CFA Institute 2015

September 10, 2017 | Author: Krzysztof Wojdalski | Category: Discounted Cash Flow, Cost Of Capital, Digital Rights Management, Valuation (Finance), Digital Distribution
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Short Description

The report was dedicated for CFA Research Challenge 2015...

Description

CFA Institute Research Challenge hosted by

Local Challenge CFA Society of Poland J

[IT, Video Game Development, Digital Distribution]

Team J Student Research This report is published for educational purposes only by student competing in CFA Institute Research Challenge

Date 12/02/15

Current Price PLN 16.16

Target price PLN 16.27 (+0.3%) Ticker: (Warsaw SE: CDR)

Recommendation: Hold

Main revenues growth drivers: Market profile  On-going triple-A games 26-week price range (PLN) 16.27 releases Average daily volume (last 3M) 128.2  Entrance into the new domain: mobile phone As % of shares outstanding 0.13% games industry Free float 45.1%  Steady growth in sales via P/BV 9.38 GOG.com platform. The business is driven by a high Shares outstanding (in mn) 94.95 level of heterogenous Market Cap (PLN bn) 1.54 substitutes. The success of P/E 350.0 the CDP releases relies on the mix of high quality, Earnings per share (in PLN) 0.046 meeting customers’ ROE (2014E) 1.71% requirements, and adjusting to their hardware;  GOG which will start selling triple-A games and will introduce its new platform  A very good reputation of The Witcher saga. We estimate that the company will have high ability to generate cash and will be selffinanced. Currently, the success of the company is determined by a very good reception of the W2. We do not believe that the company will be capable of sustaining its very dynamic growth in the future and our assumption is that the CDP will suffer from a decrease of its CAGR.; One of CD Projekt's business domains will be sold in 2016 for nearly PLN 20mn (CDP.pl). According to our calculation, the sales of The Witcher 3 and Cyberpunk 2077 will reach 7mn and 6.5 mn, respectively. We estimate that 2016 is going to be the best year in terms of generating cash flows for the company due to the W3 release. The main factors affecting the CDP’s future is currency risk and perception of gamers.

Table 1

20

11/03/2014 The postponement of The W3's release date

18

14

1/03/2011 The publication of an unfavourable quarterly financial report

20/04/2011 The bankruptcy of the daughter company Optibox Sp. z o.o.

The CD Projekt stock price

12 10

16/11/2010 The news about The W2's release date

2/08/2011 The Optimus S.A. transformation into CD Projekt Red S.A.

12

10 5/03/2013 The disclosure about negotiations with PC Factory S.A.

27/03/2012 The GOG.com released issues

8 19/12/2014 The news about the CD Projekt Brands S.A. shares' disposal

6

8 4

6 4 2 0

Volume (in mn)

16

26/11/2014 The CDP.pl shares' disposal

5/02/2013 The announcement about The W3's releasing

2

0

Source: The company's data, The WSE's website

2

Figure 1 Structure of CD Projekt Capital Group

Business Description CD Projekt Capital Group is a Polish company which operates on the global digital entertainment market and is especially known for its video games development department. It was established in 1994, but the contemporary form of the business was adopted due to association with Optimus enterprise. In September 2011 the company has changed its name from Optimus S.A. to CD Projekt Red S.A. The brand became internationally recognized among investors in 2002 thanks to initial public offering at the Warsaw Stock Exchange. The main business domains are:

GOG Ltd.

GOG Poland Sp. z o.o. CD Projekt S.A.

Brand Projekt Sp. z o.o.

  

CD Projekt Inc.

CD Projekt Brand S.A.

The group is cooperating with 17 worldwide sales partners, what gives it the opportunity to physically distribute on 109 markets (see the Figure 2). The scope of sales is enhanced mainly by distribution through digital platforms such as Steam, PlayStation Network, and Xbox One Marketplace.

Source: The company data. Figure 2 CD Projekt’s sales The Witcher 3:Wild Hunt, 2015

partners

worldwide,

Source: The company data. Figure 3 Gross profit per quarter (in mln)

Global digital distribution of games

30 000 25 000

Distribution and publishing in Poland

20 000

Games development

15 000 10 000

Other activities 5 000 0

Q3 2014

Q2 2014

Q1 2014

Q4 2013

Q3 2013

Q2 2013

Q1 2013

Q4 2012

Q3 2012

Q2 2012

Q1 2012

-5 000

Development and distribution of video games around the world by CD Projekt Red studio, Digital distribution of computer games via GOG.com platform, Delivery of packaged video games, movies, audiobooks, ebooks, and electronic devices by CDP.pl operating in the Polish market.

Consolidation eliminations

Source: The company data. Figure 4 The structure of shareholders Marcin Iwiński Michał Kiciński PKO TFI S.A. MetLife PTE S.A. Piotr Nielubowicz Aviva OFE Aviva BZ WBK Adam Kiciński Free float

Source: The company and the WSE data.

The company’s main product is an action-RPG The Witcher saga based on Andrzej Sapkowski’s novels. The consumer’s perception of the market position of the game is going to be strengthened by titles like Cyberpunk 2077 and The Witcher Battle Arena. Over 200 high-class specialists have got involved in the process of creating adventures of Geralt of Rivia. Not only graphics, programmers and designers, but also musicians and screenwriters have been engaged in the process of game developing. The Witcher saga total sales have reached about 8 million copies worldwide (until the end of 2014). According to pre-order data estimated by VGChartz, almost 240k gamers (a colloquial word for a player) from the U.S. have purchased the newest title (The Witcher 3: Wild Hunt) via 3 game platforms (PS4, XboxOne, and PC). Game has won over 170 international awards before its release, including the biggest global public-voted gaming award - Golden Joystick Award in "Most Wanted" category. On average, 39% of CD Projekt’s total gross profit (as presented in Figure 3) is generated by CD Projekt Red developing video games. Moreover, gross profit from sales of games via GOG.com platform, distribution and publishing in Poland (CDP.pl) constitutes respectively 35% and 30% of the total profit. The company, on average, makes a gross profit on sales in the amount of PLN 16.15mn per quarter. [the above calculation was prepared on the basis of the last 11 quarters] The company’s strategy for the upcoming years can be summed up in the following points:  Release of new products - CD Projekt is still working on the two leading-edge releases: The Witcher 3: Wild Hunt and also Cyberpunk 2077: these games are high-budget products, their developers’ primary focus lies in the highest quality of their products (‘tripleA video games’), they employ highly advanced technologies to achieve that aim,  Maintenance of the customers’ loyalty - this strategic objective is going to be achieved by supporting their franchise: CD Projekt plans to release two games based on one of their core franchises; although such products are mid-range (circa 20 hours of gameplay), they will also be characterized by the highest quality,  Development of innovation - as a digital distribution platform, the company has constantly invested in R&D projects to develop platform’s facilities and also strengthen its position in the global market,  Commercialization of proprietary technology - starting to license the game development technology, the REDengine, to third-party developers: the newest version of this multiplatform engine is powering their major releases,  Entrance into the new domain - the company assumes that digital and mobile entertainment market is going to rise, so that they are creating new products for users of mobile devices, e.g. The Witcher: Battle Arena. The structure of shareholders by the amount of shares and by the amount of votes at AGM are coincident. During the years 2002-2014, there were several changes in CD Projekt shareholders’ structure. Currently, there are three institutional shareholders (each one holding more than 5% of shares): PKO TFI S.A. (9.48%), MetLife PTE S.A. (5.27%), Aviva OFE Aviva BZ WBK (5.20%). The rest of Company’s equity belongs to the treaty of CD Projekt Red shareholders (35.81%) and to individuals such as ‘Free float’ (44.24%). The majority of votes belongs to business founders and Board Members and is split as follows: Marcin Iwiński (13.28%), Michał Kiciński (12.94%), Piotr Nielubowicz (6.30%), Adam Kiciński (3.29%). CD Projekt’s management is represented by professional and highly devoted people. CD Projekt originated as a small commercial business. Then, after the merger with Optimus, the company evolved into a leading video games developer in the Polish market. Its franchise has started to be internationally recognized after release of the first part of The Witcher saga. Members of CD Projekt S.A. Board are: Adam Kiciński – President and Joint CEO, Marcin Iwiński – co-founder and joint CEO, Piotr Nielubowicz – CFO, Adam Badowski – Studio Head, Michał Nowakowski – SVP Business Development. The company, thanks to its effective management, has taken advantage of many opportunities appearing on the developing Polish market as a grantee of European Regional Development Fund. Since December 2007 it has managed to carry out six projects, amounting to about PLN 155.6k and

3

Figure 5 Projects co-financed by the European Regional Development Fund, 2007-2013

EUR 100k. Currently, CD Projekt is conducting three more projects. One of them is dedicated to the upcoming production The Witcher 3: Wild Hunt.

Corporate Governance 100%

As company listed on WSE CD Projekt is obligated to comply with corporate governance rules stipulated in ‘Good Practice of Companies Listed on Warsaw Stock Exchange’. In connection with that, CD Projekt published on its webpage a list of rules, which are not obeyed by it along with explanation. Main factors having impact on our evaluation of the corporate governance were:

90% 80% 70% 60%



Members of a supervisory board - well-educated and experienced professionals: a solicitor, a Ph.D. in technical sciences, a CFA charterholder, a tax advisor, an IT specialist, lawyer,  Shareholder Rights - one-share-one-vote policy, minority shareholders are authorized to revoke shareholder’s resolution, a special procedure for appointing members of the supervisory board which allows minority shareholders to nominate candidates,  Audit and Oversight – the whole board of directors creates audit committees, annual reports are audited by PKF Consult a well-experienced consulting company;  Compensation - disclosed motivation plan for the board of directors, compensation and benefit scheme was made public. On the basis of our evaluation we claim that CD Projekt follows standards of best practice in corporate governance. Lack of special committees the supporting supervisory board as well as the corporate governance officer arises from facts that both the company’s structure is not extensively developed.

50% 40% 30% 20% 10% 0%

Project Value

EU financing

Source: The company data.

Industry Overview It is estimated that global expenditures on entertainment and media are going to increase from USD 1.56tr in 2013 to USD 2.12tr in 2018, what equals to CAGR of 6.4%. Analysis of the global results reveals that inhabitants of the Asia-Pacific region are world’s top spenders in entertainment and media in comparison to inhabitants of other regions. It is worth noting that Central and Eastern European market growth will be significantly faster than the growth of Western Europe’s markets, although Latin America will be the fastest-growing region over the next four years, with annual growth of 10.9%. Such expenses are strongly correlated with the global economic situation. In countries with a stable economy, society citizens’ wealth has increases and thus spending on entertainment are greater. However, thanks to the Internet and facilities provided by other technologies, people from all over the world have more possibilities to fulfill their needs in the ways they really want. These days lots of traditional methods of distribution have been replaced by digital countertypes/equivalents. For more information, please see the Appendix 9.

