Tinybuild (TBLD) dropped 96% in price since its IPO. Is this the beginning of a turnaround?

Nov 24, 2023

I was a gamer growing up. Now, all these years later, I still play games with my 8-year-old son. Combining my love for gaming and investing led me to Tinybuild.

Who is Tinybuild?

Tinybuild was founded in 2011 by Alex Nichiporchik and Tom Brien. It started as a game development studio and became a game publishing company in 2013. It has since grown organically and by acquiring other development studios. Tinybuild publishes games and other merchandise based on in-house IP and 3rd party IP.

In 2021 it went public for a 473 million dollar valuation. On the 19th of November 2023, it traded at an 18 million dollar market cap on the AIM London stock exchange, a 96% drop since its IPO.

How does Tinybuild make money?

Tinybuild has 3 different sources of revenue.

Game and merchandise royalties:
1. Tinybuild has its own and third-party IP. It uses a distributor to sell its games and merchandise. Although they have sold books, over 95% of revenue is from digital sales. They receive a royalty from the distributor (like Steam, Apple, Meta, etc.). The revenue is booked when the sale happens on the platform. There is a lag (about 4-6 weeks) before the cash is deposited in Tinybuild’s bank account
2. Sometimes Tinybuild will enter into a contract with a fixed amount of royalty revenue typically when providing a game for a platform that can be downloaded for a fixed amount of time. Here the fixed fee revenue is booked on the date that the game is made available.
Development services: These are advances received from distribution partners for developing specific games where an amount is fixed. Think of VR games for Meta or a game for Microsoft’s Game Pass. The bright side is that it is an upfront advance, so lower risk, the downside is that the upside is capped as agreed upon in the contract. The distributors see a certain need in their market and ask if a company such as Tinybuild can fulfill that need.
Event revenue: This is a small part of the total revenue coming from DevGamm, their event business

Evolution of revenue by category:

Sales growth over the past 3 years is attributed to development services. Growth from royalties has stabilized. Revenue for 2023 from royalties will probably be in line with 2022.

Future strategy

Here are some key elements presented by management on their future strategy:

They want to focus on building franchises based on in-house intellectual property
They have shifted their strategy to build games with a focus on systems instead of massive content: The so-called 1000-hour game
In the past, they acquired studios through an acquihiring process. A deal with a studio involves a cash and shares payment to bind the studio to the overall company and create long-term incentives for everyone
They want to publish games with bigger budgets, moving from Indie to AA games

This is the 5-year plan that was presented during the last earnings call. (GAAS is gaming as a service like Game Pass.)

5-year strategy outlook from H1 2023 results presentation

Income statement: Past performance

There is a reason that the stock has suffered so much over the last few years. Let us take a look at revenue generation by source:

We see that the growth rate for royalty sales has been steadily decreasing, up until a complete standstill in 2022. This is the core business of the company, their bread and butter.

Since 2019, they started to offer development services to distributors. This portion of revenue has increased rapidly over the last 3 years but is also decreasing by 53% YOY if we compare H1 2023 to 2022. Management mentions that these services follow a technological cycle. Examples are cloud gaming with Google Stadia and the metaverse for VR games. Demand is decreasing in this cycle which explains why it is slowing down.

Finally, we have the event business, and although it has increased again having been impacted in the past, first by Covid and then by the war in Ukraine, it does not have a meaningful direct impact on the top line.

For the first year since the IPO, total revenue will decrease. Comparing the first halves of 2022 and 2023, we see a decrease of 20%.

The price of the stock, which is currently a falling knife, is driven by the slowdown in growth in the core business. The services should be seen as a nice addendum to the core business, and revenue might increase again in the future, based on the decisions of the platforms and the start of a new technological cycle.

This is and should be their prime focus: To make the top line grow again while at the same time managing their cash position. We will then discuss the investment cycle when looking at cash flow.

