at a specific company because for example in 2023 the call of duty game won't be releasing for the first time that year in a long time and that could lose a few billion dollars in spending for that year which could impact the growth of the industry however that has no effect on ubisoft they could actually benefit them because gamers might be looking for something else so yeah i honestly and for gaming i look at on a case-by-case basis yeah there is some tie to the console cycle still um just in that you know when people buy a new playstation and i believe i forget where i read this but i believe a lot

more of ubisoft sales come from the playstation um than the xbox don't quote me on that but i i thought i read that well yeah yeah playstation is larger so yeah and they uh but when you buy a brand new PlayStation, you also pick up a few games. So there can be some benefit to Ubisoft anytime there's sort of an upgrade cycle. And that's also having an impact on 2022. There's some consoles. The chip shortage is impacting the consoles,

the ability for PlayStation and Xbox, the two big consoles, to get their stuff out the door. So if people aren't getting their consoles, they're not going to buy a game. That can affect the industry as well. I'll give some notes on the different segments of the gaming market. I don't have VR, but maybe in a few years, people will have numbers on that.

The size of the video game console market is expected to be about $37 billion. And then the size of the PC video game market is also approximately $37 billion. So PC and console are two fairly large industries. They're lower growth, though. And then the size of the mobile video game market is around $100 billion and has been the vast majority of the growth for the last decade. we'll see what happens with the new consoles that are you know really high tech now with the ps5 and the xbox series whatever they're calling them they always have the strange names but the mobile

market is a bit different because a lot of that growth yes there was north american growth and european growth but a lot of the mobile market growth has been from emerging places uh that might be a little bit poorer than north america and europe like southeast asia um china although that, you know, they're kind of an insulated market, Latin America, stuff like that, because consoles are expensive and a lot of people have access to smartphones. And that's kind of why that's proliferated so much. Now, when we look at competitors, they mainly operate Ubisoft does in the console and PC market, like Ryan mentioned. So the big competitors include Microsoft slash Activision Blizzard. If you haven't read Activision Blizzard, the maker of

call of duty and then some of the fantasy games like diablo world of warcraft overwatch is getting bought by microsoft so they're kind of combined competitor for ubisoft right now there's electronic arts there's take two interactive which has the games red dead redemption and grand theft auto that are competitors in some fashion to assassin's creed for those kind of you know core gamers the people like to game a lot for those story mode franchises there's the embracer group which is probably competing a lot with acquisitions. They're buying up a ton of gaming studios and trying to be a conglomerate in that regard. There's Tencent, which has bought the Chinese video game company. They're really a multinational tech giant, but they're a huge acquirer of video

game companies. They're a competitor as well because you're looking for studios to buy. But they're also a partner, which is kind of strange because when someone wants to enter the chinese market which is a gigantic gaming market you have to partner with a local company it's the benefit and the restrictions of the chinese market ubisoft has a partnership with tencent doesn't seem like it's gone that well but that's who they have they're working with to go into the chinese market then there's a bunch of smaller gaming studios i mean anyone can really start a gaming studio you gotta have experience i guess but any experienced professional in the industry can start a small studio and start producing games so the competition you know

There's these giant publishers, but it's really just competing for consumers' time. All right, let's move to management and ownership. Like Ryan mentioned, the company has been run and loosely controlled in various ways by the Guimauve brothers since the beginning, with all five of them still the company in some capacity. The most important is Yves, which is spelled Y-V-E-S if you want to research him. He is the chairman and CEO and has been leading the company for 35 years. So really, it's him.

He's there. He's in charge. He's the chairman and the CEO. So he has a lot of control here. Executive compensation, as you might expect here, and we go into compensation, it's way too complicated. As always, there's so many metrics. And as you might expect, they have a base, annual bonus, and then equity incentives like a lot of companies have these days. Long-term variable compensation is based on total shareholder return versus the NASDAQ index. that's 60% of the weighting. There's also a metric of growth in monthly active users, which has 20% of the weighting. And then the other 20% is a reduction in carbon intensity.