Figure 6 Expected Global Game Market in 2014

Game industry revenue (in bn USD)

40

LATAM

35 30

NAM

25 20

APAC

15

MEA

10 5

EU

0 0

200

400

600

800

1 000

Gamers (in mln)

Source: NewZoo. Figure 7 Total global spending on entertainment by category 300

US $ millions

2012

2013

250 200 150 100 50 0

In-Home Video Entertainment

Audio Entertainment

Cinema

Out-of-Home

Consumer Books

Video Games

Video games development According to Global Games Market Report, worldwide game revenues amounted to USD 75.5 bn in 2013, growing by approximately 14% as compared to the previous year. The top revenuegenerating region is APAC (Asia and Pacific), where the game industry generated 42% of total income. Moreover, revenues of the global games market are expected to increase to USD 102.9bn by 2017. By contrast, on the basis of data from Forecast: Video Game Ecosystem, revenues of the game industry reached USD 93bn in 2013 (Appendix 10 and 13). Sales of games for TV consoles as the most profitable market segment brought USD 23.6bn in revenues (31% of total revenues in 2013). However, revenues from sales of PC/MAC games will grow at 3.3% CAGR over the next six years, while the annual growth rate of games on TV will be four times lower. The total number of video game consoles sold worldwide was about 42m in 2013, twice less than in 2008. The best-selling TV console was Sony’s Playstation 3, reaching the sales of 8.94m units. Please refer to the Appendix 7 and 8. It is expected that the number of gamers exceeded 1.7bn in 2014. 47%, 19% and 13% of them respectively come from regions such as Asia-Pacific, Europe and Middle East-Africa. The profile of an average gamer could be as follows: age 31 and 14 years of video games playing. There are almost as many women as men(who/that are)playing games. Games are the most frequently purchased by 36 years old gamer on average. According to ESA’s estimates of the best-selling video games, nearly one in three gamers choose the action genre and also every fifth sold video game is the shooter. Sales of RPGs constitute more than 12% of computer games and 7% of sold video games units. According to Newzoo‘s data, the Polish games market generated revenues in the amount of USD 280mn and it consisted of 13.4mn players in 2014. They are mainly young men, pupils and students, who spend an average of 21 hours a week playing games. Earnings of nearly half of working Polish gamers amount to or exceed the national average salary. Moreover, the vast majority of Polish gamers plays games via PC platform. The most popular game genres are shooters and role-playing games (Appendix 14).

Source: McKinsey&Company’s, Global Media Report 2014.

4

Figure 8 Global Games Market, 2013-2017

Casula Webgames

100% MMO Games

80% 60%

(Mid)-Core PC/Mac Games

40%

Mobil Phone Games

20%

Tablet Games

Competitive Positioning To understand CD Projekt Red Capital Group competitive position, we should take into consideration the fact that the company consists of three businesses functioning in different market environments. All of them have much in common, but we should remember to analyze each industry very carefully. We want to determine the position of CD Projekt in comparison with its competitors, its future position in the next years. To achieve accurate results, we have analyzed CD Projekt Red Studio, cdp.pl, and GOG.com as compared them to both local and global leaders of their industries, using analytical methods such as Porter’s five forces analysis and SWOT analysis.

Advantage of differentiation of buyers and products’ substitutes

0% 2013 2014 2015 2016 2017

Handheld Games

TV Console Games

Source: NewZoo. Figure 9 Share of total spending on console games (USA) DLC

65% 71% 68%

23%

Pre-owned

65% 66% 64% 80%

14% 9%

77% 75%

21% 27% 22%

20% 23%

12% 9%

Boxed

6%

16% 17% 15% 8% 12% 7% 8%

The modern world of entertainment, performing a part of media industry, has wide perspectives of development, because both customers from developed and emerging markets spend much money on its products: about USD 590mn in 2013, which is 5% growth as compared to 2012 (please refer to Appendix 9). We have analyzed the gaming market from a global perspective. The gaming market is characterized by huge bargaining power of mature and aware buyers with specific expectations. What is more, an easy access to entertainment poses a considerable threat to product substitution. To see more details, please refer to the Porter’s five forces analysis in Appendix 11. Potential buyers are gamers from all over the world and their number is estimated at nearly 2bn people. The majority of purchasers of games are people who consciously choose products: they are aware of their consumer needs and they also know how to meet them. Due to the strong growth of the game industry, high product differentiation and unlimited access to substitutes, bargaining power of buyers is constantly increasing. Another characteristic which has a significant impact on the game industry is wide access to substitute products. Traditional entertainment products such as movies, books, audio books, board games are becoming slightly old-fashioned in the ‘digital age’, but they still have its supporters. According to McKinsey&Company’s Global Media Report 2014, participation of these products in a total global spending on entertainment in 2013 is estimated at 35% compared to 12% spent on video games (Appendix 9). Furthermore, there is clearly noticeable phenomenon in vogue - ‘healthy lifestyle’. It encourages people to do sport instead of spending time in front of a computer screen.

Progressive internationalization and increasing number of competitors Source: NewZoo. Figure 10 Porter’s five forces analysis for CD Projekt Red Studio

Bargaining Power of Suppliers

Threats of New Entrants 5 4 3 2 1 0

Competitio n in the Industry

Source: The team estimate.

Many well-known international brands (like Warner Bros Interactive Entertainment, Namco Bandai Games, Screenlife, 1C, Spike Chunsoft, and Megarom Interactive) have entered into cooperation with CD Projekt, working together on releasing the newest game The Witcher 3: Wild Hunt. Therefore, the operational risk of dependence on the only one publisher decreases. Furthermore, the company does not have to be concerned about promotion and distribution, because it has signed agreements with major local sales partners, what enables CD Projekt Red Studio to distribute its products in 109 countries. Its main product will be physically available in North and South America, Europe, Asia Continental and Pacific, Africa, and Australia. Thanks to that they have guaranteed worldwide sales and improvement of their global performance.

Bargaining Power of Buyers

Threat of Substitute Products

The company is consistently implementing its strategy of internationalization. In accordance with that strategy, it also has sold the majority of shares in cdp.pl, which is functioning only in the Polish market. As a result of the transaction, the company downscaled its shares in cdp.pl to only 8.29% in November 2014. Regardless all those steps cdp.pl still is going to publish The Witcher 3: Wild Hunt on the Polish market, but its cooperation with the Capital Group depends on achieved bottom line. These ‘international’ operations yield positive results, but on the other hand they have a sideeffect in the form of an extremely fast increase of number of potential competitors. One of the most important strategic problem is to choose the best date of the product release. It certainly has a great influence on the future company’s future profits. CD Projekt has changed the date of the premiere a few times. That fact confirms us in our conclusions that main product of CD Projekt Red Studio competes globally.

Mobile Game Segment The mobile game segment is the fastest growing segment of market. We assume that over the following years this trend will continue. In our view, over the next few years there will be following key factors leading to rise in market value: Developed markets – increase of the share of paying players. According to Newzoo 2014, in twoyears time number of paying gamers will rise from 36% to 46% in Western Europe and the US combined. Developing markets – rapid growth in number of smartphones and tablets will make global market larger. It will be an essential trigger of rise in revenues.

5

Hardware innovation – fierce competition among tablet and smartphone manufacturers will drive constant and rapid growth in mobile technology, creating new opportunities for game developers toattract more gamers and improve the quality of games.

Figure 11 Competitive positioning of GOG.com Steam

GOG

Origin

Uplay

Foreign Currency

USD

USD, EUR

Many

Many

Console Game

Limited

NO

NO

YES

Software

YES

NO

NO

NO

Movies

NO

YES

NO

NO

DRM

YES

NO

YES

YES

Demo

Many

No

Few

NO

For You

Special Tools

NO

NO

NO

Optional Voting+Customer Review

YES

YES

NO

NO

Media Gallery with Trailers

YES

YES

NO

NO

Forum for Gamers

YES

YES

NO

NO

In our view, console game producers have a comparative advantage in mobile phone game segment. According to survey the third main reason to start playing a game is, that a certain game is a sequel of games that gamers used to play before. Loyal gamers who play on console are likely to choose the same game on a mobile phone. Well-known console game brands attract gamers. Gamers also stated that a knowledge of a publisher is one of the most important reasons to choose a particular game. Number of games offered on mobile phones is extremely high due to lower cost of production and other factors. The Witcher Battle Arena. CD project is engaged in a process of developing first free-to-play mobile games. We think that the company has a huge potential in this segment. We base our opinion on following facts. Almost all world-renowned console game developers create games for mobile devices. The console game producers have an advantage of well-known game brand which can help them to obtain a high number of downloads. Currently, the company is gaining experience and it's first games will probably not be very profitable. Although, we think that in long term the company will make profit on mobile game segment.

Digital Distribution Direct links to: Discussions/ Guides/News/ Official WebPage

YES

NO

NO

NO

MMO Game

YES

NO

NO

NO

Only Own Brands

NO

NO

YES

NO

Graphics of Webpage (Our Personal View)

Medium

Medium-

High-

High+

Source: The team estimate. Figure 12 Best-Selling Video Games by Units Sold 2013 Strategy Other Games/Complications Action Adventure Arcade Casual Children's Entertainment Family Entertainment Fighting Flight Racing Role-Playing

Source: The 2014 Essential Facts About the Computer and Video Game Industry, ESA. Figure 13 Share of digital distribution and physical copies in selected countries

Belgium Netherlands Italy Spain France Germany UK Europe US

41% 47% 39% 40% 44% 35% 42% 42% 58%

59% 53% 61% 60% 56% 65% 58% 58% 42%

Digital Distribution is growing at two digits number. According to ‘Entertainment Software Association and the NPD Group in 2013, digital distribution accounted for 53% of distribution in comparison to only 29% in 2010. The growth is driven both by the rapid development of the game market for mobile phone and smartphone as well as increase in popularity of digital distribution among gamers. Highly Concentration in Industry. Few market participants monopolize the segment of digital distribution. Leader, Steam accounted for more than half of total revenue. Steam webpage offers the great variety of functionality for the users and is not only a virtual shop but also a platform for communication between gamers. Digital distribution provides a higher profit margin for Developers. Retail distribution in more costly (physical production, transport cost, higher operating cost). Digital distribution offers consumer unlimited access to a great variety of games for people around the world. According to the CDP data, the net receipt from digital distribution of each The Witcher 3 will be about twice higher than in retail distribution. GOG is the leader in digital distribution of older classical games. Based on analysis of revenue structure of GOG, we assume that classical games are mostly attractive for gamers who used to play in those games (developed markets). Global market growth is driven by increase the number of new gamers who could not have a sentiment for older games. Additionally the number of older games, which could attract gamers is limited. We think that in the long run GOG could not grow only by adding additional games to portfolio. Based on the official presentation, we assume that GOG Galaxy will be offering new functionality. Technology gap between Steam and GOG will become smaller. Advantage of GOG is base of loyal customers who support DRM-free policy of platform but the mainstream publisher still relies on DRM and do not want to cooperate with GOG because of lack of DRM protection. We assume GOG Galaxy due to a new technology will be able to limit unauthorized copying without the necessity of internet connection. GOG have loyal customers who support DRM-free policy of platform. We assume that when new titles will be offered by GOG, DRM-free supporters could change platform only because of their personal belief.

SWOT conclusion GOG.com is a digital distribution platform offering a wide range of computer games, especially old titles. A SWOT analysis helps to look at the company’s internal strengths and weaknesses, and also to identify external opportunities and threats. One of its strengths is an international cooperation with publishers and developers from all around the world, which supports product diversification. The GOG’s weakness is the fact that the platform is focusing on the sales of old titles, whose distribution isn’t as profitable as distribution of the newest releases, especially ‘triple-A video games’. Moreover, the fast-growing digital industry offers opportunities for effective development of the business and acquirement of new competitive advantages. However, one of the threats is that Steam will further strengthen its position in the market. Please refer to the Appendix 12 for the SWOT analysis.

Share of Digital Distribution Share of physical copies

Source: The team estimate.