Here’s an overview of the year 2023 and the games released. The Top 3 releases on Steam are highlighted in the picture:

I included the release for Hello Neighbor 2 because although it was released at the end of 2022, some of the cash will trickle in Q1 of 2023. (Kill It with Fire VR had very good reviews on Meta too.)

The goal of building franchises is to create more longevity and increase the revenues of the long tail, but good revenue numbers at the start are a good indication of the popularity of the game.

So far, 2023 hasn’t been a good year for Tinybuild.

Capital allocation strategy

Before Tinybuild was public, it raised cash on two occasions:

2018: 3.75 million dollars in seed funding from Makers Fund
2019: 15 million dollars in series A funding from an undisclosed investor

The IPO served as a way to raise 28 million in additional capital and start the next growth cycle.

It takes time to develop and market games. Tinybuild is focusing more and more on higher quality games (AA, not AAA) with bigger budgets which take longer to develop. We’re talking games with a budget from 1 to 5M USD and developing cycles of 2-5 years.

The funds raised during the IPO have been invested, but the benefits of these investments will only show later on:

Screenshot from TBLD H1 2023 presentation

For the last 3 periods, the company has been investing heavily but during the half-year earnings call decided to pause the acquisitions for the moment. Investments in 2022 and 2023 will only start to show an impact on revenue at the earliest in 2024 and 2025.

Up until now, they have:

Invested in organic growth through software development
Invested in growth through acquisitions

The company has no debt. It does not pay any dividends.

On the last H1 2023 call, an analyst asked if they would consider buybacks because of the depressed price of the stock. Management has stated, not at this time, but it could be put on the table later this year or in 2024.

I hope the company will not go through with these buybacks. Buybacks are something you do when you’re growing, generating excess cash, and have no better opportunities like reinvestments in organic growth. As long as revenue and profits are declining, a buyback will add nothing of value to the shareholder. I may even consider a buyback decision as a red flag.

They have a revolving credit line of 35 million dollars with the Bank of America, but the idea behind it was offensive and not defensive, meaning it was meant for opportunistic M&A, not as a defensive safety net for when things would go sour.

Their future growth will now depend on the return on investment they will generate on the investments they have made in the past 3 years. Performance since IPO has been declining.

Up until now, because of the proceeds of the IPO and the internal cash generation, they were able to perform these investments. Here’s the evolution of their cash flows:

Data from cash flow statements in annual reports

Free cash flow is negative because of the investments. Their cash balance has decreased and will probably land at about 10M USD at the end of the year. The operational cash flow has also decreased back to the level of 2020.

This means that they will come to the end of their investment cycle. There are only 2 options going forward:

See an increase in operational cash flow to have more leeway for future investments
Use the credit facility

I believe management will pause the investment cycle, maintain a healthy cash balance throughout 2024, and focus on increasing operational cash flow.

Management and incentives

In 2023, 2 C-level members of the company resigned for personal reasons:

Compilation from previous shareholder presentations

Insider ownership

Here’s an overview of insider ownership over the last few years:

The CEO, Alex Nichiporchik owns 37.8% of the outstanding shares.

On the last earnings call, an analyst asked if the CEO would buy shares. He cannot (based on a vote during the latest General Meeting) because he already owns more than 30% of the company. If he could he would.

There is no other insider buying or selling going on at this time.

The management team is rewarded mostly in cash through their annual salary and bonus. Here’s the latest table from the 2022 annual report:

The share count is rising every year:

This increase in share count is dilution generated by stock options and restrictive stock awards. Shares are used alongside cash during acquisitions.

Corporate structure

The company is decentralized, with different development teams spread out over the world. Two supporting layers are available to support the different local development teams.

MOAT analysis

Let’s go through our MOAT analysis checklist as outlined here.

