The Gearbox Entertainment Company, Inc. (EMBRACB) Earnings Call Transcript & Summary

Thanks for joining the call today to focus into the acquisition of Gearbox Entertainment by the Embracer Group today, which excitingly will become the seventh operating segment of the Embracer Group. My name is Ben. I'm one of the analysts who covers Embracer at Berenberg Bank. And I've kindly been asked to host the Q&A today. But before we do so, we're going to hear from both Lars, Embracer's CEO, and the Gearbox management team who are with us today. [Operator Instructions] So Lars, why don't I hand over first to you to run through some of the, I guess, strategic rationale, and then we can hear from the Gearbox team.

Thank you, Ben, and hello, and welcome, everyone, to this call. I'm Lars, and I'm the CEO. And we are broadcasting from Sweden. I'm thrilled to have the management team of Gearbox Entertainment Company that we announced this morning, that we are to acquire. I will have the rationale and the actual transaction in the end of the presentation, Ben. So with that said and further ado, I will leave over to Randy, the Founder and CEO of Gearbox.

Hi, everyone. There's many noble and valuable pursuits in this world. And it seems to me that more than any other motive we can imagine, what makes our lives worth living is that we can experience joy and happiness. And we are such a clever species that we have commoditized the creation of joy and happiness in the form of entertainment. And here and now, we live in an exciting age where our species has finally invented a new medium for entertainment that is the most engaging and stimulating medium in the history of our species. It's a medium that invites the audience to become interactive with the entertainer. We've developed the technology to instantly deploy products and services of our meeting, our video games to billions of people around the world. And so we are very fortunate that the enterprise to which we have dedicated our lives creating joy and happiness in the form of digital interactive entertainment, has become one of the most prized and valued commodities on the planet. In 1999, when my partners and I founded Gearbox, I knew I was dedicating my life to Gearbox's mission to entertain the world. Gearbox's mission is to entertain the world. My metrics for success in this mission have been about quantifying the number of people we can reach and qualifying the degree of gratification, the amount of joy and happiness that we have created for those people that we reach. And fortunately, for our business and for you, these metrics directly correlate to sales and revenue and goodwill for continued and growing success. We've had quite a lot of success. In my seat within our Gearbox family, I've had the good fortune over the course of the last couple of decades of building many of the most loved, valued and successful video games and video game franchises of all time. And if we were to stop here, our legacy would be powerful and lasting and without many equals. But we find ourselves in quite a different condition. We find ourselves with a thirst to do more, to go faster and to do better. And we feel there is vastly more ground ahead of us than behind us, and we are eager to run for it. As we say inside our studio, we hunger to crush. And we are just getting started. We are excited to be here today with you to celebrate the union of the Gearbox Entertainment Company with the Embracer Group. It is a perfect match and the foundations of this event will become a catalyst for Gearbox's explosive growth into this new decade and the Embracer Group's exciting and promising future for now and beyond. Let me introduce you to the Gearbox Entertainment Company. We are creators and distributors of entertainment. We are an entirely private founder-and-employee-owned company that has enjoyed profitability every single year of its 20-plus year existence, doing no small part to our commitment to values of happiness for ourselves and our customers, a will to enjoy and stimulate creativity and a concern for generating more value than we consume on our mission to entertain the world. We tend to think about our business in 2 respects. On one hand, we seem to feel genetically made to need to build and create experiences that are designed to create joint happiness for others. Gearbox's entire existence is driven by talent, inventing ideas and experiences and property for the value of the customers. On the other hand, we seem to have this unrelenting drive to always push ourselves towards our mission and the maximization of the value of our creative work through forging greater and greater pathways to our customer. Gearbox Publishing's entire existence is driven by evolving process and technology designed to spread the value of our creations to as many people as we can and as many places as possible. And it is people who share our vision and our values and subscribe to our culture that make this happen. Our headquarters in Frisco, Texas is home to hundreds of talented and motivated leaders of our industry. And our studio in Québec city is now over 150 person strong and is a clear demonstration of our ability to grow our creative engine. And this is important as we prepare for a new phase of increased scale to meet the demand of all of the tremendous opportunity that lies before us. The ambition is driven by leadership and will throughout our organization and managed by an experienced and committed leadership team that, of course, includes myself. And I'm going to introduce you to some of the other members of this leadership team. You will meet Steve Gibson, who is a legendary 25-plus year veteran of our industry and the Founder and President of Gearbox Publishing. You'll meet Steve Jones, who is the smartest, most intellectually honest and sincere man of the highest integrity that I have ever known. And he is the head of all technology at our company. Jenna Hardy is a force to be reckoned with. With years at Disney and years at Warner Bros. before joining Gearbox, she came to our family to build and manage our financial systems and practices with world-class rigor and robustness. And you'll meet Sean Haran, who after doing landmark deals during his time at the world-renowned Marvel Studios and Riot Games, has been serving as Gearbox Chief Business Officer, which, of course, includes him leading Gearbox on this very transaction. We'll briefly hear from each of these leaders. And let's start with my colleague, Steve Jones, who has been on this journey with me since the very beginning. Steve?

