Disclosure: I have been holding shares in CDR since Q4 of 2015.
Oh dear. Alright, let me take some time here to reflect on the launch of Cyberpunk 2077 and the future of CD Projekt SA.
First of all, no, this is not the launch I expected. Yet I also cannot say I am entirely surprised. Especially in hindsight, it is not out of character for CDR to make blunders – particularly when it comes to bringing their games to consoles. You may recall that in my first post on CDR I mentioned how they almost went under when they failed to port their first title to Xbox 360 and PlayStation 3. That time, they had outsourced a lot of that work, having been too small a studio to work on The Witcher 2 and the port simultaneously. Perhaps somewhat ironically, the current scenario demonstrates an almost parallel situation in the sense that though this time they chose not to outsource the work on the console version of CP2077, due to the increase of scale and ambition of the title, even the now much larger studio failed to deliver a console version that lived up to the expectations. Of course, in most other ways the present developments are rather different from those 2009 days. This time, though buggy and poorly optimized, there are working and playable console ports available of the game on launch and they were developed in-house. The company has a strong balance sheet, secondary sources of income and is not pushed to the brink by having failed to fulfill contracts with external publishers and console manufacturers (mostly because CDR have grown to take control of almost all publishing activity directly where feasible). Of course, the context of this greater financial freedom is not particularly flattering on the decisions that were made to publish the title too early. That was clearly a significant miscalculation by the very top of management. But more on that later.
Similarly to the third Witcher title (The Wild Hunt), the launch of the PC version of CP2077 was plagued by optimization issues, glitches and a UI that needs a rework. But importantly and unlike the old-gen console versions, the PC and Stadia experiences are fine. Certainly, they are not perfect and will benefit a lot from at least several months of updates and polishing but they are perfectly enjoyable. Had the launch only involved PC and Stadia, there would have been very little blowback and it would have been a roughly average AAA title launch in terms of technical problems and very successful in terms of sales. I think both of those things hold true, looking at the PC version alone. The real problems stem from the console launch and the resultant reputational damage for the firm.
The truth is that no game publisher/developer can grow indefinitely without turning from plucky underdog into uncaring corporation in the eyes of consumers. Until this release, CDR had managed to cultivate an immensely valuable asset – consumer goodwill that reached almost fanatical proportions. And despite the significant damage sustained, particularly among old-gen console users, CDR still retains an above average reputation. Yet they will have to work diligently and without significant faux-pas for a solid number of years to recover and will never quite regain that pristine halo of being unable to do any wrong whatsoever.
To a significant extent the damage that has occurred is proportionate to the success of CDR’s marketing efforts and the exceedingly high expectations that have built up over the 8 years since the announcement of CP2077. Naturally, CP2077 has not actually been in full development for that long because resources were repeatedly diverted for The Wild Hunt. Which brings me to what I think is the crux of the cookie. CDR’s management systematically overextended. Though they have exploded in size and means, no organization can grow forever without experiencing at least some diminishing returns. That is because in the real world, some problems cannot be solved by mustering more money and manpower alone. In development work, too, there are bottlenecks that occur which need to be completed before deeper inroads can be made. And those bottlenecks are at times like baking a cake or carrying out a pregnancy. Impossible to rush significantly without serious consequences.
The strategic overextension on part of CDR is everything but unusual in the games industry. I would in fact call it the norm rather than the exception in the AAA segment. I remember well the release of Total War: Rome II and what a mess that was for Creative Assembly, a studio that had just previously made one of the (in my estimation) greatest games of all time, Total War: Shogun 2. There it was the very same story of having cultivated an incredible team, only to divide it too early and chase two hares at once for the sake of strategic expansion. Those are without fail, by nature, top-down business decisions because only by having some separation from the hands-on process is it possible to misjudge the under allocation of resources to a project quite so drastically. There was no unbearable external pressure or financial imperative for CDR to release this year. The decision was squarely management’s.
This is both good and bad. It is good because it means that nothing is wrong with the core engine and most important asset of CDR: the employees. Having played CP2077, that was obvious to me very quickly.
On the obverse, if this decision-making is indicative of serious lack of judgement of management and thus of the handling of future releases, that bodes ill.