Production advantages

Here are the different production advantages when looking at the process and if Tinybuild has one:

Complexity: Although game development is hard and complex, Tinybuild does not have an advantage compared to other game publishers/developers
Protection: This is probably the main advantage that any gaming company has, that is its intellectual property. I a game is developed with a strong IP (think The Last of Us) this can lead to other business streams or can be used to increase to the longevity of the game sales, the long tail of game publishing).
Resource uniqueness: Tinybuild has no specific resource it uses that others do not
Process cost: Tinybuild has a slight advantage in that several teams are located in areas where employee benefit cost is lower. Imagine you have a game development company in the US, and your cost base will be significantly higher than for example in Eastern Europe

When we look at scale advantages, we can do the following analysis:

Distribution: Most of their sales go through a digital distributor. They have no advantage compared to other publishers
Purchasing: No specific suppliers, no advantages
R&D: The game development should not be considered as an R&D endeavor where new advancements will be discovered. Tinybuild has no advantages compared to its competitors
Advertising: Here, Tinybuild has a slight advantage based on its focus on social media like YouTube and Twitch and using influencers to market its product. Here’s an example of a slide from their H1 2023 results:

Consumer advantages

When looking at consumer advantages:

Habits: You could consider gaming addiction, but no more than other publishers
Switching costs: There is no switching cost advantage
Network effects: Is the product becoming better because of more people using it? This depends on the game. A game like Minecraft has increased exponentially in content based on what other people are building. If the game allows multiplayer and some way to build or impact the world around it, then there can be some sort of network effect. In other words, it depends on the game. The 1000-hour game strategy that they are focusing on can help with this.

The gaming industry

Tinybuild is competing in the Indie and AA parts of the gaming industry. It focuses on all platforms, not only PCs. There is a lot of competition. There are low barriers to entry. The number of games published on Steam has seen a dramatic increase due to the digital distribution model which means a developer can now more easily distribute its game to the world:

ROIC vs WACC

When we look at the past return on invested capital and rolling 3-year return on incremental invested capital, we get this:

The average cost of capital is around 10%, so the company has started destroying value since 2022. The 3-year rolling return on incremental invested capital shows the same trend year over year.

Conclusion

I do not think that Tinybuild has a MOAT, meaning a long-term sustainable competitive advantage that will allow them to earn a return on invested capital higher than their cost of capital, and this for a long time into the future.

The only thing that might be considered a MOAT is the intellectual property (like the Hello Neighbor franchise). This is what Tinybuild is pursuing. developing franchises that go beyond gaming and give more longevity to sales.

The short-term competitive advantages are:

Cost-effective marketing through social media which they put a lot of effort into (cost advantage)
Lower wages or cost basis due to their international presence

Their higher gross margin up until 2022 seemed to confirm this.

Except for the IP, the other advantages can be competed away in the future. The decrease in ROIC confirms that this is a very competitive industry.

Competition

Let’s compare Tinybuild to some competitors. The table below shows Tinybuild, Team17, Devolver, and Paradox Interactive for different criteria:

First off, the lifetime revenue is an estimate done by vginsights.com. It should not be taken as an absolute value, but because the method of calculation is the same for all the companies, it can be used to compare values between companies.

Tinybuild has a lifetime revenue per month that is closer to Devolver but is the lowest in this comparison. Tinybuild is the youngest of these companies (Team17 was founded in 1990, but the data only goes back to 2015).

When we dig a little deeper into the individual games, the gaming industry reminds me a little bit of Berkshire Hathaway. Warren Buffet mentioned that the entire 60-year success of Berkshire can be backtracked to about a dozen great investments. That is 1 every 5 years.

Are the lifetime revenue for these companies also driven by a couple of big hits? Let’s take a look:

Paradox Interactive: Half of lifetime revenue is generated by 4 games (Crusader Kings, Stellaris, Cities: Skylines, and Hearts of Iron)
Devolver: Half of the revenue is related to 10 games
Team17: 2 games make for half of the revenue (it’s not Worms, I have no data that goes back that much)
Tinybuild: 1 third of revenue is made by 3 games (Speedrunners, Graveyard Keeper and Surgeon Simulator)

Devolver and Tinybuild are more similar in that revenue distribution may be more spread out than the other 2. But there is a concentration effect, where the goal is to publish game after game in the hopes that a hit game will increase the performance of the company substantially. As in managing a stock portfolio, a publisher manages a game portfolio, hoping that the ROI on some of them will go through the roof.