Thank you, Randy. Gearbox was started by designers, artists and programmers. We each had our different specialties, but we are all game makers, and that's still at the heart of who we are today. In these logos, you can see the evolution of our studio. As a very small team, we began by taking on work-for-hire projects. But even from this humble beginning, we sought to work with the best and most exciting IP. Our first projects were expansions for Half-Life on PC. We then ported Half-Life itself to the PlayStation 2 and created a new co-op focused expansion as part of that port. Our other ports included bringing Tony Hawk's Pro Skater 3 and the original Halo to PC. In bringing Halo to PC, we created a technology that allowed Halo's multiplayer to be played over the Internet for the first time. And then for our first full title, we got to plan the James Bond universe with Nightfire. Through these early projects, we are exposed to many different technologies, multiple platforms and got to work with several publishing partners. Building on this experience, we started work on our first original IP, Brothers in Arms. For our take on a World War II shooter, we emphasized authenticity, added tactics and SWAT command to the first person shooter game play mechanics and told a character-driven story about what this war was like. Our fresh approach to the genre was a critical success and outperformed competitors of the day from Call of Duty to Medal of Honor. From the successful launch of Brothers in Arms, we started on our next original IP, Borderlands. With this project, we created not just a new IP, but by integrating the progression and loot mechanics of a role-playing game with the action and combat of a first person shooter, we created an entirely new genre. Supporting this ambitious design required us to develop a new process and tool set for building games that we've been iterating on ever since. Building on our success in creating IP, we then acquired the Homeworld and Duke Nukem properties, both of which we've leveraged for new releases, like the Homeworld Remastered Collection and Duke Nukem 20th Anniversary World Tour. Those titles were also the beginning of our publishing business. Focusing on Borderlands for a moment. You can see what we have accomplished with this franchise over the last decade. While Borderlands 3 was released in late 2019, we shipped native versions for the PlayStation 5 and Xbox Series X and S, alongside the launch of those new consoles. With these versions, Borderlands 3 can take full advantage of the performance and fidelity of those new platforms. We also have a second season of add-on content for Borderlands 3 going on now with the release of the Director's Cut DLC up next this spring. While we've accomplished much with Borderlands so far, wherever we will be taking it next will be even bigger. Now I'm going to hand off to Steve Gibson to speak more about our publishing business.

Thanks, Steve. We have created the most developer-friendly game publisher in the world here at Gearbox. Our publishing business was born from a development studio that has been building games for over 20 years. We've brought more than 20 games to market around the world and are working hard to reach and win over more consumers every day. Because our beginning is in development and that we still create titles in-house, we understand firsthand the unique challenges developers face. Our development partners trust us because they know we come from a place of authenticity and from experience. We have a seasoned, agile and diverse team currently that we are immensely proud of, and we are continuing to grow. This will deepen our bench of expertise and diversify our capabilities. As a game publisher, we have tremendous success in our -- since our founding. Each game we publish at Gearbox or partner with developers on is brought to consumers more expertly than the previous one. Most recently, we partnered with Sony, Epic Games and Counterplay Games for the holiday launch of Godfall in PlayStation 5 and Epic Games Store. This was well received by the target audiences, and now we are hard at work to bring Godfall to even more people in 2021. The future of Gearbox Publishing is an exciting one. For 2021, I look forward to the upcoming launches of Tribes of Midgard in partnership with Norstel Games and Homeworld Mobile in partnership with Stratosphere Games. Homeworld Mobile sets the table for Homeworld fans who have long awaited Homeworld 3, which is in active development. We've added even more games in the pipeline, and we can't wait to announce those soon. I hope this shows that the next steps for Gearbox Entertainment are clear ones, and joining the Embracer family adds a rock appeal to those plans. In short, we're going to make great games and bring great games to market. Sean, you want to share some of our plans beyond games?