Personally, I do not feel that way presently. Nevertheless, it ought to be crystal clear to Marcin Iwiński that they need to work on internal leadership and communication structures and then listen to them. Most importantly – and I am confident management have understood this for months or even years – they are spread too thin. This release is a wake-up call that the pace is too high, the timeline too ambitious as of yet. Some internal consolidation and rest are sorely needed. Everything else time and good work will fix (though they need to be smarter on the GOG side).
In the long run such a forced regrouping may turn out to be a blessing in disguise, as it does not existentially threaten the firm but punish intellectual complacency and shake up the leadership a little, causing them to think more realistically about the still very long road ahead.
As to how I think this will shake out, I will once again reference Rome II. Despite being literally unplayable on many PCs, Rome II went on to become Creative Assembly’s up until then most commercially successful title already on launch day. Months of patches turned the game from buggy mess to stable and enjoyable game. The management learned a little but not a lot, repeating (or perhaps more accurately, continuing to follow through on) the mistakes several times with Thrones of Britannia and Troy, as well as other, smaller projects. The reputation suffered, thousands were incensed. But ultimately, sales continued their record-breaking streak more or less unperturbed. Commercially, the apparent miscalculation may not necessarily have turned out to be one, seeing the success of the Warhammer series that would have been impossible (or occurred many years later) otherwise. Artistically and technically, of course, there were sacrifices. I still believe that CA have yet to make another game quite as good as Shogun 2. Nevertheless, seeing The Three Kingdoms and the Warhammer titles which I consider to be of high merit be released at such tempo, it cannot be said that the studio’s expansion has been a failure. Perhaps these trade-offs are closer to a structural inevitability of the AAA segment than I previously thought, disillusioning and cynical as that may be to ponder.
Speaking of cynical, let me for completeness’ sake do a very rough attempt at guesstimating around the sales numbers and whether or not the share price decline is likely to be rational quantitatively (again, provided one agrees with my conclusion that this launch is not evidence of new and fatal flaws in the company).
Let us pretend that there are no console sales (with Sony’s decision to pull CP2077 – very serious loss of face for CDR by the by – a much more realistic heuristic than anyone would have projected) and that PC and Stadia is all we will see for the period one to two months after launch. Very conservatively, what kind of revenues and earnings might one expect? Well, SteamSpy puts CP2077 ownership on Steam to between 10’000’000 and 20’000’000 users and as of this writing, 10 days after release, CP2077 remains at the very top of the global best sellers list on Steam at full price (50£, 60USD). So, let us say there are 13M on Steam and 2M on Stadia (both of those are guesses but probably on the low end all considered). That makes 15M copies sold at 60USD, making $900M, ca. 80% of which actually goes to CDR, thus resulting in revenues of $720M (I am ignoring currency conversion etc. as sales are geographically reasonably diversified and the US is a large market; plus, this is an incredibly rough guesstimate, not a projection).
With $720M in revenues, a roughly 40% net profit margin (historically that is about right) gives $288M in net profit. In other words, if CP2077 cost somewhere between $300-350M to develop (CDR always aggregate development cost, so the true figure is not publicly known), this pretty conservative guess pegs revenues at already twice that and net profit in the ballpark of 1x. Not too shabby.
For size, 2019 earnings were PLN175M (roughly $48M). 288/48 = 6. So, if that is all the earnings CDR made all year (which, you know, is not the case) that would be 6 times previous year earnings. If current P/E is about 100x, 100x/6 = ~16.7x. Unless I have made some egregious error somewhere, that seems like a darn ok deal to me.
[Funnily enough I did end up making an error that is significant by forgetting the P/E I was referencing is TTM. There was a significant difference in earnings TTM vs 2019 – PLN279M/$76M vs the supposed $48M. So the actual is 288/76 = ~3.79 and 100x/3.79 = ~26.4x which is obviously less desirable than a 16.7x. Mea culpa.]
In any case, read the disclaimer, this is not investment advice. I am heavily biased. Also probably insane, delusional and a velociraptor foaming at the mouth.
I hope that despite this, you have found this post worthwhile
Tom
The Financial Flâneur 