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Sumo Group Plc

Sumo Digital Positioned strongly for FY19

Sumo Digital (LON:SUMO) is a market leading, independent global video games co-developer which has deep, long-term relationships with the world’s largest publishers providing full turnkey solutions. Today’s trading statement revealed that FY18 results are “at least in line with management expectations” which mean no change to our estimates (which in turn are in line with consensus). Additionally, we make no changes to our FY19 forecasts, which are marginally above consensus. Staff utilisation rates in H2 ’18, we estimate, remained around mid-nineties percent for direct UK FTE’s and we foresee no material change to this going forward. This is backed by stable, long-term contracts with current visibility for FY19 which we believe are at least in line with historical levels, and therefore represent 75% or more of Zeus FY19 forecast third party development fees. The shares currently trade on an EV/EBITDA of 12.0x and P/E of 19.0x to December 2019, a 8% and 21% discount to the UK peers respectively. This is in our view an attractive valuation given the positive games market outlook and Sumo’s differentiated market positioning.

FY19 will focus on development milestones of new games already signed from blue chip clients for delivery in 2020 and beyond. This strong order book visibility somewhat de-risks our forecasts. Three of Sumo’s games have been announced and have / will have been released by May 2019 (Hitman in November 2018, Crackdown in February ‘19 and Team Sonic Racing in May ‘19). There are new, undisclosed games under development in FY19, which should ensure near full deployment levels in the current year.

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 scale of VGTR in Sumo’s numbers is a consequence of Sumo being one of the largest independent developer of games in Europe. And 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. Our adj EBIT and eps estimates for FY19 are around 1% above consensus. Notably, 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 forecast Cash Out Flow from Operations to be c5m in FY18; materially unchanged from our estimates at the H1 18 stage. However, this should be strongly positive in FY19. This effect is partly due to up-front funding of a co-developed game in 2018, which is now selling well. The net cash balance at December ’18 was £3.7m. However, we forecast a balance approaching £20m at December 19, assuming no acquisitions. We estimate a high cash inflow from operations FY19, at over 130% conversion from EBITDA, again is unchanged from our prior assumption.