Dissecting Luminosity Gaming's Financials

Disclaimer: the information contained herein is not intended to be a source of advice with respect to the material presented and the information does not constitute investment advice.

Roundhill Gaming, an RIA focused on the esports and gaming space, recently did an interesting twitter thread about the financials recently released by Luminosity Gaming that I found to be particularly enlightening. As a result, it encouraged me to look into these financial statements myself and see what I could learn and what I could share with you all.

But first, what is Luminosity Gaming? It is an esports holding company with several franchises in several different leagues, including titles such as Call of Duty, Hearthstone, World of Warcraft, Smite, Overwatch, Tom Clancy's Rainbow Six: Siege, Fortnite and Apex Legends. It was founded in 2015 and is based in Toronto, and operates a US presence as well. It is one of the fastest growing esports franchise owners out there. But to be clear, they don’t just own one esports franchise (and it’s not technically correct to call it a franchise, but we are going to use that for simplicity’s sake). Like the Kroenke Sports & Entertainment (owned by Billionaire Stan Kroenke), they own a ton of different franchises in different leagues. Kroenke owns the Los Angeles Rams, Arsenal (of the English Premier League), Denver Nuggets of the NBA, Colorado Avalanche of the NHL, Colorado Rapids of Major League Soccer, Colorado Mammoth of the National Lacrosse League, and the newly formed Los Angeles Gladiators of the Overwatch League. This shouldn’t be too surprising - a lot of the venture backed esports “teams” actually own multiple teams. So looking at their financials tells the tale of owning multiple teams, not just one entity.

So why does it matter that we look at their financial statements? Most esports competitive organizations are either (i) privately held and still in startup mode, or (ii) owned by massive publicly held organizations who don’t list out their financials in such specific detail. Either way, it’s very difficult to find a good composite picture of what the financial state of these businesses look like. So when you get an opportunity like this, it’s worth digging into.

And how did these financials become public? Well, it’s a long story, but it ultimately boils down to an extremely complicated transaction between Luminosity, Enthusiast Gaming, and a couple of other companies. Luminosity essentially became an arm of a publicly traded company based in Canada. And whenever a transaction like this occurs, a pretty significant amount of information needs to be made public for the shareholders of the new company. You can find the financial information here, on SEDAR’s website.

As we dive into the financials, I think it’s important to remember that this is just one company. Although it’s a decent proxy for understanding the inner workings of a competitive gaming organization, it cannot possibly tell the whole story. Also, I already put the disclaimer in here, but this is in no way financial advice and should not be taken as such. This is not any sort of recommendation and, at most, this should spur conversation and not generate directional movement.

First, let’s look at Revenue. The Company made ~$3.8 million in revenue in 2018, which represents a significant increase from the two prior years. This increase is largely due to the growth in streaming revenue. Streaming made up 60.3% of overall revenue in 2018, by far the largest source of income for the Company. However, the Company’s streaming contract in Q1 2019 expired, so they lost a significant portion of their revenue at the first half of this year. As a result, it’s hard to tell exactly what the revenue multiple was for this company when acquired, but the stated acquisition price was around ~$20 million (mix of cash and stock), which would imply close to a 5.0x revenue multiple. It is important to note that Company is currently in contract negotiations for renewing that streaming contract.

Where does this streaming revenue come from? The Company receives streaming revenue based on the numbers of viewers and amount of time spent watching its players. So as the brand grows more popular and attracts more attention, it increases its potential gain from streaming. As far as I can tell, it’s not disclosed what legal entity this contract was through, but there are only so many places to look.

One of the offsetting revenue declines was a decrease in Sponsorship Revenue. The MD&A points out that the decrease in 2017 and 2018 was largely due to not being appropriately staffed in this department - they made a hire in 2019 that they hope to remedy this issue. Also, sponsorship revenue and merchandise sales can be driven by team performance - so when they win tournaments (like the 2016 MLG Major Championship in Columbus, Ohio) they tend to do better in that department.

The Company also credits its decrease in prize revenue to the increased competitive landscape in the sector. As more and more esports franchises pour into the space, there’s a good chance that a dilutive impact occurs to the top-line revenues for these companies. Growing pains are to be expected in such a wild, wild market. This should, in theory, be offset by an increase in attraction to the space, increasing the revenue that leagues and events bring in, which can then be distributed to more teams (via streaming and other league fees). This is an important trend to follow - if that equilibrium gets out of whack, the space might overheat. On the otherhand, teams might focus less on just winning and more on attracting fans via personality.

The Company’s operating expenses are broken out from its salaries and player contracts. Opex for the Company is largely focused on travel for a variety of league play, which can include traveling all over the world. Competitive gaming is a global phenomenon, and globe-trotting can be expensive. However, the largest expense for the Company, by far is player contracts. The economics for any sports organization can be tough because they are largely set by the contracts you can pay your best players. For some leagues, like the NFL, there is a salary cap which can massively improve your margins because it artificially suppresses the amount you have to pay your players. This means your gross margin is purely a factor of how much revenue you bring in. However, if you operate a team in a league without a salary cap, there are competitive natures which can cause businesses to be much less profitable or even extremely unprofitable. Most esports leagues don’t have salary caps because they are way too early in their maturation to even consider something like that. But it’s something to keep your eye on as valuations for these teams increase. The gross margin (Revenue less Player Contracts for Luminosity in 2018 was 19.9%. For context, the gross margins for a software company are expected to be between 75-80%.

Despite the low margins, for year end 2018, the Company had a positive net cash flow. One note that’s particularly interesting about the Company’s cash position is that Luminosity has never raised outside capital. According to its MD&A, the Company has funded its efforts purely through revenue generated by operations. However, there is mention that the Company’s future will likely rely on it issuing debt, which could help accelerate growth. Now that it’s a part of a larger, stabler organization, it could issue debt at a cheaper rate (probably) and generate more value from that capital.

The financials for Luminosity paint a pretty interesting picture. This a bootstrapped, global brand that has found a way to turn on the revenue stream (pun intended) through various mechanisms. The biggest question mark for the Company moving forward is its ability to land a solid streaming contract. It seems hard to believe, with the growth in gaming, that this doesn’t occur, but it is the lynch-pin for the Company’s success.

Disclaimer: this blog is not a broker/dealer, we are not an investment advisor, we have no access to non-public information about publicly traded companies and this is not a place for the giving or receiving of financial advice, advice concerning investment decisions.