Hutch Games Ltd. (MTGB) Earnings Call Transcript & Summary

Ladies and gentlemen, thank you all for standing by, and welcome to this MTG Investor Presentation. [Operator Instructions] We must advise you all that this conference is being recorded today, Wednesday, the 9th of December 2020. And without any further delay, I would like to hand the conference over to our first speaker of the day, CFO, Lars Torstensson. Please go ahead, sir.

Thank you, and good morning, everyone, and welcome to this investor update related to the recent and very exciting announcement made by us yesterday night. My name is Lars Torstensson, and I'm the CFO and Investor Relations at MTG. And today, I'm joined by Maria Redin, our Group President and CEO, and also Arnd Benninghoff, Executive Vice President of Gaming and Esports. We will start with a formal presentation followed by a Q&A. So please keep in mind, questions are only enabled for those participating through dial in. Our webcast is listen-only. So without any further delay, please, Maria, the floor is yours.

Thank you, Lars, and good morning, everyone. We are very excited about hosting this call today and to walk you through our news release about the Hutch acquisition yesterday, and similar also to walk you through the transaction announced Monday relating to our increased ownership in InnoGames and creation of the jointly owned gaming holding company. Before going into the details of the gaming holding company and Hutch specifically, I would like to make a short recap of our strategic priorities for everyone's benefit. So let me start by sharing my thoughts on MTG's vision and priority. So if you can move to the next slide, please. MTG's vision is to be the home of esports and gaming entertainment. We want to deliver value through our buy-and-build strategy, focused on organic growth and strategic M&A in both our esports and gaming verticals. As part of our Q3 results, we concluded on our strategic review. And while the creation of the 2 separate equity stores remains our long-term goal. For the foreseeable future, we intend to retain both verticals within MTG and concentrate on building the value, both on organic and through acquisition basis. Move on to the next slide. We're having a very strong starting point. We operate in 2 of the fastest-growing segments within the entertainment industry, esports and gaming, and we have a clear growth strategies within both segments. Like all others, COVID-19 has impacted our operations and quite adverse so between the 2 segments. Though through the work done within our teams and the operations, I feel very strong that we stand stronger than ever with a clear focus on operational execution that lies ahead of us as well as the strategic M&A opportunities that will drive shareholder value going forward. If we then the move slide again. For us, it's clear that we want to accelerate our M&A agenda to complement our organic growth. I believe that we are strongly positioned to participate in the ongoing consolidation in the gaming market and with a clear focus on quality assets within the cash flow to the mid-core genre and equally important, with a good culture fit from the organizational wise. Further, with Monday's announcement and with the creation of the jointly owned gaming holding company, we're also improving our synergetic approach and expect to use acquisition, live ops and BI, which complements our decentralized operating model. For us, it's extremely important to be the best home for great entrepreneurs. And before I let on talk about the fantastic entrepreneurs behind Hutch and the company that they built, I just want to briefly talk about the transaction we announced Monday. So if you move to the next slide. On Monday, we shared with you the increased ownership in InnoGames through the utilization of one of our call options. InnoGames have had fantastic performance before this year and equally has a very interesting pipeline on new games in development. More strategically important, we further agreed with the founders and commented to the buy-up in ownership to combine the remaining shareholders in a newly created gaming holding company that will hold 100% of our existing gaming companies and will be the acquiring entity for the new acquisitions within gaming. This is in order to maximize the synergies within the gaming vertical. So the table is now set to create a world-class gaming company. And with that said, I would like to leave it over to Arnd and let him give you intro to Hutch and the team behind it.

