CD Projekt: A Not Surprising Positive RoR

seekingalpha10-06

CD Projekt's valuation is currently too high, and I recommend holding or selling unless the price drops below 120 PLN per share.Despite the Cyberpunk 2077 setback, CD Projekt has improved, showing ...

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It is, in fact, almost my only stake in a gaming company because I got it at prices that I viewed as extremely attractive about 1-2 months after it troughed after my previous article back in June of 2022. You can find that article here. This is not a victory lap as such - because I actually didn't update the article in time before it bounced back up, at which point I no longer viewed the company as undervalued. So all I have as of this time is a relatively small, 0.22% position of my portfolio in the company. And it's only 0.22% because it's actually up over 70% in 2 years, in accordance with the RoR you can see below. Seeking Alpha CD Projekt RoR (Seeking Alpha CD Projekt RoR) Many of you might not know that I am, at heart, a \"gamer\" or a \"nerd\" - whatever you'd like to call it. I've been playing games and enjoying fiction in various forms for over 33 years at this point. I play things like computer games (including many CD Projekts), I play figure games like Warhammer/Warhammer 40k, and I avidly watch TV shows such as The Witcher. But when it comes to investing in such companies, I'm far more careful - and I'll argue against myself that I've had issues finding appealing and credible valuations for some of these companies when it comes to buying them. The debacle with the company's latest property, Cyberpunk, was a giant kick in the shins for CD Projekt (OTCPK:OTGLF, OTCPK:OTGLY). What had been one of gaming's most beloved and trusted developers after the success of The Witcher 3 got a lot of \"doubt\" aimed against it - and the developer has been struggling to recover ever since. It's not close to backing up to Witcher 3 levels, back when it peaked during ZIRP, but it's slowly recovering. In this article, I'll see what the company might be worth after 2 years. CD Projekt - Investing in gaming is difficult. It's no secret that investing in these sorts of companies is something I view as very difficult. This is doubly difficult when it comes to more of a legacy developer which does not hang its hat on mobile gaming, like CD Projekt. Cash cows such as Candy Crush aren't really this company's Forte - they spend years and years on a single project, hoping (and working) for a good payday once the game is released. That's why Cyberpunk 2077 was such a giant disappointment - the company should have, and likely did know better, but it chose to release it in the state anyway. Fortunately, things since then have improved markedly. The company has worked hard to win back trust, faith, and respect from the community. CP2077 has improved, the expansion was more than a breath of fresh air, and I'm currently doing my third playthrough and finding the game not only playable but enjoyable - now a 7 or 8/10 for me. For a developer like this one, that's a \"must\" if it wants to stay on top. The company is currently in a \"swing\" of enjoying strong sales of their legacy titles in conjunction with TV show traction and the quality of the CP2077 game increasing. CD Projekt IR The company is currently in a \"development stage\". No one knows really what the company is doing aside from what's been released, given that it's working on a number of code-named projects, with the following specifications. CD Projekt IR Employing 639, for the most part, highly specialized developers is not cheap - and the important part for the company is keeping the cash flow going while it works on its next big blockbuster - which in this case is Polaris (given the number of devs). And thankfully, the company financials here are very positive. Net profitability is up almost 13%, and now stands at 40%, with net 1H24 profits of 170M PLN - a decent number, given that one year ago it was 90M. Almost all of that is coming from the RED Segment, not the GOG (Good Old Games) segment, where the company barely ekes out a 1.2% profitability. Still an appealing operation though - and I don't want them to lose it. Spending/Expenditures on the company's new projects have been ramping up during the YoY period, PPE/I costs are up, but the company has improved its equity/assets position slightly. With companies like this, you need to keep track of what sort of cash/capital the company is spending on maintenance, research, and development. That's why I have been \"out\" for some time. I believe the company spent quite a bit on maintenance, and I don't want to invest during that time. Now we're seeing this mix change, and as of 1Q24, we're really back to a development-heavy tilt, which is positive. CD Projekt IR The company's cash position also continues to be impacted by the size of the dividend payout, which amounts to nearly 100M PLN at this time - meaning its covered by net profit, which is a positive. When it comes to investing in a company such as this, you have to have faith, trust - whatever you want to call it. You need to know the company, know how it works and know what it does in order to really be able to \"go in\" with conviction. In essence, you need at this time to have belief in the company's project Polaris, and that it's going to be one of the next big things on sale when it actually comes out. What do we know about Polaris? It's a Witcher game, first of all. It's The Witcher 4. Many view this as a positive. I view it as a neutral. On one hand, the company is going back to things where it's seen success. Comfortable ground, so to speak. That's good. On the other hand, the risk is getting too comfortable in what it's already done and retreading old ground because the company doesn't want to take the risk of taking on new things - which It obviously eventually has to do unless it wants to go into a tailspin such as Ubisoft. It's supposed to be the first of a multi-installment AAA RPG trilogy, and it's moving into production this year. Positives also include that the company is moving from its own RED Engine to Unreal 5. This is positive because it helps the company focus on just the game, instead of making its engine work as well. Another reason the company is streamlining is likely also to avoid another catastrophe with Console releases - as was the case with the release of CP2077. The company is also trying to avoid the \"Crunch\", an industry term for overwork during a certain stage of the project cycle, which apparently and according to reports, was an