I wanted to look a little under the hood when comparing different game publishers. All these publishers go through Steam for a big part of their sales. Tinybuild has a multi-platform focus, so the PC-only data only gives us a partial picture. We know that Steam wishlists are a good indicator of future sales, but we do not have that data. When looking at the past, a great game often has more reviews. Here’s an overview of the number of reviews per game released yearly for Tinybuild, Team17, and Devolver Digital.

Although we’ll need to wait for the end of the year, at this moment in time, 2023 is the worst year in the history of Tinybuild. Its competitors aren’t doing that great either.

This only gives us an idea about PC game sales, but in most cases, if a game does well on PC, it is ported to other platforms.

Steam allows for an iterative approach to game publishing:

List the game on Steam with a demo
Try to create the first traction through marketing
If validated -> continue development and release in early access
Continue iterating on game design with feedback from players
Full release on PC
If successful, port to other platforms

We can also see that Tinybuild since 2019 has started ramping up its release cycle:

Almost releasing 10 games each year.

Because the biggest problem for Tinybuild is its top-line growth, how is it faring compared to the others?

When looking at gaming companies, we can understand the strategy to get more predictability and manage an entire portfolio to minimize downside risk. But the upside is still determined by the big hitters. This is the case for all these companies and Tinybuild. The future upside will be related to the heavy hitters.

When we compare revenue growth between these 3, all are slowing down.

When we compare EPS growth

Tinybuild is falling off a cliff, Team 17 is dropping steadily and Devo is trying to recover.

And finally, when comparing gross margins over the last 5 years:

Tinybuild was able to boast a higher gross margin than its competitors from its vertical integration (publishing/developing/lower direct sales costs). The drop in 2023 is mainly due to the drop in revenue. The spike in 2020 for Devolver was due to the success of specific game releases.

The question now becomes: Even if the other companies seem to show slightly better metrics, is Tinybuild a good investment?

Destination Analysis

Market Expectations

What does a price of 7 pence in the market mean when we use an inverse DCF model?

Theoretically this: If they start with a free cash flow of 200k (2024) and generate an 8% growth rate, to arrive in 10 years at a free cash flow of 400k, and when taking into account a P/FCF multiple of 10, you’ll arrive at the current enterprise value of the company.

The problem: An inverse DCF will not help us write down what the market is thinking about the future. The past free cash flow has been too erratic. However, 200k in free cash flow, with a growth rate of 8% and a terminal multiple of 10, seems low.

Instead of looking at what the market is expecting, we can look at it differently. What would the company need to do to get back to where they were from a performance point of view in 2020?

Before diving into this question, let us see what the professional analysts are saying.

Analysts' recommendations

Here are the current recommendations from marketscreener.com

Analysts' consensus has evolved from an overall buy rating last year, up until the publication of the half-year results where since then, only 2 analysts have recommended buying. The mean consensus is to outperform with an average target price of 20 pence.

Downside risk

As mentioned before, the company has no debt, currently has a cash position of about 14 million USD, and is trading in the market at 18 million dollars. The enterprise value is 4 million dollars. The company has no tangibles, only intangibles as assets.