Again, it's really hard to, I have to read these things like three times to kind of get the understanding because they're wanting like legalese stuff in these SEC filings. But I guess, how would you describe this? Basically, if they get paid, if their total shareholder return is better than the nasdaq index and then also some of their long-term incentives are based on growth and maus so users on their games and then reduction in carbon intensity which really doesn't make sense for a gaming company but i guess that's fine it's only 20 of the compensation okay one of their performance metrics is as you mentioned reduction and carbon intensity games going online game sales becoming predominantly digital in in and

of itself reduces the carbon intensity yeah i mean at least they're literally yeah being paid for i mean obviously they have to develop the software to to sell it digitally but they're i mean they're they're they're getting performance metrics basically for just being a byproduct of the industry. Yeah. And like, I have this written here. I don't really care about any of these metrics as a potential investor in the business. So it was a bit of a downer to see that they're getting paid on these things that really don't drive like, yeah, okay. Shareholder returns are the long-term are what you want, but- They're also not hitting these metrics. Yeah. They're not hitting the shareholder. They're not getting paid much.

Well, yeah, the stock hasn't done well recently. But again, short-term price movements aren't really how I want my executives to get paid. And by short-term, I mean yearly or maybe two to three-year price movements. I want them to get paid if the business is generating consistent cash flow. Didn't like that. Now, if we move to their annual variable compensation, it's a bit better. They're based on non-IFRS. And IFRS is just kind of the gap. But for international, I think it's, I forget what it stands for, but it's international financial something. Reporting standards. Yeah. Reporting standards, I'm guessing. So it's based on non-IFRS, which is their non-GAAP,

essentially EBIT. And that's 60% of the weighting. And then net digital bookings are 20%, which is great. Those two I like. And then quality of life at work is the other 20%, which is kind of a fake one. A little bit better, but still, again, they're really strange metrics here to be paid on. Didn't really enjoy that. However, if we look at their total compensation, it's pretty low. Their board of director compensation was totaled at 640,000 euros last fiscal year, or only 0.03% of revenue, so pretty insignificant. However, I saw the Guillemot brothers got paid as board members, which feels a bit greedy. Don't like that. Then if we look at annual executive compensation, it was only 2.4 million euros, so not a large

percentage of overall revenue either. There was no egregious pay that I saw, although the target metrics like i mentioned are strange and it was actually a bit concerning to see how little some of the other executives i mean yves i think i'm saying that right uh he gets paid a good amount but some of the other smaller executives that they listed there i honestly want like it was pretty insignificant what they've had i wish they maybe got paid more they maybe they get a little bit better incentives i mean you know it's it's we sometimes complain about the executives uh especially in american companies that get paid like 20 million a year 40 million a year and you know it's really really high these ones are pretty low you want them to care about their work exactly

i mean there's a good balance you want somebody to get paired fairly for the business they have not overpaid not underpaid um but maybe i was looking at that wrong um but i don't think so i looked at it a few times overall though if we're looking at this what all it comes down to is the Guillaume brothers. They still own a sizable chunk of Ubisoft. They have board seats. They are the executive team, or at least Uves is the chairman and the CEO. And they will benefit if the share price goes up over time. Another note, they've actually fought off multiple takeover bids throughout the decades. I think this is an important note because it shows that the Guillaume brothers want to have control of this business. The EA was kind of being sneaky

with them. They took a stake in the company in the 2000s. Vivendi wanted to buy them in 2016. And then recent, there has been rumors of takeover chatter that they shut down and said they didn't want to do. Now, as the brothers age, oh gosh, I think they're in their 60s. Sounds about right. Yeah. Given when they founded it, that does sound right. It is plausible that they will be looking to sell the company eventually, but it's unclear what they want to do because they really seem to want to retain control of this business. Now, if we look at the shareholder table that I laid out here, I don't want to list off everything, but basically the Guillaume brothers on a consolidated

basis have 21.8% of the voting power and 15.4% of the ownership. So they do not have majority voting power, but they do have a good chunk in this thing. So as Ubisoft share price rises or fall, that really impacts their wealth. And if we look at the public float, it is at 79% of the economic rights, and 74.8% of the voting power. So if someone takes a sizable stake here, there could be some takeover speculation, some activist potential. That was kind of the big takeaway I had. All right, Ryan, do you want to hit earnings?