6

Figure 14 Global Games Market 2012-2017

Investment summary 102,9

70,4

12,7

2012

2013

26,3

21,8

17,6

95,2

88,4

81,4

75,5

2014

2015

Sustainable improvement of financial position

30,7

2016

35,4

2017

Total Games Revenues (in bn)

Source: NewZoo. Figure 15 CD Projekt S.A. stock price and WIG20 index performance in the last 5 years CD Projekt

So far, CD Projekt has not paid any dividends to its shareholders. It also do not use long-term loans. The company benefits from such political conditions as e.g. the fact that Polish companies can utilize European Funds as members of EU with developing economies.

Possible Investment Risk

Mobile Game Revenues

1600%

The CD Projekt financial situation in short-range forecasts is acceptable for current investors and for those who would like to invest short-term basis, especially among Polish stock companies. CD Projekt is approaching the release of its new valuable product, namely The Witcher 3: Wild Hunt, which seems the most significant driver for the growth of the company’s future value.

WIG20

1400%

Investors should be aware of two risks with the highest impact on the company and its profitability, apart from high fluctuations of exchange rates. The company has to expand its activities, adapt to rapidly changing trends in consumers’ needs and also keep on updating its strategic goals. One of them is perception of developed game risk - if product does not meet gamers expectation, the final sales results will be significantly lower than our estimates. Moreover, the huge impact on the structure of CD Projekt’s revenues has seasonality of the game sales. The rest of investment risks has been identified in Investment Risk section.

Hold the Witcher’s producer

1200%

Our recommendation for CD Projekt S.A. is to Hold stocks with a target price PLN 16.27, which is very similar to its current price of 16.16 (estimated change over the next year is roughly 0.3%). The analysis in terms of attractiveness of the whole industry and prepared valuations confirms strong position of CD Projekt S.A. on the market. CD Projekt has a leading position within the Polish WIG Informatics index and it is the leader on the domestic market as a video game developer and as a provider of different types of entertainment.

1000% 800% 600% 400% 200%

Valuation Methods

0%

Source: The team estimate, Stooq.pl. Data as of January 29, 2015 (Base=100% for January 29, 2010).

Our target price was derived by using the Discounted Free Cash Flow method. The approach was chosen because the company’s sales have significant a seasonal factor. By 6 years period, we captured 2 such periods which lasts 3 years each. Our terminal growth (3%) derives from the strong fundamentals of the Polish economy. We assume that both video game development and digital distribution will still grow but slower while the physical distribution in Poland business will be sold in 2016.

Industry overview and its prospects

Table 2 Total Sales until 2020 forecast for the Witcher 3

The company is operating in a steady growing entertainment industry. Consumers are spending more on entertainment and media YoY – 6.4% of annual increase. The rapid development of new technologies and continuously rising consumer demand are the reasons for which further growth directions have been appearing. Looking at global gaming market, its revenues are expected to increase to over $102bn, with its fastest-growing market segments being mobile phone and tablet games as well, with respectively CARG of 15.2% and 28.2%.

Doubtful long-term increase

Retail Distribution

Digital distribution

The US

1 493 100

614 900

2 108 000

Europe and the rest

3 348 000

1 397 900

4 745 900

According to our calculations nearly 70% of the company’s future assets of the company are going to consist of cash. This fact may lead to a conclusion that the management should implement a well-thought-out strategic plan to guarantee stable long-term prosperity of the company. As the company’s cash generation ability is relatively high, it should use its own funds to create and implement a new investment project. Otherwise, the business is going to be unprofitable.

Sum

4 841 100

2 012 800

6 853 900

Valuation

Sum

Source: The team estimate. Table 3 Total Sales until 2020 forecast for Cyber Punk 2077 Retail Distribution

Digital distribution

The US

1 255 000

598 000

1 853 000

Europe and the rest

2 936 000

1 425 000

4 361 000

Sum

4 191 000

2 023 000

6 214 000

In order to valuate CD Projekt S.A., we used 2 methods – DCF model and ratios model, with weights of 100% and 0%, respectively. The first method consists of the estimated cash flows in the following 5 years (2015-2020, and partially – 2014), with taking into account different scenarios. The ratio analysis has a zero weight because we assume this business too cyclical. Several ratios, such as P/E may be not too accurate because Price discounts expectations of future earnings while Earnings (Net Profit) are strictly accounting-driven measure.

Sum

DCF Model Sales

Source: The team estimate.

Video games development We have estimated Sales according to other AAA games (Table 2, more in Appendix 19). The most convenient video game which is comparable in both production cost and genre is Destiny (Appendix 17). We consider it also as a game heavily based on preorder sales. Additionally, it was released in the middle of 2014. Also counted how does the game sales outside the EU and US (Appendix 26) The next step were estimations of the console base. It is important to notice that The Witcher 2 was released when there had already been dozens of millions of PS3. To estimate how much the fact

7

Figure 16 Estimation of Sales as a percentage of Total Sales of The Witcher 3 and Cyber Punk 2077 in the following years after a game release 60.4% Median Mean

19.2% 5.3%

2.8%

6.6%

1

2

3.4%

3

Our assumption is that a fraction of gamers who will buy the CDP’s product is going to be the same as in the case of Dragon Age 3: Inquisition. We consider the mentioned game as a good indicator as it is also from RPG genre and had a similar budget. To estimate the sales pattern of both The Witcher 3 and CyberPunk 2077, we used the median value of sales for 7 AAA video games (Call of Duty, God of War, Tomb Rider, and others), which was released in the 1st or 2nd quarter of the year. We have omitted the releases during Christmas time (Appendix 24-25).

46.5%

14.9%

of a lower number of consoles affects sales of The Witcher 3, we have used historical data of the new generation consoles in the last months.

4

By calculating the whole pattern of triple-A video games sales, we have assumed that in the first year, The Witcher 3’s sales will equal to over 60% of its lifetime sales (Figure 16). Among other things, in conjunction with very high hardware requirements we decided, however, to flattening of sales to 50% in the first year (Appendix 14). Five independent report results are that video games market is going to grow dynamically with the medium value equals to 8.2% CAGR (Appendix 12). Moreover, Newzoo has published estimations from which we can read that PC/MAC will be growing to 2017 by 3.3% (CAGR) while for TV consoles this rise will equal to 0.8% (Appendix 10.4). Based on the Newzoo data, we calculated how it will shape the relation of sales between consoles and PC and average growth (Appendix 18-19).

Source: The team estimate, VGChartz.com.

The CybePunk77 estimate is performed in the same way as in the case of the W3, however, we believe the total sales will cover only 85% of total sales for the W3. It is due to the fact that The Cyberpunk, as a brand, is relatively unknown outside the U.S (Table 3, more in Appendix 22).

Figure 17 GOG.com Sales Sales

EBITDA

CAGR

350%

70%

300%

60%

250%

50%

200%

40%

150%

30%

100%

20%

50%

89%

38%

39%

38%

35%

33%

0%

10% 0%

2011

2012

2013

2014E 2015E 2016E

Source: The team estimate.

Physical distribution GOG Video game development

100 000

50 000

0 2014F 2015F 2016F 2017F 2018F 2019F

Source: The team estimate. Table 4 Weighted Cost of Capital for CD Projekt S.A. Poland 10Y Bond YIELD (R F rate)

2.29%

Equity Risk Premium

5.07%

Risk for the Polish market SEM

4.92%

Risk for the US market SUS

3.72%

Country risk premium

1.63%

Beta monthly data

1.17

Adjusted monthly beta

1.11

WACC

Source: The team estimate, Stooq.pl.

After 5 years, we assume the stabilization of Sales (low price, much more consoles, more customers in the emerging markets). GOG In the next years, Sales for GOG will increase, however, much slower than as of 2014. It is because there is a limited number of old titles to acquire that can be sold on the GOG platform. We think that the growth in Sales will be partially driven by entering new segments of the market, such as movies and newer titles (from 2010s). Between 2014 and 2016 CAGR in Sales will converge to 6.4% and this value has been a base for estimation for years 2016-2020.

Margins

Figure 18 Net profit breakdown

150 000

In our estimation, total units sold will be divided equally between the U.S. and Europe while the rest of the world share will equal to 16.9%. We have assumed that a factor of growth in total revenues lies in gamers from Asia, Africa, and Latin America. As previously mentioned, though video games market will be growing, this tendency is going to shrink in the developed countries. The expected growth for those 2 regions is weak and equals to nearly 0%-2%.

10.12%

Video games development We have assumed that margins will be lower in case of video games developing and GOG.com. In the first case, it is due to the increasing cost of labour. We believe that salaries of high specified knowledge workers will converge to the Western Europe and North America numbers. Thus, EBITDA margin will decrease. GOG Our expectations are that margins for GOG will decrease. The strategy of acquiring old titles is going to change because of capacity of the old video games market, as mentioned in the previous section. CD Projekt will have to switch to acquisition of newer titles. As a unit cost of more recent video games is higher, we believe it will surely affect margins in a negative way. At this point, GOG is a niche entity and the leading one in its segment. Having a position of a monopsonist helps the company to improve its additional markup. With newer titles, by which we mean video games from 2010s, the entity is going to position itself in a much broader and competitive market.Full graph of EBITDA margin is in Appendix 18. Retail distribution In this segment, margins will remain constant as the company does not consider any changings in the near future, except for eventual selling this part of the business.

WACC In our estimation, calculated Weighted Cost of Capital equals to 10.12%. We have utilized CAPM model by performing regression of CD Projekt’s stock monthly returns against monthly returns of WIG20. Period used for calculations consisted of the last 5 years (period between December 31, 2009 and December 31, 2014). Obtained Beta coefficient equals to 1.17 and this value is justified over the whole forecast period as we believe its core business, which is still game development and digital distribution, will not change anytime soon. We think that diminishing share in revenues from retail distribution will be offset by a greater share of GOG, which operational risk is the similar. The company does not have any debts, as of 2014, and does not wish to have any in the future. Therefore, WACC equals to Cost of Equity.

CAPEX The core business of CD Projekt is not capital intensive. Most of its costs are incurred immediately, e.g. for salaries for its employees. Therefore, we think CAPEX will equals to roughly 1.3mn a year in the analyzed period.

Dividends We assume that the company is going to continue no dividend policy. CD Projekt relies on 100% self-financing, so we assume it wants to have some buffer in the future.

8

Tax We have assumed that tax rate will remain constant over the period of our analysis.

Terminal Value The terminal value was based on the average cash flow in years 2017-2019. This assumption captures the whole cycle for the company – from a year before a game release, through a game release year, to a year after a game release. Additionally, we assumed terminal growth to be 3% as we believe it is the long-term GDP growth in Poland. Table 5 Cash Flow and Terminal Value Forecast mn PLN

2014E

Net Sales

2015E

2016E

2017E

2018E

2019E

159 882

499 659

250 223

251 052

567 195

228 405

EBIT

5 056

146 548

55 235

64 125

150 473

49 968

NOPLAT

5 902

172 633

90 262

77 593

187 383

61 352

676

694

720

749

779

812

6 578

173 326

90 982

78 341

188 162

62 164

+ Depreciation = Net Operating Cash Flow CAPEX

3 848

-1 177

-1 239

-1 305

-1 376

-1 452

Change in NWC

-18 461

63 597

-72 697

242

92 138

-98 738

=Free Cash Flow

28 888

108 553

162 441

76 795

94 648

159 451

=Discounted Cash Flows

28 888

98 581

133 967

57 516

64 376

98 489

PV of Cash Flows

481 816

Discounted Terminal Value

1 063 389

WACC

10.1%

Equity Value

1 545 205

Number of shares (in mln)

94.95

Share price

16.27

Source: The team estimate.

