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edicated for CFA Research Challenge 2015


CFA Institute Research Challenge hosted by

Local Challenge CFA Society of Poland J

Video Game Development,

Digital Distribution]

Team J Student Research This report is published for educational purposes only by student competing in CFA Institute Research Challenge

Date 12/02/15

Current Price PLN 16

Target price PLN 16

Recommendation: Hold

Main revenues growth drivers: Market profile  On-going triple-A games 26-week price range (PLN) 16

The business is driven by a high Shares outstanding (in mn) 94

The success of P/E 350

Earnings per share (in PLN) 0

and adjusting to their hardware

 GOG which will start selling triple-A games and will introduce its new platform  A very good reputation of The Witcher saga

We estimate that the company will have high ability to generate cash and will be selffinanced


the success of the company is determined by a very good reception of the W2

We do not believe that the company will be capable of sustaining its very dynamic growth in the future and our assumption is that the CDP will suffer from a decrease of its CAGR

One of CD Projekt's business domains will be sold in 2016 for nearly PLN 20mn (CDP

According to our calculation,

the sales of The Witcher 3 and Cyberpunk 2077 will reach 7mn and 6

We estimate that 2016 is going to be the best year in terms of generating cash flows for the company due to the W3 release

The main factors affecting the CDP’s future is currency risk and perception of gamers

Table 1

The CD Projekt stock price

transformation into CD Projekt Red S

6 4 2 0

Volume (in mn)

Source: The company's data,

The WSE's website

Figure 1 Structure of CD Projekt Capital Group

Business Description CD Projekt Capital Group is a Polish company which operates on the global digital entertainment market and is especially known for its video games development department

It was established in 1994,

but the contemporary form of the business was adopted due to association with Optimus enterprise

In September 2011 the company has changed its name from Optimus S

The brand became internationally recognized among investors in 2002 thanks to initial public offering at the Warsaw Stock Exchange

The main business domains are:


GOG Poland Sp

CD Projekt S

Brand Projekt Sp

CD Projekt Inc

CD Projekt Brand S

The group is cooperating with 17 worldwide sales partners,

what gives it the opportunity to physically distribute on 109 markets (see the Figure 2)

The scope of sales is enhanced mainly by distribution through digital platforms such as Steam,

PlayStation Network,

Source: The company data

Figure 2 CD Projekt’s sales The Witcher 3:Wild Hunt,

Source: The company data

Figure 3 Gross profit per quarter (in mln)

Global digital distribution of games

Distribution and publishing in Poland

Games development

Other activities 5 000 0

Q3 2014

Q2 2014

Q1 2014

Q4 2013

Q3 2013

Q2 2013

Q1 2013

Q4 2012

Q3 2012

Q2 2012

Q1 2012

Development and distribution of video games around the world by CD Projekt Red studio,

Digital distribution of computer games via GOG

Delivery of packaged video games,

pl operating in the Polish market

Consolidation eliminations

Source: The company data

Figure 4 The structure of shareholders Marcin Iwiński Michał Kiciński PKO TFI S

MetLife PTE S

Piotr Nielubowicz Aviva OFE Aviva BZ WBK Adam Kiciński Free float

Source: The company and the WSE data

The company’s main product is an action-RPG The Witcher saga based on Andrzej Sapkowski’s novels

The consumer’s perception of the market position of the game is going to be strengthened by titles like Cyberpunk 2077 and The Witcher Battle Arena

Over 200 high-class specialists have got involved in the process of creating adventures of Geralt of Rivia

Not only graphics,

but also musicians and screenwriters have been engaged in the process of game developing

The Witcher saga total sales have reached about 8 million copies worldwide (until the end of 2014)

According to pre-order data estimated by VGChartz,

almost 240k gamers (a colloquial word for a player) from the U

have purchased the newest title (The Witcher 3: Wild Hunt) via 3 game platforms (PS4,


Game has won over 170 international awards before its release,

including the biggest global public-voted gaming award

On average,


gross profit from sales of games via GOG

distribution and publishing in Poland (CDP

pl) constitutes respectively 35% and 30% of the total profit

The company,

makes a gross profit on sales in the amount of PLN 16

[the above calculation was prepared on the basis of the last 11 quarters] The company’s strategy for the upcoming years can be summed up in the following points:  Release of new products

their developers’ primary focus lies in the highest quality of their products (‘tripleA video games’),

they employ highly advanced technologies to achieve that aim,

 Maintenance of the customers’ loyalty

although such products are mid-range (circa 20 hours of gameplay),

they will also be characterized by the highest quality,

the company has constantly invested in R&D projects to develop platform’s facilities and also strengthen its position in the global market,

 Commercialization of proprietary technology

to third-party developers: the newest version of this multiplatform engine is powering their major releases,

 Entrance into the new domain

so that they are creating new products for users of mobile devices,

The Witcher: Battle Arena

The structure of shareholders by the amount of shares and by the amount of votes at AGM are coincident

