Shutting Three Gates after the bulls have bolted

There is a new(ish) Nordic issue in town, see the documentation yourselves here. This is how I unpack what is presented:

History Three Gates is a company, founded in 2011 and  which listed originally in 2016. It now has 600 investors. The majority of shares is held by founders and some private equity firms and directors. For a Swede the coolest thing about them is they are based in Gotland in the middle of the Baltic Sea, imagine the Iron Islands but with fibre.

Production this is solid, repeatable games production company with a clear niche that allows them to follow a segment of gamers and know their market better than others, the fishing, hunting, sports segment of the market is not a sexy segment (if you ask me) but they have found their niche and some interesting cooperation partners and good luck to them.

Even if you don’t like the genre, we’ve all spent some time on a pixellated golf course in the 90s, or chased a fish in Minecraft. I also like the mix of own development and contract work, that gives them stability and cash flow to support the development work. Their list of cooperation partners looks good but I can’t verify this.

Intangibles I look at it as every IPO has to get over the hurdle of why would the owners of a company want to sell out now? How are their interests possibly aligned with the people they are selling their shares to, what is wrong with the business model that the cash injection will fix?

Here I got myself hung up on two issues – firstly the CEO, Don Geyer, in marketing this issue says the following “Med mobilspelen fokuserar vi nu på att utveckla monetariseringsmodellerna i spelen för att öka intäkterna”.  Roughly translated that means  “for the mobile games we are focussing now on developing the monetisation models in the games to increase income“.  I really hope that is not their focus now, monetisation is not a new part of mobile development landscape and this should be already state of the art, they have had several rounds of funding and this should be a USP, not an area of development. The second issue was the mention of an intention to start a share incentive program this Spring.  I can sort of understand this given their stressed finances, but dishing out shares to employees is one of my pet hates in any company, profit sharing is ok, but giving away equity is not my cup of tea.

Financials they are also working on “backwards” development of their mobile games to consoles. This is based on the acquisition of the exclusive rights to issue the Professional Bull Riders games in the future.  This is a huge bet for them, 11mSEK in costs last year, mainly acquisition of the PBR rights (8mSEK). As a result, they hope to sell 1m console units, leading to a big jump in income by 2020:

The upside is the following: lets say that they a) launch the product on time and on budget, and b) sell 1m units.  That translates to profit of about 6mUSD, after their costs that would be a profit of around 20 mSEK for a couple of years. So for a brief while they might have profits of 20mSEK and the current valuation of 28mSEK would look very attractive. But is that repeatable? It’s certainly grounds for a spike in the share price, but that’s not enough for me to invest.

The downside though is very clear. Like any developer the IP is not worth much outside their house. So there is no safety net in the balance sheet. They have staked everything on the PBR concept and potential other tie-ups from their US partners Miss Universe but if that doesn’t pan out then there are only very thin pickings from their contract work and other games. Even if the PBR gamble works out, its potentially only two years of profits for them then back to square one without a sustainable business model.

Lastly their business model includes some gambling elements (No Limit Golf), its not a big part of their income but is something I would like to avoid as much as possible for ESG reasons, not least reputational risk following the recent storms about “treasure boxes”.

Summary  Three Gates are too small and too much of a short-term bet for the managed portfolio that I am building, but if you want to have a punt, my strategy would be to wait until closer to the console launch of 8 to Glory later this year, by then some of the risk will have passed and there should still be some room for a boost in value following a sucessful launch.