Sensitivity Analysis In this section, we have performed the sensitivity analysis with WACC and Terminal growth as variables. Default values, based on DCF model, were 10.12% and 3%. In the following matrix of results, we have shown the dependence of price on WACC and Terminal growth. The values differ significantly and this is determined by the fact that we have estimated only 31% of value by Discounted Cash Flows in years 2014-2019. The most of variation comes from Terminal growth factor. Due to the fact that we have estimated Terminal Value with Gordon Model, the results are especially sensitive when Terminal growth converges to WACC. Table 6 Sensitivity matrix for CD Projekt stock price WACC

Terminal growth

7%

8%

9%

10%

11%

12%

13%

0%

17.95

15.84

14.19

12.86

11.77

10.86

10.08

1%

20.17

17.46

15.41

13.81

12.52

11.47

10.58

2%

23.29

19.61

16.98

15.00

13.45

12.20

11.18

3%

27.96

22.64

19.08

16.52

14.60

13.10

11.89

4%

35.74

27.17

22.01

18.56

16.08

14.22

12.76

5%

51.30

34.72

26.41

21.41

18.06

15.66

13.85

6%

97.99

49.83

33.74

25.68

20.83

17.58

15.26

Source: The team estimate.

Comparable Valuation We think that comparable valuation approach is not suitable for CD Projekt. First of all, CD Projekt releases one game for every few years. Profits from developing games are the most important drivers of earrings but are very violate due to the fact that roughly 60% of them is generated in the first year. International peers release games every year, their profit are more stable. Secondly, in last quarter’s ,due to lack of release of new games, 47% of CDP gross profit was derived from sales of games via GOG.com platform. The digital distribution segment is not such an important driver of profit for peer’s companies. Steam, the major international competitor in digital distribution, is not a public-listed company and its financial data are not distributed into public and hence could not be used for valuation. We have performed peer group multiples analysis. The group consists of the major international competitors such as Activision Blizzard, Electronics Arts, Ubisoft Entertainment, and other game developers and distributors. Finally, we have excluded Ubisoft Entertainment from comparable valuation because its impact on mean has been too huge due to extremely high P/E in comparison to others.

9

Financial Analysis We have used financial ratio analysis to research the ways in which CD Projekt is currently performing and compare these results with the past performance and financial situation of the company.

Self-financing and cash generation abilities The company mainly uses internally-generated funds to finance and expand its activities. In addition, CD Projekt has effectively utilised grants received from the EU to realise its projects. In our opinion, cash generation ability of the company’s core activities, especially future earnings from sales of The Witcher 3: Wild Hunt and Cyberpunk 2077, and also revenues from distribution via digital platform will be enough to cover expenses in a long-term perspective. The liquidity ratios have confirmed CD Projekt’s ability to meet its obligations without any difficulties (Current Ratio 2012: 2.48 2013: 2.72). We predict such a trend will increase in the estimated period. The amount of the most liquid possessed assets will be 3 times greater than shortterm debts in 2017 (Cash Ratio 2017E: 3.2). For more key financial ratios please see Appendix 4. In previous years, it took the company only 66 days on average to collect account receivables. Payments are being carried out so quickly in view of the most commonly used method – made by credit cards. That’s why, in our opinion, this trend will continue in the projected period. The average inventory days ratio was 97 days during the period between 2011 and 2013, however, the ratio for 2013 amounted to more than 133 days due to ongoing preparation for the huge release. We expect that the ratio will increase to an average of 132 days in the period of forecast due to the work of games development in progress and the physical delivery of future titles.

Profitability Ratios Gross Profit Margin decreased over the years 2011-2013, but it is still over 40%. The changes of margins may depend on the product lifetime. Developing of the main product – video game, which generates the majority of changes in revenues and costs of sales, is a long-term process. After the releases of The Witcher 3: Wild Hunt and Cyberpunk 2077 (2015E – 2018E), Gross Profit Margin is expected to remain above 50%. Other businesses (GOG.com, cdp.pl) are generating a rather sustainable profit YoY. Costs are balanced by revenues. Maintaining constant correlations, the Gross Profit from sales increases while the costs are lower or while the scale of sales expands. In the researched period 2010-2013, the company was still building up their core business – developing of video games. The quality of their products improves so that total costs were constantly growing. We assume that usually the release of a new video game is a reason, which has the main impact on gross profit from sales. The changes are cyclical, but the Gross Profit Margin of CD Projekt Capital Group is rather stable thanks to profits from other businesses. Operating Margin as well as Gross Profit Margin could be analysed in the context of product lifetime and thus Operating Margins is expected to reach the highest rates in years 2015E: 29.3% and 2018E: 26.5%, while the company’s’ main products will be released. To confirm, it is worth noting that the highest ratio in 2011-2013 was recorded while The Witcher 2: Assassins of Kings was released (2011: 20.3%). Calculation of a Net Profit Margin shows us that every PLN of sales allowed to the company earn: 17.6% in 2011, 17.1% in 2012 and 10.5% in 2013. According to our calculation, during the forecasted period, the CD Projekt will be able to cover its operating costs including indirect costs. Return on Assets displays that CD Projekt is able to turn its assets into profit. Even comparing CD Projekt ROA in 2013 (6.8% - the lowest one in 2011-2013) to its global competitors like Ubisoft (5.5% - the highest one in years 2011-2013) or Take-Two Interactive Software Inc (4.8% - the highest one in years 2011-2013) the situation of a Polish company seems to be favourable. CD Projekt has found the way to operate more efficiently against its competitors. We expect future level of return on assets ratios to be an average of 8% in mid-term. However, ROA is estimated to amount only 1% in 2014E due to delays in the process of game development.

Figure 19 Matrix risk for the CD Projekt

Return on Equity forms as follows: 19.4% in 2011, 18.6% in 2012, 8.9% in 2013. In comparison with CD Projekt ROEs, Polish Treasury 10-Y Bonds return was about 6.07%, 5.91%, 3.73% and 4.35% YoY in the analysed period. Our analysis shows that levels of ROE in 2015E-2019E will be attractive for investors, however it should be taken into consideration that a potential for further and stronger growth is highly limited. There is a strong correlation between results of ROE and games’ releases. The company's profits depend on the quality of developed and sold products and therefore the purchasers’ satisfaction.

Investment Risks Concentration of Revenue Among Top Titles ‘Hit’ titles earn a significant portion of total revenue in each segment. According to The NPD Group, in 2013 the Top 10 bestselling titles accounted for 38% of the sales in the industry in the USA in comparison to 30% in 2012. Market participants expect that trend will be continued in the industry. The CDP needs to deliver the best games in each segment. otherwise revenue could significantly drop. (Activision Blizzard Inc. Annual Report 2013, Electronic Arts Annual Report and Proxy Statement 2014). Please be informed that detailed analysis of Investment Risks is presented in Appendix 34, 35 and 36.

Source: The team estimate.

10

Console and Equipment Figure 20 Estimated sales vs Metacritic rating

Introduction of new console system produces additional cost of switching. During transitory period game developer release titles on both console, what is costly. Constant improvement in game quality is the effect of increasing computing power of hardware. The CDP success will depend on ability to develop the best game on upcoming platforms.

Piracy Risk Entertainment software industry is highly affected by data piracy laws and consumer attitude to piracy. Intellectual protection on the internet is the key issue for the whole entertainment industry. Percentages of illegal software used by consumer differ significantly across countries. According to Business Software Alliance Survey, the global rate at which PC software was installed without proper licensing was 43% in 2013 in comparison to 42% in 2011.

Perception Of Game Source: Ars Technica. Green dots represent the median sales performer at every individual Metacritic score. Figure 21 Monthly salaries across industries in Poland and USA

USA

Poland

18 16 14 12 10 8 6 4 2 0

Perception of Game is the key point to success in the game industry. As a result of one game under consumer’s expectation, perception of a whole franchise may be harmed. The CDP could incur substantial costs and also lose both customers and revenues.

Channel Partners Risk Video games are sold to customers through channel partners as Sony, Microsoft. They have a freedom to set rates that the CDP must pay to provide games via online channels. Channel partners could change fee structures for online channels. It could adversely impact costs, which led to a loss in profitability and margins. In comparison to PC producer, Sony and Microsoft need to accept a game before release. According to ‘PWC Global entertainment & media outlook 2014-2018’ Hong Kong total game consumer spending on PC games will decrease 13% from 2013 to 2018 but spending on console game grows 22% from 2013 to 2018. It is highly probable bargaining power of console producers will increase.

Personnel Risk In this industry, human resources are essential. Good reception of CD Projekt-produced games opens their personnel opportunities to work for other companies. Salaries offered by top entertainment software producer located in the USA are greater than these offered by the CDP. Thus, this brain drainage is highly possible.

Risk of Change in Public Taste and Preferences

Source: Bankier.pl. All values on vertical axis in PLN. Figure 22 EURPLN and USDPLN exchange rates

Video games are a substitute for watching TV, going to the cinema and watching movies. According to Entertainment Software association, about 45% gamers who play more video games than they did three years ago are spending less time watching TV, going to the cinema and watching movies. Change in public preferences connected with spending a leisure time could have a negative impact on the industry.

European Union Funding CD Project use conditional funds form European Union. The company need to fulfill all provisions of agreement in other case will be obligated to return all money. The extension. The scope of EU funding show Figure 5

Risk of Change in primary devices used to play video games Constant and rapid development of personal devices like tablets and smartphone could change public preferences. Improvement of hardware system could lead to switching game player from PC and console to tablets and smartphone. According to ‘Newzoo Global Games Market Report’ global mobile games revenue is forecast to rise at CAGR of 19.1% in comparison to total game industry growing at CAGR of 8.1%. Main drivers of growth will be rising smartphone ownership which will lead to increasing access to mobile phone games.

Risk of Seasonality Video Games business is seasonal with the highest quantity of sales in the 4th quarter due to Christmas time. All delays in production could adversely impact revenue if a game would be not finished on time.

Currency Risk The CDP operates in Poland but most revenue, approximately 80%, earns in foreign currencies (U.S. dollar and Euro). Hedging position is possible only in short-time and generates costs. Change in exchange rates could adversely impact company profitability and margins. As it is shown on Figure 7, the market volatility for those quotations were especially high during the crisis. If it occurs the next time, CD Projekt will suffer from it with a high probability.

Source: The team estimate, stooq.pl. Left axis contains values for exchange rates, right axis contains 60 days standard deviations of log returns for quotations.