During the years 2002-2014,

there were several changes in CD Projekt shareholders’ structure


there are three institutional shareholders (each one holding more than 5% of shares): PKO TFI S

MetLife PTE S

Aviva OFE Aviva BZ WBK (5

The rest of Company’s equity belongs to the treaty of CD Projekt Red shareholders (35

The majority of votes belongs to business founders and Board Members and is split as follows: Marcin Iwiński (13

Michał Kiciński (12

Piotr Nielubowicz (6

Adam Kiciński (3

CD Projekt’s management is represented by professional and highly devoted people

CD Projekt originated as a small commercial business

after the merger with Optimus,

the company evolved into a leading video games developer in the Polish market

Its franchise has started to be internationally recognized after release of the first part of The Witcher saga

Members of CD Projekt S

Board are: Adam Kiciński – President and Joint CEO,

Marcin Iwiński – co-founder and joint CEO,

Piotr Nielubowicz – CFO,

Adam Badowski – Studio Head,

Michał Nowakowski – SVP Business Development

The company,

thanks to its effective management,

has taken advantage of many opportunities appearing on the developing Polish market as a grantee of European Regional Development Fund

Since December 2007 it has managed to carry out six projects,

Figure 5 Projects co-financed by the European Regional Development Fund,


EUR 100k


CD Projekt is conducting three more projects

One of them is dedicated to the upcoming production The Witcher 3: Wild Hunt

Corporate Governance 100%

As company listed on WSE CD Projekt is obligated to comply with corporate governance rules stipulated in ‘Good Practice of Companies Listed on Warsaw Stock Exchange’

In connection with that,

CD Projekt published on its webpage a list of rules,

which are not obeyed by it along with explanation

Main factors having impact on our evaluation of the corporate governance were:

Members of a supervisory board

minority shareholders are authorized to revoke shareholder’s resolution,

a special procedure for appointing members of the supervisory board which allows minority shareholders to nominate candidates,

 Audit and Oversight – the whole board of directors creates audit committees,

annual reports are audited by PKF Consult a well-experienced consulting company

compensation and benefit scheme was made public

On the basis of our evaluation we claim that CD Projekt follows standards of best practice in corporate governance

Lack of special committees the supporting supervisory board as well as the corporate governance officer arises from facts that both the company’s structure is not extensively developed

Project Value

EU financing

Source: The company data

Industry Overview It is estimated that global expenditures on entertainment and media are going to increase from USD 1

Analysis of the global results reveals that inhabitants of the Asia-Pacific region are world’s top spenders in entertainment and media in comparison to inhabitants of other regions

It is worth noting that Central and Eastern European market growth will be significantly faster than the growth of Western Europe’s markets,

although Latin America will be the fastest-growing region over the next four years,

Such expenses are strongly correlated with the global economic situation

In countries with a stable economy,

society citizens’ wealth has increases and thus spending on entertainment are greater


thanks to the Internet and facilities provided by other technologies,

people from all over the world have more possibilities to fulfill their needs in the ways they really want

These days lots of traditional methods of distribution have been replaced by digital countertypes/equivalents

For more information,

Figure 6 Expected Global Game Market in 2014

Game industry revenue (in bn USD)

Gamers (in mln)

Source: NewZoo

Figure 7 Total global spending on entertainment by category 300

US $ millions

In-Home Video Entertainment

Audio Entertainment


Consumer Books

Video Games

Video games development According to Global Games Market Report,

worldwide game revenues amounted to USD 75

growing by approximately 14% as compared to the previous year

The top revenuegenerating region is APAC (Asia and Pacific),

where the game industry generated 42% of total income


revenues of the global games market are expected to increase to USD 102

By contrast,

on the basis of data from Forecast: Video Game Ecosystem,

revenues of the game industry reached USD 93bn in 2013 (Appendix 10 and 13)

Sales of games for TV consoles as the most profitable market segment brought USD 23


revenues from sales of PC/MAC games will grow at 3

while the annual growth rate of games on TV will be four times lower

The total number of video game consoles sold worldwide was about 42m in 2013,

The best-selling TV console was Sony’s Playstation 3,

94m units

Please refer to the Appendix 7 and 8

It is expected that the number of gamers exceeded 1

Europe and Middle East-Africa

The profile of an average gamer could be as follows: age 31 and 14 years of video games playing

There are almost as many women as men(who/that are)playing games

Games are the most frequently purchased by 36 years old gamer on average

According to ESA’s estimates of the best-selling video games,

nearly one in three gamers choose the action genre and also every fifth sold video game is the shooter

Sales of RPGs constitute more than 12% of computer games and 7% of sold video games units

According to Newzoo‘s data,

the Polish games market generated revenues in the amount of USD 280mn and it consisted of 13

