Razer Inc: $4.5 Billion Privatisation Deal

Management

Business Segments

Razer operates three business segments related to computer gaming and gaming related services these include _[3]:

Hardware

This segment generates revenues through the sale of physical components of a computer or electronic system,  and are separated into two sub segments which include:

• Peripherals which is defined as optional electronic hardware designed to enhance the usability of a computer. The three main core categories include mouses, keyboards and headsets. Currently Razer is the market leader in gaming peripherals worldwide where this segment is the core driver behind Razer’s growth.

In 2019 the most popular sales include the Deathadder V2 mouse, Huntsman keyboard and the Kraken headset in 2019. In 2020 growth was driven by sales in the Razer Viper 8K Hz mouse and Razer Huntsman V2 Analog keyboard.

• Systems refer to the sale of computers and laptops where Razer is currently the market leader in premium gaming laptops in the US. Razer also has strong positioning in emerging markets such as China and Latin America.

The pandemic has lead to a digital acceleration through more dependency on technology and computer systems this combined with pent-up demand and supply chain issues resulted high growth in this segment. This growth was driven by the launch of the new Blade laptop series, and the sales in the Kiyo camera and Seiren streaming microphone.

Razer anticipates more demand from these trends where it has expanded it’s product offering to a ‘wireless portofolio’ some of which include the Razer Orochi V2 mouse and BlackWidow V3 Mini Hyperspeed keyboard.

Software

The Software segment is rapidly growing with more than 100 million users as of June 30, 2021. It’s huge increase in popularity is is attributable to growth in gaming, esports and livestreaming themes as a result of the stay at home environment.

Inspired by these trends Razer has rolled out the Streamer Companion to enables users to broadcast their RAZER CHROMATM RGB lighting effects. In addition, Razer partnered with Microsoft to release the Xbox Game Bar SDK to increase user experience in playing games thus increasing it’s value proposition.

Meanwhile, the RAZER CHROMATM RGB Connected Devices Programme,an initiative started in 2018 to bring more third-party brands to the Razer ecosystem, contributed to increased user adoption. As of June 30, 2021, over 180 games and applications are integrated to Razer’s increasing ecosystem.

In the future, Razer plans to develop new services to increase user acquisition, engagement, and retention, explore new monetization initiatives and deepen big data analytics capabilities to drive user acquisition and nurture user activity.

Services

Razer provides services direct to consumers and to businesses, which makes the company uniquely diversified compared to it’s competitors. These include Razer Gold and Razer Fintech.

Razer Gold

Razer Gold, is a virtual credits platforms for digital entertainment from over 130 countries. Thailand, Malaysia and MENA regions were the key growth markets. As of June 30, 2021, Razer Gold has 30 million registered users, 2,000 digital entertainment titles including Call of Duty: Modern Warfare, Ragnarok X: Next Generation, Perfect World Mobile, MU Archangel, BLEACH: Eternal Soul.

Razer Fintech

Is Razer’s financial technology arm and is one of the largest offline-to-online digital payment networks in Southeast Asia.The segment has grown rapidly driven by new merchants and surges in online shopping and digital entertainment due to the COVID-19 lockdown. The Fintech unit has recorded 63.7% CAGR in TPV over the last 3 years.

Razer Fintech comprises of Razer Merchant Services (B2B) and Razer Pay (B2C). RMS accounts for the majority of Razer Fintech’s revenue, where the segment has online and offline categories.

• RMS Online is a card processing gateway, which saw significant growth in online transaction volumes due to the surge in online shopping.

RMS Offline is an offline payment networks which saw growth, driven by increased games and entertainment spending such as mobile top-ups and point-of-sale activation gaming and entertainment gift cards.

Growth Initiatives:

Mobile/Cloud Gaming

Razer has partnered up with industry leaders Google Stadia, Microsoft Xbox Game Streaming, and Tencent Cloud to provide and distribute goods and services to increase Razer’s leading position in mobile gaming.

For software, the Razer Cortex Mobile game recommendations app has 3.3 million users as of June 30, 2020, a 19-fold increase year-on-year. In the first half of the year, Razer continues to promote Razer Gold as the key choice to support the monetization of mobile games and lifestyle content.

ESports

Razer is one of the world’s leading brands in esports. Team Razer supports some of the top esports teams competing across the U.S., Europe and Asia Pacific, including China. Esports viewership saw a dramatic increase during the first half of 2020 as national/regional shutdowns which led sports fans and players across the world to turn to esports events.

