Remedy Q2'24: Negotiations on the fate of Control games are coming to an end

Translation: Original comment published in Finnish on 08/12/2024 at 8:02 am EEST

Remedy’s Q2 figures were better than expected and the game projects seem to be progressing well. However, AW 2's sales developed somewhat slower than we expected, and we pushed our royalty assumptions forward by a quarter. Although negotiations on the publishing model for Condor and Control 2 are still ongoing, it is clear that Remedy will take much higher risk on these than before. Reflecting this, we made some preliminary changes to the underlying assumptions of our estimates, and we now assume that Condor will be co-published with a partner and Control 2 will be self-published, which will require additional funding. Remedy’s long-term potential seems interesting with the current valuation, and in the short term, we believe decisions concerning the fate of Control games will act as a driver for the stock. We reiterate our Accumulate recommendation and EUR 20.0 target price.

Better than expected Q2 figures, AW2's sales disappointing compared to our expectations

Remedy’s Q2 revenue grew by 16% to 10.3 MEUR, which clearly exceeded our 7.5 MEUR forecast. This is explained by development fees (Q2'24: 9.4 MEUR, +39%), which were well above our expectations from the Max Payne project that moved to production in Q2 With the higher revenue, Q2 EBIT (-3.2 MEUR) was also significantly better than our forecast (-6.8 MEUR). AW2's sales were not opened, and it did not produce royalties in Q2. Remedy commented that the game had covered “most” of its development and marketing costs. The previous wording was a ‘significant part’ referring to 50-80% of the costs. So this is now over 80%. We previously expected the game to start generating significant royalties from Q3, which would have required information on costs being recouped now in connection with the Q2 report. Thus, we postponed our royalty expectations to Q4, when, e.g.,  Christmas sales, the second DLC to the game and the release of a physical game version support sales. Condor is proceeding in production toward the release we expect next year, and Control 2 also progressed as expected into pre-production during the quarter.

Changes to underlying assumptions: We expect self-publication of Control 2 and co-publication of Condor 

In February, Remedy acquired all rights to the Control game brand from 505 Games at a very good price. For Condor and Control 2, the level of development fees over the next few years will be significantly affected by the publishing agreements under negotiation or the decision to self-publish these projects. We have now made the assumption in our estimates that Remedy will self-finance Control 2 and co-publish Condor with a partner. As a whole, our earnings estimates for the coming years decreased significantly due to lower development fees. Correspondingly, long-term royalty estimates increased significantly and with self-publication, the potential in future projects also grows further. Our current estimates expect highly successful games, but there is also potential for much better. With our updated assumptions, Remedy would need approximately 20 MEUR of additional funding to ensure that the balance sheet can withstand the investments needed for the self-publication of Control 2 in the next few years with a small leeway.

Long-term potential is attractive at current valuation

Due to the timing of game releases, Remedy's earnings development, and valuation multiples, continue to fluctuate annually for a long time in our estimates, and the more consistent strong earnings performance enabled by the multi-project model will not materialize until the 2030s. With our estimates, the result is still in the red for a few years and the EV/S ratios (2024e 4.3x) are quite high. The value of our DCF model, which assumes strong long-term earnings growth, is now EUR 21.7. Naturally, the model is very sensitive to key assumptions, and in Remedy’s case, a single game can generate a big surprise in both directions. Overall, Remedy’s steps toward taking greater responsibility for its game projects increase the long-term potential, and the current valuation of the stock appears interesting.