Epic's $18B Valuation: Too High or Too Low?
This analysis is a part of Deconstructor of Fun’s Digest newsletter. You can sign up to the newsletter at the bottom of this text.
The recent announcement that Sony has invested $250M for a 1.4% stake in Epic Games suggests the valuation of Epic now stands at $17.86B. It was earlier reported that Epic would seek to raise $750M in total under a separate deal which would suggest a valuation of over $18B if that additional deal closes as well!
How much of Epic’s valuation is based on actual revenue/profitability vs. a grander hope for Epic to realize future gains from fuzzy notions of a future Metaverse or around gaining traction against troubled initiatives like Epic Store?
While we have limited data, I present a very speculative (and admittedly rough and simplified) view on Epic’s valuation and try to determine how much is based on hope vs. reality.
Comps!
Let’s start with public comparables. Although we have limited access to Epic’s financial data, we do have at least 2019 revenue and EBITDA data for Epic.
Let’s first compare current market valuation relative to 2019 revenue and EBITDA data (because that’s all we have) and notice that in comparison to public game companies, on an EBITDA multiple basis, Epic Games definitely seems fairly valued.
Source: Gossamer Consulting
Note:
To be clear, I believe FCF is a better basis of comparison
The analysis presented here is a very limited comparison: we are comparing current market cap/valuation against a single year of data and from 2019 and not current metrics
Thanks to Eric Kress from Gossamer Consulting for the comps analysis above!
Based on our limited comparables basis, I would argue that Epic Games is likely valued at a significant discount.
Why?
Unlike the other game companies, Epic has massive potential to drive big new businesses that the other companies just don’t have. Whether it’s the “Metaverse”, Epic Store (sure it could be doing better), or even HouseParty, etc.
Let’s try to look at Epic roughly valuing the sum of its major parts and examining potential option value.
Valuing the Parts
Taking another view of Epic’s valuation, we can try to come up with a rough estimation of its value through very rough estimation of the value of Epic’s primary existing business lines.
*Very Rough* Estimations
Fortnite HD Business Line
$1.8B reported revenue from SuperData
I subtract ~$400M of mobile revenue based on Sensor Tower data below. I assume SuperData is counting revenue gross rather than net
We’ll use a revenue multiple (yes, I know this is not a great comparable methodology but that’s all we have) for the HD side of the Fortnite revenue using EA and ATVI as comps (8.7x average Revenue multiple)
Fortnite Mobile Business Line
Mobile Net Revenue for Fortnite on Apple reported = $286M (source: Sensor Tower).
Let’s gross up the $286M to $400M and double the revenue as a rough approximation for Android. While Android revenue is not clear (likely low given Google Play fiasco), it shouldn’t impact long term valuation on an on-going basis. Epic announced they will launch on Google Play. Further, there is some unreported revenue due to alternative payments off mobile stores in certain countries e.g., SE Asia, Latam, etc.
We multiply this mobile revenue by the average of Glu and Zynga revenue multiple = 5.1x
Unreal Engine Business Line
Very simply roughly estimate that Unreal is as valuable as Unity
Unity raised $150M Series E at a $6B valuation in May 2019
Epic Store Business Line
Consider Epic Store to be simply and very roughly valued at roughly 25% of Valve
Valve was valued at $10B in March 2019 by Michael Pachter/Wedbush Securities
Biggest Risk
Looking at the valuation of Epic from its parts, we quickly realize that the majority of of the value in Epic comes from Fortnite. Hence, a material decline in Fortnite could potentially wipe out much of the value in the company.
However, offsetting this risk will be Epic’s big bets on games publishing and its ability to quickly “fast follow” new hit games. Further, Epic has potential to leverage its massive audience base to market newer games it develops.
Conclusion
In summary, I believe a rough look at Epic with limited data and lots of swag can absolutely justify its current valuation and is potentially a discount relative to other game company comparables.
In conclusion, this very rough analysis would estimate Epic’s valuation at:
Epic Valuation: ~$25B + Option Value
Option Value meaning valuation from the potential future value of currently in development business line initiatives. For example: Houseparty (I know it looks bleak, but it’s possible), its new games publishing initiative, or taking some of the existing Fortnite technology to create some new kind of game experience or Metaverse (maybe not the media version, but a more practical version).
While Houseparty has been in decline and only made $170K revenue in 2019 (according to Sensor Tower), the potential of the application to become a billion dollar business more similar to Zoom or Slack, while very small, is non-zero.
Games publishing is a unique area where the size of Epic’s massive war chest should give it a strong competitive advantage and where its existing developer relationships via Unreal Engine should pay dividends.
We believe that a more practical version of the Metaverse will exist in some form and can be highly monetizable… eventually. This may take 5–10 years or more. The current Metaverse extrapolation of Fortnite, we believe, are less likely as opposed to an extrapolation of other game experiences like with Grand Theft Auto or its mods. In this area, we believe Epic will have the technology through its experiments with Fortnite but another company will likely develop the initial market proof point.
Given the aggressiveness of Epic’s management team and the ability for the company to execute against new opportunities, I would roughly value “Option Value” of their basket of opportunities at $2–3B. Remember also that existing company assets like Unreal Engine and Fortnite, may continue to unlock tangential business lines in the future.
Given this analysis, I believe Epic’s valuation is not only fairly valued but likely a discount compared to other game companies in the market. Buy!