Thank you, Maria, and good morning, everyone. Over the last 3 years, we have been screening the games market quite intensively. And we have been active in all key M&A processes. We looked at over more than 250 companies. But with Hutch, we have now found a highly unique games company, an ideal partner in our efforts to build a gaming powerhouse. So why is Hutch so unique? I mean they're chasing a big vision to build the biggest automotive community on mobile, and they're clearly set really to become the category leader in mobile racing games. They are active in the highly attractive mid-core genre , targeting an underserved racing sports games market. They're a highly innovative team that are able to lead this genre development through innovation. Their portfolio is nicely diversified with 3 titles in growth mode, which is never seen before, and 2 more in the development pipeline. They have very strong financial profile with a high profitability at this growth stage and a high top line growth as well. So they are really best positioned to become here the category leader. But let me introduce you to this rough diamond. Next slide, please. Hutch is a London-based mobile free -- free-to-play mobile games developer focused on racing games. The top 3 titles are Formula 1 Manager, Top Drives and Rebel Racing, all are in an early growth phase with large future growth potential. None of them is older than 3 years. Additionally, Hutch has a promising new games pipeline with titles planned for launch in '21 and '22. Hutch has also demonstrated, as you can see in the middle of the slide, an impressive growth over the years with -- say it's growing by 158%. But what is also remarkable is the high EBITDA margin, and there is only a small gap then to EBIT, which we haven't seen in any other games company. So a 25% margin already now in such a growth phase. They have 30 live games, but the top 3 games are driving the revenue. And this is all led by a highly experienced management team. If you go to next slide, please. They all know each other from Sony PlayStation, some have been with other racing game developers. They have built a stellar corporate culture and created an exceptional transparent team spirit. This is a great fit with our approach of building the best home for entrepreneurs. The reason why they have chosen to partner with us is they are long-term committed, they want to own Hutch as an independent entity. At the same time, based on our mid-core know-how in live ops and marketing in InnoGames, we can help them to accelerate. But let me show you how Hutch has become a champion in mobile racing. Next slide, please. Hutch drives innovation in mobile racing to combining different proven game mechanics like collecting strategy and racing. The 3 growth games are all younger than 3 years. They're still in early growth phase, as I said, with a huge growth potential and which is also very unique is that they have not a single game dependency. Next slide, please. As you can see here, the revenue is equally allocated. So Formula 1, with roughly 35% of the revenue and Top Drives on the same level. Rebel Racing has just been launched end of last year and is still optimization phase. All 3 games are nicely growing and have huge upside potential to spending more on marketing and also doing more live ops, releasing more content. The fourth game, which is now in development, will be launched in the first half of '21 is Puzzle Heist. Puzzle Heist is a combination of a Match-3 mechanism and RPG, addresses even a broader audience and can onboard also more casual players. They're inspired by Fast and Furious and Grand Theft Auto, with a huge potential. And the fifth game is also in development which might be launched in '22. What is also remarkable with Hutch is their fast time to market. Within 1 year from the concept idea to full commercial launch is really unheard of. And now with this well-balanced games portfolio, they will continue their strong growth. Next slide, please. When you look at the top 10 racing games, we haven't seen any company which has 3 games under the top 10. So Hutch is clearly well positioned to become the category leader here in mobile racing. And again, through the innovative approach of combining different game mechanics, they can address broader audiences and put them into their games. Next slide, please. Hutch is uniquely positioned here in the mid-core market. If you look at the graph, you see on the left side more casual games. With their games, Formula 1 as a manager game, combining racing elements and strategy elements, then Top Drives the classic collecting game with racing elements and then Rebel Racing focused on racing, they have shown exceptional KPIs, have a strong growth potential and offering for the committee in motion hooks into the games. Next slide, please. The addressable audience is even much bigger since they are also targeting all automotive fans. And if you look at the reach of the franchise like Formula 1, close to 2 billion fans. And then also, we have our esports audience. And here, we can leverage our esports infrastructure in ESL, where we are already running mobile esports leagues for racing games. And now we can support Hutch's growth through esports tournaments, which will just increase retention and engagement of the users. Next slide, please. To summarize the investment rationale and why I believe this is really a unique asset, Hutch has a deep know-how and attractive niche category in mobile racing growing by 27%. It's a very unique combination of a highly profitable growth company with 3 growth games in an early growth stage. They have a world-class IP with Formula 1, and there's huge synergy potential with our other mid-core company, InnoGames, where we can help them in UA and live ops. So that's why we believe it is a very attractive investment and exactly what we were choosing to do after 3 years screening the market to introduce a new cornerstone asset for our games portfolio. And our games portfolio, by adding Hutch, is now nicely diversified. Please to the next slide, as you can see here. On the left side, we have all the games in production and development, where we have a nicely filled funnel. Then at the next phase with introduction phase and still web racing from Hutch is the introduction phase. We have games from Kongregate, which are in the introduction phase. And then the most important phase where we see popular growth is the growth phase with Rebel Racing, Formula 1 and then games from Kongregate. And at the end of the growth phase, we have Forge of Empires and Elvenar, which have shown strong growth in '22. And then in the established and harvest space, there, it's all about the craftsmanship in live ops, releasing fresh content, doing safety events and developing new features. Plus our best-in-class U.S. platform and InnoGames helps us to further scale these games. So now we have a highly profitable nicely balanced portfolio in our games vertical. And with that, I want to hand over to Maria, who will introduce you to the deal terms and show you the financial impact on the games vertical through this acquisition.