Let us take the following conservative assumptions:

The cash position at the end of the year will be about 10 million USD. We consider the value of this cash in the market to be worth about 7 million USD (30% discount). Based on this assumption, the enterprise value is 11 million USD at this time
Future cash generation from development services drops to 0. Based on the operational cash flow in 2023 (estimated at 13 million USD), this would mean you would generate about 10 million in operational cash flow in the future from your existing portfolio of games
All acquisitions made over the last 3 years are worth 0 dollars

If you had 11 million dollars, and you could buy the entire company, you would get:

The past: A business that is generating about 10 million in operational cash flow
The future: Tinybuild has just invested more than 80 million (I consider the acquisitions to be worth 0) over the past 3 years for future releases and based on their latest H1 presentation (50 projects in the future pipeline)

Although to complete those 50 projects, more investments will be needed, I can then only conclude that the current price in the market is based on:

The current portfolio not being able to deliver the operational cash mentioned
The future portfolio is worth nothing

My conclusion: The downside risk seems low.

If you have any feedback on this thought exercise please do.

Pre-mortem: Why do gaming publishers die?

To get a better view of the risks related to Tinybuild, we take a look at why game publishers fail and what the main reasons are with some specific examples.

The bankruptcy of Telltale Games: A pretty well-known developer of Narrative-driven AA games was caused by:

High development costs Telltale developed narrative games with detailed storytelling and unique art styles, branching paths. The fact that a lot of content fuels the games can lead to higher development costs.
- Risk for Tinybuild: Their changing focus on games that employ systems instead of games that mainly focus on content might mitigate this risk somewhat
High licensing costs. Telltale developed games based on popular franchises like Game of Thrones and The Walking Dead. Using licences can increase the probability of reaching a larger audience, but comes with a higher cost and thus higher risk.
- Risk for Tinybuild: They are focusing more and more on their intellectual property instead of having to license other IPs. 81% of revenue is derived from their IPs. This keeps the upfront costs lower. They have claimed to have refused certain projects that would have been built by 3rd parties to protect the quality of their IPs.
Episodic release schedule. Claiming to release a game in episodes means you need a constant influx of revenue to keep up. If sales of certain episodes are not strong, it could impact the release of the total series.
- Risk for Tinybuild: Except for the Hello Neighbor animated series, Tinybuild does not use an episodic release schedule
Too rapid expansion: Telltale games expanded rapidly, spreading development teams very thin which led to delays in release schedules.
- Risk for Tinybuild: This could be a concern. Tinybuild has also grown rapidly to about 400 employees. The number has now been stable for the past 2 years. No information is available if the teams are spread too thin.
Lack of financial reserves: The gaming industry is competitive and fluctuates on trends and market demand. Good years cycle with bad years. A strong balance sheet is required to get through the bad years.
- Risk for Tinybuild: Tinybuild has no debt. Due to heavy investments over the last years, their cash position has gone down to probably about 10 million USD at the end of this year. Management has mentioned their goal is to keep this cash position stable throughout 2024.

And some other risks based on other gaming companies that went bankrupt in the past:

Lack of diversification: Several past gaming companies have bet the house on 1 or 2 big projects. If they succeed, this can be a home run for the company, but failure leads to the end of the company:
- Risk for Tinybuild: Tinybuild has a diversified portfolio of 90 games. It currently has 50 projects in the pipeline. Some projects are bigger than in the past. Here’s the slide from the H1 2023 report:

No steady cash flow: Because of the cyclical nature of releases, some gaming companies struggle with the ability to generate a steady cash flow.
- Risk for Tinybuild: Although there is a cash flow from the past gaming portfolio, operational cash flow is dropping due to a reduction in development services and no or limited growth from new game releases in 2023. Cash flow is steadier due to several games being released throughout the year (and the diversification of projects) but it needs to become more stable in the future
Legal disputes and uncertainty: Some companies were impacted severely because of this.
- Risk for Tinybuild: There is 1 low-level lawsuit ongoing but management has claimed they want to resolve it quickly and is considered the lowest level that a lawsuit can be. They do not foresee any negative impact of this
Insufficient funding and too much debt: Certain companies like 38 Studios had to take on debt to fund their operations but were unable to meet their financial obligations in the end.
- Risk for Tinybuild: Growth in the past has been fueled by 2 capital raises pre-IPO and the IPO proceeds together with the success of certain games. It remains to be seen if the past investments will fuel future growth. It is uncertain if more capital injections will be needed, this will depend on the overall ROI of the past investments.

