I bought some CD Projekt shares in my previous portfolio update here. I am very excited to finally become a partner in this wonderful business after following it for 3 years.
I will first discuss CD Projekt’s business at a high level and then go into the recent debacle with Cyberpunk 2077.
As I wrote in my previous blog post – Thoughts on video games:
As an investor, I prefer game companies with incredibly strong game franchises and a proven game development track record. There are very few game companies that fulfil both criteria. Netease, Tencent and Nintendo are some examples. The goal is to buy such game companies at a discount to its existing game franchise value and future game value is margin of safety.
CD Projekt has one strong game franchise – Witcher and in the process of building out a second franchise – Cyberpunk. Despite the launch drama, I think CD Projekt has a reasonable track record as a game developer. So CD Projekt does not fulfil those two criteria – owning strong game franchises and proven game development capabilities – very convincingly.
But I think there is sufficient evidence that CD Projekt can continue to develop its capabilities and strategically build out future game franchise. So there is not really a lot of margin of safety here and hence this is a 2% position.
I always prefer game companies that own and operate persistent game worlds which provide game-as-a-service revenue model rather than game-as-a-product revenue model. Unfortunately, CD Projekt adopts the game-as-a-product revenue model which means its cashflow is very tied to game releases and very dependent on the success of each game release. This has historically lead to a hit-driven business model which many investors hate because it is impossible to predict the sustainability of the company’s earnings.
This has been my biggest reservation about CD Projekt. But a few things changed my mind – 1) the launch Witcher mobile game; 2) the launch of Witcher Gwent card game, 3) the planned launch of Cyberpunk multiplayer online game and the 4) the release of Witcher series on Netflix
In some sense, CD Projekt has a very similar business model to Disney. Disney use movies to anchor its IP franchise which can then be further monetised through theme parks, merchandises and video games. For CD Projekt, it anchors its game franchise with flagship AAA games such as Witcher 3 and Cyberpunk 2077 and then develops spin-off games based on these core game franchises. It also produces TV series to further expand the influence of its game franchise.
CD Projekt’s real upside comes from 2 sources – 1) it builds out new game franchises and 2) transition one or more of its game franchise into persistent game worlds which can build strong customer loyalty and generate stable cash flow. With Witcher mobile game and the planned release of Cyberpunk multiplayer game, we are already seeing some signs that it is happening.
On valuation – it is very hard to value CD Projekt. As part of the company’s incentive program, it announced a goal of generating an average net profit of PLN 1.5-2bn for the period between 2020 – 2025. Assuming that they hit this goal, then I paid 15x multiple based on earning base of PLN 1.5-2bn net profit. Not too ridiculous but also not very cheap.
CD Projekt share price plunged after the disastrous launch of one of the most anticipated game in 2020 – Cyberpunk 2077. Here is a good Bloomberg article that documented the events that lead up to the game’s launch. In short, Cyberpunk 2077 built up an incredible hype but ultimately disappointed gamers as the game was full of bugs and glitches. It was so bad that Sony had to take the game off the shelves because it was almost unplayable on consoles.
Marcin, the co-founder of CD Projekt, posted a video to apologise for disappointing gamers and explain what happened.
He cited the technical challenges of making the game work with the next-gen and current-gen console & COVID-19 restrictions leading collaboration challenges as reasons for the failed launch.
From the outside, it is absolutely clear that the management team had huge pressure to get the game released before Christmas 2020 and that pressure led to the bad decision of launching before the game is ready. I am sympathetic to the challenge of COVID-19 situation which would have really complicated the entire development process.
The legendary game developer, Shigeru Miyamoto, once quipped that “a delayed game is eventually good, but a rushed game is forever bad”. This comment was made when games are primarily sold on physical copies and played with consoles that had no Internet connection. So there was no way to update the game after launch.
Fortunately, CD Projekt (CP) lives in the Internet era where it is possible to continuously update and improve the game once launched. In fact, Witcher 3’s launch was very problematic too. See this Eurogamer article written in 2015 to recount the disaster! And it feels eerily similar to Cyberpunk 2077 – last-minute crunch, graphic downgrade issues and the 2000 game bugs. Post-launch, CD Projekt continued to support Witcher 3, patched the bugs, launched DLC and won universal praise for the game. I believed something similar is going to happen here and that Cyberpunk has the potential to become another great franchise.
Ever since CP transitioned from a regional game distributor to a game developer in the mid-2000s, CP has been pushing its technical and game-making competence with every game. With Witcher 3, CP had to make a game engine that worked in an open-world while developing the game at the same time. CP has insane ambitions to grow as a world-class game developer.
I think with Cyberpunk, CP was trying to push the limits of what they can accomplish again. For example, they had to upgrade the game engine for FPS and driving. The Cyberpunk world was bigger and more complex. Except for this time, they had the complication of COVID, higher expectations, bigger gamer base and co-existence of two generations of consoles.
CD Projekt clearly screwed up this time. But from an investment perspective, I focus on three things – 1) what does this incident show about the company’s game development capabilities, 2) what does it reflect about the company culture and 3) the long-term potential of Cyberpunk 2077 franchise.
For me, it seems like CD Projekt’s ambitions might be ahead of its game development capabilities this time. But it is also clear that CD Projekt is improving as a game developer and based on the company’s historical track record of learning from mistakes, this could be another learning opportunity for CD Projekt albeit an expensive one. I am more concerned about how this incident could crash their ambition and kill the operational momentum that they have been on.
Few game companies have developed such a strong brand within the gamer community. CD Projekt always believed in treating gamer well which is exemplified by their ethos of providing good value for money – free DLCs and DRM-free games. I personally don’t believe there is anything sinister going on here except for the fact that there is immense pressure to release before Christmas 2020. During game development, there are constant trade-offs to be made and we could argue whether CD Projekt has made all the right trade-offs. But I don’t think there are any bad intentions here. I guess we will see how CD Projekt make up to the gamers in the months ahead.
After reading through many reviews and playing it myself, I think it is a good game and has the potential to become another long-running franchise for CD Projekt in the same way as the Witcher franchise.
Ultimately, I think there is a pretty good chance that CD Projekt can bounce back from this fiasco and become a better game company in the process.