Thank you, Arnd. So to summarize the transaction, we believe it's quite -- and I believe Hutch joined by a quite unique asset with 3 live games in early growth phase. Hence, it's attractive growth profile. 158% sales growth Q3 year-to-date and then also the positive outlook going forward. Even though games are in the early growth phase, we do put a lot of investment into marketing. The company produced strong EBITDA margins. And as capitalization rates are quite conservative, it's important to note as well that there is little leakage between EBITDA and EBIT. On top of this, as Arnd also presented, Hutch has an exciting pipeline of new games to be launched in 2021 and an early development of a game that is potentially to be launched in 2022. As a part of this transaction, we are paying an upfront payment of $275 million, predominantly in cash on a smallish MTG share component. And back on the growth profile, we are looking at a valuation in the lower teens in respect to the EBITDA multiple in 2021. There is further an earn-out component of approximately $100 million, which is to be paid over the next 4 years on back on the financial performance of the company. This is to ensure the long-term commitment as well as alignment between MTG and the founders. Also, with the creation of the gaming holding company, we are well positioned to realize the synergies between Hutch and the other gaming companies in the portfolio. If you then move to Slide 19, there we can look at the combined financial statements and to see the impact of Hutch. And as you can see, Hutch has not only significantly diversified our games portfolio, to Arnd's point, but it also improves our financial profile in respect to more diversified revenues and also accelerated growth profile while sustaining margins. The newly combined gaming company will, for Q3, year-to-date, report net sales of around SEK 2.5 billion, with a margin of 28% or SEK 780 million in adjusted EBITDA market. This, on back of 35 released titles and yet 7 more in the pipeline. So to move to the next slide. I just want to have a quick recap before we go to the Q&A, what we actually talked about today. So as we announced Monday is that we increased our ownership in InnoGames by 17%. We're further done with the remaining shares, rolled up the remaining shareholders and launched a new company together with the InnoGames founders gaming holding company, that is to be the acquisitive entity going forward within the gaming entity. And then yesterday, within the newly established gaming company, we actually executed the first transaction with the acquisition of Hutch. So with that said, I will hand back over to Lars.

Thanks, Maria, and that ends our presentation, and we are now ready to take any questions that you might have. Operator, could we have the first question, please.

[Operator Instructions] Our first question comes from the line of Tom Singlehurst from Citi.

It's Tom here from Citi. Congrats on the deal. Very exciting to see you guys on the front foot. A couple of questions. The first one is, I'm just interested on the sort of level of integration you guys are aiming for sort of medium term, in the sense that with the earn-out structure, does this -- will you be keeping Hutch sort of essentially sort of separate and independent within the group? And is that going to be a sort of key part of the model going forward? And then I suppose linked to that. I'd just love a sort of sense of cadence for these type of transactions. It's -- as I say, signals that you're much more on the front foot and more proactive, but should we see deals of this size coming through much more regularly from here on in? Or is this a one-off step, do you think?

Thanks, Tom. I'm actually going to repeat because of the quality of the line. But -- and first of all, thanks for the digital flowers on the transaction. The first question is level of integration between the companies, now a part of the new gaming company. And the second one is then that we are now more proactive in the market when it comes to M&A activities. Is this deal one-off or would we more expect more activities from MTG. I guess we could start with you, Maria, and then Arnd you could step in if there are additional flavors that should be shared. Please, Maria.

