Focus Home Interactive (EPA:ALFOC) - Deep Dive
“An independent game publisher with strong momentum and trust issues”
Summary
Focus Home Interactive is growing at 20-25% a year with $8.7m excess cash whilst trading at a TTM EV/EBITDA of just 5x.
There is an ongoing investigation into Valve and five other publisher’s (Focus Home Interactive included) into ‘Geo-blocking’ practices, a form of cartel behaviour. The maximum fine represents up to 10% of annual turnover.
Reputation tainting fallout with one of their previous developers ‘Frogwares’ in regards to the delisting of their games after the expiry of their Publishing and Distribution Agreement.
They are currently working on 24 ongoing projects with 17 different studios, guiding towards an indicative $150-200m in revenue the Financial Year ended March 2022.
User reviews are increasing gradually, with an average metacritic score of 67, albeit not amazing the consistency of positive scores has improved in more recent years.
Business Overview
Founded in 1995, Focus Home Interactive is a French video game publisher whose mission is to produce and distribute original video games on all platforms worldwide.
Focus Home Interactive has worked with development studios in the games production monitoring which it provides communication and marketing based on its partners in distribution networks - that is to say wholesalers, networks and stores with regard to physical distribution, or download platforms for digital distribution.
Management
Each and every person on the Focus Home Interactive executive team has been there for at least 10 years, with an average tenure of 15.5 years between them. The position of executive president of Focus Home Interactive is awarded to Jürgen Goeldner. He was notably director of operations for the British company Eidos and organized its merger with the Japanese publisher Square-Enix. Jürgen Goeldner also supervised the takeover of Chillingo, which until 2010 was editor of the mobile game Angry Birds , by EA. He replaced the previous chairman Cedric Laggarigue after a tenure of over 20 years. So it’s reassuring to see some long-term commitment with this company prevalent in the management team.
As for incentives, The single largest shareholder is the Chairman of the Supervisory board, Denis Thebaud owning 34% of the shares outstanding indirectly through a holding company called ‘Nabutoto’ and ‘Innelec’, putting him in place as a key stakeholder of the company. He’s been in his current role for 5 years now. The remainder of Management and employees own 8% of the total shares outstanding.
Product Momentum
Focus Home Interactive has great momentum and an ever-improving back-catalogue of games. Large spikes in revenue align closely with particular game releases. For instance H1 2019-20 Financial year marked the release of 3 games, all of which showed huge success, driving revenue up 80% as compared to H1 2018-19, which also drove the success of the back-catalogue as well showing an over 100% increase in already released game sales. Furthermore, it’s reassuring to see a decreasing contribution by retail sales and consequently a larger portion of digital/online sales, predominantly international of over 90% coming from outside of France.
Of course, the back-catalogue only can be bolstered by continued strong game releases, of which the company has 24 new games in development. Considering just 3 game releases contributed to $30m in revenues in H1 2019-20, 24 games gives rise to plenty of opportunity to continue to drive revenues and bolster Focus Home Interactive’s revenue base.
Legal Issues
First of all I will mention a seemingly resolved issue, but one that tarnishes the Focus Home Interactive reputation directly involving ‘Frogwares’, the developer of the Sherlock Holmes video games, and The Sinking City. In short Frogwares received notification from Focus Home interactive that their Publishing & Distribution Agreement had expired, which is not the issue. The issue is in regards to a proclaimed new policy in accordance with which they will not transfer the title ID of the developer’s IP if their games had been removed from the Focus Catalogue. This caused outrage by Frogwares due to being enforced suddenly rather than informed ahead of time. There was some speculation about it, but since then Frogwares has managed to self-publish all the previously published by Focus Home interactive titles.
Secondly, There is an ongoing investigation into Valve and five other publisher’s (Focus Home Interactive included) into ‘Geo-blocking’ practices. This is essentially preventing EU consumers from shopping around within the European Union to find the best deal for the games they offer. The Commission, which oversees competition policy in the 28 EU countries, said that the companies were Valve Corp, the owner of the world’s largest video game distribution platform ‘Steam’, and five game makers - Bandai Namco, Capcom, Focus Home, Koch Media and ZeniMax. At this stage, Focus Home is still continuing its cooperation with the European Commission. Companies found guilty of anti-competitive behavior can be fined up to 10 percent of their annual global turnover, of note is that Focus Home has not included a provision in their accounts for this.
Financial Information
The balance sheet of Focus Home Interactive is in an excellent position, being majority funded by operating cash flows proven by a consistent net debt position of which currently stands at 8.7m cash net of debt. Other notable liabilities include tax debt of 5.7m & Developer studio payables of 35m offset by trade receivables of $44m. Finally, the prepayment of $40.6m which is mainly advances to development studios paid under contracts for the acquisition of publishing and distribution rights.
As for profits. The top line cost of sales involves studio royalties, which i estimate an average 60% of sales is distributed to the owners of the IP. Any further fluctuation in gross margin relates to manufacturing costs, which you could most likely see stabilising with the increasing digital sales. The remainder of variable operating costs is largely marketing/production costs and personnel expenditure. So in essence you have a structural range on the gross margin between 30-40% which depends on how low they can keep manufacturing costs. Further operating expenses are entirely variable depending on the efficiency of their own operation. In saying this the operating margin tends to fluctuate around 10-20%. With little room to cut costs, I could see most growth coming from revenue growth rather than margin expansion.
Capital allocation is important for us to highlight the source of returns going forward. Firstly, the business paid a 68c dividend per share in September 2019, representing a Dividend yield of 3.15%. At a TTM EPS of 2.65, this represents a payout ratio of ~25% of after tax profits, with most excess being retained. Recently there has been an ongoing process of accumulating treasury shares through a buyback process. Management classifies the use of these as “actions of conservation for the future as payment or exchange or connection with potential acquisitions, merger, demerger or contribution”. So this is interesting, but in short, the capital allocation is quite conservative and not particularly appealing besides an ongoing dividend payment.
Enterprise Value can be calculated using the market cap of 114m and taking away the net debt of 8.7m which is equal to 105.3m. Putting this in the context of TTM operating income of 21m before tax. This gives us a pre-tax EV/Operating income of about 5x. Assuming a tax rate of 33.3% (France Corporate tax rate) i calculate a post-tax EV/Operating income of about 7.5x. Either way this stock is very cheap and given strong momentum I consider it a good buy for my portfolio.