On December 14, 2020, Electronic Arts (NASDAQ: EA) announced its intention to buy the UK studio Codemasters (LSE: CDM) for $ 1.25 billion. The price of EA is 14% higher than the price Take-two interactive (NASDAQ: TTWO) offered in November. The deal has not yet been finalized, but it looks like EA is the frontrunner to acquire the studio. This is what investors need to know about the racing-focused gaming business.
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What is Codemasters?
Codemasters is a 30 year old British video game developer with a specialty in the racing genre. DiRT, GRID, Project motors, en Formula One are some of the best franchises. None of these are household brands, and they do not have the name recognition of something like a FIFA or Call of Duty, but the titles are popular with racing enthusiasts of all kinds. For example, DiRT Rally 2.0, the company’s rally car game, has hit just 9 million users.
As Codemasters publicly trades on the London Stock Exchange, we can look at the financial statements to see what EA shareholders are getting and at what price. Over the past 12 months, Codemasters has generated approximately $ 151 million in revenue and $ 28 million in net revenue. It also had $ 74 million in free cash flow (FCF), which gave a juicy FCF margin of 49%. An FCF margin of almost 50% is unlikely to be sustainable in the long run, and historically Codemasters’ FCF margin was closer to 40%, but it shows the quality of the business.
At a proposed buyout price of $ 1.25 billion, EA would acquire Codemasters at a price-to-sales ratio (P / S) of 8.3 and an FCF multiple (market value divided by backward FCF) of 17. This is a bit of a premium on the 6.6 P / S ratio of EA, but it’s not that important that investors think the company is paying too much for these assets. In fact, in such a buyout, it is typical that the acquired company goes at a premium valuation.
Why EA wants to own it
In the press release accompanying the buyout offer, EA said the joint ventures would create a world leader in racing entertainment. EA owns Crave for speed, one of the most popular racing games in the world, so the joint ventures will have the most popular console / computer games in the genre.
EA also wants to add Codemasters’ games to EA Play, the company’s subscription service. At $ 4.99 per month or $ 29.99 per year, the service offers discounts, exclusive content and unlimited access to a collection of EA games. If Codemasters’ catalog is added to the service, the value of EA Play will increase, which will hopefully move more users to sign up. And if more people sign up, it means more revenue for EA.
Lastly, EA can buy Codemasters because it has too much money. At the end of last quarter, EA had nearly $ 6 billion in cash on its balance sheet, generating nearly $ 2 billion in FCF over the past twelve months. Yes, it’s a good problem to have, and it may end up being a smarter step to just buy back its own shares, but buying another business at a reasonable price is smarter capital allocation than just to leave idle cash in government bonds.
While not going to be a big part of EA’s business, the EA Play subscription service makes for a better value enhancement and strengthens EA as the best studio for racing games. Investors in EA should be excited about the consolidation of the racing market and rejoice that it looks like the acquisition will go through at a reasonable price.