Yeah, so they report on, I guess I should just mention that their financial reporting being a French company is a little different than a U.S.-based company. So there might be a little annoying, as I might say, the SEC, whatever. Let's get some SEC standardization over there. Yeah. And so just, I would just focus on the annual report. They do give updates on sales on a quarterly basis, but there's not a whole lot of color

there. So their 2022 results are going to be what I talk about. So $2.1 billion. Wait, wait, wait. Before when that ended in March, they have a fiscal year that ends in March, right? Yeah. So they've had one quarter in 2020, that would be 2023 fiscal year. So they've had their one quarter ends.

This is one quarter removed, but their 2022 results, $2.1 billion in revenue. That was minus 4% year over year. And then bookings are quite similar for them. So there isn't quite as large of a discrepancy between bookings and revenue as you'd have for some more in-game purchase focused businesses like EA or Activision Blizzard, or even Take-Two. And then they have 87% gross margins, really strong. Those have been trending upwards as sales have become increasingly digital. And then they had $241 million in operating income.

Operating income probably isn't a perfect figure because they do have some interest expense that they pay sort of below that on debt that they have. And then they had roughly $700 million in operating cash flow that was down 26% year over year. However, they have a fair amount of depreciation, which is a non-cash charge that gets added back. And then they actually do want to talk about how they expense and change, convert operating cash flow to their free cash flow. Yeah. I mean, just unlike maybe some of the American companies, they will consider their game development as capital expenditure. So they're going to have high depreciation, but their operating cash flow is going to look strong. However, they're going to be treated as more as a quote unquote, capital intensive business. So I would look at free cashflow because they're going to have high gain development costs each

year. If we look at last fiscal year, the end in March of this year, they had $856 million, or excuse me, 856 million euros. Although euro to dollar parity right now is equal. So it's not really that big of a difference. Yeah. So 856 million euros last year, 753 million euros the year before. I'll probably make a chart now that we're talking about this. I'll make a chart of their internal development costs to see how large it is. Because compared to the business, what do you have the number here? 2.1 billion in revenue last year. I mean, it's sizable. It's like gain development. Almost just under half their expenses. Half their revenue. Yeah. I mean, it's high and that's what do you have here? Negative $282 million in free cashflow.

It's way worse than that operating cashflow line. Yeah. And here's a great example of show me your incentives i'll show you the results kind of thing where they don't get paid on cash generation it's on non-ifrs ebit so yeah so here's your free cash flow for the last five years you put this down and anyone can anyone that's listening to this can easily go check it out on our google sheet here but it's they generated 100 roughly 100 million dollars in cash in 2018 300 million in 2019 negative 200 million in 2020 70 million in 2021 and negative 300 million roughly uh last year so in total over the last five years they generated about 20 million dollars which is basically flat for the size of this business yeah so it's a really

underwhelming cash generation from ubisoft over the last five years now you could probably argue especially over the last three that it's been very much a they're in it yeah they're in a game development phase but aren't they always i yeah it's interesting because they have been talking about that and if you look at kind of the share price you can see that i think investors have grown impatient because they keep saying just wait just wait just wait no no we're making the games we're building these games and yeah they do have some huge games we'll talk about the avatar game but uh i don't know there's just some indications yeah like activision blizzard ea even take two which is investing a ton in gta6 uh has generated more consistently better cash

than uh ubisoft and i don't know they're supposed to be one of these scale publishers as well and then i'll dive into the balance sheet here um as far as liabilities go they've got some really low rate, low interest debt, about $2 billion in total debt. Small percentage of that is current, but about 1.6 billion of that debt. So I don't know, the majority, 75% comes in the form of three different bonds. They've got, and they're almost all split equal. So they got 486 million in zero interest convertible bonds those are due in 2024 500 million in five year 1.3 percent interest bonds due in 2023 and then 600 million in seven year less than one percent so 0.9 percent interest bonds due in 2027 very low rates across the board all fixed thank you yeah thank you

europe yeah yeah so they uh i mean it looks like they did a good job sort of cap the both those were issued i believe all those were issued between 2018 and 2020 so they kind of uh i guess i'm not really up to date on the european interest rates but it seems like they capitalized on sort of the low rate environment um and then in terms of assets and cash flow as well uh about 1.3 billion dollars in cash and bank balances which is basically just cash cash equivalents and then 200 million in short-term investments. So almost as much cash as they have in bonds. So assuming that they're able to generate some level of cashflow over the

next five years, I think it's going to be all right paying, paying those, that debt off. Pretty, pretty good balance sheet. Not, not,

not bad. Yeah. Pretty clean all around. Not, not a whole lot to report as far as like, like it's not going to make or break any thesis here. Yeah. There's no balance sheet concerns.

