(Please note: going forward, titles and the introductory paragraph to new idea write-ups will not include the name of the given company being analyzed for 3-4 weeks post publication. This is to further protect and enhance the value of the idea discovery being offered to subscribers)

What if I told you there was a small company growing extremely quickly in a hot (and getting hotter) sector, led by a founding owner-operator who still owned 40% of the stock; that already possessed a dominating brand position and premium products; that was also already profitable but seeing an explosion in operating earnings as revenues hockey-sticked; and that had no meaningful debt – is that something you might be interested in? What if I further told you this same company traded at 10x current year earnings, and around 7x EBIT – despite putting up 75% topline growth last year and seeing growth accelerate to 91% in Q1 – and only 5x EBIT/6.5x P/E on next year’s (conservative numbers)? How interested would you become?

It’s not often I begin a writeup gushing like a used-car salesman; on the other hand, I am not sure I have ever found a bargain like Endor AG (Munich: E2N), the subject of this analysis. Upon discovering the company, I truly felt like a kid in a candy-store – such was my delight at the combination of secular growth; company and product positioning within its industry; and, of course, the eye-wateringly cheap valuation. Putting it another way, it’s not often you find stocks where you think the market hadsthe price wrong by 50% looking out a year; but finding a stock where you think the market has the price wrong by 3x today – well, that’s a rarity indeed.

Enough lavishing of praise for now, let’s consider some of the obvious reasons why the stock is so cheap, upfront. Endor is a small-cap, German company, listed on the Munich stock exchange – that is, not the major Frankfurt exchange. It is illiquid, only trading 100-200k EUR in value per day, often with wide-ish bid offer spreads (1-2 EUR bid/offer is not unusual). Furthermore, there are NO English financial disclosures (that’s right I did a lot of Google translating!); and overall disclosures, even in German, are sparse. For example, here we sit in mid-May 2020, and yet the company has only reported revenue and net income for 2019 – no audited balance sheet, or income statement. It gets worse: even for 2018 (the last year we have audited financials), the company discloses precious little by way of segment or additional information in the footnotes; and as a small German company under local laws, they are not required to file a cashflow statement.

You can probably understand, then, why this company hasn’t garnered many eyeballs so far. And yet, as we shall discuss, this is all part of the opportunity. For if a growth story with this trajectory and such a strong near-term performance was already on a major exchange, publishing English financials, or – heaven forbid – listed in the US on the Nasdaq, there would be no valuation arbitrage available to report, as the stock would already trade at 50x earnings. In this case, then, the opacity, and detective work required at times, is the essence of our opportunity.

With that preamble out of the way, let’s dive in. This report will be lengthier than normal (there is a lot to discuss), and will be divided into the following sections:

1. Introducing Fanatec – it’s all about the brand
2. iRacing: secular interest in the sport is exploding
3. Piecing together Endor’s 2019 financials
4. Modeling 2020/21 and thinking about future earnings potential
5. Valuation is beyond compelling
6. The competitive landscape and other risks

Introducing Fanatec – it’s all about the brand

Endor AG is a holding company whose sole business is Fanatec: a manufacturer of premium iRacing accessories, such as steering wheels, wheel bases, pedals, shifters, etc, used by gamers as they engage in virtual races against competitors online. These accessories ‘bundle’ together in various configurations and can be used across PC games, Playstation, and Microsoft Xbox racing games of many types. You can see the full suite of their products here, but to give a sense of some of their main offerings, I have included screenshots below:

iRacing/sim racing is a niche but rapidly growing segment of the eSports market, revolving around video gamers engaging in virtual races against one another over the internet. As you can imagine, the quality of your experience as a gamer – either a casual player or as a professional racer – is directly related to how realistic, and how immersive, your experience is. In many ways, Fanatec’s products become the gateway to this experience: for professional racers, Fanatec’s top-of-the-line pedal sets and highest-end wheels allow them to shave time and simulate exactly how a real car would perform on the track. For more casual gamers, entry-level products allow for a still-slick entry into the world of sim racing. Endor’s founder and CEO, Thomas Jackermeier, explains much of the ecosystem in this video.

If you spend any time at all exploring the Fanatec site you will immediately notice a number of characteristics of the Fanatec product:

• these are expensive, luxury items: racing/steering wheels begin at 400-500 EUR, and complete integrated bundles (comprising wheel/wheel base/shifter/pedals/etc) often run in the the thousands of EUR;
• branded, custom products: Fanatec manufactures specific branded products that match exactly the specs of auto OEM racing cars. Hence the Porsche wheel is designed to look and feel exactly like a Porsche racing wheel; the same for BMW, etc. Fanatec has an exclusive license to manufacture the F1 and World Rally Championship (WRC) iRacing products as well;
• direct distribution: Fanatec self-distributes almost all their own products, with only extremely limited third-party distribution (the only online channel is Amazon, for example, outside of Fanatec.com and even that is a very limited selection). In other words Fanatec controls the availability and route to market for all their products;
• committed, hardcore fans/customers: even a cursory review of the Fan Forum site demonstrates a huge affinity for the product with many items sold out within days of release, and mostly repeat customers.

In other words, before we even examine the industry and the company’s position within it, it’s crucial to realize that whilst these are technically ‘accessories’ to video gameplay, they are in fact highly engineered, value-added products – more akin to a core components business than a typical video game accessories business (such as headset manufacturers). Since a good portion of the user base is either a professional iRacer, or a very serious amateur, there is a real cost to switching equipment – something that is difficult to argue applies to other gaming peripherals like headsets or controllers. The fact that there is such a cost to switching – and an obvious benefit in trading up to the higher-end, higher-margin products – also benefits the Fanatec business flywheel in ways similar to other branded luxury manufacturers (like Ferrari, for example). In short, there is real brand value here.