Yes. And thank you, Tom, for the congratulations. Much appreciated. But if you look at the level of integration, what is important for us is to find great companies with great funders that are committed to continue to drive the companies in a successful way. So that's the foundation where our model starts with. That means that we are going to continue to run a decentralized model. At the same time, why is the gaming holding so important this past Monday that we announced? Well, it actually creates a perfect alignment between us because now you're going to have one holding company owning 100% of all the assets and there is a lot of center of excellences in our different portfolio of companies. And of course, we want to make sure we utilize that and share that know-how and best practice between the companies. So that's how we will ensure that we reach the synergies to continue to keep the founders and the entrepreneurs accountable and mandated to run their business and continue to run their business in the most successful way that they've done, but to accelerate that through the knowledge and their know-how in our best practice centers that we have. So that's how we will run it. And that should, in a perfect world, of course, have a positive earn-out structure and also have a positive result for us. So it's a win-win scenario. So I think that is the first question. And if we go to your next question, of course, I mean, we've done too big transactions, to be fair, on our account this week. And we do believe that the Hutch acquisition is a transformative acquisition for us and marks sort of a new era on what we're trying to do. And it's quite important for a strategic growth driver for us. We would continue to screen and scout for great gaming assets. That goes without saying, and we will continue to also screen what we can do on the esports side to further accelerate the growth on the eports side. So we are not stopping down. But I mean, I'm not going to give an indication on how many -- how sizeable they are. But where there are great opportunities, we will, of course, try to be there and look at them.

Thanks, Maria. Tom, do you want a follow-up?

Yes, one follow-up, if that's okay. And forgive, I suppose, the simplicity of the question, but I just wanted to understand the sensitivities around using equity. I guess in the very short term, it's a question of sort of getting the necessary shareholder approvals. But the -- more broadly, longer term, should we see equity as being much more part of the mix when it comes to deals at this time?

So the question then is around the structure of the transaction and how that could potentially change over time. I think that's also a question for you, Maria, to elaborate on.

I think each transaction is unique in its own merits on how you set up the structure. What is important for us is that you bring on a long-term commitment and alignment between MTG and the founders. In this instance, we use the MTG share, and that also creates an alignment between us and the founders. Going forward, I think that in one way or another, you should probably expect us to utilize an equity components because I think that is a quite interesting way. And with the newly created gaming holding, that could be one way or an entity share could be another way.

Okay. Tom, any follow-up on that? Or are you...

I was going to say, and part of that might be at some point, an equity in the MTG Gaming AB. So it could be equity at that level as well as the group level.

Yes, that's correct.

Our next question comes from the line of Matt Singh . Matt, can you check you're phone if it's on mute or we'll proceed to the next question.

Let's go to the next question.

Next question comes from the line of Oscar Erixon.

That should be me. So first of all, a question on Hutch here. If you could talk a little bit about the synergies that you see between perhaps InnoGames, Kongregate and Hutch. What are sort of the low-hanging fruits? What can be done better? And what sort of growth potential do you see in the next sort of 3, 4 years?

Thank you, Oscar. Good question. So when it comes to synergies between the 3 existing companies within the gaming holding, Arnd, would you like to elaborate a little bit on the benefits of working together between Hutch, Kongregate and maybe especially InnoGames?

Yes. Sure. Thank you for the question. Since Hutch is active in the mid-core genre, the InnoGames team has been involved in the due diligence. And the key filings were super positive that, a, there's huge upside potential on marketing to spend more based on InnoGames' predictive KTV model, where they can calculate an LTV, lifetime value of a user, which we've acquired over 2 years, they can spend much more than most of competitors. In Hutch's case, they calculate the LTV so far based on 100, 180 days, up to 250 days only. So much shorter, but they still have very strong return on advertising. And that's a solid base to do much more higher UA spend and also to use InnoGames' platforms and systems for UA spend. And so that's one synergy area where there will be a collaboration between InnoGames and Hutch. The second one where we see a huge upside potential is the live operations of the games. So once again, it's live and since all 3 games are really in early growth mode, also compared to InnoGames, if you look at Forge of Empires, which is like 6, 7 years old, still nicely growing through live ops. So here, Hutch will benefit from the live ops playbook and best practice exchange with InnoGames. So again, this is a matter of centers of excellence where the companies, InnoGames and Hutch, would collaborate. Here, we can help them to do more live events to also scale with the studios since their studio team are much smaller than InnoGames. So we have the knowledge base, which built up, and then Hutch can benefit from this and improve their live ops and further scale the game. So these are the 2 main areas, and we focus here the synergies on the 2 mid-core companies.