11

APPENDIX Appendix 1 Comprehensive balance sheet in years 2011-2019 ASSETS

2018E

2019E

94 964

108 690

122 588

194 413

442 647

479 997

557 208

810 400

799 950

9 819

26 866

39 684

68 572

177 124

339 565

416 360

511 008

670 459

Receivables

32 757

35 882

20 920

29 759

84 078

42 105

42 245

95 442

38 434

Inventories

31 112

33 367

51 966

85 626

166 498

83 380

83 657

189 003

76 110

Other current assets

21 276

12 575

10 018

10 456

14 947

14 947

14 947

14 947

14 947

Fixed assets

90 762

94 202

95 047

94 206

96 644

100 339

104 305

108 564

113 136

Current assets Cash and cash equivalents

PPE Intangible assets

2011

2012

2013

2014E

2015E

2016E

2017E

9 924

10 755

11 187

6 663

7 146

7 665

8 221

8 817

9 457

77 923

34 801

36 403

40 122

43 080

46 257

49 668

53 330

57 262

2 002

46 417

46 417

46 417

46 417

46 417

46 417

46 417

46 417

913

2 229

1 040

1 004

Long-term investments Goodwill Other non-current assets Total assets LIABILITIES Current liabilities

185 726 2011

202 892 2012

217 635 2013

288 619 2014E

539 291 2015E

580 336 2016E

661 513 2017E 130 255

918 964

913 085

2018E

2019E

196 661

125 498

54 327

43 758

44 991

106 390

182 475

130 081

Payables

28 869

104 954

52 559

52 734

119 140

47 977

9 583

Other current liabilities

25 458

61 196

7 568

53 657

63 335

82 104

120 672

196 661

125 498

Long-term liabilities

7 590

7 604

5 276

6 651

6 651

6 651

6 651

6 651

6 651

Short-term borrowing

Long-term liabilities Other non-current liabilities Equity

Retain earnings

7 590

7 604

5 276

6 651

6 651

6 651

6 651

6 651

6 651

123 809

151 530

167 368

175 578

350 165

443 604

524 607

715 652

780 937

201 655

200 150

208 256

220 834

220 834

220 834

220 834

220 834

220 834

101 530

76 459

55 987

54 133

51 182

62 340

111 530

161 748

274 274

278

286

199

5 926

Other equity components Net income Total liabilities and equity

23 962

28 125

14 900

2 951

113 522

49 190

50 218

112 526

40 420

185 726

202 892

217 635

288 619

539 291

580 336

661 513

918 964

913 085

Source: The team estimate, CD Projekt data. Appendix 2 Profit and loss statement in years 2011-2019 P&L STATEMENT

2018E

2019E

136 210

164 040

142 172

159 882

499 659

250 223

251 052

567 195

228 405

COGS

54 504

89 618

83 186

114 214

215 619

112 426

117 567

239 636

118 207

Gross profit (loss) from sales

81 706

74 422

58 986

45 668

284 040

137 797

133 485

327 559

110 198

SG&A

49 567

38 306

40 874

41 344

138 044

85 139

70 075

180 679

60 871

4 517

7 749

3 238

732

552

2 577

716

3 593

641

27 622

28 367

14 874

5 056

146 548

55 235

64 125

150 473

49 968

Sales revenues

Other net expenses EBIT Net Financial Revenues

2011

2012

2013

2014E

2015E

2016E

2017E

393

80

2 316

4 958

2 803

6 842

2 429

10 204

2 092

EBT

28 015

28 447

12 558

10 014

149 351

62 077

66 554

160 677

52 060

Tax Expense Profit from continued operations Profit from discontinued operations

3 267

162

2 339

5 487

23 282

9 058

11 038

26 706

9 292

24 748

28 285

10 219

4 527

172 633

71 135

77 593

187 383

61 352

Net Profit

24 748

28 285

10 219

4 527

172 633

77 593

187 383

61 352

19 127 90 262

Source: The team estimate, CD Projekt data.

12

Appendix 3 Cash flow statement in years 2011-2019 CASH FLOW STATEMENT Net Profit

2011

2012

2013

2014E

2015E

2016E

2017E

2018E

2019E

27 229

28 125

14 851

4 527

172 633

90 262

77 593

187 383

1 536

1 978

2 617

676

694

720

749

779

812

Change in NWC

14 427

5 920

4 506

18 461

63 597

72 697

242

92 138

98 738

Change in long-term liabilities

10 517

2 436

4 990

Change in other equities

14 595

1 711

6 231

Total Operating Cash Flow

10 774

23 458

24 183

23 665

109 730

163 679

78 099

96 024

160 902

CAPEX

2 634

3 939

4 108

3 848

1 177

1 239

1 305

1 376

1 452

Change in Financial Asset

3 865

3 512

143

1 177

1 239

1 305

1 376

1 452

Depreciation

Investment Activities Total cash from investing Cash flow from financing

61 352

260

302

162

6 239

125

4 127

3 848

263

9 523

5 109

1 375

263

(9 523)

(5 109)

1 375

-

-

-

-

-

5 791

17 047

12 818

28 888

108 553

162 441

76 795

94 648

159 451

15 610

9 819

26 866

39 684

68 572

177 124

339 565

416 360

511 008

9 819

26 866

39 684

68 572

177 124

339 565

416 360

511 008

670 459

Dividend paid Total cash flow financing Net change in cash Beginning cash Ending cash

Source: The team estimate, CD Projekt data. Appendix 4 Ratios in years 2011-2019E RATIOS

2011

2012

2013

2014E

2015E

2016E

2017E

2018E

2019E

Gross Profit Margin

60.0%

45.4%

41.5%

28.6%

56.8%

55.1%

53.2%

57.8%

48.2%

Operating Margin

20.3%

17.3%

10.5%

3.2%

29.3%

22.1%

25.5%

26.5%

21.9%

Net Profit Margin

17.6%

17.1%

10.5%

1.8%

22.7%

19.7%

20.0%

19.8%

17.7%

Return on Assets

12.9%

13.9%

6.8%

1.0%

21.1%

8.5%

7.6%

12.2%

4.4%

Return on Equity

19.4%

18.6%

8.9%

1.7%

40.1%

14.8%

13.1%

22.7%

7.5%

Current Ratio

1.75

2.48

2.72

1.80

2.43

3.69

4.28

4.12

6.37

Quick Ratio

1.18

1.72

1.57

1.00

1.51

3.05

3.64

3.16

5.77

Cash Ratio

0.18

0.61

0.88

0.64

0.97

2.61

3.20

2.60

5.34

66.6%

57.4%

66.9%

58.9%

19.3%

40.1%

41.5%

19.1%

49.5%

NWC Turnover

0.22

0.32

0.36

0.30

0.48

0.60

0.65

0.67

0.74

ACC Receivable Turnover

4.3

5.2

8.3

7.6

5.9

5.9

5.9

5.9

5.9

Days of Sales Outstanding

84.5

69.5

43.8

47.8

61.4

61.4

61.4

61.4

61.4

Inventory Turnover

4.38

4.92

2.74

1.87

3.00

3.00

3.00

3.00

3.00

Days of Inventory on Hand

83.4

74.2

133.4

195.5

121.6

121.6

121.6

121.6

121.6

Payables Turnover

2.51

3.75

3.16

1.50

2.74

1.92

1.93

2.88

1.82

Number of days of payables

145.6

97.4

115.5

242.9

133.3

189.7

189.4

126.6

200.6

Cash Conversion Cycle

22.3

46.4

61.7

0.4

49.7

-6.7

-6.3

56.5

-17.5

Long-Term Debt to Assets

0.04

0.04

0.02

0.02

0.01

0.01

0.01

0.01

0.01

Debt Ratio

0.33

0.25

0.23

0.40

0.35

0.24

0.21

0.22

0.14

Financial Leverage

1.50

1.34

1.30

1.65

1.90

1.75

1.73

1.86

1.71

0.25

0.30

0.16

0.03

1.20

0.52

0.53

1.19

0.43

Profitability Ratios

Liquidity Ratios

Efficiency Ratios Fixed Asset Turnover

Solvency Ratios

Shareholder Ratios Earnings Per Share

Source: The team estimate, CD Projekt data.

13

Appendix 5 Average margins and physical and digital share in distribution for The Witcher 3 and Cybyrpunk 2077 in years 2014-2019

Timeline

Average margin

2014

43.4% 43.4% 43.3% 43.5% 44.4% 44.7%

2015 2016 2017 2018 2019 Distribution

2014E

2015E

2016E

2017E

2018E

2019E

Physical

74.00%

72.57%

71.06%

69.47%

67.79%

66.02%

Digital

26.00%

27.43%

28.94%

30.53%

32.21%

33.98%

CAGR

5.50%

Source: The team estimate. Appendix 6 CD Projekt and its competition’ financials Company

PL JPY JPY JPY JPY JPY JPY

Stock Exchange WSE NIKKEI 225 NIKKEI 225 NIKKEI 225 NIKKEI 225 NIKKEI 225 NIKKEI 225

USD USD USD USD USD

NASDAQ NASDAQ NASDAQ NASDAQ NASDAQ

KARW EURO GBP

KRX EPA LON

Market Cap in B 1.56 126.36 159.49 460.08 315.35 524.58 310.07

EV/EBITDA

ROA

ROE

719.1 74.4 18.0 7.4 31.1 19.4 59.9 35.0 24.0 49.0 14.2 N/A 10.4 24.4 20.2 241.8 17.8 45

445.2

1% 3% 7% 72% 3% 6% 1% 16% 7% 0% 24% -2% 7% 7% 11% -5% 53% 13%

1% 5% 8% 120% 5% 10% 2% 25% 11% 0% 46% -2% 10% 13% 15% -8% 68% 21%

All Peers Mean (excluded Ubisoft)

29

6

CDP Projekt premium versu video games peers (exclude Ubisoft)

25

78

0.66PLN

0.29PLN

CD Projekt Capcom Tecmo Koei Holdings GungHo Online Entertainment Square Enix Holdings Namco Bandai Holdings Konami NIKKEI Peers Average Activision Blizzard Electronic Arts Take-Two Interactive Software Zynga Perfect World NASDAQ Peers Average NCSoft UBISOFT Entertainment PlayTech All Peers Mean

Currency

CD project value based on the comparables

14.80 15.17 2.48 2.39 0.95 4.77 1.81 2.01

P/E

13.8 20.2 4.0 20.0 5.7 4.7 10.4 5.3 6

Operating Margin 1% 5% 18% 56% 5% 8% 4% 16% 30% 1% 17% -8% 11% 10% 25% -10% 34% 14%

Data on 2014 2014 2014 2013 2014 2014 2014 2013 2014 2014 2013 2013 2013 2014 2013

Source: The team estimate, Yahoo! Finance.

14

Appendix 7 Game consoles sold worldwide (in millions of units)

Please be informed that the following data show the quantitative trends in cumulated and annual sales of video game consoles. These information help to indentify users and to estimate future directions in development of selected game platforms worldwide. The 20 best-selling game platforms No.

Platform

North America

Europe

Japan

Rest of the World

Global

1 2 3 4 5 6 7 8

PlayStation 2 Nintendo DS Game Boy PlayStation Wii PlayStation 3 Xbox 360 Game Boy Advance

53.65 57.37 43.18 38.94 45.37 29.00 48.26 40.39

55.28 52.07 40.05 36.91 33.75 33.45 25.57 21.31

23.18 33.01 32.47 19.36 12.77 10.21 1.66 16.96

25.57 12.43 2.99 9.04 9.28 12.07 8.99 2.85

157.68 154.88 118.69 104.25 101.17 84.73 84.48 81.51

9 10 11 12

PlayStation Portable Nintendo ES Nintendo 3DS Super Nintendo ES

21.41

24.14 8.30 13.37 8.15

20.01 19.35 18.12 17.17

15.26 0.77 3.10 0.90

80.82 61.91 50.45 49.10

13 14 15 16 17 18 19

Nintendo 64 Sega Genesis Atari 2600 Xbox Game Cube PlayStation 4 Xbox One

20.11 16.98 23.54 15.77 12.55 7.51 6.87

6.35 8.39 3.35 7.17 4.44 7.39 2.91

5.54 3.58 0.53 4.04 1.01 0.05

0.93 0.59 0.75 1.18 0.71 2.69 1.27

32.93 29.54 27.64 24.65 21.74 18.60 11.10

20

Game Gear

5.40

3.23

1.78

0.21

10.62

33.49 15.86 22.88

Source: VGChartz. Appendix 8 Global unit sales of current generation video game consoles from 2008 to 2012 (in million units)

Unit sales of current generation video game consoles Video game console

2008

2009

2010

2011

2012

2013

Sony Playstation 3

10.2

13

14.18

15.09

12.98

8.94

Sony PSP

14.05

9.86

9.61

7.71

4.5

3.08

3.77

3.12

Sony Playstation Vita Xbox 360

10.91

10.16

13.53

14.07

11.33

6.11

Nintetndo Wii

24.19

21.3

17.68

11.83

5.36

2.06

2.37

3.09

8.86

3.05

0.82

13.72

14.91

14.74

Nintetndo Wii U Nintendo DS Nintendo 3DS

29.66

27.57

20.97

Source: Statista

15

Appendix 9 Global trends: Expenditures on media and entertainment 1.