Love to. Naturally, gaming is at the core of what we do. But we're an entertainment company first and foremost that creates world-class IP. We apply a 360-degree franchise approach to all of our core properties to fuel the passion of our fans and create new ones through things like T-shirts and toys from great partners like Funko, McFarlane, Bioworld and also film and television. Just last week, we announced that Kevin Hart is joining already -- an already all-star cast led by academy award winner, Cate Blanchett. The film is directed by Eli Roth, penned by Emmy Award winner, Craig Mazin from Chernobyl and Hangover fame, and produced by Arad Productions, the co-founders of Marvel Studios and producers of such amazing films as Into the Spider-Verse. Our studio partner is Lionsgate. As we speak, the crew is preparing in Budapest for principal photography. It's an exciting moment for us here at Gearbox. Outside of the Borderlands franchise, we have more things in store. We have more things in-store with our first IP, Brothers in Arms, and we plan on bringing that to the small screen. With an amazing script produced by Marvel Studios, with a showrunner, Scott Rosenbaum, with from Queen of the South, V, Chuck and The Shield fame, we will bring an experience true to the game franchise known for authenticity, realism and relatable characters, but also a new and fresh take both for the genre and hopefully for the medium. Expect more and more news from Gearbox on our ambition to entertain the world through film and television in the coming months and years. I'd love to hand it over to my colleague, Jenna Hardy, who will walk you through our finance organization.

Thanks -- thank you, Sean. Okay. So I'm so glad to be presenting to you today. This is an incredible moment, and we are looking forward to the future. When I joined Gearbox 4 years ago, I was excited to join a proven studio. During my time here, I can tell you that, that excitement has been joined with a remarkable feeling of pride. Gearbox has an amazing track record and an exciting future. We have built a best-in-class finance function that's designed to support the next stages of our evolution. I can say with confidence that as Gearbox grows, our business will become more complex and more valuable, and we're prepared for that today. We can already run with the best of them, and our world-class finance system and processes are poised to grow and scale with the business. As Randy touched on earlier, Gearbox's core values are happiness, creativity and profit. And because of a core value of Gearbox is then profitability, we've been able to achieve an unbroken record of ending every year in the black. This fundamental principle of making more money than we spend has allowed us to invest in world-class talent, content and our infrastructure. And it's these strategic investments that have allowed us to recruit and retain the most creative and talented artists, storytellers and professionals in the video game industry, leading to great results. Looking at Borderlands 3, for example, yes, it was critically acclaimed, but it was also a commercial success and added momentum to what we will continue to build on. With that, I'll pass it back to Randy.

Thanks, Jenna. Well, thank you to everyone who is joining us on this call and sharing your time. I'm glad you could join us for this brief introduction to the Gearbox Entertainment Company and some of its members of our key leadership team. We're very excited to join the Embracer Group as we forge ahead towards our next step. Before I pass it back to Lars, I feel compelled to share with you my perspective that Lars' vision of Embracer as an allied partner group committed to fueling and accelerating the ambitions of a series of decentralized, successful entrepreneurial member companies, while magnifying the collective value and advantages of diversification across the entire group, it's the most brilliant strategy and design for short, medium and long-term success in this industry that I have ever encountered in my 30 years in this business. The feeling at Gearbox is that we are just getting started. When we talked about this move with our team, the energy in the room was palpable. The excitement is there. This transaction is not merely a stimulant for the talent of our employee-owned company, but a propellent for the exciting and powerful future we have planned together as part of the Embracer Group. Thank you. Lars?

