How to value a game company ?
The valuation of a tech company is a not-so-difficult topic that is often discussed in the medias, especially during a string of acquisitions such as the 2 last years in the game industry.
What are the main methods to valuate a tech/game company ? If you sell your company, how much can you reasonably expect ? Here’s an overview of valuation methods, taking Valve and your average indie studio as examples. Hopefully this will help smaller studios/publishers to understand the basic mechanisms to assess a company’ valuation.
Foreword : there’s a difference between the VALUATION of a company, and the PRICE a buyer will pay for it. Valuation depends on the intrinsic properties of the company (its people, its assets, its history etc.), whereas the price adds the buyer and the market to the equation : is the market bullish or bearish ? In the buyer super motivated by the potential acquisition ? etc.
A. VALUATION METHODS
1rst method : DCF / Discounted Cash Flows.
Aka business plan modeling. This is one of the most accurate valuation method, though it requires an in-depth knowledge of the sector and similar companies, plus very granular metrics (revenues, ebitda, working capital, tax.) on a 3 to 5 years time horizon. Objective is to project cash flows generated by the company, compute costs, then the net revenues, basically enabling a direct ROI computation to amortize acquisition cost. This method works better for more mature business. Ebitda is public information for listed companies, but arguably one of the most jealously guarded metric for private companies, making them very hard to evaluate.
2nd method : Comparables, using multipliers.
For the numerous acquisitions in the indie & mobile studios space, this is an interesting method though, as it’s pretty easy to compare studios based on sales, experience, staffcount or download/MAU. For comparables, you find a metric and to get the EV (entreprise value) you can apply a “multiplier” that depends on the metric.
- The most used metric is Ebitda (quasi net income), an excellent proxy for cash generation. Multiplier is between x10 to x20.
- Sales & gross profits are used for businesses at growth stage, especially those with a negative-ebitda but that are highly innovative, invest a lot to conquer market shares and delay the “path to profitability” to a later stage. For sales, multiplier is usually x1 to x4 and for Gross Profits (gross profit=sales-production costs), it is logically between sales & ebitda multipliers. If company is not publicly traded but has a monopoly or a known % of market share, you can estimate their gross revenues.
3rd method : Comparables, by historic of transactions in the same sector.
This works better in a space with lots of acquisitions, such as mobile studios since a couple of years. Beware though, EV of an acquired company can include a premium of around 30% of analytic valuation, to convince shareholders to sell. Coupled with 2nd method, screening historic of transactions also give a historic of multipliers, which in turn provides a good metric for « hotness » of a market (lots of demand drive multipliers up)
4rth method : Market capitalisation.
If the company is publicly traded, easy : valuation is roughly the amount of outstanding shares multiplied by the price of each share. Although share price does include some level of anticipation by the market, so this measure can be quite volatile, and at time decorrelated from the real value of the company (ex : CDPR shaving half its valuation a few weeks after Cyberpunk 2077 release)
- Valuation based on expected return : For early stages startups or when market fit is not proven, valuation can be more difficult. For example VCs can valuate a startup based on expected returns of their initial investment (they invest 10M and expect x3 in 3 years, so if things go according to play they will valuate the company at 30M 3y after).
- Valuation of assets : For startups with a handful of rare talents that could get a $1M salary at google, you can addup the costs of getting such talents together, even when the first line of code has not been written. Sleeping IPs (eg that don’t generate money right now) or patents can have also a good value.
- Book value : this is a purely an accounting method that doesn’t really pain an accurate picture of a company’s true value
Usually a combination of methods is employed to determine a valuation range by triangulation.
B. FACTORS IMPACTING PRICE
What are the factors that increase the price ?
- First of all, if a company is targeted for acquisition, there’s a~30% acquisition premium to nudge shareholders into selling. This premium will vary based on agressiveness of acquisition.
- Tangible or intangible assets. In the tech world, it can be a back catalog of IPs, patents etc.
- Unfair advantage : strong barrier of entry (aka « walled garden »), a monopoly, a strong brand premium pricing strategy and high operational margin (like Apple)
- A strong culture of innovation, a solid and reputable management team
- A big addressable market that is growing
- For indie studios : no game BUT a splendid number of wishlists is a good signal as it will convert under various thumb rules.
- Boiling M&A market or overall market growth, like today for game industry, increase multipliers (though it can be heterogenous depending on geographic zone, US multipliers are significantly higher than EUR)
- The way the buyer is financed and the way the deal is structured (with earn-out, partial payment in buyer’s shares etc.)
Conversely, those factors decrease the price
- Lots of paid revenues (=unsustainable business model)
- Negative signals : excessive debt, low margin, high volatility of revenues, etc.
- Dependancy on a few revenue streams or key people (even if they can be temporarily locked with earn-out clauses)
- A niche or shrinking market
- For indie studios : company with less than a handful of millions of net income (eg the overwhelming majority of indies) are considered small and will bring the multipliers down.
A. Valve : 2nd method
- Not publicly traded
- MIB level secretive
- Valve’s ebitda is unknown, but PC market gross income is around $35Bn, Valve has 75% of that market. Say it generates around 25% of those revenues as platform fee (fee is 30% but let’s haircut to 25% to account for F2P transactions that don’t use steam wallet), that’s about $6.5Bn revenues. Considering it only has a few hundreds of staff, operational margin is likely extremely high. Let’s say a fat 35% of operational margin. With a 35% operational margin that would lean $2.3Bn of net revenues. An acceptable proxy for valuation would x10 to x20 ebitda, which would give us a valuation between $23Bn to $46Bn. Steam walled garden and a load of unfair monopolistic advantages might easily bring the valuation in the 35–40Bn$ range, and a 30% acquisition premium would gives us to a potential acquisition cost of ~$45-50Bn for Valve.
B. Your indie studio : 1rst method
- Not publicly traded
- Sales can be estimated with BI tools (appannie, etc.), thumb rules (boxleiter method & abacus for console sales) or by directly getting the sales data.
- Let’s take a small indie studio “IndieLife” of 10 people, based in France, who manage to crank a reasonably successful indie game every 2/3 years. It’s a quality team of former AAA professional that build modest IPs and a catalog that grows over time. They are self-published and after 3 titles, on year 6, they are approached by a publisher who wants to buy them.
- 1rst method and a 5 years ROI from buyer’s perspective gives us a valuation of around 2.4M€. With a 30% acquisition premium it’s a 3M€ price, fairly consistent with a 2x multiplier on gross revenues (1.977M€) and a x10 multiplier on net income with a slight decrease due to volatility of revenues.
At the end of the day, there’s no “one size fits all” valuation method : the price is what the acquirer is willing to spend (#CaptainObvious) and it will vary significantly depending on the market conditions and the context. But if you’re selling your studio, hopefully this article gave you a few pointers to determine a rough estimate.
Last but not least, remember the rule 0 : if you thing your company is worth X => don’t be afraid to ask for more !
Noteworthy article (more technical) : https://online.hbs.edu/blog/post/how-to-value-a-company
Feel free to my video game finance ramblings on twitter.