Fri 08/13/2021 04:51 AM
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Mid-market funds are monitoring a spate of video game developers expected to come to market in September after the online gaming industry performed robustly throughout the Covid-19 crisis. About 82% of global consumers played video games during the height of the Covid-19 lockdowns last year, analysis from data and market measurement firm Nielson showed. Traditionally, the video games sector has been dominated by venture capital and large game studios such as Microsoft and Sony, but now both direct lenders and private equity have started to enter the sector in pursuit of attractive returns. Continue reading for our EMEA Middle Market team's reporting on the online gaming industry, and request a trial for access to reporting on hundreds more performing, stressed and distressed credits. 

Direct lenders are willing to offer leverage of 6x or more for gaming assets with consistent recurring revenue to support their scale-up ambitions, sources commented.

Robert Connold, head of Alternative Lender Debt and Capital Advisory at Deloitte, told Reorg: “Leverage levels for game developers with demonstrated recurring revenue can be as high as levels seen for strong healthcare, SaaS and cloud assets.”

One sellsider commented that European game developers sold for “aggressive West-Coast U.S. style multiples of 20x.”

Private equity group Carlyle acquired U.K. independent and online video game developer Jagex earlier this year for a multiple of over 15x, sources said. Permira Debt Managers provided a unitranche facility of around €300 million to back the deal, according to a Deloitte report.

This week, EMK Capital acquired Outright Games, which had a marketed EBITDA north of £10 million and was expected to reach a valuation of £150 million. The Rockpool Investments-owned business reported a 75% year-over-year increase in revenue to £22 million in the fourth quarter of 2020, mainly due to contracts with Sony, Universal, Nickelodeon and Cartoon Network, and a minimal impact from the pandemic.

Northedge-owned game developer Catalis is expected to market in the upcoming months, sources said. Catalis’ revenue jumped to £58.9 million in the year to Dec. 31, 2020, from £14 million in the previous year due to a rise in Covid-19 related demand, according to its report. Northedge declined to comment when contacted by Reorg.

Private equity groups are expected to face stiff competition from large game studios such as Epic Games, Sony and Tencent who have in-house M&A teams and are able to pay high multiples to snap up smaller developers, sources said. Recent consolidations include Epic Games' acquisitions of SuperAwesome from Mayfair Equity Partners and Tonic Games from Synova Capital and Tencent’s acquisition of Sumo.

Ian Livingstone, founder of Lara Croft video game and partner at gaming private equity fund Hiro Capital, told Reorg “the games industry has been traditionally undervalued and even with high multiples, private equity will still generate significant returns.”

Valuations have risen primarily due to the increase in players downloading online games during the Covid-19 lockdowns across Europe, sources commented. Revenue in the global video game market rose 20% year-over-year to $179.7 billion in 2020, according to a report from Latham & Watkins.

Persuaders and Dissuaders

Direct lenders and private equity have a strong preference for video games assets with strong recurring revenue, subscription-based models and interactive elements.

Sources said private equity group Carlyle was attracted to online game developer Jagex as it owns the Runescape game franchise which has an estimated 1.1 million players paying a monthly subscription fee and several millions more playing the free version and making in-game purchases. Permira Credit backed Carlyle’s acquisition with a “competitive” unitranche facility and sources said the direct lender was comfortable with the relatively high leverage due to Jagex’s subscription-based model.

Investors are wary of game developers that rely on licensing from large entertainment companies. Last year, London-based game developer Marmalade attempted to launch a sale but failed to attract offers from private equity, sources added. Marmalade primarily works with board game company Hasbro to transform games like Monopoly into online games and its license with Hasbro was coming up for renewal.

This contract renewal exposure can be mitigated if game developing companies diversify its offering and have a larger number of licensing agreements, sources said. Earlier this year, Sagard invested in French game developer Asobo Studio which has a number of licenses with Disney-Pixar, Codemasters, Ubisoft, Microsoft, Focus Home Interactive to develop video games.

Sources also identified intellectual property and ESG concerns. Lawyers from Latham & Watkins said in a report: “Dealmakers will need to verify key IP and software ownership issues, including use of open-source software, external developer risks, and securing trademark protections and other IP rights across key jurisdictions.” Additionally, some game developers produce games which have strong themes of violence and this could raise ESG concerns for socially-conscious funds.

While there are some risks surrounding licensing and intellectual property and fierce competition for the stronger performing assets, the online game development sector is growing for mid-market funds. A number of sources expressed surprise that private equity and direct lenders have been relatively slow to enter the video game industry and predicted the sector will likely provide healthy returns for private credit and private equity firms that target game developing companies that have subscription-based models and consistent recurring revenue.

--Lara Gibson
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