Even as Game Digital (GMD) faces short-term trading pressure, its developing BELONG gaming arena concept is arguably part of the answer of what to do with the UK’s high streets and shopping centres. The first BELONG sites under the February 2018 agreement with Sports Direct are now opening. With GMD’s share price still less than net cash of 32p, neither the existing business, which currently contributes £10m of EBITDA, nor BELONG which we value at 23p, are attributed any value by the market. Our total valuation is 75p.
The original change strategy at IPO in 2014 has coalesced around the roll-out of the BELONG gaming arena concept. Two years’ trial in 19 locations has shown that arenas beyond a critical size have strong returns, and the concept fits with shareholder Sports Direct’s “elevation strategy”, which includes other experiential concepts such as gyms in large-scale retail formats. The February 2018 collaboration agreement formalises and funds that strategy, and the first resulting sites are now opening. We now model BELONG in detail to achieve EBITDA of £22m by FY22, with 4,079 playing stations in 126 locations (GMD’s target is 5,000).
GMD’s change in strategy was always designed to counter the threat from declining terrestrial retailing of games products. FY18 has seen an accelerating shift towards digital content. In H1 gross margin (as a percentage of gross transaction value) slipped 150bp, mitigated by £5m cost savings. In H2 the mix trends have intensified. We believe that may be, in part, a by-product of the current Fortnite craze disrupting the market globally, and to that extent be temporary. Savings progress has continued in all areas, with opportunities from a large number of short-term lease expiries. Following the August 2018 pre-close we trimmed our FY18e EBITDA by 7%, and FY19e by 13%, which also reflects initial inertia around the collaboration agreement.
GMD trades at a discount to its net cash of 32p per share. We value the shares on three metrics: peer comparison, DCF and sum of the parts (SOTP). Our peer valuation of 93p is an average between US operator GameStop, whose valuation points to a GMD value of 59p, and UK special interest operators, indicating 126p. Our DCF valuation using a high 15% WACC is 61p. Our SOTP metric adds the BELONG roll-out valued as a project, net cash and the existing business conservatively treated as a perpetuity at 30%, totalling 71p. Our blended valuation between these three metrics is 75p (previously 74p). However, we note that our SOTP indicates that BELONG and cash alone are worth 55p per share.