CD PROJEKT RED - The AMEX of the Big Gaming Industry? (Update)
1Q23 Earnings Call Summary (May 29)
I’ve previously described CD Projekt Red (CDPR) as “The AMEX of the Big Gaming Industry” — if you’d like to learn more about why I ascribe this moniker to the globally recognized gaming studio of The Witcher and Cyberpunk 2077, head over to my CDPR Part 1 report:
I've also decided to “spin-off” the Big Gaming Industry Primer section into its own article — and improved on the admittedly atrocious font formatting in my earlier CDPR stock reports. If you're a paid subscriber, they should be more readable now — please have another look!
In this article, I’ll only be covering the quarterly updates presented in CDPR’s latest 1Q23 earnings call, which was held earlier this week (May 29). I’ll also be adding some new significant points which only came to my attention after I had already published my earlier CDPR stock reports.
Seeking Alpha: CDPR 1Q23 earnings call transcript
Accompanying slides: CD Projekt Group 1Q23 Earnings
Since I published my first C.D. Projekt Red (CDPR) stock report on 15th May, CDPR’s share price has climbed by 12; and over the past month by ~15%. The initial wave of excitement was due to some rumors about CDPR potentially entertaining a lucrative buyout offer from Sony — this was later quashed by both CDPR and Sony. While I certainly do not take credit for such serendipity, it still was a good start to the middle of my month.
However, this news also provides further credibility to the possibility of CDPR being acquired by a Gaming/Media/Tech megacap hybrid in the LT future — something which I’ve explored in detail in my Big Gaming industry primer. Coupled with MSFT’s recent acquisition of ATVI at a whopping 37x PE — which I’ve previously described as Microsoft’s Marvel Moment — this has only made me more excited for CDPR’s future potential, its presently higher share price notwithstanding.
Without further ado, let’s jump straight into their 1Q23 earnings call.
Witcher 3 crosses 50 million units sold
The first major development which occurred during 1Q23 was the 3rd installment of CDPR’s Witcher series (The Witcher 3: Wild Hunt) crossing the 50mm units sold milestone. As a benchmark reference, the majority of AAA titles can be conservatively expected to achieve lifetime sales of 40mm copies — this happens to align with JPM’s forecast for lifetime unit sales of CDPR’s future individual titles. Thus, for Witcher 3 to already have achieved 50mm units sold today is no small feat, especially since its shelf life is expected to run for at least a decade more — the Witcher franchise as a whole is expected to see a ST boost in sales from the premier of the Witcher Season 3 Netflix show later this month; while its LT shelf life will likely be further extended by the already-announced future Witcher 4-6 AAA titles (Project Polaris) which will be released by CDPR over the coming decade.
Phantom Liberty expansion pack for Cyberpunk 2077
However, the more exciting development actually belongs to CDPR’s Cyberpunk 2077 franchise — with the upcoming marketing campaign in June of the supposedly massive expansion pack Phantom Liberty. Unlike most expansion packs of AAA games (which are mostly money grabs), all current signs point to Phantom Liberty being nearly as large as the original Cyberpunk 2077 title — the video below even goes so far as calling it a ‘remake’ instead of an ‘expansion pack’. This would align with prior expansion packs made by CDPR for its Witcher franchise in terms of both scale & scope — and would also somewhat explain why Phantom Liberty is expected to be CDPR’s last entry under its newly cultivated Cyberpunk franchise until Project Orion (Cyberpunk 2) is released around 2032. It certainly cannot come early enough for fans.
Slide 4 of the presentation deck linked above demonstrates the outsized commitment that CDPR has been making towards Phantom Liberty. Notice the light blue bars which takes up the most space in the middle of the bar charts above? That’s the amount of development resources which has been contributed towards Phantom Liberty over the past several half-years. Even if we just eyeball it, it looks like CDPR has committed >50% of its total development assets over the past 2 years towards the production of Phantom Liberty alone (>320 developers). Remember how I was saying earlier that most expansion packs of AAA titles are just money grabs? This expansion pack is really looking to be more like an entirely new game.
