UbiSoft: Still Considerable Upside After The Rally

| About: UbiSoft Entertainment (UBSFY)

Summary

Stock's valuation (23x P/E) remains reasonable after the recent rally in light of EPS upside and expected earnings growth.

M&A is another major source of upside.

Should Vivendi launch a takeover offer, a 30-40% premium could make sense and convince investors to tender their shares.

French video game maker UbiSoft (OTCPK:UBSFY) delivered again a strong quarterly performance with Q1 revenue up 47% at constant FX to EUR139m, 11% above guidance, thanks to the continued strength of its two Q4 blockbusters, "The Division" and "Far Cry Primal."

As it generates most of its revenue and earnings in the second half of the year, UbiSoft cautiously left unchanged its guidance for FY17, which points to +22% revenue growth and +36% operating income growth. That said, we remain convinced that continued market strength, the return of several strong franchises (notably "Watch Dogs" and "Ghost Recon") and significant catalog sales ("The Division" and "Far Cry Primal") will give rise to positive revenue revisions over next quarters.

Digital sales could also be a major source of upside, specifically on margins, as they accounted for 75% of revenue in Q1 vs. 32% of revenue over FY16. Even if their contribution is likely to be lower during the holiday season, this strong start to the year for digital bodes well for UbiSoft's operating margin this year. In our view, the 14% margin guidance is underwhelming in light of the ~30% margins at Activision (NASDAQ:ATVI) and Electronic Arts (NASDAQ:EA) and we are confident the company will gradually move toward a 20% margin by 2019, thanks to a richer AAA game lineup and the rising contribution of digital.

Hence, we stick to our view that EPS could grow at a 30-40% pace over coming years, suggesting that the stock's current valuation (23x P/E) remains reasonable despite the recent rally.

While we feel comfortable about UbiSoft's valuation as a standalone company, we also view the battle between the Guillemot family (9.6% of shares, 16.5% of voting rights) and French media conglomerate Vivendi (OTCPK:VIVHY) for the control of UbiSoft as an additional source of upside (see our previous article).

In line with our scenario, Vivendi, which has finally taken over UbiSoft's sister company Gameloft, keeps increasing its stake in UbiSoft and now owns 22.6% of shares and 20% of voting rights. The Guillemots are widely expected to increase their stake as well, thanks to the proceeds from their Gameloft stake disposal.

The long battle for Gameloft (Vivendi had to pay EUR8 per share to get the deal done, while it bought its initial stake around EUR4) suggests that the Guillemots and institutional investors are unlikely once again to let Vivendi take control of UbiSoft without launching a formal takeover with a significant premium.

At 23x FY17 earnings and 16x FY18, UbiSoft is trading in line to slightly below its US peers Electronic Arts and Activision (22x and 19x) while it offers a higher EPS growth profile (30-40% vs. 10-20%). This earnings growth differential could justify a 20% premium and a control premium of another 10-20%.

In all, we believe that a 30-40% premium on the current price could make sense and convince investors to tender their shares to a (potential) takeover offer.

Should Vivendi's chairman Bolloré fail to take over UbiSoft, he will probably try to sell Vivendi's large stake in the company to an industry leader, the way he did with British advertising agency Aegis which was sold to Japan-based Dentsu a few years ago. Natural acquirers are large video game makers Activision and Electronic Arts, which already tried in the past to take control of the French company.

Disclosure: I am/we are long UBSFY, EA, ATVI.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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