Nacon (NACON)
French video game publisher in difficult financial situation
Introduction
A growing video games company trading at 0.2 P/B and 3.7 P/E seems like a jackpot, right? At first glance, this €60m French microcap looks pretty cheap, but we will show that this discount is justified and that P/E investors need to be cautious in the stock market.
The first thing you find out about Nacon is that it is a subsidiary of BigBen Interactive. In addition to Nacon, its video games division, it has an audio/telecommunications business that is profitable but lacks quality, as it outsources development to China and puts a logo on its product. This company is even cheaper than Nacon. It trades at €27m, below its 60% stake in Nacon, and at 1.2 times PE. You may have heard that earnings are a tricky metric as they can hide future losses with a bit of accounting magic, we think this is one of those cases.
As they invest significant capital in new projects, it is evident that they require financing to support their current initiatives. They have numerous games in development with promising potential, yet they have been unable to monetise these effectively, resulting in a negative cash flow since their IPO.
Industry context and Nacon positioning
Nacon operates in a highly competitive industry where anyone can develop a fun game that might get better reviews than a high-cost game. In this environment, the only sustainable way to compete is to build a moat. For gamers, a brand represents reliability and trust; if they have enjoyed a company's previous games, they are more likely to enjoy future releases. This brand loyalty is particularly important in niche markets, such as cricket or simulation games, where there are fewer major players.
To build a strong brand, Nacon has pursued two main strategies: investing time in developing good games and acquiring established studios. KT Kylotonn, for example, was acquired when it held the licence for WRC Generations, providing a strong moat. However, the loss of this licence has been detrimental, and the studio's recent releases, such as the €30 million Solar Crown, have received poor reviews, damaging the KT brand. To recover, KT Kylotonn needs to focus on releasing better games that do not compete directly with AAA racing titles, and return to its niche rally games. However, their recent moves do not inspire confidence.
On the other hand, Cyanide Studios has developed a strong and diversified brand with consistently positive reviews, demonstrating the potential for success through strategic acquisitions and quality development.
The video games industry is capital intensive and Nacon's financials reflect this. The company currently spends more cash than it earns, and although earnings are positive due to the amortisation of development costs over 12-36 months, this has not yet translated into sustainable profitability. The company's balance sheet is heavily weighted with goodwill and intangibles, which are at risk of impairment if game performance continues to be disappointing.
Given the current state of Nacon, the stock price reflects the challenges the company faces. However, the question remains: is the current discount, or any discount, enough to justify an investment? The company's future success will depend on its ability to launch successful games, manage its capital efficiently, and build a strong, reliable brand, of which Nacon has not shown enough signs.
Company description
Bigben Interactive, founded in 1981 by Alain Falc, started as a distributor of electronic goods and later diversified into multimedia and video games. By the late 1990s, Bigben expanded internationally, becoming an important European player in third-party console accessories by the early 2000s.
In 2019, to improve financial clarity and investor communication, Bigben decided to spin off its Gaming division, which included video games and accessories, into a new company called Nacon. This spin-off was finalized on 31 October 2019. Nacon, now heavily capitalized with significant debt, focuses on video game development and publishing, as well as the design and distribution of gaming accessories. The Group initially developed the video games Publishing business by outsourcing to external development studios but its approach changed in 2017 after its acquisition of interests in a number of studios in the past few years.
Despite reporting earnings, Nacon has been burning substantial cash and has had to dilute shares and extend debt to finance new game developments. The company's high debt levels and unsustainable spending patterns pose significant financial risks. If new games do not generate sufficient returns, Nacon could face severe financial issues, including potential bankruptcy or a continuous dilution spiral.
Strategy
Premium game console accessories
Under its “Accessories” line of business (40% of revenues) Nacon fabricates premium console controllers and headphone sets. Their premium game console accessories are a niche market as not a lot of companies have official licenses with Sony and Xbox to fabricate them.
Nacon’s products are of high quality, even though their price is very high, clients seem happy about them and say they are worth the money.
The segment has not shown much growth in the past and operating margins are not disclosed. Even if operating margins are above average for this line of business given the premium status of its products we find it hard to come up with a number above 20% given competition and market dynamics. Guillemot Corporation is an established player in the market of premium hardware and it has never reached an operating margin above 20% during its best years.
Positioning as automotive videogame developer and provider of hardware
Nacon is looking to become an integrated motor racing games developer and hardware provider. The company intends to do so by expanding its Accessories LoB to sell steering wheels, chairs and racing stands to capitalize its presence in the racing video games segment.
We believe this can be a very lucrative niche as there have been some companies able to do well in the past. This strategy can help the company find synergies with their rally games that have positive reviews. Nacon’s subsidiary KT Racing lost the license for World Racing Tour in 2022 which was their best selling series. This is why the company is moving into developing other styles of racing games although the latest release “Solar Crown” has not been received well in the market.
The company intends to launch its first set of products into the market at the end of 2024. As there is no past performance or indications from management this part of the business could be quite speculative as it could become a primary source of revenue if successful. Nevertheless, capital expenditures have already been incurred which requires the company to obtain returns for its financial health.
This launch comes at the worst possible time, following the unsuccessful launch of Solar Crown and the recent loss of the WRC license. The racing leg of the studio has lost confidence among gamers. While a return to rally games could help smooth this recovery, the company has no immediate plans to do so. Synergies with the KT branding will be postponed until the KT brand regains its name.
Niche game developer
The company claims to have positioned itself as a publisher and developer of AA games for console and PC which encompasses all games with sales volumes of between 200,000 and 3 million copies. The development costs for these kinds of games are usually kept below €20 million.