everyday thing during phases of CP2077. While I applaud this, I don't believe avoiding it entirely is plausible given the demands put on games these days - especially AAA games. I see both risks and upsides with the company's current path. The release of this game is likely a year or years off - I'm thinking 2025-2026 at the earliest (which honestly, as I am getting older, isn't that long), but it's not as though it's 5 years off either. I find that we today have enough to look at company valuation and see if an entry here makes sense. CD Projekt Valuation - my stake is looking cheaply bought - but I may add more if the price is attractive. The company currently has studios across the world, representing over 1,130 people across 45 nationalities, with people situated in Krakow, Wroclaw, Vancouver, Seoul, and Tokyo, with managers across the world. Its primary asset is the Witcher trilogy games, with new things coming, Cyberpunk (Project Orion), and an entirely new IP that is still in its infancy (Hadar). The company is still owned in large parts by founders and the board - over 30% is owned by 4 individuals, with 60.8% being free float. The native ticker here is CDRDR on the Polish stock market. It's now well above my previous PT, at 167 PLN, with a 30% 1-year CAGR. Current market expectations for CD Projekt are for the new IP to be released in 2026-2027, with much of the revenue recognition in 2027. CD Projekt Revenue Estimates On the basis of this, I consider the company's current valuation trends to be somewhat excessively optimistic for the next few years, especially considering the estimated 2025E trough, which is estimated to see EBIT moving below 160M PLN, making it more difficult to maintain the dividend. 2025E is, in fact, according to most KPI's, expected to be the worst year, and this forms the backbone of my current thesis. I believe due to the release window until the new IP, despite good maintenance work from CD Projekt, that we're likely to see a better entry as the 2H24-2H25 result presentations come. The company may be able to offset the valuation pressure using media pushes for its new IP and for Witcher 4, but in the end, over 150 PLN is far too much for the company at this time and in its current development state, with what else is available on the market today. Current target averages come to between 85 PLN to 205 PLN, and an average of 134 PLN. I would go lower than this. While I believe my 85-90 range in my last article was too low, I wouldn't start adding or buying more PLN unless it dropped to below 120 PLN. That's also my PT here. When it comes to game developers, I tend to look at things like sales multiples to get a sense of the company's trends and where they might be going (using estimates). Given that I believe we're going to see sales increases with Witcher 4 in 2025-2027E, as well as earnings increases, I estimate between 8-12% CAGR revenue growth rate for the next 2-3 years, peaking with 12-15% in 2025-2026, with a YoY development of between 60-90% when the company's new title comes out. I estimate this will translate to at the very least a quadrupling or quintupling of the company's 2026-2027E EBITDA, with EBIT up around 150% or so. This is based on what happened during CP2077 and TW3, and what I believe the \"hype\" will be for TW4, which is, granted, somewhat speculative. Based on this, we look at current sales multiples which for the native are near 13x to revenues on a trailing basis, which can be put into context to a 14-15x P/S high and a 7-8x Low. EBITDA is currently at 31x to EV on an LTM basis, which can be put into context to an 18-19x Low. Estimating for both sales and EBITDA for 2026-2027E, the period when sales proceeds for this company are expected to come in, and at what level, and discounting this back for 2024 we get a 150-180 PLN (other analysts are likely estimating higher growth and EBIT for the sales/revenues), which I then in turn discount by 20% to make up for what I believe the uncertainty and risk of a company like this - 120 PLN for the lower end. CDR can also be put in relation to some peers, but the problem with peers here is that they are extremely divergent. Take for instance multiples between Take-Two (TTWO), Ubisoft, and CDR. This puts CDR not only art a current overvaluation but also a historical one - with a mean EV/R of 10.5x, while Ubisoft doesn't even manage 2x and TTWO is at 5.33x. These companies, while being in the same sector, are very differently valued for various reasons - so we need to find the \"right approach\" for each depending on their pipeline and assets. This is mine for CDR, and it's currently not that attractively valued. Analysts echo this estimate and this view. With 18 analysts following CD Projekt, only 2 consider the company a \"Buy\" here (Source: TIKR.com Paywalled Link) Most analysts are at \"Hold\" or \"Underperform\", with 6 also at a \"Sell\" here. In fact, I am considering rotating the company myself and taking home some profits. It's a valid choice after this sort of run, and the company is quite far above my overall estimates for where the value should be. Since January, it has moved up significantly. My thesis for the company as of October 2024 is as follows. Thesis  CD Projekt is an impressively managed game company that produces some of the best games on earth. It's also had a recent fizzle in the form of Cyberpunk 2077, and this will weigh on the company for some time yet. The company's pipeline is weighted beyond 2025, which means that any investment in the company needs to be forward-looking with at least 3-5-year timeframe. At the current estimates, I believe the company to be too richly valued for this. I believe you can make a credible case for a 100-200% RoR when the company's next blockbuster title releases if you buy the company at below 120 PLN/share. The further below this, the better. This is also my new PT for CD Projekt as of October 2024.  This forms the current basis of my thesis. Here are my criteria and how the company fulfills them (italicized).  This company is overall qualitative. This company is fundamentally safe/conservative & well-run. This company pays a well-covered dividend. This company is currently cheap. This company has a realistic upside based on earnings growth or multiple expansion/reversion.  The company fulfills 2 out of my 5 criteria, making it a \"HOLD\" here, bordering on a \"SELL\", but the company has incredible potential - so expect me to keep covering it here going forward.  Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. 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