it's i mean they're already spending a ton on studios and they're not burning too much cash you know it's not they're not going to burn through all this cash and they'll be able to pay that back all right you want to talk valuation yeah let's hit that quick you know again we'll have a link to the dynamic valuation that'll update actually no this one uh google finance api does not sorry to say use the european company so i had to hard code it but that's not a big deal. All right. Market cap is about $5.6 billion. Enterprise value is slightly higher at about $6.27 billion. So they're, from an enterprise value perspective, a lot smaller than Take-Two, Activision, Blizzard, and EA. Take-Two is about $20 billion, EA is about $40

billion, and Activision is getting bought out at about $60 billion. So those are significantly higher from an enterprise value perspective. Now, we look at their valuation ratios or multiples. their enterprise value to operating income is 15.4 but since they're free cash flow negative the free cash flow is negative 22.2 really i mean the operating income one can be kind of helpful but the multiples are not that useful for valuing a video game publisher they're gonna have lumpy revenue they got this new assassin's creed thing coming out unfortunately they're actually announcing that on september 10th which is right after we're recording this but if you're listening and you're interested in this company,

check out that announcement. And they have that avatar game that we're going to talk about. I mean, yeah, you got to kind of look at the game lineup and look at whether cashflow could be over the next three to five years. It could paint a much better or grimmer story for Ubisoft this decade.

But yeah, valuation is kind of tough. Really, really hard to put any numbers here. All right, let's move to anecdotal evidence. Ryan, what'd you have? This is a good one, I guess, company to have because you can kind of see what gamers like, dislike about the company. I have not played

well I played 2048 which is like one of their smaller games I played Just Dance I think yeah they have that one that was big on the Wii and yeah it's a small franchise for them but it's a fun one yeah I maybe have

played Mario and Rabbids but the bulk of their revenue I've never sort of interfaced with however I watched a few long YouTube videos on the evolution of two of their titles far cry and assassin's creed and it's been cool to watch how the game not only the graphics have gotten much much better so it's cool to see like the actual brand evolve with the industry um but just to see the different story modes and the

different storytelling that goes on in these games they've done a pretty good job i think capturing an audience um with with both brands and assassin's creed maybe it's just me but i find it really like a really interesting concept the actual game itself you're basically this like spy they get sent back yes spy but like in a time yeah you're like a sci-fi not an alien but you have like a superpower thing and you can explore all these it's like giving the game studio an excuse to explore this vast array of historical areas and i think the next one they rumored again the official announcements haven't really come out i rumored to be in india and again that's like cool you're an assassin in india in some famous historical period yeah and like i think

the last one valhalla was uh that was the last one right valhalla yeah was that was like viking era if i'm not mistaken and so there's basically there's been a lot of them though revolutionary war was a really popular one that time frame yeah i actually played that one when i was a kid the i mean it's a great it's a good franchise that's my anecdotal evidence it's a great franchise but it seems to be a bit mismanaged because a lot of the gamers have been kind of yeah they've been upset about the quality of some of the new games and they're upset about well they're upset about other things like the nfts which we may talk about and a lot of the microtransactions that they're trying to upsell people within the assassin's creed game in an

unhealthy manner but it just seems a bit more mismanaged than say some of the rockstar games that come out and i'm not saying rockstar i'm saying rockstar studio games which would be grand theft auto and red dev redemption assassin's creed should kind of be up in that echelon but they haven't reached that yet and it might be because they've been releasing too many games too quickly because if they had a grand theft auto game every year i think people will get tired of it um and maybe they were they were doing that with assassin's creed i just don't think that was the right move however another anecdotal one here they have the avatar slash pandora game and avatar being the disney slash fox movie that james cameron's making um they're having the sequel

