Sumo Group (LON:SUMO) announced today the small but strategic acquisition of Red Kite Games for (net) £1.5m, satisfied by the issuance of approx.1.2 million new ordinary shares in Sumo Group, due one-year post completion. Based in Huddersfield, with 27 employees, the acquisition brings an engineering-based coding solutions capacity to the group. We increase FY19/20 revenues by 2 to 3% (from £48.7m and £55.5m), and EBITDA by 1 to 2% (from £13.7m and £15.8m). EPS increases by c1%. We continue to expect organic revenue growth in development fees (the main business unit) at least in the mid-teens, going forward.
Red Kite Games blue chip customer list includes Activision, Codemasters and Sony Computer Entertainment. Following completion, the founder, ex Rockstar Games developer Simon Iwaniszak and other senior members of Red Kite will remain with Sumo Group. Red Kite and Sumo have worked closely together in the recent past and around 40% of Red Kite’s sales are to Sumo, with the remainder arising from third party projects that are not publicly disclosed.
As commented on at the recent trading update, we continue to forecast EBITDA margins of around 28% going forward. This includes VGTR which is available until the end of 2023 (and in all likelihood thereafter). The commercial contract pricing negotiated by the Group is reflective of VGTR received, on a game by game basis. Additionally, margin should be underpinned by an increasing royalty and Own IP revenue streams in FY19.
Sumo’s margins are higher than broad based video games outsourcing peers. This is due to involvement of AAA games management from concept to launch, rather than work on only one element of a game (such as QA, sound, FX, Artwork etc), and significantly the benefit thus derived through utilising Sumo’s strong technology library.
We believe that the valuation remains compelling at these levels. EV/EBITDA and PE ratios are 12.2x and 18.8x respectively and represent around 10 to 20% discount to the UK (sub) sector. Additionally, the visibility of the order book and the expected continued staff high utilisation levels somewhat de-risk the forecasts and differentiate Sumo vs the peer group.