Total spending by region from 2013 to 2018 Total spending on entertainment and media by region (in mn USD) Region

2013

2014

2015

2016

2017

2018

2013-2018 CAGR

North America

448 930

476 142

497 816

527 166

552 123

584 809

5.4%

Western Europe

396 362

406 626

419 349

434 316

450 186

467 433

3.4%

Central and Eastern Europe

56 715

61 425

66 936

72 735

78 935

85 462

8.5%

Middle East-Africa

35 012

39 871

44 727

50 977

57 722

65 203

13.2%

EMEA total

488 089

507 922

531 012

558 028

586 843

618 098

4.8%

Asia-Pacific

506 855

547 672

591 305

637 993

685 338

734 395

7.7%

Latin-America Total

111 477

125 360

137 802

154 536

169 760

187 153

10.9%

1 555 351

1 657 096

1 757 935

1 877 723

1 994 064

2 124 455

6.4%

Source: Global Media Report 2014, McKinsey&Company 2.

Spending by digital and non-digital status worldwide from 2013 to 2018 Global spending by digital/non-digital status (in mn USD) Status

Digital* Non-digital Total

2013

2014

2015

2016

2017

2018

624 058 931 293 1 555 351

704 940 952 156 1 657 096

787 642 970 293 1 757 935

877 022 1 000 701 1 877 723

971 163 1 022 901 1 994 064

1 069 251 1 055 204 2 124 455

2013-2018 CAGR 11.4% 2.5% 6.4%

Source: Global Media Report 2014, McKinsey&Company * Digital consists of spending on broadband, transactional video-on-demand through TV subscription providers, OTT transactional digital video, OTT subscription digital video, digital recorded music downloads, digital recorded music-streaming subscriptions, consumer magazine digital circulation, daily newspaper digital circulation, electronic consumer books, digital learning materials, online video games, and mobile video games 3.

Total global spending on entertainment by category Total global spending on entertainment by category (in mn USD) Category

2012

2013

2014

2015

2016

2017

2018

In-Home Video Entertainment

270.59

283.084

296.49

311.168

325.943

340.694

355.112

Audio Entertainment

93.567

96.544

96.376

98.009

100.337

102.965

106.049

Cinema

35.914

37.223

39.184

41.226

43.383

45.629

47.901

Out-of-Home

30.27

31.822

33.604

35.496

37.713

39.997

42.388

Consumer Books

70.574

71.454

71.958

72.532

73.13

73.635

74.084

Video Games

63.698

70.028

77.455

85.284

93.285

101.308

109.31

Source: Global Media Report 2014, McKinsey&Company

16

Appendix 10 Global Trends of Game Market

1.

Gamers and revenue in 2014E

2.

2013-2017 Global Games Market

Global Game Market 2013-2017, in %

Global Game Market in 2014E by gamers and revenue Region

Gamers

Revenue (in bn)

Market Segment

Total

1 775 489 000

81.4

TV Console Games

LATAM

185 180 000

3.3

NAM

195 016 000

22.2

APAC

826 544 000

36.8

MEA

230 435 000

1.4

EU

338 314 000

17.7

2013 2014 2015 2016 2017 31 6 6 17 10 20 10

29 4 8 19 9 22 9

27 3 10 20 9 22 9

25 3 11 21 8 23 9

24 2 12 22 8 23 9

0.8 -14.7 28.2 15.2 3.3 11.2 5.8

75.6

81.5

88

95.2

102

8.1

Handheld Games Tablet Games Mobil Phone Games (Mid)-Core PC/Mac Games MMO Games Casual Webgames Total Revenue in bn USD

CAGR in %

Source: NewZoo Source: NewZoo

3.

Global video game markets, segmented by forecast rate of growth and scale, 2013-2018

Lower-growth, larger-scale Markets worth more than 750mn USD in 2018 but less than 7% CAGR to 2018

Higher-growth, larger-scale Markets worth more than US 750mn USD in 2018 and 7% or more CAGR to 2018

North America: Canada, US APAC: Australia, China, Japan, South Korea EMEA: France, Germany, Italy, Netherlands, Spain, UK

APAC: India EMEA: Russia Latin America: Brazil, Mexico

Lower-growth, smaller-scale Markets worth less than 750mn USD in 2018 and less than 7% CAGR to 2018 APAC: Hong Kong, Malaysia, New Zealand, Pakistan, Taiwan EMEA: Austria, Belgium, Denmark, Finland, Greece, Ireland, Norway, Portugal, Sweden, Switzerland, Israel, Romania, Rest of MEN

Higher-growth, smaller-scale Markets worth less than 750mn USD in 2018 and 7% or more CAGR to 2018 APAC: Indonesia, Philippines, Singapore, Thailand, Vietnam EMEA: Czech Republic, Hungary, Poland, Turkey, Egypt, Saudi Arabia, UAE, Kenya, Nigeria, South Africa Latin America: Argentina, Chile, Colombia, Peru, Venezuela

Source: Global entertainment and media outlook 2014–2018, PwC. 4.

Estimated CAGR of global game market segment

CAGR in 2013-2018 of game market segments Casual Webgames

5.8%

MMO Games

11.2%

(MID) - Core Games

3.3%

Mobile Phone Games

15.2%

Tablet Games

28.2%

Handheld Games

-14.7%

TV/Console Games

0.8%

Source: Newzoo

17

Appendix 11 Porter’s five forces analysis for CD Projekt RED Studio Threats of New Entrants

5 4 3 Bargaining Power of Suppliers

2 1

Bargaining Power of Buyers

0

Threat of Substitute Products

Competition in the Industry

Final rating: 3.8 1.

Threat of New Entrants a. low legal barriers to do business b. high operating expenditures are needed, although low registered capital is necessary c. fast-growing video game market d. difficulties with gaining publishers’ and distributors’ trust e. growing digital market attractiveness for new independent developers

2.

Bargaining Power of Buyers a. great number of potential buyers worldwide b. huge product differentiation c. aware and mature gamers with defined expectations d. high diversification of video game buyers e. unlimited availability of substitutes

3.

Threat of Substitute Products a. easier, wider and cheaper access to traditional entertainment like movies, books, audiobooks, board games b. fast-growing digital entertainment market, especially apps and games for portable devices c. growing use of tablets and smartphones due to social changes and necessity to commute d. spending leisure time in an active way as a result of healthy lifestyle trends

4.

Competition in the Industry a. a few leading developers heavily competing on a global market b. high growth rate of game industry c. huge involvement of fixed costs in game development d. high level of product differentiation because of original character of each product

5.

Bargaining Power of Suppliers a. lack or marginal role of external suppliers cooperating in a process of developing a game b. necessity of hiring highly qualified professionals - suppliers of know-how c. medium-concentrated market of publishers d. advantage with forward integration – publishers becoming competitors for developers

18

Appendix 12 SWOT Analysis for GOG.com

S

• international cooperation with publishers and developers (more than 200 partners worldwide), • synergy effect of capital group - support by distribution of games developed by CD Projekt RED Studio and loaning money within the group, • high quality of customer service: consumer loyalty programs, in-home supportive service, bonuses and other conveniences such as ”30 days Money Back Guarantee” • acceptance of payment in different currencies (USD, EUR, GBP, AUD and Rubles), • auto-updating platform GOG Galaxy, which could enhance usage of GOG.com as a link between gamers from GOG.com and STEAM;

W

• lack of DRM system - no protection against unauthorized users and illegal copying, • focus on sales of old titles - smaller scale of operation and thereby lower revenues, • lack of A-triple video games in sales offer (apart from The Witcher 3: Wild Hunt), • limited range of marketing activities, • offer addressed to PC owners, who enjoy doing online shopping, not meeting the needs of gamers who prefer to have a traditional ‘box’-edition;

O

• changes of customers’ habits - traditional methods of distribution replaced by digital methods • suceeding proccess of game development by partners, • further development of new technologies, • wider access to the Internet, • decreasing viability of physical distribution of classical games (costs of transport, packaging);

T

• high concentration in the digital distribution market, • deepening problem of illegal online activities, • further development of the market leader (Steam) at the expense of smaller, independent distributors, • changes in customers’ attitude towards a digital sales channel, • risk that offered games may not meet customers’ expectations;

Source: The team’s estimation.

19

Appendix 13 The profile of a gamer, based on The 2014 Essential Facts About the Computer and Video Game Industry, ESA

The following data show characteristics such as age, gender, types of game spending and needs of world game-population. Selected facts inform about interesting trends in the game industry. It’s worth mentioning that that the group representing the majority of players is potential purchasers of game developed by CD Projekt Red Studio. The company’s products are targeted to mature and aware gamers appreciating high quality. 1.

Age of game players

2.

Gender of game players

29% 39% 48%

52%

32%

under 18 years 3.

18-35 years

36+ years

male

female

Total Consumer Spend on Games Industry 2013 18 16 14 12 10 8 6 4 2 0 Content

4.

Hardware

Accessories

Best-Selling Computer Games by Units Sold in 2013 Strategy Other Games/Complications Action Adventure Arcade Casual Children's Entertainment Family Entertainment Flight Racing Role-Playing Shooter

Facts: “Adult gamers have been playing for an average of 16 years, with adult men averaging 18 years and adult women averaging 13 years.” “The number of female gamers age 50 and older increased by 32% from 2012 to 2013.” " Smartphone and wireless device use increased by 22% and 37%, respectively, over 2012.”

20

Appendix 14 – The profile of an average Polish gamer 1.

Frequency of playing games* 3%

2.

Time spent playing games* (a week)

1%

to 10 hours Everyday

18%

8%

25 hours and more

11%

2-3 times a week once a week

36%

20-24 hours

15%

15-19 hours

occasionally

78%

10-14 hours

30%

3.

Devices used to play games*

Net salary working gamers (in PLN)

92% lack of information more than 3200

50%

2401-3200

36% 1601-2400

12%

801-1600 to 800

Computer

Mobile Phone or Tablet

Console

Handheld console

0%

10%

20%

30%

40%

Source: Jestem graczem, Ipsos 2014 Appendix 15 Expectation of CAGR for global games markets

PwC IDC Gartner DFC Newzoo

Average

7.2% 9.3% 10.5% 6.0% 8.1% 8.2%

Source: Global Games Market Newzoo Note: Compound annual growth rates cover different periods: PwC (2012-16), IDC (2011-16), Gartner (2011-2015), DFC(2012-17), Newzoo (2012-2016).