coming out soon i forget exactly when but they're making a game to go along with that it's like exploring pandora age of frontier something i forget the exact name but that game has a ton of potential to become the next big franchise for ubisoft if they execute well on this and they can ride really the major movie releases from disney because they're releasing an avatar game or excuse me avatar movie once every two years whenever they release the second one they have like three or four more planned if that franchise garners a lot of interest from i don't know movie fans that could translate into game sales as well although again a lot of that's speculative all right let's move to future growth opportunities ryan what do you have i mean it's gaming so yeah

it's really hard to like i'm not going to be able to predict their next big like franchise that's not one they already have so basically just iterating on their existing brands and then also in terms a sort of bigger picture i think their games especially their console-based games are going to become more accessible to more households over time especially if cloud gaming um starts to see some adoption soon and i've kind of been looking at xbox because we'll be talking about them i think in a week um next week yep that's next week's episode they have they are close i think to kind of piecing the whole cloud gaming universe together if if they're able to do that that presents a much bigger customer pool for uh for ubisoft and so then then it really isn't even on

them they just got to make the games and they're going to have some level of better adoption so basically skating where the puck goes um as the industry evolves being kind of having your ip front and center for uh gamers to play and then also if vr ends up being sort of a the the form of gameplay i feel like these i feel like ubisoft's brands lend themselves really well to vr gameplay like pretending to be that assassin or whatever i think that would end up i think that would be very successful in vr um so i don't know just kind of skating where the puck goes there isn't a whole lot i can say here aside from like making good games yeah and my future growth opportunity is just the resurgence of the assassin's creed franchise it was this game was

really well or not was the not game the franchise was really well loved um maybe five to ten years ago but it's kind of gotten people have been a little upset about the game and i think it really had the potential and still does to reach the same level as a grand theft auto or red debt redemption in the quality of the storytelling and then the open world gameplay. However, it's kind of fallen flat in recent years. It hasn't taken that next step to become kind of a billion dollar bookings franchise,

which some of these other big titles from publishers have been, which again, Grand Theft Auto, maybe some of the sports franchises like FIFA, they haven't executed as well on that. We're recording this on September 5th and the company, or excuse me, Ubisoft is announcing their updates

for the franchise on September 10th. So it's their most important franchise. So it'll be interesting to watch that because they've been talking about revamping it. And I believe from the rumors I read, again, we don't know for sure, they might try to make it more like Grand Theft Auto where you have a premium game,

but there's this big online world that's a lot better. However, it just takes a lot of execution. So we'll see. All right, highlights and lowlights. Ryan, what did you like and dislike about this business? Uh, well, the franchises are all pretty unique. Um, and I think we've kind of mentioned this before, but having brands that people love and really finding that niche allows being in that position in the gaming industry allows them to adapt pretty well. If the landscape changes at

all, if it moves to a cloud gaming, um, or if it moves to VR, having the IP, you're going to be able to kind of skate where the puck goes as i mentioned earlier second one industry tailwinds increasing amount of games being sold digitally helps their margins it helps executive compensation a little bit because they can uh it's less of a carbon footprint and um also just as as the industry grows more people are going to be able to access these games both those are big tailwinds for ubisoft uh and then third and this is one we haven't really talked about given the recent fascination with media companies buying video games or video game studios i think this is a potential acquisition candidate netflix could be big here i would never buy

something because i think it could be like some potential acquisition candidate unless i like had a really good feeling it would be but i can give you a floor give you a floor here right yeah i just question how it sounds like the guillemot brothers aren't going to be that inclined to sell yeah i do think that is a downside here i don't i'll be much we'll get to this when we get to the end i'd be much more interested in this company if we ever saw them step away because they just seem to run it for themselves and they've bought and they've acquired studios that one of the other brothers started. Ubisoft has acquired a studio called Gameloft

that one of the other brothers started, which again feels greedy. There's just a couple of red flags with the brothers here. But the other thing is they don't have control. So if someone actually wants to acquire them, the board could vote in favor. Yeah. And then lowlights for me,

