Earlier this week, Electronic Arts (EA) announced an agreement to purchase Codemasters for $1.2 billion. The deal trumps the $971 million pact Take-Two Interactive Software (TTWO) agreed to with the British video game developer in November. It might seem curious that two U.S. gaming giants would be involved in a bidding war over a studio best known for its F1 and Dirt racing games, but the company has solid IP—most of which is owned,” said MKM Partners media and entertainment analyst Eric Handler. “They’re profitable and there are meaningful growth opportunities ahead for the business within live services and mobile.”
There are also cost synergies that can be achieved with an acquisition that would increase the buyer’s underlying profitability (like bringing the distribution of games in-house), and both suitors have the cash to spend. In other words, it makes total sense.
Our Take: Video game companies are typically valued on a forward basis at about 4.5x revenue (bigger companies like EA and TTWO can command valuations in excess of 5x) and at a high-teens multiple on forward-year EBITDA. Without knowing EA’s and TTWO’s expectations for 2020-21, it’s difficult to say if they’re overvaluing Codemasters. But looking at current-year revenues, $1.2 billion would be “a high multiple [to pay] based on historical multiples,” Handler said (the company reported $109 million in H1 ’20 revenue), although he added, “As you layer in the synergies, that multiple should come down substantially.” For what it’s worth, EA’s offer was a +13.1% premium to Codemasters’ closing price on Dec. 11.
Looking at the deal strictly from a comparison standpoint, esports and gaming consultant Rod Breslau argued that Codemasters is overvalued at $1.2 billion. “EA bought Respawn for $400 million. Many people in the gaming community thought that was a ‘prime’ studio,” he said of the 2017 acquisition. “So how could Codemasters [viewed as a lesser developer] be worth more than a billion dollars just three years later?” Breslau did concede that Formula One’s rising popularity and COVID-19, which “accelerated sim racing and the race [gaming] genre in general,” has “definitely pushed Codemasters’ value [north].”
It’s not clear if Take-Two will counter EA’s latest offer. But Handler said the company “definitely has the ability to pay more” should it choose to do so.
Video gaming is among the industries that benefited from COVID-19 (industry revenues are expected to be up +20% YoY). So with a vaccine rollout underway, it’s reasonable to wonder if EA and TTWO are buying at the peak of the market. Handler didn’t see it that way. “With technological advancements and improvements in gameplay mechanics, there’s still a long road ahead for the business,” he said. “And when you look at both EA and Take-Two, you have two companies with very healthy balance sheets—little or no debt—tons of cash on hand and very strong free cash-flow generation, so now is as good a time as any to make a strategic, accretive acquisition.”
Some gaming industry analysts have suggested EA’s pursuit of Codemasters is defensive in nature. They argue several of the company’s titles have fallen out of favor with gamers (and thus there is a need to add a premium title) and point to the fact that its bid trailed Take Two’s. But both Handler and Breslau see EA’s $1.2 billion bid as an aggressive, offensive move. “It’s a way to increase scale and expand margins,” Handler said. It’s also “a way to totally dominate the racing market; sim and arcade racing and everything in between,” Breslau added. Should the deal close as expected in Q1 ’21, the only racing games that won’t be under EA control will be the ones from Forza Motorsport.
While Handler believes “Codemasters could be very successful within either company,” he suggested EA’s having Need for Speed would make integration a bit easier for that publisher to achieve. Breslau didn’t sound so sure. “EA has royally screwed up every single racing franchise they have,” he said, citing the Burnout series. “A lot of people are worried they’ll try and squeeze every dollar out of the [Codemasters] games over the next few years. The quality will drop and the games will eventually die. That process has played out several times for EA with racing games that they’ve bought from other studios.” It should be noted that fans of Codemasters games have similar fears about a TTWO takeover.
Consolidation is a trend within the video game industry (see: Microsoft’s $7.5 billion acquisition of ZeniMax Media in September). While the pursuit of scale and the pandemic-induced gaming boom have been contributing factors, Handler said the importance of owning valuable IP cannot be ignored. “The number of franchise titles has been shrinking over the last 15 years,” he explained. “But the titles that have been surviving, people are spending more time and money on. It is also easier to build off a successful title or brand than it is to launch new IP.”
(This story has been updated to remove a reference to Rod Breslau’s consulting relationship with Sony, which has concluded.)