Yes. Thank you so much, Randy, and thank you, everyone, for a very good presentation. Before leaving over to Ben, I would like to just take you through the actual transaction, the merger, because that's how I see this, that it's more of a merger than an acquisition. And obviously, getting to know you -- and we are sharing this long-term mission that this active transaction has been extended to a 6 years transaction. But I think both me and Randy would aim for working longer together than the 6 years defined here. So taking the overall transaction, we had a maximum consideration of close to $1.4 million. So the upfront consideration makes up of $363 million in the enterprise value, whereof $175 million is paid in shares and $188 million in cash. Then we have a 6 years alignment. Here is a summary of the actual transaction, a very brief summary. So we have up to $300 million over 6 years condition on what we define as operational targets, meaning, in general, the -- making games and staying onboard. And then we have further $715 million over 6 years condition on financial targets. So -- I'm sorry, my colleague here wants to take control of the presentation. So I'm super excited to having Randy joining in the management team, but as well as all the employees in our warehouse together to build this. And I will support you with our resources. And you already built a fantastic business that's been profitable over 2 decades. And looking at the current business, 2020, you had a growth from the year before, here, defined as adjusted operational EBIT of just above SEK 1 billion with SEK 400 million in profitability. Looking at the corporate structure, it's simple. We will acquire shares of Gearbox Entertainment from Sweden, and Randy and the management we'll be reporting direct to Sweden, and there will be an independent 7 operating units within the group. And here you can see a bit of the ambitions illustrated. So we're having a high and low adjusted EBITDA target, illustrated example. And this shows a bit of the ambition that the team had and that we have together. And from my perspective -- or from our perspective, by looking at Gearbox, I'm not talking about the IPs and the business itself because I think you brilliantly have done that already, and we will do that in the future. But what I see is -- as a business, I will see a significant organic growth in the coming 6 years and beyond. I'll see the opportunities. I know Gearbox historically hasn't been acquiring at -- in the same light and speed as Embracer. But I'm sure you had friends and partners in the industry. I'm not saying that Gearbox are to become an M&A monster, but I'm saying, I think there's an opportunity. And that's the resources we have at Embracer, and I give you that opportunity. Perhaps you have created talents that would like to join the Gearbox family. And I will support that. I think it's important to point out here that Gearbox is independent business. It's led by Randy. It's led by the management team. He built an amazing relationship with the industry over 2 decades. And that field will remain strong and unchanged. Becoming part of Embracer will create a lot of opportunities. And we are not forcing synergies, but I can see the long-term synergies. If there's a will of the management and the employees and the company to engage in a wider Embracer in terms of distribution in parts of the world or platforms, publishing, development resources and IP utilization, and obviously, we would have a business intelligence and many, many other things we could share across the group. So with that said, I'd like to leave over to Ben.

Great. Thank you very much for that. That was great. [Operator Instructions] So perhaps I'll start, Randy, by asking you probably quite a simple question, but also quite a complex question at the same time. What is it that attracted you most to joining the Embracer Group? I mean, I can imagine you've self-funded this business with the team over the years. There are probably no shortage of opportunities of investment or businesses trying to acquire you. So I always like to hear firsthand what attracted you most. If you had to mention one thing, perhaps beside Lars' persuasiveness.

It's a great question. There was a moment about 5 years ago when Gearbox began proving its ability to create a publishing business that -- with that in hand, with access to the customer both in platform and in retail, whether it's digital or physical, we -- it became pretty clear, we saw pretty clearly that our limiting factor was going to rapidly shift from the kinds of games we wanted to make to just the capital that we can deploy to fully take advantage of the opportunity that we had and what was before us. So we kind of began this process thinking that our immediate objective was about getting access to capital. And I will tell you that going into that, the concept of M&A was about as far from my mind as you can possibly be. I think that there's probably many people within our executive team, including myself, that almost felt a fierce independence would just completely prohibit such a consequence. And as such, the first time that I think we interacted with Embracer as a business concept was couple of years ago when we were out looking for capital. And I was blind to the possibility, and I've learned a great lesson there because I had lived in a world where every -- there's a friend of mine who has a show that he did just now on Hulu called In & Of Itself. And every entity out there just looked like a dog. And here was not a dog. Here was a wolf. And I could not see the difference. And it took my allies in the executive team to help me realize that I had a lot of cynicism about the kinds of drivers of this industry, that when they look at a company like Gearbox or the companies that they tend to acquire, they look at them from a purpose of like capturing and controlling and sort of almost stripping its value. Maybe there's an IP that's really interesting. Okay, let's maximally split that IP to the detriment of all other possibilities of ambition. In fact, this idea has almost become a virtue in the industry. It's -- we tend to look at is like, well, we need to focus. And of course, focus is important. We can't succeed in anything without sufficient focus. But Lars has started with a completely different concept. I did not realize that Lars was not like the suits that I'm typically interacting with at that level in our industry. Lars realized that the power of this business is about creativity, having the ability to take creative risks and to be disruptive with entertainment. And the things that are disruptive right now are coming from the middle, yes, where there's huge amounts of value from the big properties that we can trust. And Gearbox, obviously, is a part of that with our Borderlands franchise. But even Borderlands itself would never have existed, but for an intrepid risk at a lower stake to try to do something that no one has ever done before. And when we see what's actually going on in the wider industry, everything from transformative, disruptive games from Minecraft to Fortnite. These things don't come from staying safe. These things come from creatives that know how to do what we do and are hungry to try to make something meaningful in the world of entertainment. And if we have the support and fuel necessary and some safety with diversification and measurable, responsible risk tolerance, let the creators run and chase. And this decentralized approach of independent ambitions that can attack a wide industry from a lot of different vectors is absolutely brilliant. And I don't see anything like it anywhere else in the industry. And once I saw this wolf for what it was, I just wanted to run with it.