Thank you, Arnd. Oscar, I'm sure you would like to follow-up there.

Yes. That's very helpful. And another question on sort of M&A in general. First of all, what sort of competition are you seeing now this being partly VC owned? Are you seeing a tough competition for targets? And what can you say about sort of the pipeline here of acquisitions going forward? Because you've shifted the strategy quite recently back to buy-and-build, what does the pipeline look like? What does the competition look like, if you will?

Thank you, Oscar. So looking at the M&A climate currently, the competitive level when it comes to transactions and also how our current pipeline is looking like, I would say that, Maria, if you start and then Arnd can build on your answer.

Yes. No, absolutely. I think that coming out of the COVID last couple of months, I think it goes without saying that gaming is a highly attractive segment to operate in. And I think that we've seen over the last sort of 6 to 9 months an increased competition within. But I think what is important for us is to continue to focus on the type of companies that we want to acquire, the segment which we've very clearly specify, which is mid-core and casual. And then to be the greatest home of entrepreneurs. And I think that that's what makes us extremely happy that we were able to buy the Hutch team because we saw a mutual fit from both parties, about the culture, the values and what we together wanted to do. And hopefully, that is also a positive signal out of the market and the great entrepreneurs out there that we have great teams that want to come on board to our family, and that's what we will continue we'd like to onboard.

Arnd, would you just generally elaborate the M&A pipeline as well on how things are.

Although we have done a strategic review of the games strategy, we always have been active in processes and learn. And for us, it's always important that our concept is best for entrepreneurs, resonate with the founders. Because these are exactly teams we're looking for, who are long-term committed and appreciate our vertical operating system. We have a pretty strong M&A pipeline with a short list of probably 15 companies. We are constantly working with and updating our context. So this funnel is pretty solid. And as I said, we are constantly -- continuously screening also new companies. And our sweet spot is here exactly like Hutch, found that a company, sometimes we have -- we see investors, but most of the companies are really controlled by the founders. And exactly, this is the right trajectory we're looking for, profitable, well balanced portfolios and mid-core cash flow. These are our investment criteria.

Our next question comes from the line of Erik Lindholm from Nordea.

Yes. So looking at the Q3 year-to-date numbers, what sort of levels of UA to net sales did Hutch [indiscernible] bit strong growth with? And what sort of return if Hutch is sitting on this [ USC? ]

Thank you, Erik. So if I hear you right, it's a question around user acquisition cost in relationship to total revenues. We don't disclose that level of detail, but then we could elaborate when it comes to the general level of UA and so to speak and what sort of returns we get.

Yes. No, I think that Arnd mentioned it in his -- as part of his presentation. I mean if you look at InnoGames, and I think what we told about them is that, I mean, they do marketing on back of 2 or 3 years, overall levels, which means, of course, that requires high proportion of their revenues as a sort of direct marketing cost. If you look at Hutch, given that they actually calculate the return of ad spend in a much shorter time frame between sort of 180 to 250 days, the proportion of revenues is, of course, much lower. And that's also where we see an upside, both in that we could actually increase that spend through actually adding the InnoGames sort of modeling, I would probably call it, to calculate, I mean best return of ad spend and so forth and predictability models. And then also the fact that you can diversify the channels that you're using because InnoGames have a much more sophisticated and a broader range of channels that they use. So today, I would say that it is relatively low for being a mid-core asset, and we do believe that there is an upside to proportionally increase that to some extent. So we will only scale it to the extent that the games can actually manage.

So Erik, do you want to follow-up?

Yes, please. So yes, a question on the IDFA changes here. So how do you think Hutch portfolio is positioned for the upcoming IDFA changes from Apple? And will this sort of change the way you think about marketing channels here for Hutch?

Thank you, Erik. So IDFA and the impact on Hutch. I think, Maria, you could also elaborate on that one.