Appendix 16 The Witcher 3: Wild Hunt PC system requirements

Minimum System Requirements Intel CPU Core i5-2500K 3.3GHz AMD CPU Phenom II X4 940 Nvidia GPU GeForce GTX 660 AMD GPU Radeon HD 7870 RAM 6GB OS 64-bit Windows 7 or 64-bit Windows 8 (8.1) DirectX 11 HDD Space 40 GB

Recommended System Requirements Intel CPU Core i7 3770 3.4 GHz AMD CPU AMD FX-8350 4 GHz Nvidia GPU GeForce GTX 770 AMD GPU Radeon R9 290 RAM 8GB OS 64-bit Windows 7 or 64-bit Windows 8 (8.1) DirectX 11 HDD Space 40 GB

Source: The company data

21

Appendix 17 Cumulated preorders upon the Destiny release. Weeks to the game release 26 25 24 23 22 21 20 19 18 17 16 15 14 13 12 11 10 9 8 7 6 5 4 3 2 1 2 1

PS4

Xbox One

PS3

Xbox 360

326 576 331 252 338 146 344 189 349 799 353 898 363 493 376 158 387 325 395 248 402 202 410 132 417 058 446 458 502 794 542 618 586 279 644 139 700 200 754 233 782 701 820 567 852 977 874 856 902 879 935 999 902 879 935 999

284 131 288 004 293 022 298 295 302 951 306 902 321 254 330 548 337 242 344 278 350 016 356 998 364 454 374 829 397 012 419 299 443 884 495 289 536 169 592 676 642 101 673 053 695 467 710 041 726 522 750 052 726 522 750 052

60 792 61 497 62 407 63 988 64 920 65 963 68 484 70 772 72 740 74 059 76 039 78 093 79 987 81 476 83 967 85 766 88 463 96 301 106 341 121 089 130 404 133 984 137 067 137 867 140 436 144 854 140 436 144 854

132 823 134 009 135 622 137 642 139 374 141 285 145 272 148 727 152 308 155 137 157 406 159 610 162 610 165 537 169 644 173 886 178 958 196 857 213 905 245 025 266 834 282 905 289 117 293 753 303 575 326 573 303 575 326 573

Source: VGChartz. Sales of the Destiny prior to the game release helped in estimating Sales for the W3. Appendix 18 GOG Sales and EBITDA margin

Sales

EBITDA

CAGR

120 000

70%

100 000

60% 50%

80 000

40% 60 000 30% 40 000

20%

20 000

89%

39%

38%

38%

35%

33%

32%

32%

32%

32%

2014E

2015E

2016E

2017E

2018E

2019E

2020E

0

10% 0%

2011

2012

2013

Source: The team estimate, the CDP data. Values for CAGR series are on the right axis. Values on the left axis are in th PLN.

22

Appendix 19 Sales forecast for The Witcher 3 PC All values in USD the US

Timeline

Classical retail distribution

Europe and the rest

2015 10w 2015 6m

59.99 49.99

67.79 56.49

2016 2017 2018 2019

42.49 29.99 24.99 19.99

48.01 33.89 28.24 22.59

232 005 65 497 37 158 25 605

2015 10w 2015 6m 2016 2017

59.99 49.99 42.49 29.99

67.79 56.49 45.19 33.89

2018

24.99

2019

19.99

Average price Europe and the rest

the US

Sales

Unit sales Europe and rest

Unit sales in the US

Total Revenues

Sales

17 319 853 1 791 667

59.99 49.99

79.09 67.79

1 210 940 148 119

523 569 66 912

42 802 056 4 508 627

60 121 909 6 300 294

105 749 29 851 16 953 11 768

7 177 951 1 430 210 676 369 373 768

42.49 29.99 24.99 19.99

59.31 45.19 28.24 22.59

725 015 196 490 108 778 73 143

330 465 89 553 49 629 33 616

19 193 752 3 875 934 1 467 799 791 492

26 371 703 5 306 144 2 144 168 1 165 260

813 285 164 379 20 106 94 480 28 784

361 148 71 072 9 083 43 065 13 119

28 769 818 9 224 621 953 881 3 671 761 821 662

59.99 49.99 42.49 29.99

79.09 67.79 56.49 45.19

2 462 485 493 137 60 319 295 251 86 353

1 093 745 213 215 27 249 134 577 39 357

72 639 660 30 794 434 3 243 344 13 342 601 3 011 425

101 409 478 40 019 055 4 197 225 17 014 362 3 833 087

28.24

17 655

8 055

420 099

24.99

28.24

51 684

23 580

1 229 796

1 649 895

22.59

13 180

6 057

251 475

19.99

22.59

37 648

17 303

718 349

969 825

338 585

150 451

15 343 498

1 024 392

455 281

52 339 950

67 683 449

Sum

Digital distribution

Video game consoles

Average price Unit sales Unit Europe sales in and the the US rest 403 647 174 523 49 373 22 304

Sum

Source: The team estimate. Appendix 20 Sales forecast for CyberPunk 2077 PC

All values in USD

the US average price

Timeline

Classical retail distribution

Unit sales Europe and rest

Unit sales in the US

Sales

the US average price

Europe and the rest average price

Unit sales Europe and the rest

Unit sales inthe US

Sales

Total Revenues

2018

59.99

67.79

540 000

230 000

23 055 891

59.99

79.09

1 570 000

660 000

55 032 969

78 088 860

2019

49.99

56.49

170 000

71 000

6 009 740

49.99

67.79

480 000

200 000

14 267 409

20 277 149

710 000

301 000

29 065 631

2 050 000,00

860 000

69 300 378

98 366 010

2018

59.99

67.79

250 000

110 000

14 109 648

59.99

79.09

740 000

310 000

45 792 187

59 901 835

2019

49.99

56.49

87 000

37 000

4 046 870

49.99

67.79

250 000

100 000

12 989 718

17 036 588

337 000

147 000

18 156 518

990 000

410 000

58 781 905

76 938 424

Sum

Digital distribution

Video game consoles

Europe and the rest average price

Sum

Source: The team estimate. Appendix 21 Average fraction of SGP received by the CDP

Europe

North America

XBOX ONE / Playstation 4

PC

XBOX ONE / Playstation 4

PC

Classical retail distribution

42%

31%

55%

41%

Digital distribution

56%

56%

70%

70%

Source: The team estimate, the company data. Appendix 22 Platforms share in the next years

2013

2014

2015

2016

2017

2018

2019

2020

PC/Mac

10

9

9

8

8

8

8

8

TV consoles

31

29

27

25

24

24

24

24

PC/Mac share

24.4%

23.7%

25.0%

24.2%

25.0%

25.0%

25.0%

25.0%

TV consoles share

75.6%

76.3%

75.0%

75.8%

75.0%

75.0%

75.0%

75.0%

Source: Newzoo,the team estimate.

23

Appendix 23 Suggested and estimated retail price for the Witcher series games

$70

The Witcher

$60 $50

The Witcher 2

$40

The Witcher 3 rational

$30 $20 $10 $0 day m4 one

m8 m12 m16 m20 m24 m28 m32 m36 m40 m44 m48 m52 m56 m60 m64 m68 m72

Source: Steam, the team estimate.

Appendix 24 Sales in the first 10 weeks.

Game

Call of Duty: Modern Warfare 3 God of War: Ascension Tomb Rider

Platform

Appendix 25 Sales in the first year.

Sales in the first week

Sales in the first 10 weeks

Quotient

Game

Platform

Sales in the first 10 weeks

Sales till the first year

Quotient

PS3

5 091 237

10 213 861

201%

God of War: Ascension

PS3

1 169 381

1 765 174

66.25%

PS3

676 538

1 169 381

173%

Tomb Rider

PS3

1 433 701

2 130 650

67.29%

The Last of Us

PS3

3 131 268

4 374 477

71.58%

Middle Earth: Shadow of Mordor

PS4

1 579 436

1 969 566

80.19%

InFAMOUS: Second Son

PS4

1 522 589

2 172 439

70.09%

Watch Dogs

PS4

2 940 880

3 662 514

80.30%

PS3

653 396

1 433 701

219%

The Last of Us

PS3

1 319 206

3 131 268

237%

Middle Earth: Shadow of Mordor

PS4

565 699

1 579 436

279%

Watch Dogs

PS4

1 970 969

2 940 880

149%

Destiny

PS4

3 657 685

4 548 845

80.41%

Destiny

PS4

2 260 312

3 657 685

162%

Mass Effect 3

Xbox360

2 101 128

2 569 500

81.77%

Call of Duty: Modern Warfare 3

Xbox360

6 667 933

10 803 622

162%

Average

74.7%

Median

75.9%

Average Median

197.8% 186.7%

Source: VGChartz. Quotient is calculated as a division of Sales in the first 10 week by Sales in the first week.

Source: VGChartz; Quotient is calculated as a division of Sales in the first 10 week by Sales in the first week.

24

Appendix 26 Sales outside the US & the EU (in %)

Game

Platform

Call of Duty: Advanced Warfare Destiny FIFA 15 Titanfall InFAMOUS: Second son Middle Earth: Shadow of Mordor Watch Dogs The Last of Us Tomb Raider Diablo III Sims 4 StarCraft II: Heart of the Swarm Average

XboxOne XboxOne XboxOne XboxOne PS4 PS4 PS4 PS4 PC PC PC PC

Sales outside the US & the EU (in %)

8.1 7.9 11.2 7.1 23.2 24.9 26.4 24 30.1 12.8 14.2 12.5 17.6

Source: VGChartz.

25

Appendix 27 Average Rate of Unlicensed Software Use

Appendix 34 Piracy and unauthorized copying

70% 60% 50% 40% 30% 20% 10% 0%

Source: Business Software Alliance (BSA). Appendix 28 Global Self-Reported Piracy- "How often do you acquire pirated software or software that is not fully licensed?"

Always Mostly Occasionally Rarely Never Refuse

Source: Ninth annual BSA Global Software Piracy Study 2011. Appendix 29 Most Pirated Games on Web in 2010 (in millions)

Piracy and unauthorized copying is a persistent problem in an entertainment industry. The biggest risk of unauthorized copying is connected with game developed on PC. Downloading and installation of unlicensed console game from technical point of view is much harder and almost impossible in wider scale. So far, the effort to control piracy is unsuccessful. Companies in the industry take technical steps to make the piracy more difficult. Insufficient legal protection with the enforcement of intellectual property rights could be costly and time consuming, especially in countries where protection of this kind of rights is limited. Society of developing countries benefit from a less protective law because software are mostly developed by other countries. Governments do not have an motivation to enforce strive intellectual property rights. According to “Go-Gulf Online Piracy in Numbers 2010” more than 75% of PC have installed at least 1 illegal software and about 95% of music downloaded online is illegal. Finally, website with non-copyrighted content receive more than 146 Million visitors per day. According to „Ninth annual BSA Global Software Piracy Study 2011” the biggest drivers of software piracy are emerging economies. Developing countries are responsible for 56% of the world’s new PC shipments in 2011. In those countries, the rate of unauthorized software is the highest. We assume that main factors having impact on piracy are:  Public Education and Attitude to Intellectual Property – Physical and Intellectual Property are treated differently in relation to theft. According to “Go-Gulf Online Piracy in Numbers 2010” 70% online users find nothing wrong in online piracy.  Social welfare and Country Development – Average rate of unlicensed software is very different among countries. Correlation between economics development and piracy is observed. On the other hand, differences between countries on similar stage of development are significant. The rate of unlicensed PC software installations in Poland is 51%, in comparison to 37% in Slovakia and 34% in the Czech Republic.  Effective Law – Legal frameworks are a key point in IP protection. Companies need to enforce their rights in a quick and inexpensive proceedings.  IP Protection Policy – Countries governments need to support IP protection to make it effective. We believe that in many countries, especially in developing ones, governments do not have an incentive to provide effective IP protection because most of application are delivered by foreign companies.