Business Strategy Analysis

Razer is a differentiation focused company with it’s three major segments targeting a narrow demographic in youths and millennials (Aged 13-35) who are interested in gaming. Razer’s products are priced as premium electronics as Razer’s brand value is geared towards providing high quality products. Due to this strategy Razer is capable of obtaining higher margins due to it’s pricing power being seen as the premier brand among gamers. This combined with a diversified and growing revenue stream is indicative of Razer’s competitive edge relative to it’s competition. This strategy does have it’s downsides as the target audience is narrowed down due to the specificity and usability of the products to the general population, this results in lower overall revenues for Razer than it’s Tech competitors which target a much more broader audience. 

BCG Matrix

By separating the revenues into it’s operating segments we can visualise which segments drive growth which is important to understand the future performance of the company. As seen below, the vast majority of revenues are driven by the hardware segment specifically the peripherals, followed by systems, software and services and lastly others.

Hardware (Peripherals & Systems) – Is a “Star” as this segment has shown consistent and stable growth over the last 5 years, the peripherals segment is a faster grower (40% CAGR) than the systems segement (27% CAGR) respectively. Razer is widely known for being the industry leader in gaming hardware internationally. It’s peripheral sub segment is the leader worldwide in all regions, whilst it’s system sub segment is the leader in gaming hardware in the US, and is among the top 5 companies in the APAC and EMEA regions.

Software and Services – Is a “Cow” as it is currently Razer’s fastest growing segment with a whopping 407% CAGR YoY. It is very likely that this growth rate is not sustainable in the long-term, which is evidenced by the slowing growth in the last two years. In the future it is possible that this segment could become a bigger driver in total revenues.

Others – Is a “Dog” because this segment has not shown consistent growth and remains volatile on a yearly basis creating a degree of uncertainty on where this segment will be into the future, given it’s small weight to revenues (<1%) this is not something to worry about.

As seen below, peripherals and systems which are subsections of hardware drive 90% of Razer’s total revenue, therefore as an investor it’s very important to monitor the volume and pricing of Razer’s physical products to get an understanding of where Razer could be in the near future.

Sustained Competitive Advantages | VRIO Framework

1. Razer’s value primarily comes from it’s branding and diversified ecosystem where it has positioned itself as the leader in the computer hardware and software gaming segments. The perception of the quality of it’s products attracts consumers to Razer’s ecosystem. Furthermore Razer’s software segment through it’s various partnerships has enabled Razer to attract entertainment and content partners including popular gaming titles such as Call of Duty which further enhances user stickiness. Lastly, Razer has built a fully integrated value chain from payment to product, where it’s Fintech segment has provided diversification by providing a way to buy and sell products using Razer’s own proprietary payment system. 
2. Razer is rare because of it’s business strategy in being a differentiation focused company focused on a narrow demographic in youths and millennials. Razer’s premium is geared towards providing high quality products. Due to this strategy Razer’s is seen as the premier brand among gamers. This combined with a diversified and growing revenue stream is indicative of Razer’s competitive edge.
3. Razer is a unique product and is very difficult to imitate primarily due to how diverse it’s business operations are, not only does it sell hardware and peripherals it has segments in software and providing services both to consumers and to businesses which creates an ecosystem that is vertically integrated. Razer, is also geographically diversified serving over 130 countries, with high growth in the APAC region. Furthermore Razer believes it will continue to grow it’s leading position in key developing technologies driven by increasing consumer sentiment in mobile gaming and esports. However this space is increasing becoming competitive with Alienware, MSX and Logitech being the biggest threat to Razer.
4. Razer is very organised which is highlighted by how each segment is vertically integrated to each other and is ordered to creating a unique ecosystem specifically for gamers.

Overall, Razer has sustained competitive advantages which is a strong indication for long-term future growth, however, the number of industry competitors may pose a potential threat. Given these sustained competitive advantages, a growth period of 10 years is used in the DCF model.

Industry Overview

The global demand for gaming hardware is anticipated to expand with an impressive 25% CAGR over the next five years.

Razer: Industry Drivers

The primary drivers of growth is the increasing expenditure on advanced next generation gaming consoles _[4]. Moreover, the advent of an increase in number of games requiring high computing power, will further fuel the market. A shift towards VR, increasing internet penetration and the advent of advanced multiplayer games is driving the growth of competitive gaming which requires high end consoles and peripherals _[5].  