However, this does not reflect the whole picture, as the €30 million spent on "Solar crown" represents nearly 40% of their annual spending, competing with AAA titles, which suggests their claim may be misleading.
Nacon tries to focus on neglected or less competitive niches in its four strategic ranges: Racing, Sport, Simulation and Adventure. For example, in the Sport segments it develops games on Cricket, Rugby, Cycling.
Nevertheless, the video games market is extremely fragmented and in almost every segment there is fierce competition that is why Nacon has to rely on well known brand names, trademarks and sagas to put out its video games.
Relying on licenses poses a significant risk, as the loss of a license can lead to decreased revenue and damage Nacon's brand. This was recently exemplified by the loss of the WRC license.
Aggressive growth which may continue
The company strategy over the past three years has consisted in an aggressive inorganic expansion of its game development capabilities targeting small and medium sized studios as BigAnt Studios, Midgar, Passtech Games, etc.
The company has acquired a total of 12 studios since 2017 and manages them in a decentralized manner but having control on the licensing for project validation.
There is no guidance from management if the growth strategy will continue or if they are hoping to get into a consolidation phase and try to develop new games from current in-house expertise.
Insights from the analysis
Book value analysis:
A large part of Nacon's balance sheet is made up of goodwill and other intangible assets, at €137 million and €213 million respectively. These two categories together account for approximately 70% of total assets.
Given the performance of certain video game releases, we believe that these values may be subject to impairment and amortizations.
Goodwill arose from the acquisition of other studios, with BigAnt and Daedalic accounting for 50% of the total.
The company does not report revenues or earnings per studio, making it difficult to assess the potential impairment of the goodwill amount.
Nacon expected to generate revenues of €400m in FY23 and this did not materialise, making it difficult to justify the absence of any impairment for all acquisitions as the whole company has been underperforming for quite some time.
Other intangible assets consist mainly of 'game development costs'.
This increased by €330m in the year under review and was amortised by €131m. The company must maintain the same rate of investment in order to preserve the value of the assets, which are amortised at a rate of approximately €100 million per annum.
Under IAS 38, the amortisation rate can be affected by the performance of the games in the market, as management must estimate forecast revenues and margins. Where those cash flows are lower than the net carrying amount of the games, impairment reducing the net carrying amount of the relevant games is recognised for accounting purposes.
In summary, a few poor releases could trigger the destruction of value across a large part of the balance sheet, affecting goodwill and other intangibles. This could further deteriorate the viability of the company by increasing the debt/equity ratio.
Cash flow analysis
The company has had positive net income during its history but this does not mean that Nacon has been able to generate cash. This seems to contradict the net change in cash metric as cash flow from operating activities amounted for €73m and €47m for FY24 and FY23.
Given the nature of its business the company must heavily invest in the development of new videogames beforehand. This expenditure is allocated to non-current assets, which are then generally depreciated over the life of the video game. In FY23 and FY24, the company invested €116m and €87m respectively in the development of new games and the acquisition of studios.
This strategy resulted in negative change in cash and cash equivalents of €34m and €22m in FY23 and FY24 respectively, despite the company raising cash through debt and equity issues.
Nacon started FY25 with €24m in cash and raised €18m through a capital issue in July 2024. By 30 September 2024, the end of the first half of FY25, the company's cash position was just €17m. In the first half of FY25, the company burned through around €25m of cash.
During 2025, the company will certainly need to dilute shareholders again if there is no turnaround, meaning that one of the releases becomes incredibly popular.
Quality of latest releases
The company claims to be a niche AA game developer, but is this the case? Taking one of Nacon latest releases “Test Drive: Solar Crown” as an example does not give much confidence on future developments.
The company disclosed an investment of €30 million (50% of current market cap) on the development of the “Solar Crown” title which is above their target for AA games. The game is priced at around €50 which is just a 20% off the price of any AAA game. This price point may already turn down some potential buyers as the expected quality compared to the big racing games names is way lower.
The company states that on release the game was one of the top five best-selling games in the countries in which it is distributed. However, the 4k reviews on Steam are mostly negative and the game downloads are on a path that will make profitability difficult having incurred €30 million in its development.
Management
Lack of cost conscious development: Development cost for games have been increasing over the years without a clear transposition into the quality of published games. In the annual report of 2020 they stated that “development costs would reach around €60 million a year” however in the latest annual report they expect development expenses to stabilise at around €75 million.
Lack of transparency: The company does not provide clarity on the strategy as it does not celebrate earnings calls with investors or communicate clear plans for the future. The company only reports a simplified income statement quarterly which does not allow for a correct interpretation of the evolution of the business.
Forecasts: management stopped giving guidance in its latest annual report. Past guidance was aspirational at least the Group was anticipating €300 and €400 million in sales for 2022 and 2023 respectively. The revenue for the first half in 2024 was €77 million.
Dilution agreement with BigBen: the company has an issuance agreement with the parent BigBen Interactive. This agreement gives preference to BigBen as a buyer for 60% of all stock issuances that Nacon puts in the market. Effectively this allows BigBen to maintain its ownership stake in Nacon which may have incentivized the aggressive issuance and growth strategy.
Conclusion
We view Nacon as a complex company facing significant financial challenges in the short term. Addressing these issues in the long term will require a shift in strategy, a clearer focus, and improved financial planning.
We expect Nacon to require further dilution in 2025 to avoid going into default with his debtors. We believe the likelihood of the company publishing a hit game and being able to turn around its revenues is quite low given its track record.