Wow, that's very helpful and interesting to hear your view on that. I mean, when you spoke about one of the important things driving your decision about the access to capital as well, but Lars also saying that he didn't envisage Gearbox becoming an M&A machine, does that mean that this access to capital was more for organic investment in development capacity to either expand the number of titles you're working on or just enlarge the size of titles you're working on?

I think, Randy, if it's fine, I can answer that one. Sorry, Ben.

Okay.

We have been working true with due diligence and speaking to the management, understanding the business and what we are investing into in more respects. And I am big believer in the business plan. And I've been -- I told the team, I'm supportive, if they need organic investments to execute that business plan, we are -- we will support that. So there is an amount and we're -- there is a resource for that. And on top of that, I briefly talked with Randy about the opportunity. Because I think they're about position. I would never force any, obviously, M&A. It has to come from the team and from the companies that want to do something together. Otherwise, it would never work. But yes, if Jenna and other things -- this is right IP, it's a great company. We -- they could be within the Gearbox family, I would be happy to support the resources in terms of capital or stock to arrange a similar deal like Gearbox for employees and the owners. So I think we are very open minded. You know, Ben, we like -- I love organic growth. I love investing into games. We have 100 -- close to 100 games under development. And this can drive our growth in the future. And you being a financial analyst, you we talk about organic growth, not acquired growth. And that's always the best to have organic growth that generate cash flow and then you reinvest and you reinvest. So sorry for taking that answer a bit from you, Randy.

No worries. I mean the Gearbox has built all of its success under the weight of its own value. It's -- we've never had any outside investors to build this business. And when we're working in the margins of our own success, our optionality is what it is. And so optionality had been mostly constrained by organic growth. And we've gotten very, very good at that. And we have an extremely robust plan that I'm thrilled to go after. And I think fans of Gearbox games, especially fans of our family of IPs are excited for us to more maximally deliver into the demand for entertainment within these IPs. And there's probably equal excitement about what hasn't Gearbox yet created that we can't even imagine. Gearbox literally invented a genre when we introduced Borderlands, and we turned genres upside down when we did Brothers in Arms. We have a lot within us. But now we have a new tool with our relationship with Lars and Embracer and access to capital for inorganic growth. And this is going to be a very, very exciting set of possibilities. We have limited experience with acquisition. We've done some very tiny acquisitions of talent and some modest acquisitions of property. But now we have an entirely new set of tools that I cannot wait to explore how to deploy.

And maybe one of the things that -- one of the slides that Lars showed was sort of the ambitious targets that Gearbox has over coming years and a low and a high end on what potentially could be achieved. When you're looking at the pipeline, Randy, and you're thinking about what you know is coming out and what you potentially could think about coming out, how much visibility do you have, not that you need to detail any specifics, but just over the next few years' pipeline? Have you already got major developments in process right now?

Yes. The pipeline that informs that ambition is fully realized from a planning and execution point of view within Gearbox. There's almost certainly potential beyond that, that we have yet to explore. But what we're planning and counting on, we have a lot of confidence in.