Lastly, a shift towards mobile phones and tablets, will draw in casual gamers which further boosts the growth of the global gaming hardware market _[6]. This was evidenced by the global sales of gaming PCs growing by 16.2% during 2020, which was due to the stay at home environment and increase reliance on technology _[7] where the industry is expected to grow at a 25% CAGR to 2024 _[8].

Interestingly the most popular devices are premium gaming computers, which account for 47% of gaming PC profits over the past 5 years. The biggest threat to premium gaming hardware is cloud computing which can provide low end users and casual gamers the gateway to get into high-end gaming _[9]. This combined with the increasing adoption of 5G technology could drive Cloud technology to reach an even wider audience. So far 5G is still in it’s early stages and it’s effects on gaming is relatively unknown but is definitely one trend to watch into the future _[10].

Comparison to competitors

Revenue

All major market share holders in the gaming and peripherals sectors saw year-on-year growth in terms of revenue. However, despite that, Razer saw an increase that was in a league above its competitors.

Razer in 2021 saw an increase of 68% in revenue, with peripherals growing by 104.1% and systems by 24.2%.

During the same timeframe, Corshair saw a net revenue of $1.00 billion, an increase of 45.2% year-over-year. The Gamer and creator peripherals segment net revenue was $331.1 million, an increase of 78.0%. Gaming components and systems segment net revenue was $671.2 million, an increase of 33.3% year-over-year.

Similarly, MSi saw a revenue of NT$94.3 billion in 2021 from, a 47.8% increase from its NT$63.8 billion in 2020, with the majority coming from its computers and peripherals division. Meanwhile, Turtle Beach’s net revenue rose from $114.7 million to $171.6 million, a 49.6% increase.

Gross Margin

Cost of goods sold did not see any significant jump up as a percentage of revenue across the industry. Razer ranks similar to its competitors in terms of gross margin.

In 2021, Razer had a 27.1% gross margin, which rose from 2020’s 22.0%. Corsair saw similar figures, with its gross profit was $130.4 million, equalling a gross margin of 27.6% which is flat year-over-year. MSi recorded a margin of 19.8%, and Turtle Beach recorded an impressive 37.0% gross margin. However it should be noted, that Turtle Beach’s product offerings are the least comparable to Razer, with significantly less variety as they specialise in gaming headsets and controllers, hence explaining the gap in gross profit margin.

Net income (LTM)

Corsair’s net income rose from $103.2 to $119.3 million ( 15.6%). MSi saw increases to NT$15.0 billion from NT$7.60 billion ( 97.4%), while TurtleBeach saw a decrease from $ 38.7m to $29.5m (-23.8%). Razer has seen the most positive and substantial growth of net income when comparing the last 12 months to the figures reported on December 31, 2020, from $5.6m to $56.9m.

Income Statement Analysis

Revenue

Razer generates its revenue through 4 business segments:

1. Peripherals
2. Systems
3. Software & Services
4. Other

Note: both Peripherals and Systems are classified under its Hardware business.

Revenue increased by 68.0% from $447.5m to $752.0m. This has come in large part due to its gains in its Hardware and Software & Services businesses.

All comparisons will be made between the six months ended June 30, 2020 and June 30, 2021

Hardware

Hardware, mainly composed of Peripherals and Systems, had its revenues increased by 77.0% from $382.7m to $677.3m. Revenue from the Peripherals segment increased by 104.1% from $252.7m to $515m; the Systems segment increased by 24.2% from $130.m to $161.5m as refreshed model lines helped to boost sales. Overall, the growth seen this year from this business segment is encouraging and impressive.

Software and Services

Revenue from the Software and Services segment increased by 13.8% from $64.0m to $72.8m, due to the additional products and channels offered.

Others

Revenue from the Others segment increased by 111.1% from $0.9m to $1.9m. This growth was driven by increase in sales arising from THX and Respawn products. Software & Services as well the Other business segments follow suit similar to the Hardware segment as being good signs.

Cost of Goods Sold

Cost of sales increased by 57.1% from $349.0m to $548.4m, with gross profit increasing by 106.7% $98.5m to $203.6m. Gross margin rose from 22.0% to 27.1%.

Hardware

Segment cost for Peripherals increased by 86.8% from $189.4m to $353.8m, while Systems increased by 23.8% from $122.2m to $151.3m – both are inline with its respective revenue growths. Gross margin for Peripherals increased from 25.0% to 31.4%., and Systems segment slightly increased from 6.0% to 6.3%. Both come as a result of Razer shifting its focus to higher margin products.

