CD PROJEKT STILL WAY TOO DEAR

After the disastrous release of Cyberpunk 2077 on December 10, 2020, CD Projekt’s share price declined by 83.2% from peak to bottom and the company became the most shorted stock in Poland. According to Polish Financial Supervisor KNF, some 4.82% of its shares remain in the hands of short sellers. 

The share price started to recover after the release of Cyberpunk: Edgerunners on Netflix

Around September 13 this year, CDR’s shares began to recover. On that day, Netflix published the anime series Cyberpunk: Edgerunners, which so far has received very good reviews (98/100 according to Google) and has also led to a significant increase in the number of Google searches for the Cyberpunk 2077 game. This immediately reminded investors of the situation in December 2019, when ²The Witcher series first appeared on Netflix. In Q4 19, CD Projekt’s sales went up by 129.7% qoq to PLN213.3m due to a significantly higher number of The Witcher games sold. More importantly, sales remained significantly above Q3 in Q1 20-Q3 20, thus until shortly before the release of CP2077. 

In our view, there are two reasons why CD Projekt’s share price has increased by >47% since the beginning of September: 1. investor expectations that the Cyberpunk: Edgerunners series will have the same effect as The Witcher on sales of CDR’s respective games, and 2. a squeeze-out of short-sellers, which likely also stemmed from an ongoing share buyback programme that foresees the purchase of up to 2m shares at max. PLN200 per share (max. value of PLN400m or 3.4% of CDR’s current market cap) between October 5 and 28.

Current valuation not justified by the fundamentals

With the mobile games GWENT, Thronbreaker and The Witcher: Monster Slayer still performing very poorly, CD Projekt remains a two-product company. Even after adjusting our model for higher sales of Cyberpunk 2077 and the planned release of The Witcher 3 for next-gen consoles in Q4 22, our estimates do not justify the company’s current valuation. While the current peer group P/E 2022E and 2023E multiples stand at 23.1x and 15.5x respectively, on our updated net income estimates – PLN 299m (+43.1% yoy) in 2022E and PLN 400m (+33.8% yoy) in 2023E – the stock’s P/Es are 38.7x and 28.9x respectively. Although CDR has recently announced plans to release several new The Witcher games, a continuation of Cyberpunk and a third AAA franchise in the coming years – also in a multi-player version – their actual impact on the company’s results remains highly uncertain. In our view, a lot will depend on whether the management have learned their lessons and improved the company’s organisation and processes over the last two years.

A potential takeover could be beneficial for shareholders, but the management rules out a sale of CDR

In recent months, there have been several M&A transactions in the gaming sector and the segment remains attractive for investors due to its non-cyclical character and rapid growth (according to e.g. PwC, gaming hit a value of USD214.2bn in 2021 globally and is supposed to grow to USD>320bn by 2026). Probably the most prominent transaction was the takeover of the largest gaming company worldwide Activision Blizzard by Microsoft for USD68.7bn  at an implied P/E of 25.5x (still in progress with the EU and UK watchdogs not that happy). The Chinese media giant Tencent has also been very active. In France, it has bought a 11.3% stake in Ubisoft (directly and through Guillemot Brothers Ltd., the entity of UBI’s founders) valuing the French company at an implied P/E of 57.1x. In Poland, it has purchased a 21.97% stake in the listed developer of horror games Bloober Team at an implied P/E 2021 of 20.9x.

Due to its two strong AAA franchises The Witcher and Cyberpunk 2077 CDR could also be an attractive M&A target, however the management has so far ruled out the possibility of a sale. They want to remain independent and are rather considering further acquisitions. 

Valuation

CD Projekt’s ROCE and FCF Yield remain impressive: in 2021, they equalled 21.3% and 4.7% respectively, which is above its peers. Also, at PLN951.3m the company’s net cash position remains very strong. It allows CDR to both distribute cash to its shareholders – in the form of dividends or share buybacks – and finance new projects without debt. 

Nevertheless, all our valuation methods indicate a significant overvaluation of CD Projekt’s stock at present.