They are mainly young men,

who spend an average of 21 hours a week playing games

Earnings of nearly half of working Polish gamers amount to or exceed the national average salary


the vast majority of Polish gamers plays games via PC platform

The most popular game genres are shooters and role-playing games (Appendix 14)

Source: McKinsey&Company’s,

Global Media Report 2014

Figure 8 Global Games Market,


Casula Webgames

80% 60%

(Mid)-Core PC/Mac Games

Mobil Phone Games

Tablet Games

Competitive Positioning To understand CD Projekt Red Capital Group competitive position,

we should take into consideration the fact that the company consists of three businesses functioning in different market environments

All of them have much in common,

but we should remember to analyze each industry very carefully

We want to determine the position of CD Projekt in comparison with its competitors,

its future position in the next years

To achieve accurate results,

we have analyzed CD Projekt Red Studio,

com as compared them to both local and global leaders of their industries,

using analytical methods such as Porter’s five forces analysis and SWOT analysis

Advantage of differentiation of buyers and products’ substitutes

Handheld Games

TV Console Games

Source: NewZoo

Figure 9 Share of total spending on console games (USA) DLC


77% 75%

20% 23%

The modern world of entertainment,

performing a part of media industry,

has wide perspectives of development,

because both customers from developed and emerging markets spend much money on its products: about USD 590mn in 2013,

which is 5% growth as compared to 2012 (please refer to Appendix 9)

We have analyzed the gaming market from a global perspective

The gaming market is characterized by huge bargaining power of mature and aware buyers with specific expectations

What is more,

an easy access to entertainment poses a considerable threat to product substitution

To see more details,

please refer to the Porter’s five forces analysis in Appendix 11

Potential buyers are gamers from all over the world and their number is estimated at nearly 2bn people

The majority of purchasers of games are people who consciously choose products: they are aware of their consumer needs and they also know how to meet them

Due to the strong growth of the game industry,

high product differentiation and unlimited access to substitutes,

bargaining power of buyers is constantly increasing

Another characteristic which has a significant impact on the game industry is wide access to substitute products

Traditional entertainment products such as movies,

board games are becoming slightly old-fashioned in the ‘digital age’,

but they still have its supporters

According to McKinsey&Company’s Global Media Report 2014,

participation of these products in a total global spending on entertainment in 2013 is estimated at 35% compared to 12% spent on video games (Appendix 9)


there is clearly noticeable phenomenon in vogue

It encourages people to do sport instead of spending time in front of a computer screen

Progressive internationalization and increasing number of competitors Source: NewZoo

Figure 10 Porter’s five forces analysis for CD Projekt Red Studio

Bargaining Power of Suppliers

Threats of New Entrants 5 4 3 2 1 0

Competitio n in the Industry

Source: The team estimate

Many well-known international brands (like Warner Bros Interactive Entertainment,

Namco Bandai Games,


Spike Chunsoft,

and Megarom Interactive) have entered into cooperation with CD Projekt,

working together on releasing the newest game The Witcher 3: Wild Hunt


the operational risk of dependence on the only one publisher decreases


the company does not have to be concerned about promotion and distribution,

because it has signed agreements with major local sales partners,

what enables CD Projekt Red Studio to distribute its products in 109 countries

Its main product will be physically available in North and South America,


Asia Continental and Pacific,


Thanks to that they have guaranteed worldwide sales and improvement of their global performance

Bargaining Power of Buyers

Threat of Substitute Products

The company is consistently implementing its strategy of internationalization

In accordance with that strategy,

it also has sold the majority of shares in cdp

which is functioning only in the Polish market

As a result of the transaction,

the company downscaled its shares in cdp

Regardless all those steps cdp

pl still is going to publish The Witcher 3: Wild Hunt on the Polish market,

but its cooperation with the Capital Group depends on achieved bottom line

These ‘international’ operations yield positive results,

but on the other hand they have a sideeffect in the form of an extremely fast increase of number of potential competitors

One of the most important strategic problem is to choose the best date of the product release

It certainly has a great influence on the future company’s future profits

CD Projekt has changed the date of the premiere a few times

That fact confirms us in our conclusions that main product of CD Projekt Red Studio competes globally

Mobile Game Segment The mobile game segment is the fastest growing segment of market

We assume that over the following years this trend will continue

In our view,

over the next few years there will be following key factors leading to rise in market value: Developed markets – increase of the share of paying players

According to Newzoo 2014,

in twoyears time number of paying gamers will rise from 36% to 46% in Western Europe and the US combined

Developing markets – rapid growth in number of smartphones and tablets will make global market larger

It will be an essential trigger of rise in revenues

Hardware innovation – fierce competition among tablet and smartphone manufacturers will drive constant and rapid growth in mobile technology,

creating new opportunities for game developers toattract more gamers and improve the quality of games