Upside potential?

Let us look at the boundary conditions. Could Tinybuild multiply its revenue by 100?

This would mean generating revenue of 4 billion USD. Gaming companies that generate this kind of revenue are companies like Take-Two Interactive, who own Rockstar Games, the developer of one of the best-sold games in the world: Grand Theft Auto. Take-Two has about 6000 employees worldwide.

For Tinybuild, with a focus on Indie and AA games, this outcome seems impossible.

If Tinybuild can achieve its performance in 2020, what upside could be obtained?

In 2020, Tinybuild achieved an EPS of 0.06 or 0.054 in Gbp. If we look at the drivers of the P/E multiple, a P/E multiple of 15 could be reached under the following conditions:

We assume a 10% discount rate
A revenue and EPS growth rate of 15%
A ROIC higher than the discount rate, it needs to create value

Under these conditions, if Tinybuild would earn an EPS of 0.054 the price in the market would be 81 pence or a 11x upside from the current price. Remember their performance over the last 2 years, this is not an easy feat. Flawless execution, great capital allocation decisions, and some luck will be needed.

Optionality

I try to look for companies that have some sort of optionality, some sort of exposure to outsized returns, to luck. A gaming company like Tinybuild has more upside optionality than Dino Polska which I previously covered.

Dino is a long-term compounder with a MOAT
Tinybuild is an asymmetric bet with upside optionality

Since Tinybuild’s strategy is to focus on the 1000-hour game, by focusing on systems instead of pure content, a game like Minecraft comes to mind. My son is crazy about Minecraft. Minecraft is the definition of a 1000-hour game where an entire community has revolved around it: a marketplace, several variations, a Minecraft Star Wars, you name it.

Minecraft on itself has generated about 400 million in sales in 2022. That is 10 times what Tinybuild is generating with its entire portfolio at this time. But Minecraft is an anomaly. However, I do think that Tinybuild is exposed to this kind of optionality.

Is this kind of outcome possible? Yes
Is it plausible? No

Summary

Tinybuild is a game publisher that wants to become a media publisher and build and expand its intellectual property. As with most publishers, the real MOAT lies in the quality of the IP. Tinybuild does show some short-term advantages with its marketing strategy being heavily focused on social media and development costs that are lower due to the teams being spread out around the world with lower wages in some areas.

For Tinybuild to get out of this rut, there seems to be only one path forward:

Find growth in the top line, specifically in royalty revenue
Once the top line starts increasing, focus on profitability

They made some important investments over the last 3 years and will need to continue investing in the future. Time will tell if these investments will pay off.

Based on the valuation of the company, this is a bet that has significant upside potential and is somewhat protected from the downside because of the beating it has already taken in the market. The market is pricing the company in such a way, that the investments over the last 3 years will have a negative ROI and will not contribute to the existing cash flow from the current portfolio of games.

I consider TBLD to be an asymmetric bet with a potential high upside and limited downside. It will however take time to reveal the value of the company.

Disclosure: I am long TBLD with a minimum holding period of 5 years

The most important parameters to track are Revenue and once the company becomes profitable, EPS growth, and ROIC.

Final 100-bagger checklist

When we take into account our 100-bagger checklist, there’s a lot of red in it. This is logical because the checklist is aimed at small-cap compounders. Tinybuild is not a compounder, it is a company that needs to recover, hence the result of the checklist.

In practice: Where to buy?

Tinybuild is currently trading on the AIM market of the London Stock Exchange under the ticker TBLD. It is also traded on the Frankfurt Stock Exchange under the ticker 8Z3. You might have some trouble trying to buy shares from the United States. This was mentioned to the company and they are looking into options to facilitate trading in the US.

Atmos Invest 100-bagger hunting

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