On December 14, 2020, Electronic Arts (NASDAQ: EA) announced its intention to buy a UK gaming studio Codemasters (LSE: CDM) for $ 1.25 billion. EA bid has a 14% premium over price Take-Two Interactive (NASDAQ: TTWO) offered in November. The deal has not yet been finalized, but as of now, it appears that EA is the pioneer in acquiring the studio. Here’s what investors need to know about the racing-focused gaming company.
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What is Codemasters?
Codemasters is a 30 year old British video game developer specializing in the racing genre. Dirt, NETWORK, Project Carsand Formula One are some of its main franchises. None of these are familiar brands and do not have the name of recognizing something like a FIFA or Call of Duty, but the titles are popular with racing fans of all kinds. For example, DiRT Rally 2.0, the company’s rally car game, reached just 9 million users.
As Codemasters publicly trades on the London Stock Exchange, we can look at your financial data to see what EA shareholders will receive and at what price. In the past 12 months, Codemasters brought in about $ 151 million in revenue and generated $ 28 million in net revenue. He also had $ 74 million in free cash flow (FCF), giving him a juicy 49% FCF margin. An FCF margin of almost 50% is probably not sustainable in the long run and, historically, Codemasters’ FCF margin has been closer to 40%, but it shows the quality of the business nonetheless.
At a proposed acquisition price of $ 1.25 billion, EA would be acquiring Codemasters at a price / sales (P / S) ratio of 8.3 and a multiple FCF (market capitalization divided by the subsequent FCF) of 17. This is a bit of a premium to EA’s 6.6 P / S ratio, but nothing so worrying that investors think the company is overpaying for those assets. In fact, with acquisitions like this, it is typical for the acquired company to come out with a premium rating.
Why EA wants to own it
In the press release accompanying the purchase offer, EA said the combined companies “will create a global leader in racing entertainment”. EA has I need speed, one of the most popular racing games in the world, so the combined companies would have the most popular console / PC games of the genre.
EA also wants to add Codemasters games to EA Play, the company’s subscription service. For $ 4.99 a month or $ 29.99 a year, the service offers discounts, exclusive content and unlimited access to an EA game collection. If the Codemasters catalog is added to the service, EA Play’s value proposition will increase, which hopefully will drive more users to sign up. And if more people sign up, that means more recurring revenue for EA.
Finally, EA may be buying Codemasters because, well, frankly, it has a lot of money. At the end of the last quarter, EA had almost $ 6 billion in cash on its balance sheet and generated almost $ 2 billion in FCF in the past 12 months. Yes, it is a good problem and it can end up being a smarter move to just buy back your own shares, but getting another deal at a reasonable price is a smarter capital allocation than just leaving idle money invested in government bonds.
Overall, while not becoming a giant part of EA’s business, purchasing these racing games makes EA Play’s subscription service a better value proposition and solidifies EA as the best racing game studio. EA investors should be excited about the consolidation of the racing game market and happy because it looks like the acquisition will be made at a reasonable price.