Software and Services

Segment cost for Software and Services increased by 22.3% from $34.6m to $42.3m, consistent with the increase in sales. Gross margin decreased from 45.9% to 41.9%, primarily due to higher service costs.

Other

Cost decreased by 65.5% from $2.9m to $1.0m, mainly because spare parts relating to Razer Phone were written down in 2020. Gross margin increased from -222.2% to 47.4% for the six months ended June 30, 2021 for similar reasons.

Selling and marketing expenses

Selling and marketing expenses increased by 56.4% from $54.8m to $85.7m. Drivers behind this increase include:

• overall increase in sales marketing spending of $20.0m, focusing on online marketing
• increase in personnel costs to support the growth in regional sales and marketing activities.

Research and development expenses

R&D expenses increased by 22.9% from $24.9m to $30.6m, mostly attributed to a rise in personnel costs.

General and administrative expenses

General and administrative expenses increased by 32.1% from $35.8m to $47.3m, stemming from:

1. legal costs provision relating to licenses and potential claims of $6.0m
2. storage charges of $5.6m.

Other non-operating (expense)/income

Other non-operating income decreased from $0.1m to -$0.4m, caused by foreign exchange loss arising from the Hardware business.

Net finance income

Net finance income decreased from $3.5m to $1.3m primarily due to a reduction in the interest rate on fixed deposits.

Profit/(loss) before income tax

From -$13.3m to $40.8m, an increase of 406.8%.

Income tax expense

Income tax expense increased from $4.4m to $9.5m as a result of pre-tax income increase.

Profit/(loss) for the period

Profit for the six months ending June 30, 2021 was $31.3m, which is an increase of $49.0 from -$17.7m in 2020. Overall, it can be said that the first six months have been spectacular for Razer in terms of the Income Statement.

Balance Sheet

Liquidity

Working Capital Ratio

The working capital ratio measures a company’s ability to pay obligations within a year.

A working capital ratio of 2.0 or higher indicates the company has sufficient liquidity and is a sign of good health – this is something to keep in mind.

Quick Ratio

The quick ratio excludes some of the current assets that cannot easily be turned into cash, such as inventory and represents immediate liquidity. A ratio of 1.0 or higher indicates adequate liquidity to operate.

Financial Strengths

Secondly, we evaluate the company’s financial strength through 3 parts. First, we analyze (1) debt-to-equity ratios, (2) interest coverage, (3) return of equity/return on assets.

Debt to Equity Ratio

When evaluating company strength using debt to equity ratios, the smaller the ratio, the better, as a company is financially more robust, the less debt it has than equity.

The smaller the ratio, the better; debt to equity is 0.012, which is excellent. This lower is extremely low and shows that Razer is barely leveraged by debt. This signifies Razer as having a very strong balance sheet.

Interest Coverage

It is crucial in evaluating financial health to look at its current operating profit versus the amount of interest it has to pay its debt holders.

We want the ratio to be above 1 to indicate that operating profit is more than interest expense, and usually, something at 5 to 7 is considered very healthy. Razer has an interest coverage ratio is extremely healthy at 58.8.

Return of equity/return on assets

Return on total equity and return on assets measure the company’s earnings on the equity that the shareholders have invested and the profit on all capital invested in the business, which was used to acquire assets, respectively.

Business Management

Thirdly, we evaluate how well the business is being managed through 2 parts. First, we analyze (1) inventory turnover and (2) accounts receivable days outstanding & accounts payable days outstanding.

Inventory Turnover

Inventory turnover shows how well Razer is managing its inventory.

Account Receivables

Account Receivables days outstanding measure how well management turns sales into cash and represents how long it takes to collect sales. We take the Accounts Receivable balance at the end of the period, divide it by sales for the past year and multiply it by 365 days.

Razer takes an average of 67.1 days to collect on its sales.

Accounts Payable Days Outstanding

Accounts Payable Days Outstanding is an indication of how fast the company pays its bills. To calculate it, we take the accounts payable balance and divide it by the cost of goods sold and then multiply that by 365 days.

Overall Razer’s balance sheet is very healthy, as it is leveraged very little on debt. In addition, it has a relatively short RPO shows its ability to collect on its sales.           

Cash Flow Analysis

The net income was positive in 2020 for the first time since Razer became a listed company, and the trend has continued into 2021. Net income has trended from USD$-97.2m in 2018 to $5.6m in 2020 and has continued its good progress as LTM ending June 30, 2021 showed a net income of $56.9. This is particularly encouraging as we can project net income to continue this rapid growth in the near future.