Figure 11 Competitive positioning of GOG

Foreign Currency

Console Game



For You

Special Tools

Optional Voting+Customer Review

Media Gallery with Trailers

Forum for Gamers

In our view,

console game producers have a comparative advantage in mobile phone game segment

According to survey the third main reason to start playing a game is,

that a certain game is a sequel of games that gamers used to play before

Loyal gamers who play on console are likely to choose the same game on a mobile phone

Well-known console game brands attract gamers

Gamers also stated that a knowledge of a publisher is one of the most important reasons to choose a particular game

Number of games offered on mobile phones is extremely high due to lower cost of production and other factors

The Witcher Battle Arena

CD project is engaged in a process of developing first free-to-play mobile games

We think that the company has a huge potential in this segment

We base our opinion on following facts

Almost all world-renowned console game developers create games for mobile devices

The console game producers have an advantage of well-known game brand which can help them to obtain a high number of downloads


the company is gaining experience and it's first games will probably not be very profitable


we think that in long term the company will make profit on mobile game segment

Digital Distribution Direct links to: Discussions/ Guides/News/ Official WebPage

MMO Game

Only Own Brands

Graphics of Webpage (Our Personal View)


Source: The team estimate

Figure 12 Best-Selling Video Games by Units Sold 2013 Strategy Other Games/Complications Action Adventure Arcade Casual Children's Entertainment Family Entertainment Fighting Flight Racing Role-Playing

Source: The 2014 Essential Facts About the Computer and Video Game Industry,

Figure 13 Share of digital distribution and physical copies in selected countries

Belgium Netherlands Italy Spain France Germany UK Europe US

Digital Distribution is growing at two digits number

According to ‘Entertainment Software Association and the NPD Group in 2013,

digital distribution accounted for 53% of distribution in comparison to only 29% in 2010

The growth is driven both by the rapid development of the game market for mobile phone and smartphone as well as increase in popularity of digital distribution among gamers

Highly Concentration in Industry

Few market participants monopolize the segment of digital distribution


Steam accounted for more than half of total revenue

Steam webpage offers the great variety of functionality for the users and is not only a virtual shop but also a platform for communication between gamers

Digital distribution provides a higher profit margin for Developers

Retail distribution in more costly (physical production,

Digital distribution offers consumer unlimited access to a great variety of games for people around the world

According to the CDP data,

the net receipt from digital distribution of each The Witcher 3 will be about twice higher than in retail distribution

GOG is the leader in digital distribution of older classical games

Based on analysis of revenue structure of GOG,

we assume that classical games are mostly attractive for gamers who used to play in those games (developed markets)

Global market growth is driven by increase the number of new gamers who could not have a sentiment for older games

Additionally the number of older games,

which could attract gamers is limited

We think that in the long run GOG could not grow only by adding additional games to portfolio

Based on the official presentation,

we assume that GOG Galaxy will be offering new functionality

Technology gap between Steam and GOG will become smaller

Advantage of GOG is base of loyal customers who support DRM-free policy of platform but the mainstream publisher still relies on DRM and do not want to cooperate with GOG because of lack of DRM protection

We assume GOG Galaxy due to a new technology will be able to limit unauthorized copying without the necessity of internet connection

GOG have loyal customers who support DRM-free policy of platform

We assume that when new titles will be offered by GOG,

DRM-free supporters could change platform only because of their personal belief

SWOT conclusion GOG

com is a digital distribution platform offering a wide range of computer games,

A SWOT analysis helps to look at the company’s internal strengths and weaknesses,

and also to identify external opportunities and threats

One of its strengths is an international cooperation with publishers and developers from all around the world,

which supports product diversification

The GOG’s weakness is the fact that the platform is focusing on the sales of old titles,

whose distribution isn’t as profitable as distribution of the newest releases,

especially ‘triple-A video games’


the fast-growing digital industry offers opportunities for effective development of the business and acquirement of new competitive advantages


one of the threats is that Steam will further strengthen its position in the market

Please refer to the Appendix 12 for the SWOT analysis

Share of Digital Distribution Share of physical copies

Source: The team estimate

Figure 14 Global Games Market 2012-2017

Investment summary 102,9

Sustainable improvement of financial position

Total Games Revenues (in bn)

Source: NewZoo

Figure 15 CD Projekt S

stock price and WIG20 index performance in the last 5 years CD Projekt

So far,

CD Projekt has not paid any dividends to its shareholders

It also do not use long-term loans

The company benefits from such political conditions as e

the fact that Polish companies can utilize European Funds as members of EU with developing economies

Possible Investment Risk

Mobile Game Revenues

The CD Projekt financial situation in short-range forecasts is acceptable for current investors and for those who would like to invest short-term basis,

especially among Polish stock companies

CD Projekt is approaching the release of its new valuable product,

namely The Witcher 3: Wild Hunt,

which seems the most significant driver for the growth of the company’s future value

Investors should be aware of two risks with the highest impact on the company and its profitability,

apart from high fluctuations of exchange rates

The company has to expand its activities,

adapt to rapidly changing trends in consumers’ needs and also keep on updating its strategic goals

