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Morningstar | Ubisoft Reports Mixed 1H; AC Odyssey Off to Strong Start

Ubisoft posted a mixed first half of fiscal 2019 as sales of EUR 767 million came in ahead of consensus projections but operating income fell short of the Street expectations. Despite the beat on the top line, the company reiterated its fiscal 2019 guidance. Note that the firm generally generates over 60% of revenue and the majority of its free cash flow in the second half of its fiscal year. We are maintaining our narrow moat rating and our EUR 66 fair value estimate. While the stock price has pulled back over the last month, we continue to view the shares as overvalued.

Ubisoft’s strong second-quarter net bookings of EUR 365 million (up 38% year over year) benefited from the prerelease sell-through of Assassin's Creed Odyssey and the launch of The Crew 2 in the quarter along with strong back catalog performance (up 21% year over year). Digital continues to expand in importance for the firm as first-half revenue from digital distribution was up 52% year over year and player recurring investment revenue (includes microtransactions and DLC) grew 50% versus the first half of fiscal 2018. First-half non-IFRS operating income expanded strongly to EUR 110 million versus EUR 3 million in the first half of fiscal 2018 as the firm benefited from higher revenue and a 140 basis point improvement in gross margins from higher back catalog sales. Note that the non-IFRS gross margin expansion did not benefit from the higher-margin digital sales of AC Odyssey as only the presold physical copies were booked in the second quarter.

While the initial sales remain important for major AAA titles like AC Odyssey, one of the major keys to financial success for these games is maintaining player engagement and monetizing the engagement via microtransactions and DLC as we discussed in our June Ad-Hoc, "The Evolution of Video Games Continued." Though AC Odyssey had a strong launch, we are a little worried about its staying power as the fall schedule has been packed with strong releases including Activision's Call of Duty Black Ops 2 and Take-Two's Red Dead Redemption. Other recently released games such as the stalwart EA sports franchises and console exclusives like Forza Horizon 4 appear to be holding onto (Madden and FIFA) or even expanding (FH4) their audiences. Games scheduled to be released in November include EA's Battlefield V, Bethesda's Fallout 76, and the Pokemon franchise's first releases onto the Nintendo Switch. Given this competitive landscape, we think that AC Odyssey may fade into the background for many gamers, lowering both engagement and recurring revenue for the title.