Okay. I need to remind, Ben, that this illustrative is not a financial forecast from Embracer. It just illustrated to the transaction. We need to make a differentiation there for investors. We gave forecast for the 3 businesses acquired or merged this morning combined for next financial year. Sorry for reporting.

Yes. These are what the earn-outs are structured on, right? So just in terms of development, you've got some incredibly successful IPs and big titles that have been published by third parties. And I can't tell you how many comments we're getting here on the web from investors, asking about what your broader ambitions are with some of these large titles, whether or not you plan to self-publish. And I know that there's going to be restrictions on what you can say to that because there's going to be commercial sensitivity. But as a business over the long term, is that something that you're looking to do more of? Or something that you're happy to partner with others?

Well, it depends on the partner and the product. There are things that we are very good at, and there are things that other people are better at than us, other entities are better at than us. If we're thinking specifically about Borderlands, we love our relationship with Take-Two and the 2K Games label. And we are committed to working together through all of the known and planned Borderlands work that we have going on. And we anticipate -- I anticipate that we'll continue and we'll create new opportunities together. And I think that goes -- I've always had a pretty great relationship with first parties and other third-party publishers. And sometimes, there's folks that are just the right group to help maximize the potential for these creative endeavors that we have. And we are absolutely open to those relationships. Now of course, there's trade-offs, right? Now the impetus for such an interaction is less about the capital necessary to develop and publish the product and more about the expertise and capability of the partners involved. But partnerships, I think, are a big part of the Gearbox story. And I do not see that stopping.

Okay. That, I'm sure, answers the question very succinctly for a lot of people on the web today. A lot of it was about that game in particular. Maybe passing on to Steve with regard to the publishing unit. You kindly walked us through that business. I'm just wondering, you mentioned adding rocket fuel to this publishing unit. What growth drivers do you see in this business over the coming years? And is it a question of more titles or publishing larger titles in that business unit?

Yes. It's actually -- it's a mixture of both, for sure. The capital constraint has become more apparent over the years as we built success. Early on, really, it was just learning how to walk, crawl, run as a publisher. It's a complex marketplace to learn to do that effectively. But as we look ahead to our future plans, it is, indeed -- the ambition grows to the scale of those particular titles. Our most recent release with Godfall and the partnerships there, that was the largest capital investment we've had to date. I can only imagine how future house will grow in beyond that. So the partnership with Embracer, the capital access and also the potential partnership with Embracer family members, that is exciting to us, that potentially is, I would expect that we've not yet done our largest thing. I expect the next thing could be even bigger. And that's a big deal to us. But I think another important note for us is that we look a lot to the innovation of our industry. And if you look at our titles we've worked with so far, you'll see things such as, say, I think most recently interesting is Risk of Rain 2. That was a 3-person studio that we're partnering with, that's gone on to sell millions of units in collaboration with Gearbox. So I don't think that we will just start going bigger and bigger every time, we have an eye towards innovation, and that comes in all scales.

And you are seeing in the industry -- we're hearing whether or not it's Frontier Developments or Team 17 in the U.K. markets or other businesses that are creating their own, in effect, publishing labels. Are you seeing more competition for that really -- to partner with really good developers? Or is it something that you've already got very strong relationships with a set of developers that you're looking to work with over the next few years?

Yes. I do like -- the reward is really for creators, right? So being a publisher, I mean, not to do disservice to what being a publisher is, it's really a means to get those creations out to the world. So I'm really excited to be in a competitive market where creators can look at the different publishers and who are that right fit, much like Randy was talking about when we're thinking about our IP is it's working with the best partner. So as we build our expertise, we can be the best partner for a lot of folks. But I'm not about to come out here today and say I'm the best partner for every possible -- or every possible game maker. But it's also exciting to us that the tools and technology to create are getting better and better. There's more and more creators being built every day. And that is -- like to me, there's an infinite amount of space for people to be game makers and to partner with game publishers. So I don't really look at other game publishers as competitors, they all have their different expertise and strengths, and I'm happy to be a part of that. And I really feel like there are some game makers who would be the best absolute match for Gearbox. So I'm not concerned about that. Obviously, I feel great about the market, and I'm excited to be part of that to help creators reach more people.