One of them is perception of developed game risk

the final sales results will be significantly lower than our estimates


the huge impact on the structure of CD Projekt’s revenues has seasonality of the game sales

The rest of investment risks has been identified in Investment Risk section

Hold the Witcher’s producer

Our recommendation for CD Projekt S

is to Hold stocks with a target price PLN 16

which is very similar to its current price of 16

The analysis in terms of attractiveness of the whole industry and prepared valuations confirms strong position of CD Projekt S

CD Projekt has a leading position within the Polish WIG Informatics index and it is the leader on the domestic market as a video game developer and as a provider of different types of entertainment

Valuation Methods

Source: The team estimate,

Data as of January 29,

Our target price was derived by using the Discounted Free Cash Flow method

The approach was chosen because the company’s sales have significant a seasonal factor

By 6 years period,

we captured 2 such periods which lasts 3 years each

Our terminal growth (3%) derives from the strong fundamentals of the Polish economy

We assume that both video game development and digital distribution will still grow but slower while the physical distribution in Poland business will be sold in 2016

Industry overview and its prospects

Table 2 Total Sales until 2020 forecast for the Witcher 3

The company is operating in a steady growing entertainment industry

Consumers are spending more on entertainment and media YoY – 6

The rapid development of new technologies and continuously rising consumer demand are the reasons for which further growth directions have been appearing

Looking at global gaming market,

its revenues are expected to increase to over $102bn,

with its fastest-growing market segments being mobile phone and tablet games as well,

2% and 28

Doubtful long-term increase

Retail Distribution

Digital distribution

1 493 100

614 900

2 108 000

Europe and the rest

3 348 000

1 397 900

4 745 900

According to our calculations nearly 70% of the company’s future assets of the company are going to consist of cash

This fact may lead to a conclusion that the management should implement a well-thought-out strategic plan to guarantee stable long-term prosperity of the company

As the company’s cash generation ability is relatively high,

it should use its own funds to create and implement a new investment project


the business is going to be unprofitable

4 841 100

2 012 800

6 853 900


Source: The team estimate

Table 3 Total Sales until 2020 forecast for Cyber Punk 2077 Retail Distribution

Digital distribution

1 255 000

598 000

1 853 000

Europe and the rest

2 936 000

1 425 000

4 361 000

4 191 000

2 023 000

6 214 000

In order to valuate CD Projekt S

we used 2 methods – DCF model and ratios model,

The first method consists of the estimated cash flows in the following 5 years (2015-2020,

with taking into account different scenarios

The ratio analysis has a zero weight because we assume this business too cyclical

Several ratios,

such as P/E may be not too accurate because Price discounts expectations of future earnings while Earnings (Net Profit) are strictly accounting-driven measure

DCF Model Sales

Source: The team estimate

Video games development We have estimated Sales according to other AAA games (Table 2,

The most convenient video game which is comparable in both production cost and genre is Destiny (Appendix 17)

We consider it also as a game heavily based on preorder sales


it was released in the middle of 2014

Also counted how does the game sales outside the EU and US (Appendix 26) The next step were estimations of the console base

It is important to notice that The Witcher 2 was released when there had already been dozens of millions of PS3

To estimate how much the fact

Figure 16 Estimation of Sales as a percentage of Total Sales of The Witcher 3 and Cyber Punk 2077 in the following years after a game release 60

Our assumption is that a fraction of gamers who will buy the CDP’s product is going to be the same as in the case of Dragon Age 3: Inquisition

We consider the mentioned game as a good indicator as it is also from RPG genre and had a similar budget

To estimate the sales pattern of both The Witcher 3 and CyberPunk 2077,

we used the median value of sales for 7 AAA video games (Call of Duty,

God of War,

Tomb Rider,

which was released in the 1st or 2nd quarter of the year

We have omitted the releases during Christmas time (Appendix 24-25)

of a lower number of consoles affects sales of The Witcher 3,

we have used historical data of the new generation consoles in the last months

By calculating the whole pattern of triple-A video games sales,

we have assumed that in the first year,

The Witcher 3’s sales will equal to over 60% of its lifetime sales (Figure 16)

Among other things,

in conjunction with very high hardware requirements we decided,

to flattening of sales to 50% in the first year (Appendix 14)

Five independent report results are that video games market is going to grow dynamically with the medium value equals to 8


Newzoo has published estimations from which we can read that PC/MAC will be growing to 2017 by 3

Based on the Newzoo data,

we calculated how it will shape the relation of sales between consoles and PC and average growth (Appendix 18-19)

Source: The team estimate,


The CybePunk77 estimate is performed in the same way as in the case of the W3,

we believe the total sales will cover only 85% of total sales for the W3

It is due to the fact that The Cyberpunk,

is relatively unknown outside the U

S (Table 3,

Figure 17 GOG

Source: The team estimate

Physical distribution GOG Video game development

100 000

Source: The team estimate

Table 4 Weighted Cost of Capital for CD Projekt S

Poland 10Y Bond YIELD (R F rate)