As a result, cashflow from operations saw a similar upturn in 2020 that has continued, from US$-38.4m in 2018 to US$159.5m in LTM ending June 30, 2021. This was primarily caused by the leap Razer made with regards to accounts receivables, which jumped from a range of $46.6m-$59.2m during 2017-19 up to $219.3m.

During the past year and a half, Razer has increased its activity in terms of investing in financial assets and equity securities. This incursion has seen cashflow from investing go from $-10m in 2018 to $-288m in 2020. The boost of cashflow from operating activities has opened opportunities for capital investment and has been reflected on the cashflow statement.

There were very little changes to Property, Plant and Equipment. In addition, there has been a slightly increased spending on capital expenditure, but nothing particularly anomalous.

Discounted Cash Flow Model

Valuation

We will take you through each phase of the Discounted Cash Flow Model (DCF) and provide our key assumptions. Our analyst selected the DCF Multiple Exit model, where the driver of value is based on the forecasted cash flow of the company alongside the pricing of similar assets in the market. Furthermore, our analysts extend the growth period for 10 years, which reduces ‘valuation drag’, the reliance of the intrinsic value on the terminal value which is important to shift value away from an abstract to a more tangible concept.

              

Cost of Equity

10-Year Risk-Free Rate = 1.47%

Beta – 1.47

Country Risk Premium = 0%

Equity Risk Premium = 4.62%

Cost of Equity = Cost of Equity = Risk Free Rate Beta * (Equity Risk Premium) Country Risk Premium

Cost of Equity = 8.27%

Cost of Debt

Interest coverage ratio = EBIT/Interest expense = 70.5/1.2 = 58.75

Default spread = 0.63% (AAA)

Country default spread = 0%                                        

Tax rate = 21%

Cost of Debt = (Risk-Free Rate Default Spread Country Default Spread) x (1-T)

Cost of Debt = 1.66%

Weight of Debt = 4.8%

Weight of Equity = 91.6%

Weight of Minority Interest = 3.6%

WACC = 7.635%

Using 5-year historical financial statements and forecasts up to 2025 provided by Capital IQ. We extend the forecast period to 2031 by using conservative assumptions provided by our internal team and corporate partners. Our analyst used the XNPV function (XNPV = Discounted rate, cash flow, date) with midpoint discounting alongside the year fraction to ensure cash flows are discounted appropriately according to the fiscal year-end date.

Base Case: $6.99

• 5-year CAGR from 2021-26: 14.04%
• 10-year CAGR to 2031: 7.85%

We believe Razer can sustain similar revenue growth in the next 2 years before slowing down until 2025; then plateauing. This is done by projecting revenues to continue its 25% growth that it has seen through the first 3 quarters in 2021 to last until 2023, and then as it transitions further forward in the business cycle to have 2 more years with 10% revenue growth. This gives us a target price of $6.99 (181% return).

Blue-sky case – $9.00

The blue-sky case is an alternative assumption that there is a better-than-expected outlook for the growth and operations of a company.

• 5-year CAGR from 2021-26: 20.02%
• 10-year CAGR to 2031: 10.64%

In this scenario, we predict that Razer can sustain its 2021 growth up until 2025. Razer can do this by staying at the top of the industry and being the forefront of innovation within both hardware and software products. This would yield a target price of $9.00 (261% return).

Grey sky case – $5.25

The grey-sky case is an alternative assumption that there is a worse than expected outlook for the growth and operations of a company.

• Implies 8.35% CAGR from 2021 to 2026
• CAGR of 5.13% to 2031

In this situation, we presume Razer is unable to sustain its revenue growth that it has seen the last 2 fiscal years, and slums to 10% revenue growth per year until 2025 before plateauing. With this assumption we believe the target price should be $5.25 (111% return).

Overall, Razer is a good company with strong and sustained competitive advantages this stems from is vertically integrated ecosystem that is well diversified in terms of it’s product and service offering to both businesses and consumers. Furthermore, due to it’s leading position and high quality of products the company user stickiness and brand loyalty is strong. Industry and market forces in the adoption of 5G technology and cloud computer may put the companies hardware segment at risk. However, the company is already looking for ways to capture this trend through focusing on mobile gaming and it’s service segments which are fast developing into the future.

In terms of the privatisation, from a corporate strategy standpoint the take private deal makes sense as based on our analysis the intrinsic value of Razer sits at $6.99 a share which is a 181% upside and suggests that the company is indeed undervalued. If the company decides to relist in New York this could be a good investment opportunity as long as the price is right.