Piracy and unauthorized copying of The Witcher 2

The unauthorized copying PC version of the Witcher and the Witcher 2 negatively affected the company revenue. According to the Company estimation about 4.5 million of unauthorized copy Prototype of the Witcher 2 was downloaded via BitTorrent. CDP take some legal actions against users who Starcraft 2 are suspected to illegally download game. the Company DRM-free policy could be questionable. Sims 3 CDP claim that don not want to punish legal customers and introduce advanced copy protection Mass Effect 2 systems. The main competitors use DRM tools to protect their games from unlicensed copying. Mafia 2 This policy create some doubts among gamers and could negatively affected CDP perception. In Battlefield: Bad Company 2 our view, for gamers quality of game and price are the most important factors which influence Call Of Duty: Modern Warfare 2 decision about purchase and introduction of DRM will not damages trust to CDP. Call Of Duty: Black Ops RPG games have a bigger share in PC game market than in console game market, 12% in comparison to 6%. We think that this proportion should be stable over time, in shooter or action 0 1 2 3 4 5 games, suitability of keyboard as playing device is limit, in other game type like strategy gamers prefer PC. In our view, company could improve their revenue by introduction additional IP Source: Go-Gulf Online Piracy in Numbers 2010. protection. According to official announcement CDP is currently working on The GOG Galaxy Appendix 30 Most Pirated Movies on Web in 2010 (in which we assume could limited problem of unlicensed copying. Street Fighter IV

Need for Speed: Shift

millions)

Our forecast of future global trend in piracy 

Salt The Hurt Locker



Sherlock Holmes Green Zone Clash of Titans

 

Iron Man 2 Shutter Island Inception Kick-Ass



Avatar

0

5

10

15

We think that in long run piracy in the game industry will have trend downward but in short run percentage of unlicensed copy could increase. Fast developing country from Asia will become important game market as well as software producer. They will need to improve IP protection in order to stimulate domestic software producer market. Global growth will lead to limitation of piracy. Games will become more interactive with wider usage of move controllers which force gamers to play on consoles which are not negatively affected by piracy problem In short run new PC shipments in developing countries could have negative impact on percentages of unauthorized copying of game.

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Source: Go-Gulf Online Piracy in Numbers 2010.

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Appendix 31 Game Developer Salary

Appendix 35 IT trends in Poland Game Developer Average Annual Salary (in dollars) USA

83 060

Europe

46 232

Canada

71 445

Source: Game Developer Salary Survey 2014.

According to the Report Central and Eastern European IT market – Trends and Forecast Pmrpublications.com, IT market in Central and Eastern Europe (CEE) will increase by 4.5 % annually in 2014-2018%. The CEE countries seem to be quite homogenous when it comes to the IT market trends and tendencies. We assume that it could have an impact on salary in whole IT industries. Increase in salary could negatively affect CDP but we believe that cost of labor in IT industries will be increasing also in other countries/However we presume that finally the term of trade will stay at the same level. Forecasts for Polish IT labour market

Survey of International IT Companies Located in Poland Appendix 32 Salaries in IT sector

Competitive Advantages of Polish IT Markets Average Annual Salary (in dollars)

1. 2. 3. 4. 5.

Lower cost of labor Highly qualified workforce Highly motivated staff (IT is a hobby for many workers) Similar culture Geographic location of Poland in the middle Europe

Programming

92 962

Art and Animation

75 780

Game design

73 386

Polish IT labour market

Production

85 687

Audio

83 182

Quality assurance

47 910

Business

102 160

In Poland, every year, about 14 000 students graduate from Information Technology Department with IT specialist diploma. In recent years number of students graduated from IT department is declining. During last year number of students who found a job during studies and therefore have not completed it, was growing.It was one of the reasons which have negative impact on number of graduate with diploma. In order to change this trend Polish Ministry of Science and Higher Education set a special program to increase number of IT students. Both public and private schools could get additional funds from ministry, for each IT student.. Obtaining scholarship for IT studentsis much easier. We assume that this policy should have positive impact on number of IT student in long term. According to GUS data, in 2012 number of students of IT department stopped declining.

Source: Game Developer Salary Survey 2014.

Appendix 33 Salaries in IT industry in Poland Median of Gross Salary in PLN

Competitive Advantages of the CDP Monthly

Annual

CEO of IT department Manger of IT department

14 500

174 000

8 950

107 400

IT Consultant

7 000

84 000

SAP Consultant

6 550

78 600

WebMaster

3 550

42 600

Game graphics

3 000

36 000

The cost of labour in game developing industries are much lower in Poland in comparison to costs inEurope and especially on the USA Market. In our view, game developers who want to work on world-renowned games in Poland, need to work in CDP.Other Polish studios create games in much lower quality and their titles are not as well-known as the Witcher. According to Polish Information and Foreign Investment Agency 44% of graduates declare that they do not consider working abroad. In our view, in next year’s lower labour costs will be constant competitive advantage of CDP in comparison to game developers located in the USA. According to the Survey of International IT Companies Located in Poland - workforce in Poland is well-qualified and highly motivated. Polish students get an excellent results in international competitions.

List of Polish students successes in international competition

Source: Pracodawcy IT Computerworld, 2013

University of Wroclaw Final of International Collegiate Programming Contest 2014 University of Warsaw 1st place in Google Code Jam 2012 2nd place in International Collegiate Programming Contest 2012 1st place in International Collegiate Programming Contest 2007 Poznan University of Technology 1st place (twice), once 2nd and 3rd place in the IEEE Computer Society Annual International Design Competition- during the years 2000-2005 1st place in Imagine Cup organized by Microsoft in the years 2005, 2006, 2009 2nd place in Imagine Cup in 2007 3rdplace in Imagine Cup world finals – 2008 and 2010 1st place in Imagine Cup Innovation Accelerator in 2008 2nd place in Imagine Cup in 2007 5th place in International Collegiate Programming Contest in 1999 1st place in International Collegiate Programming Contest in 1998

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Appendix 36 Company strategy versus market trends We highly grade the company’s management and strategy. In our view, CDP effectively anticipated to previous and current market trends. We assume that the key trend are: According to the Report Central and Eastern European IT market – Trends and Forecast Pmrpublications.com, IT market in Central and Eastern Europe (CEE) will increase by 4.5 % annually in 2014-2018%. The CEE countries seem to be quite homogenous when it comes to the IT market trends and tendencies. We assume that it could have an impact on salary in whole IT industries. Increase in salary could negatively affect CDP but we believe that cost of labor in IT industries will be increasing also in other countries/However we presume that finally the term of trade will stay at the same level. Forecasts for Polish IT labour market

Survey of International IT Companies Located in Poland Competitive Advantages of Polish IT Markets 1. 2. 3. 4. 5.

Lower cost of labor Highly qualified workforce Highly motivated staff (IT is a hobby for many workers) Similar culture Geographic location of Poland in the middle Europe

Polish IT labour market In Poland, every year, about 14 000 students graduate from Information Technology Department with IT specialist diploma. In recent years number of students graduated from IT department is declining. During last year number of students who found a job during studies and therefore have not completed it, was growing.It was one of the reasons which have negative impact on number of graduate with diploma. In order to change this trend Polish Ministry of Science and Higher Education set a special program to increase number of IT students. Both public and private schools could get additional funds from ministry, for each IT student.. Obtaining scholarship for IT studentsis much easier. We assume that this policy should have positive impact on number of IT student in long term. According to GUS data, in 2012 number of students of IT department stopped declining.

Competitive Advantages of the CDP The cost of labour in game developing industries are much lower in Poland in comparison to costs inEurope and especially on the USA Market. In our view, game developers who want to work on world-renowned games in Poland, need to work in CDP.Other Polish studios create games in much lower quality and their titles are not as well-known as the Witcher. According to Polish Information and Foreign Investment Agency 44% of graduates declare that they do not consider working abroad. In our view, in next year’s lower labour costs will be constant competitive advantage of CDP in comparison to game developers located in the USA. According to the Survey of International IT Companies Located in Poland - workforce in Poland is well-qualified and highly motivated. Polish students get an excellent results in international competitions.

List of Polish students successes in international competition University of Wroclaw Final of International Collegiate Programming Contest 2014 University of Warsaw 1st place in Google Code Jam 2012 2nd place in International Collegiate Programming Contest 2012 1st place in International Collegiate Programming Contest 2007 Poznan University of Technology 1st place (twice), once 2nd and 3rd place in the IEEE Computer Society Annual International Design Competition- during the years 2000-2005 1st place in Imagine Cup organized by Microsoft in the years 2005, 2006, 2009 2nd place in Imagine Cup in 2007 3rdplace in Imagine Cup world finals – 2008 and 2010 1st place in Imagine Cup Innovation Accelerator in 2008 2nd place in Imagine Cup in 2007 5th place in International Collegiate Programming Contest in 1999 1st place in International Collegiate Programming Contest in 1998

Concentration of Revenue Among Top Titles ‘Hit’ titles earn a significant portion of total revenue in each segment. According to The NPD Group, in 2013 the Top 10 bestselling titles accounted for 38% of total sales in the industry in the USA in comparison to 30% in 2012. Double-digit growth in digital distribution segment Recently, Digital Distribution is growing at two digits number. According to ‘Entertainment Software Association and the NPD Group/Retail Tracking Service’ in 2013, total digital distribution accounted for 53% of total distribution in comparison to 29% in 2010. The highest number of sales are reported by franchise The world-renowned game developer create franchise. It built loyalty to brand and minimized costs of advertising as well as had a significant impact on game sales. Gamers who were satisfied by previous game are more likely to buy a new one for higher prices. Quality of game is less crucial in case of franchise than when it comes to a new title.

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Rapid growth in mobile phone game market According to “Global Game Market 2013-2017 Report” by Newzoo mobile phone game market will be growing at CAGR 15.1% to 2017. In our view, CDP is very flexible and easily adapts to market trends. Moreover the company has forecasted correctly future trends and it tries to take advantage of upcoming market opportunities. Company strategy Worldwide digital distribution of videogames via the GOG.com platform which currently ranks as the second most popular independent distribution platform in the PC and Mac segments. The GOG was established in 2008. Triple-A Video Games Development and distribution of “triple-A videogames”, with an extensive development budget, top-of-the-line production values and excellent marketing potential. Cyberpunk 2077 Role-playing game targeted for the PC and consoles. Based on Mike Pondsmith’s Cyberpunk® cult classic game, with over 5 millions of fans, 70% of whom live in the USA. The Cyberpunk 2077 will be a new franchise of CDP but in order to obtain “saga effect” the company got the right to use old “Cyberpunk” trademark The Witcher Battle Arena Company is currently developing a game designed for mobile phones. In our view, CDP is testing the market. We assume that over following years company’s leading game segment will remain developing triple-A game.

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Disclosures: Ownership and material conflicts of interest: The author(s), or a member of their household, of this report does not hold a financial interest in the securities of this company. The author(s), or a member of their household, of this report does not know of the existence of any conflicts of interest that might bias the content or publication of this report.

Receipt of compensation: Compensation of the author(s) of this report is not based on investment banking revenue.

Position as a officer or director: The author(s), or a member of their household, does not serve as an officer, director or advisory board member of the subject company. Market making: The author(s) does not act as a market maker in the subject company’s securities. Disclaimer: The information set forth herein has been obtained or derived from sources generally available to the public and believed by the author(s) to be reliable, but the author(s) does not make any representation or warranty, express or implied, as to its accuracy or completeness. The information is not intended to be used as the basis of any investment decisions by any person or entity. This information does not constitute investment advice, nor is it an offer or a solicitation of an offer to buy or sell any security. This report should not be considered to be a recommendation by any individual affiliated with CFA Society Poland, CFA Institute or the CFA Institute Research Challenge with regard to this company’s stock

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