Equity Risk Premium

Risk for the Polish market SEM

Risk for the US market SUS

Country risk premium

Beta monthly data

Adjusted monthly beta

Source: The team estimate,

After 5 years,

we assume the stabilization of Sales (low price,

more customers in the emerging markets)

GOG In the next years,

Sales for GOG will increase,

It is because there is a limited number of old titles to acquire that can be sold on the GOG platform

We think that the growth in Sales will be partially driven by entering new segments of the market,

such as movies and newer titles (from 2010s)

Between 2014 and 2016 CAGR in Sales will converge to 6


Figure 18 Net profit breakdown

150 000

In our estimation,

total units sold will be divided equally between the U

and Europe while the rest of the world share will equal to 16

We have assumed that a factor of growth in total revenues lies in gamers from Asia,


As previously mentioned,

though video games market will be growing,

this tendency is going to shrink in the developed countries

The expected growth for those 2 regions is weak and equals to nearly 0%-2%

Video games development We have assumed that margins will be lower in case of video games developing and GOG

In the first case,

it is due to the increasing cost of labour

We believe that salaries of high specified knowledge workers will converge to the Western Europe and North America numbers

EBITDA margin will decrease

GOG Our expectations are that margins for GOG will decrease

The strategy of acquiring old titles is going to change because of capacity of the old video games market,

as mentioned in the previous section

CD Projekt will have to switch to acquisition of newer titles

As a unit cost of more recent video games is higher,

we believe it will surely affect margins in a negative way

At this point,

GOG is a niche entity and the leading one in its segment

Having a position of a monopsonist helps the company to improve its additional markup

With newer titles,

by which we mean video games from 2010s,

the entity is going to position itself in a much broader and competitive market

Full graph of EBITDA margin is in Appendix 18

Retail distribution In this segment,

margins will remain constant as the company does not consider any changings in the near future,

except for eventual selling this part of the business

WACC In our estimation,

calculated Weighted Cost of Capital equals to 10

We have utilized CAPM model by performing regression of CD Projekt’s stock monthly returns against monthly returns of WIG20

Period used for calculations consisted of the last 5 years (period between December 31,

Obtained Beta coefficient equals to 1

which is still game development and digital distribution,

We think that diminishing share in revenues from retail distribution will be offset by a greater share of GOG,

which operational risk is the similar

The company does not have any debts,

and does not wish to have any in the future


WACC equals to Cost of Equity

CAPEX The core business of CD Projekt is not capital intensive

Most of its costs are incurred immediately,

for salaries for its employees


we think CAPEX will equals to roughly 1

Dividends We assume that the company is going to continue no dividend policy

CD Projekt relies on 100% self-financing,

so we assume it wants to have some buffer in the future

Tax We have assumed that tax rate will remain constant over the period of our analysis

Terminal Value The terminal value was based on the average cash flow in years 2017-2019

This assumption captures the whole cycle for the company – from a year before a game release,

to a year after a game release


we assumed terminal growth to be 3% as we believe it is the long-term GDP growth in Poland

Table 5 Cash Flow and Terminal Value Forecast mn PLN

Net Sales

159 882

499 659

250 223

251 052

567 195

228 405

146 548

150 473

172 633

187 383

173 326

188 162

+ Depreciation = Net Operating Cash Flow CAPEX

Change in NWC

-18 461

-72 697

-98 738

=Free Cash Flow

108 553

162 441

159 451

=Discounted Cash Flows

133 967

PV of Cash Flows

481 816

Discounted Terminal Value

1 063 389

Equity Value

1 545 205

Number of shares (in mln)

Share price

Source: The team estimate

Sensitivity Analysis In this section,

we have performed the sensitivity analysis with WACC and Terminal growth as variables

Default values,

12% and 3%

In the following matrix of results,

we have shown the dependence of price on WACC and Terminal growth

The values differ significantly and this is determined by the fact that we have estimated only 31% of value by Discounted Cash Flows in years 2014-2019

The most of variation comes from Terminal growth factor

Due to the fact that we have estimated Terminal Value with Gordon Model,

the results are especially sensitive when Terminal growth converges to WACC

Table 6 Sensitivity matrix for CD Projekt stock price WACC

Terminal growth

Source: The team estimate

Comparable Valuation We think that comparable valuation approach is not suitable for CD Projekt

First of all,

CD Projekt releases one game for every few years

Profits from developing games are the most important drivers of earrings but are very violate due to the fact that roughly 60% of them is generated in the first year

International peers release games every year,


in last quarter’s ,due to lack of release of new games,

The digital distribution segment is not such an important driver of profit for peer’s companies

the major international competitor in digital distribution,

is not a public-listed company and its financial data are not distributed into public and hence could not be used for valuation

We have performed peer group multiples analysis

The group consists of the major international competitors such as Activision Blizzard,