Yes. I think that no one knows exactly how the IDFA can and will implement. But I think that given that we have not pushed it, but Apple will now push it forward. We've got much, much more time to prepare, and that is something that has been done on a good level within InnoGames. And again, coming back to the collaboration between the different portfolios, what has already been started. Of course, the discussion between Hutch and Inno, given that they both work and operate in the mid-core segment, so that's why, I mean, on the biggest scheme of things, we're comfortable with it. And as we're confident that we will find working around of it, but it's important to say whether you will see very little or no impact, I mean, or that is still to be seen. But we feel well prepared on our side. And that will also -- I mean, the synergies will facilitate on this -- the collaboration.

Thanks, Maria. Erik, do you want to follow-up?

Yes, yes, sure. One more question here. So just -- I mean, the racing genre has been on fire here in 2020. Do you think there is any risk that this sort of comes from only a COVID boost and that 2021 will be much weaker?

So racing genre as a popular genre across the pandemic. I think maybe, Arnd, you could start with elaborating on the growth opportunities within the racing genre in general that Hutch is in particular, if that's the all right, Arnd.

Sure. So based on our experience in InnoGames and Kongregate, where we have seen different corona impacts, we have not seen such a strong spike to corona in March, May or June in Hutch. It's a really very constant ramp-up of the games since last year, September, October and not really a big boost of corona. So that was important for us also to neutralize or to understand if there's any corona effect. Racing itself, since this is really across sort of passionate automotive fans and then just evolving racing -- mobile racing game genre, I think, is huge growth potential. And I think it will continue to grow, as I said, by 27% next year. And driven by innovation. Because so much more are we going to see in the game's mechanics and game's quality. And Hutch, coming from AAA development, having done development for console and PC games, that's what you can see in the polished and high-quality games. So I think -- that's why I think it's super solid foundation, and now it's more about working with the community and focus on live ops in UA.

And the other one also, Erik, that could be -- we have talked about it today already on the call, but of course, it's the [gaming] portfolio that Hutch is also sitting on, which is early in the growth phase and have a very strong growth trajectory in combination and with the new games being launched in 2021 and 2022 makes us feel comfortable about the growth profile of the company as well. Would you like to follow-up, Erik?

Yes. Maybe a final question there. Just you mentioned 27% growth for the genre next year, if I understood you correctly. I mean, should we expect then that Hutch outgrows this genre growth for 2021?

Erik, that's a great question, but we're going to avoid guiding on Hutch for 2021. We have provided, as you know, just a little bit of a glimpse into next year. I think that is where we're going to stop today. And unfortunately, Erik, but let's continue to discuss the company. Operator, do we have any more questions available?

Yes. There are no further question at this time, please continue.

Okay. In that case, thank you very much, everyone, for joining today's call.

We got a follow-up question from Matt.

Okay. This is Martin Arnell at DNB Markets. Can you just help us understand the implied expectations for next year? I mean, we have a fairly good understanding for this year, given the rolling 9-month progress. And then you say mid-teens multiple for next year on the initial consideration. And at the first slide, that signals fairly limited growth next year, if we look at the implied results next year based on that communication.

Okay. Thank you, Martin. So you're wondering a little bit about the growth outlook of the company. I think it sounded like there was a little bit of a misunderstanding on the indication for next year that we have. But when it comes to our indication for next year, Maria, then could you just clarify for Martin, so he gets the different picture.

Yes. No, I think the indications that we said, I think that Arnd provided some of the basis or the foundation for growth. I mean, you have 3 games in early growth mode. You have 1 game to be launched in sort of early 2021. And those are the foundation growth. We do see incremental synergy potential with collaboration between InnoGames and Hutch, where we can drive more UA and both live ops, which will further positively impact growth, we believe. And the only thing that we said in the outlook was to say, if you look at the increased EBITDA multiple for next year, back of the growth trajection that we see, it should be in the low teens. And we do believe that we would rather see top line growth and absolute EBITDA growth and any margin expansion, given that we would like to ramp up marketing.

Thank you, Martin. And we can, of course, follow-up in more detail afterwards as well, Martin, for your benefit. So operator, do we have any more questions?

No questions, sir. Please go ahead.

Thank you. In that case, we're going to conclude today's presentation. As I mentioned, for any follow-up, please just reach out directly to myself. Or if you are a member of the press, please reach out to our Director of IR, Oliver Carra, as well. With that said, have a great day and stay healthy and speak soon. Take care, and bye-bye.