Sumo Group PLC (LON:SUMO) is the topic of conversation when Zeus Capital’s Technology Analyst Bob Liao caught up with DirectorsTalk for an exclusive interview.
Q1: I wanted to talk to you today about Sumo Group. In general, Intellectual property (IP) is highly regarded by investors when they value a video game company, how are they positioned?
A1: We’ve done some analysis of this & we benchmarked the company against a number of its video game peers & what that revealed is that the company’s business is more IP-driven than perceived by many investors.
What we did is we analysed the relationship between gross margin & IP revenue in the UK video game sector & what our analysis indicates is that video game company gross margins are directly related with the percentage of IP revenue. Now, that’s shouldn’t be a surprise, however our analysis also clearly shows that Sumo stands out as an outlier in our regression analysis, it’s got high gross margins yet low perceived IP revenues.
We believe that this indicates that the level of IP in the company is misunderstood by investors so the company’s high gross margins suggests in our regression that actual IP levels are probably closer to the higher 20’s to 30% rather than the perception of about 2-8% IP revenues that most of the market has.
Q2: What do you believe are the hidden sources of IP in the company?
A2: What we do believe is that the company’s development fees which most investors assumer to contain no IP is actually partly IP-driven. So, development revenues are delivered using technologies that can be reused & leveraged across many contracts & many customers, very similar to how IP works.
The company’s proprietary systems accelerate build times, they streamline integrations with external game engines & the libraries that they own of tools & technologies, they boost the efficiency of projects & processes.
All those things contribute to how those development fees, which make up the bulk of revenues, are really leveraged much like IP revenues are.
Q3: What does your analysis imply about Sumo Group’s valuation?
A3: As you said in the beginning, IP revenues are very highly valued by investors & this analysis concludes that the company is more IP-driven than is perceived by the market so we think the shares deserve a re-rating.
Currently, the shares trade at about 17% discount on an EV/EBITDA basis to most of the UK video game peers & we believe this is partially dragged down by investor perception that the company has low IP. I think our analysis indicates the exact opposite, that it has got some very substantial IP revenues which would then suggest that the shares should trade at a significant premium to its current multiple.