Epic Games – Bargain hunter.

Epic Games builds a war chest for bargain hunting.

• Epic Games is raising $750m at a mooted $17bn valuation from T Rowe Price and Baillie Gifford, as well as existing investors and I, suspect that the war chest will be used to pick up weakened competitors as the going gets tough in the coming recession.
• From an operational standpoint, I do not think that Epic Games has any need of money.
• Its Fortnite asset has been generating a lot of cash (see here) for some time and, in all likelihood, has done very well out of the lockdown.
• Hence, I suspect that cash flow for the last couple of months has been better than ever begging the questions: why raise money at all and why do it now?
• There are two possible reasons:
  • First, market timing: while the absolute level of the stock market has not quite returned to the high of February 2020 (except Nasdaq), falling earnings estimates have meant that valuations have skyrocketed.
  • For example, the 2020 PER for the S&P500 is close to 27.0x which was the all-time high set at the height of the dotcom bubble before the crash.
  • This combined with the high probability of a brutal recession is pointing a significant decline in the equity market during the next 12 to 18 months.
  • Consequently, if one suddenly decides that raising money is a good idea, now is the ideal time to get the deal done.
  • Second, war chest: from an economic perspective, there are very tough times ahead.
  • When times are hard, the weaker, less well-run businesses will get into trouble and will in all likelihood be available for acquisition.
  • This is what I suspect Epic Games is aiming at as when valuations collapse there will be real bargains to be had.
• Epic Games has a history of good strategic moves (even if they don’t always work out (Epic Games Store)) and I think that this will prove to be no exception.
• The company is now will be in a position to move quickly and pick-up bargains as they become available in order to boost both its presence in the gaming sector as well as widen the appeal of Fortnite.
• Fortnite is big enough to become a digital ecosystem in its own right (see here) and it has made some initial moves into media consumption with online concerts.
• The pandemic has accelerated the trend towards virtual events and distanced everything and Epic Games should be in a position to move quickly and capitalise on the trend.
• Depending on the financials (which are not public and I have not seen) this is one that I would look to back long term.