Video Game Candidates #3: Sumo Group's Renewed Focus On Own-IP

27th Apr '20 by Jack Brumby

8 comments 4783 reads

Sumo (LON:SUMO) might be one small cap to keep an eye on.

This UK-based provider of video games development and design services operates out of ten studios in the UK, India, and Canada. It is more Keywords Studios or Frontier Developments (service provider) than Team17 (IP creator), but is that about to change?

Sumo helps make games for some of the most prestigious publishers in the world, however an increasing number of its projects are Own-IP. A recent change in strategy reveals a concerted drive to become more of an owner of IP. This could help it generate better financial returns in the long term.

Today, the group lists four strategic objectives:

Generate royalties by developing franchise titles and downloadable content for clients;
Win new clients through organic expansion and selective acquisitions;
Develop additional services and revenue streams, possibly through acquisition; and
Continue to develop Own-IP opportunities.

In FY19, Sumo generated revenue of more than £16m from Own-IP. That’s more than 33% of total revenue (compared to just 10% the year before).

Sumo’s business model is changing. This could be an opportunity.

It is smaller than some of its peers, with a market cap of less than £300m, and it has yet to string together a solid track record of profitability. This is reflected in its lower StockRank, and its Quality Rank in particular:

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In November 2019, Tencent - the world’s largest video game company by revenue - acquired a near 10% shareholding in Sumo Group. This industry titan has invested in several innovative and successful game developers and publishers globally. Now it is putting its weight behind Sumo. Given Sumo’s lack of proven quality so far, I think this is an important vote of confidence.

Management is “delighted by this investment and look[s] forward to exploring game development opportunities with Tencent” - so perhaps we can expect Tencent to be a strategically valuable shareholder.

What it does

Sumo's operating businesses are Sumo Digital and Atomhawk Design.

Sumo Digital (93.6% of group revenue) is the group’s primary business.

This is one of the UK's largest independent developers of AAA-rated video games. It provides both turnkey and co-development services and has studios in Sheffield, Newcastle, Nottingham, Leamington Spa, Warrington and Pune, India. Clients include household names like Sony and Microsoft.

Sumo Digital uses leading…

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djack

27th Apr '20

Informative article Jack that was largely positive in tone. Are there any negatives that stood out, or do you have any concerns in the back of your mind -e.g. costs associated with development?

Vsihv

Hi Jack,

Nice series and great effort - saving me some time, since I am doing my own review of sector.

I understand international stocks are out of scope, but given the size / brand depth, I think they seem to offer attractive valuations relative to UK (which is not often the case!).

I think this certainly could be an attractive sector, and indeed came to the conclusion that £Sumo offered the best relative opportunity, but I can't bring myself to invest at such valuations. Indeed £Sumo seems to have reacted positively today (did you move the market??)

Keywords Studios (LON:KWS) - I was reading through and it just moved very quickly into the too difficult pile, although if the Op Margin is genuinely a one off, perhaps it can return to its higher multiples.

Have you got any thoughts on £ESGB - rightly or wrongly I find when a sector is too expensive (or more accurately I consider it too expensive / beyond my investment discipline), I think ETF can provide diversified participation, pending attractive individual opportunities.

Jack Brumby

28th Apr '20

Hey djack,

Probably the key factors that give me pause right now are valuation (not that that's held back the share price), the lack of consistent bottom-line profitability so far, and the execution risk to do with becoming more Own-IP focused. It's all good saying that's what you want to do, but it is another thing to go out and do it. I do think Sumo (LON:SUMO) has as good a chance as anyone, though.

There are also the accounting measures you allude to, which require a degree of subjectivity... Re. development costs, these are expensed as incurred when developing games for others but capitalised as an intangible asset for Own-IP. It could well be something to keep an eye on, especially as the group is looking to ramp up the latter.

It has mentioned co-development contracts, under which external funding is provided by a publisher for the development costs of games created by Sumo.

arfournier

29th Apr '20

Frontier Developments (LON:FDEV) really skyrocketed when their transition from a work for hire shop to original IP producer showed signs of success. This might be an interesting inflection point in the company. Thanks for bringing it to our attention.

30th Apr '20

Hi Vsihv,

International stocks aren't necessarily out of scope. I'm quite excited by the idea of international coverage, it's a question of if this brings value to the community. I'll definitely keep it under consideration.

I empathise re. valuations! Your point on ETFs is a good one, I have seen it mentioned before and it does strike me as a smart way to gain exposure to that 9%pa growth market without taking on too much company-specific risk. I haven't got any thoughts on ESGB right now but will take a look.

turbo

8th Jul '20

I noticed there were some large buys of £SUMO this afternoon (I hold)

18th Sep '20

Significant tick up in volume today.

An online investor presentation being hosted by management on Thursday, 8 October 2020 at 1pm.

Anyone wishing to participate will need to register with PI World at:

http://bit.ly/SUMO_FY20_piworld_webinar

Johnsy

7th Jul '21

Deferred income tax up, huge jump in net goodwill, an appearance of notes payable/short term debt on the balance sheet. All warning signs. It now qualifies for the Unholy Trinity short selling screen.

Video game candidates #3: Sumo Group's renewed focus on Own-IP

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Jack Brumby

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