I think compared to other publishers, Ubisoft's actual games don't feel optimized for in-game purchases or microtransactions and you've seen the resentment from their customer bases or their fan bases when microtransactions were kind of pushed and so that

to me that's fine it's just a different kind of business and it becomes less software like that's one of the big perks of kind of EA and Activision lately is they're able the shelf life of those games extends well beyond just the initial game purchase. And so if it's just the initial game purchase,

it's a much riskier business because you kind of spend all this money developing the game. And then if it doesn't hit, you've, you've kind of taken this big risk and it's kind of a swing and a miss as opposed to like having success and then being able to kind of juice that over the year and then recycle it and do it again. So, yeah, I agree with that. And now we may be saying this and then five days after they might be announcing entirely opposite strategy so we'll see again that and whatever they're they've said like on september 10th we're doing the future of assassin's creed so that could mean a transition to more of this live services stuff but it's harder to execute on that than say a sports franchise to get you know people to get those

microtransaction i mean there's so much about the brands that they have being story focused like following a plot whereas fortnight there is no plot you are getting on every day and it's changing and you're paying to you know be a part of that yeah like i think people have been upset that the like fortnight does well from what i've read because the the micro transactions aren't like if you you can't pay to win and people are upset that there was some pay to win stuff within assassin's creed although you know counterpoint though grand theft auto i think it's fair you know not exactly the same but fairly similar to assassin's creed and i i don't know i i feel like an assassin's creed could potentially like do well on kind of an you know an assassin's creed online

open world type thing but yeah they haven't done that yet and they haven't no you know people haven't been receptive to that type of stuff but you know could change it could change yeah i guess It's just my overall, my overarching low light is that this is a very lumpy business. It's not as software-like as a lot of other development studios. And then it does not feel shareholder friendly to like outside shareholders. And if you're not going to run a company for the outside shareholders, that is fine. Your employees are probably very happy. Your customers are maybe very happy, but I'm going to look elsewhere to put my money.

So yeah, I mean, if they control it and no one cares, fine. but yeah we're not going to invest uh my highlights i mean you know the quality of the assassin's creed franchise is high uh you know they had good ingenuity coming up with this entertainment ip i mean it's really was one of the best moves from a gaming studio in the past two decades was inventing this i think it could be a billion dollar plus bookings a year franchise which again is just revenue bookings and revenue are fairly interchangeable for these companies I really think it could get there if they, you know, execute. I think it could be like the Call of Duty for Activision or the FIFA or Apex Legends for EA or the Grand Theft Auto for Take-Two Interactive.

But it's not yet. It hasn't hit that next level. And then second highlight is the Avatar slash Pandora game. I think that has a ton of potential. You can see easy open world access there. If they really hit that off, that could be a big, big seller. People love that movie. never really understood why that was just such a big movie but people loved it um you know new

franchises are difficult to build but this is based on an already existing popular movie and they have you know they're making the game for them so that could be huge for them um again i that that is speculative though and they're clearly pouring a ton of resources into that game so there's a big risk on whether you know hit or miss but if it hits it's big now low lights um we talked about the mismanagement of assassin's creed uh we talked about inconsistent cash flow generations we talked about the guillermo brothers making moves that we don't really like that might not be shareholder friendly i guess i don't like stretching the resources too thin across you know what are supposed to be these AAA titles.

I am more in favor of the way that Rockstar Studio does it, where they, you know, kind of invest in this one title with all their employees at one time. They spend years doing it, but it seems like Ubisoft, I mean, it's fine to have a lot of experimental indie games, but I don't think it's optimal to have more than one to two big titles in development at one time. I mean, why do you think Rockstar's games

have such critical and commercial success with the fantastic reviews, it's because they have that focus. I worry that Ubisoft doesn't have that and they kind of just seemed a bit more scatterbrained to me. And then third, if we look at their revenue per employee numbers, it's actually starkly, starkly worse

than any of the other ones. I have this chart that'll be in the newsletter. I mean, just looking at the last year in 2022, to let me just pull it up ubisoft's revenue per employee was 102 000. if you look at activision blizzards 898 000 if you look at electronic arts 541 thousand dollars yeah just i mean what what's going on here like that that's just that's maybe my biggest little i mean what is going on there lastly we haven't talked about this they have made investments in web 3 and blockchain gaming i mean it's clearly a dumb idea and it has angered a ton of ubisoft's fans i mean really really