Electronics Arts,

Ubisoft Entertainment,

and other game developers and distributors


we have excluded Ubisoft Entertainment from comparable valuation because its impact on mean has been too huge due to extremely high P/E in comparison to others

Financial Analysis We have used financial ratio analysis to research the ways in which CD Projekt is currently performing and compare these results with the past performance and financial situation of the company

Self-financing and cash generation abilities The company mainly uses internally-generated funds to finance and expand its activities

In addition,

CD Projekt has effectively utilised grants received from the EU to realise its projects

In our opinion,

cash generation ability of the company’s core activities,

especially future earnings from sales of The Witcher 3: Wild Hunt and Cyberpunk 2077,

and also revenues from distribution via digital platform will be enough to cover expenses in a long-term perspective

The liquidity ratios have confirmed CD Projekt’s ability to meet its obligations without any difficulties (Current Ratio 2012: 2

48 2013: 2

We predict such a trend will increase in the estimated period

The amount of the most liquid possessed assets will be 3 times greater than shortterm debts in 2017 (Cash Ratio 2017E: 3

For more key financial ratios please see Appendix 4

In previous years,

it took the company only 66 days on average to collect account receivables

Payments are being carried out so quickly in view of the most commonly used method – made by credit cards

That’s why,

this trend will continue in the projected period

The average inventory days ratio was 97 days during the period between 2011 and 2013,

the ratio for 2013 amounted to more than 133 days due to ongoing preparation for the huge release

We expect that the ratio will increase to an average of 132 days in the period of forecast due to the work of games development in progress and the physical delivery of future titles

Profitability Ratios Gross Profit Margin decreased over the years 2011-2013,

The changes of margins may depend on the product lifetime

Developing of the main product – video game,

which generates the majority of changes in revenues and costs of sales,

After the releases of The Witcher 3: Wild Hunt and Cyberpunk 2077 (2015E – 2018E),

Gross Profit Margin is expected to remain above 50%

Other businesses (GOG

pl) are generating a rather sustainable profit YoY

Costs are balanced by revenues

Maintaining constant correlations,

the Gross Profit from sales increases while the costs are lower or while the scale of sales expands

In the researched period 2010-2013,

the company was still building up their core business – developing of video games

The quality of their products improves so that total costs were constantly growing

We assume that usually the release of a new video game is a reason,

which has the main impact on gross profit from sales

The changes are cyclical,

but the Gross Profit Margin of CD Projekt Capital Group is rather stable thanks to profits from other businesses

Operating Margin as well as Gross Profit Margin could be analysed in the context of product lifetime and thus Operating Margins is expected to reach the highest rates in years 2015E: 29

while the company’s’ main products will be released

To confirm,

it is worth noting that the highest ratio in 2011-2013 was recorded while The Witcher 2: Assassins of Kings was released (2011: 20

Calculation of a Net Profit Margin shows us that every PLN of sales allowed to the company earn: 17

5% in 2013

According to our calculation,

the CD Projekt will be able to cover its operating costs including indirect costs

Return on Assets displays that CD Projekt is able to turn its assets into profit

Even comparing CD Projekt ROA in 2013 (6

CD Projekt has found the way to operate more efficiently against its competitors

We expect future level of return on assets ratios to be an average of 8% in mid-term


ROA is estimated to amount only 1% in 2014E due to delays in the process of game development

Figure 19 Matrix risk for the CD Projekt

Return on Equity forms as follows: 19

9% in 2013

In comparison with CD Projekt ROEs,

Polish Treasury 10-Y Bonds return was about 6

73% and 4

Our analysis shows that levels of ROE in 2015E-2019E will be attractive for investors,

however it should be taken into consideration that a potential for further and stronger growth is highly limited

There is a strong correlation between results of ROE and games’ releases

The company's profits depend on the quality of developed and sold products and therefore the purchasers’ satisfaction

Investment Risks Concentration of Revenue Among Top Titles ‘Hit’ titles earn a significant portion of total revenue in each segment

According to The NPD Group,

in 2013 the Top 10 bestselling titles accounted for 38% of the sales in the industry in the USA in comparison to 30% in 2012

Market participants expect that trend will be continued in the industry

The CDP needs to deliver the best games in each segment

otherwise revenue could significantly drop

Annual Report 2013,

Electronic Arts Annual Report and Proxy Statement 2014)

Please be informed that detailed analysis of Investment Risks is presented in Appendix 34,

35 and 36

Source: The team estimate

Console and Equipment Figure 20 Estimated sales vs Metacritic rating

Introduction of new console system produces additional cost of switching

During transitory period game developer release titles on both console,

Constant improvement in game quality is the effect of increasing computing power of hardware

The CDP success will depend on ability to develop the best game on upcoming platforms

Piracy Risk Entertainment software industry is highly affected by data piracy laws and consumer attitude to piracy