Couple that with how tight-lipped CDPR’s management has been about revealing details about Phantom Liberty over the past year, and I get the feeling that this isn’t just some ordinary expansion pack. If you’ve been reading their earnings calls transcripts over the past several quarters, you’ll know that management has been especially evasive during the Q&A sessions whenever Phantom Liberty was brought up — the last earnings call was a good example of this. It’s always the same — deflect the question, respond with a short 2-3 sentences, and guide that more will be revealed in June. I really have to wonder what kind of ‘expansion pack’ would warrant such careful treatment & attention by a AAA gaming studio, much less the amount of development resources contributed — as I’ve mentioned, most studios treat them as blatant money grabs. In any case, we’re already in June so there’s only a couple weeks left before the reveal.
Project Polaris & Sirius
Now turn your attention back to the bar chart above — and look at the light green bars instead. That represents the development of Project Polaris, i.e. Witcher 4. If you’ve read my earlier CDPR reports, you’ll know that the company has committed to focusing exclusively on developing games for The Witcher franchise until 2030 — even at the expense of their Cyberpunk 2077 franchise. The justifications for such a move can be found in my Part 1 report — but regardless, this project also represents another especially chunky and growing development resource commitment.
Project Sirius relates to a casual mobile game set within The Witcher franchise which targets a slightly different demographic than CDPR’s typical AAA crowd — it was initially cancelled but was later revived. Management hasn’t given hints about what the final form of Project Sirius would look like, but the reversal of impairments apparently contributed a cumulative EBIT of PLN 90mil over the past two quarters, since the project was revived.
Finally, look at the dark green bar — that represents a casual multiplayer Witcher card game called GWENT. Management has guided that as time goes on, development resources will be gradually shifted away from both Project Sirius and GWENT in favor of Project Polaris (Witcher 4-6), as well as Other Projects. The latter refers to the already announced Project Orion (Cyberpunk 2) and the upcoming new AAA franchise, Project Hadar — we can keep track of the progress of these two over the coming years by monitoring the rate of change in the capitalization of R&D expense, since it’s likely that only these new projects will incur R&D expense which is subsequently capitalizable. Or you can also just rely on the progress bars from the slide below — notice how that bright green bar representing ‘research phase costs — new projects’ has grown quite a bit since last quarter:
After Phantom Liberty is launched (expected 3Q23), some of the resources currently tied to that project will likely shift to the yellow bar, as a small team continues to provide updates for it. However, management did guide that the majority of it will shift to Project Polaris and starting R&D into Project Orion & Project Hadar.
On a side note, the reason why monitoring the allocation of development resources is relevant is because development expenses form by far the largest operating expense for gaming studio businesses. By monitoring the scale & mix of development resources allocated toward different projects, we can get a sense of the significance & progress of the respective projects over time — just like how one would monitor the contribution mix of a profitless tech company to gain insight into underlying business performance.
1Q23 Financial Performance
The bulk of the remainder of the earnings call (including the Q&A section) was just focused on its quarterly results. Honestly, there’s not much insight to extract from these, as they were largely just questions about the accounting treatment of some of the new developments discussed above — which have an immaterial impact on CDPR’s multiyear LT endgame. I’ll just leave a bullet point list below of some of the relevant highlights:
Partial reversal of Project Sirius impairment made last year;
Tax expense fell by half YoY, mainly due to lower withholding taxes paid abroad. When asked, management explained that it was difficult to forecast future withholding taxes, as they were largely in the hands of their overseas distribution partners (e.g. Sony, Xbox, etc).
Large collection of trade receivables from the preceding 4Q22 period; and likewise a similar quantum of decrease in trade payables.
1Q23 expenditures & development costs were quite similar to 1Q22; but can be expected to rise over the LT with wage inflation and the adoption of the new remuneration policy.
On a side note, a group of former senior developers from CD Projekt Red just announced last week that they had left to start a new gaming studio called Blank;
Positive OCF of ~PLN 90M were sufficient to internally fund all development expenses for the quarter, amounting to some ~PLN 70M. The company ended the quarter with a slightly higher cash balance of PLN 1,112M:
All this shouldn’t be surprising if you’ve read my earlier CD PROJEKT RED reports and already have a good grasp over their business model. If you haven’t yet, do check them out below — there’s so much more about this ‘wonderful business at a fair price’ which I haven’t had the chance to mention here!
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