angered them they're actually saying that ubisoft now people have disliked electronic arts because of their microtransaction stuff um electronic arts actually got sued i forget what country it was for doing these microtransactions but they said that the loot box approach yeah there are people are getting sued uh the people are upset about that for a time and people are now saying that Ubisoft is the new EA that people are really disliking them. And for Ubisoft, they don't have a monopoly on sports franchises. So, you know, that might bode more trouble for them. And especially if they're investing in these Web3 and blockchain gaming stuff, that just

seems incredibly risky to me. I don't mind if we have an executive that says in a conference call, we're exploring NFTs or Web3. But when you're actually investing in these companies and wasting the money, well, I mean, pretty clearly wasting the money. yeah that's just not a good look for me all right bull case ryan what do you think for ubisoft it could go i don't know it's it's such a like a wide range of bull case because it could be like flat bookings for the next two years and then like an assassin's creed game hits and bookings are up

50 or the avatar game hits yeah right and so i think i guess sort of a realistic bull case is that over the longterm, let's say 10 years, um, all these brands that they already have maintain sort of the fan bases that they've cultivated thus far. And then they also kind of grow incrementally as the industry grows. So as more households get access to their games, they, they just basically adopt that with a whole lot of, without a whole lot of incremental expenses required to do so. So, and then maybe they catch fire with a new franchise or something like that, but that's hard to predict.

So I think if they're able to kind of grow within that, within sort of the industry overall, you're probably looking at high single digits to maybe even good success would be low double digit annual bookings growth. And then assuming they're able to do, I don't know, 20%, I would think. the thing is it's so hard to tell because the development cycles are so lumpy in terms of like costs compared to the bookings because you yeah but bookings front bookings

growth is vital because there is operating leverage here so let's say incremental margins out to I don't know 15 to 20% cash flow margins there's probably a path to like a billion dollars in free cash flow and add I think the current enterprise value is what six billion dollars

it's pretty cheap pretty cheap yeah and we're talking euros here. Like we're saying dollars, but it is euros. I mean, they're very similar on the exchange rate, but you're going to get, if they get to a,

if there's a world where they're generating a billion dollars and like true free cashflow, you're going to make money here if it's in the next five years. Yeah. They just dilute the crap out of shareholders. Yeah. And they historically, I haven't had the shares outstanding here.

Let me get over the chart. A little reference. It has been relative up a little bit, but not, not too bad. Not too bad. Yeah. All right.

my bull case is i mean you know the new assassin's creed strategy whatever it is is a success and they can you know elevate the franchise across console pc in the same way other publishers have done and combined with that if the avatar avatar pandora game is a huge success and we didn't even talk about this they had they got a deal with lucas uh whatever it's called lucasfilm games or whatever it is the star wars games and they're making those right now i don't think they're expected to come out until 2025 but they do some of those they do well again like ryan says you know you can get bookings closer to five billion dollars eventually because of all the development games there have on here you've seen other publishers of similar magnitude uh getting

into that level for bookings and you know the operating leverage is finally achieved you can get that cash flow be really hard to lose money if they can get if they start obtaining operating leverage given their bookings level now bear case uh ryan what do you think what they're currently doing yeah if they just like if they're spread too thin if they're kind of just hiring tons and tons of people and they can't seem to get like a real hit game again um you know there's i i don't like this company and this is going to be my more or less interested but like the the bear case is that there's like this big competition for attention right now and they aren't doing enough to kind

of regarner the fan base that they once had and the position and the market share they once had and so um i don't know several consecutive game flops that that to me is potential bear case and then it also if they start to lose that fan base i think the floor of an acquisition potentially coming in starts to go away because that's why someone would acquire them is because oh we can go ahead and juice this for more cash and we do re-manage this business properly yeah i mean assassin's creed far cry i mean assassin's creed is the big one you could see a strategic acquire seeing that and saying that's worth six billion dollars to us if we can utilize that correctly which but but if the fan base goes away and it kind of dies out and it continues to lose