Intellectual protection on the internet is the key issue for the whole entertainment industry

Percentages of illegal software used by consumer differ significantly across countries

According to Business Software Alliance Survey,

the global rate at which PC software was installed without proper licensing was 43% in 2013 in comparison to 42% in 2011

Perception Of Game Source: Ars Technica

Green dots represent the median sales performer at every individual Metacritic score

Figure 21 Monthly salaries across industries in Poland and USA

Perception of Game is the key point to success in the game industry

As a result of one game under consumer’s expectation,

perception of a whole franchise may be harmed

The CDP could incur substantial costs and also lose both customers and revenues

Channel Partners Risk Video games are sold to customers through channel partners as Sony,


They have a freedom to set rates that the CDP must pay to provide games via online channels

Channel partners could change fee structures for online channels

It could adversely impact costs,

which led to a loss in profitability and margins

In comparison to PC producer,

Sony and Microsoft need to accept a game before release

According to ‘PWC Global entertainment & media outlook 2014-2018’ Hong Kong total game consumer spending on PC games will decrease 13% from 2013 to 2018 but spending on console game grows 22% from 2013 to 2018

It is highly probable bargaining power of console producers will increase

Personnel Risk In this industry,

Good reception of CD Projekt-produced games opens their personnel opportunities to work for other companies

Salaries offered by top entertainment software producer located in the USA are greater than these offered by the CDP

this brain drainage is highly possible

Risk of Change in Public Taste and Preferences

Source: Bankier

All values on vertical axis in PLN

Figure 22 EURPLN and USDPLN exchange rates

Video games are a substitute for watching TV,

going to the cinema and watching movies

According to Entertainment Software association,

about 45% gamers who play more video games than they did three years ago are spending less time watching TV,

going to the cinema and watching movies

Change in public preferences connected with spending a leisure time could have a negative impact on the industry

European Union Funding CD Project use conditional funds form European Union

The company need to fulfill all provisions of agreement in other case will be obligated to return all money

The extension

The scope of EU funding show Figure 5

Risk of Change in primary devices used to play video games Constant and rapid development of personal devices like tablets and smartphone could change public preferences

Improvement of hardware system could lead to switching game player from PC and console to tablets and smartphone

According to ‘Newzoo Global Games Market Report’ global mobile games revenue is forecast to rise at CAGR of 19

Main drivers of growth will be rising smartphone ownership which will lead to increasing access to mobile phone games

Risk of Seasonality Video Games business is seasonal with the highest quantity of sales in the 4th quarter due to Christmas time

All delays in production could adversely impact revenue if a game would be not finished on time

Currency Risk The CDP operates in Poland but most revenue,

earns in foreign currencies (U

Hedging position is possible only in short-time and generates costs

Change in exchange rates could adversely impact company profitability and margins

As it is shown on Figure 7,

the market volatility for those quotations were especially high during the crisis

If it occurs the next time,

CD Projekt will suffer from it with a high probability

Source: The team estimate,

Left axis contains values for exchange rates,

right axis contains 60 days standard deviations of log returns for quotations

APPENDIX Appendix 1 Comprehensive balance sheet in years 2011-2019 ASSETS

108 690

122 588

194 413

442 647

479 997

557 208

810 400

799 950

177 124

339 565

416 360

511 008

670 459



166 498

189 003

Other current assets

Fixed assets

100 339

104 305

108 564

113 136

Current assets Cash and cash equivalents

PPE Intangible assets

Long-term investments Goodwill Other non-current assets Total assets LIABILITIES Current liabilities

918 964

913 085

196 661

125 498

106 390

182 475

130 081


104 954

119 140

Other current liabilities

120 672

196 661

125 498

Long-term liabilities

Short-term borrowing

Long-term liabilities Other non-current liabilities Equity

Retain earnings

123 809

151 530

167 368

175 578

350 165

443 604

524 607

715 652

780 937

201 655

200 150

208 256

220 834

220 834

220 834

220 834

220 834

220 834

101 530

111 530

161 748

274 274

Other equity components Net income Total liabilities and equity

113 522

112 526

185 726

202 892

217 635

288 619

539 291

580 336

661 513

918 964

913 085

Source: The team estimate,

CD Projekt data

Appendix 2 Profit and loss statement in years 2011-2019 P&L STATEMENT

136 210

164 040

142 172

159 882

499 659

250 223

251 052

567 195

228 405

114 214

215 619

112 426

117 567

239 636

118 207

Gross profit (loss) from sales

284 040

137 797

133 485

327 559

110 198

138 044

180 679

146 548

150 473

Sales revenues

Other net expenses EBIT Net Financial Revenues

149 351

160 677

Tax Expense Profit from continued operations Profit from discontinued operations

172 633

187 383

Net Profit

172 633

187 383

Source: The team estimate,

CD Projekt data

Appendix 3 Cash flow statement in years 2011-2019 CASH FLOW STATEMENT Net Profit