popularity i mean then it goes away then that floors down this is kind of maybe a little long this is like way out but um i could see a world where embracer group somehow ends up owning some of these interesting brands yeah interesting at least yeah i mean similar my bear case is kind of similar they continue to mismanage assassin's creed and they're continually inefficient with capital allocation decisions again the employee account versus what their bookings are um investing in web3 companies and then you know they're alienating their fan base at the same time if they're people are calling ubisoft the ea like they're now the new ea and people hate it a lot of people dislike ea but they still buy the games because you know it's the only way to play a

football game but that's not the same with ubisoft i think the bear case is a lot lower yeah more or less interested ryan less i am less interested and this actually i don't want to say it soured me on the gaming industry because i think the gaming industry overall will grow but it reminds me that most companies in the gaming industry i would not want to own and they it just there's just such a lack of predictability around the cash flow not only is it lumpy but you just have no idea how some games are going to be received You don't know as an outside shareholder, you don't know what the games are going to look like. It's really hard to predict the cash flow for businesses.

And if you can't trust management. Yeah. And then on top of it. Yeah. If you have that unpredictability, you kind of need to have the trust in management. I mean, we clearly don't here. I'm going to say more interested, but not, I would never buy this if the Guillaume brothers are still in charge. if they left and things kind of fell apart even more this could be because here look people could

have said a lot of the same things about take two interactive before the straw selenic team came in now if ubisoft is kind of i mean i could see a trading really cheaply they bring in someone like a strauss selenic obviously they there's no guarantee that they would execute the same way that take two interactive did but given the brands here given the franchises i i'm more interested but no way i'm buying this right now for reference for everyone who's kind of for anyone listening who's worried about the price or how it's done historically since i want to say 2008 so almost 15 years stock is up about 80 so it's severely underperformed the market yeah yeah Yeah, and Ubisoft's big because they've made a lot of acquisitions recently.

It hasn't really done that well, I don't think. Yeah, I mean, the last three years it's down 39%. I mean, yeah, clearly people are upset because the cash flow hasn't been there. They've been saying they're going to invest in these new games and they keep getting delayed. They actually love talking on the conference calls, love saying that. They're like, well, the industry's in a bad spot right now because everyone's getting game delays.

And I'm like, all I'm thinking is, I don't know. we follow a lot of other companies that are still releasing games so i think it's just your problem and you have more employees than every other company so what's the deal yeah they are like eight or ten times smaller than all these other companies with substantially more employees and they they have twice as many employees as activision blizzard the uh well maybe Activision has been losing plenty of them, but the, uh, yeah, but still, I mean, I would much, I'd much rather invest in Activision Blizzard and Ubisoft, even with the problems. I mean, they both have, we didn't even mention Ubisoft's, uh, sexual assault and allegation

issues. They've had very similar stuff, maybe not as egregious as Activision Blizzard, but they had similar stuff, which can really hurt morale, get people to quit, which, you know, obviously. Yeah. It does not, it really does not entice me. And it's really hard to predict like, okay, if this was managed by someone else, like maybe I'd reassess once there's like new people that came in or new management group that came in, but I'm not going to take it on the chance that someone else could come in. Yeah, exactly. You have to wait until that happens.

But I think the interesting thing is that if someone came in, there is that possibility that the stock would be trading absurdly cheap at that moment because the trust would be totally gone. And that's the only reason I'm going to have it on my watch list. But at the current time period, I mean, a lot of things have to change before I'd be interested in buying this thing. All right. That's going to do it for this episode. Thank you all for listening. Let's give it a little tease for those aren't on the Twitter sphere, as we know everyone isn't. For the gaming month, here is our schedule. Ubisoft this week, as you're listening.

Next week, Xbox. Week after, Capcom, Japanese gaming publisher. Next week after that, Rovio, maker of Angry Birds. And then we're going to be doing our Arch Capital episode on Electronic Arts. explaining why we own that business compared to other ones kind of as a wrap up. We're also going to be tossing in

a Dropbox episode because we do not have an interview this week for an Arch Capital episode. So look forward to that. That'll be only for CCM Plus subscribers as well. We are not financial advisors. Anything we say on the show

is not formal advice or recommendation. We are general partners at Arch Capital and clients may hold securities discussed in this podcast. Thank you for listening. We'll see you next week. We'll be right back.