Let’s go back to the roots of the company to examine how this superior brand positioning developed. The company’s origins stemmed from Jackermeier’s unsatisfaction with the quality of video-game controllers on the market in the mid-1990s (the founder was a hardcore gamer). In the early days, Endor sold a range of PC products such as the legendary joystick “Game Commander” / “Alpha Twin” or the official “Command & Conquer Mission Controller” trackball, before moving on to focus specifically on steering wheels for gaming after the successful launch of the “Le Mans” steering wheel for the PC.

Fanatec’s first hit product in racing was the official PlayStation-licensed steering wheel, the “Speedster 2”:

Thereafter Fanatec focused more on wheels and became the first to develop ‘force feedback’ capable wheels for the Xbox 360 (a huge enhancement in mimicking real racing for the time).

By the early-mid 2000s, Fanatec had evolved from developing equipment in partnership with the console manufacturers to working with premium automotive OEM brands. This was an important shift, and perhaps the key strategic development for the company, as it began to align the brand with the premium quality of its OEM partners. This relationship began with Porsche, as Fanatec steadily created true-to-original iRacing versions of various Porsche vehicle wheels such as the 911 Turbo S, the 911 GT3 RS; the Carrera; etc.

Other OEM partners such as BMW followed. Post IPO in 2006, the focus became exclusively sim racing/iRacing products. Wheels remained the core competency, but Fanatec expanded into offering a full range of products (pedals, gear shifts, etc) as well as expanding distribution into new geographies beyond the core European and North American markets.

By the later-2010s, having worked with the premium German OEMs for over a decade, the next step was to align with the key global motorsport organizations. More recent milestones have been a series of license agreements entered into by Fanatec with Formula 1 (F1), in 2018; Nascar, in 2019; and earlier this year, World Rally Championship (WRC). This led to new branded products like the F1 racing wheel, seen below (one of the hottest products in the space at the moment, and already sold out):

These license agreements are incredibly significant, both because they give Fanatec the exclusive right to develop and sell custom products (F1 wheels, for example); and also as an extension of the brand. Whenever F1 holds a big race event, they invariably co-brand iRacing events around the actual race, with professional iRacing teams competing and Fanatec products on display front and center (of course F1 is now running its own full iRacing competition independent of physical races, as well). Concomitantly, this further integrates Fanatec into the premium racing ecosystem, both in the minds of core gamers/pros (who likely already rely on Fanatec equipment) and the newer fans who are consuming or partaking in iRacing for the first time. It really is a virtuous cycle and key to the brand positioning of the group.

The final piece in the brand-building puzzle is selective sponsorship of key iRacing athletes/teams. The most important of these relationships is Fanatec’s sponsorship of Team Redline – an iRacing club with a storied 18-year history; the most competition success amongst iRacing teams; and led by top F1 driver, Max Verstappen (lending ‘real-world’ credibility). Simply put, Team Redline is the New York Yankees of iRacing. By sponsoring the best iRacing team in the world, Fanatec further credentializes the premium nature of its brand and product offering.

iRacing: secular interest in the sport is exploding

So, I think it’s fair to conclude that Fanatec (and so Endor) has an enviable position in the iRacing world, built upon over two decades of steady technological and product specialization; and association with and support of the highest quality brands in motorsports. But what of iRacing itself? Why is this space so interesting right now?

Whilst iRacing/sim racing has had a hardcore niche for a long time, and while Fanatec has been growing (off a low base) steadily for many years, all the signs point to a potential ‘tipping point’ for the sport in recent months. Today, iRacing interest is exploding and rapidly going mainstream. No doubt part of this is related to COVID, where virtual racing in the main competitions (F1 etc) has continued unabated, garnering consumer eyeballs that would no doubt have stuck with other sports like the NBA or football had they remained on. Whatever the cause, though, the numbers tell the story, and Fanatec is poised to massively benefit.

First though, let’s take it back a little. Thru 2018, Fanatec had reported compound annual growth of 41% for the prior 11 years (from 0.5mm EUR to 22mm EUR), so it’s not as if growth was shabby; rather, the absolute numbers just started very small:

But in 2019, the growth rate skyrocketed. While main competitor Thrustmaster stated that the overall iRacing market grew 22% last year, Endor saw its revenues explode, growing 80%, driven by the rapid adoption of new product launches and a surge of interest in the product. (Of course the company barely put out a one-paragraph PR to announce this; hasn’t filed financials or KPIs; and only put out the PR in German (!) so it’s no surprise this growth is flying under the radar for now).

The takeaway, though, should be that even before COVID arrived on the scene, this was a business where organic growth had already inflected, and where management was already expecting outsized growth; COVID was simply kerosene on the bonfire.

Let’s take a look at a variety of metrics to determine interest in the product of late. First, Google trends: you can see interest in Fanatec is at all-time highs:

Simracing on Reddit is seeing a similar rapid increase in following:

Viewership of Fanatec’s website has correspondingly spiked as well, with views rising ~90% YoY in recent months:

This is further evident in Fanatec’s Instagram followers:

At the same time, US TV ratings for iRacing events in March/April have been incredibly strong, completely dominating all other eSports events (including NBA related events):

Digging into the Fanatec Fan Forum, the company themselves commented on the spike in interest driving product sales and sell-outs, with the below comment coming from April:

There are a whole host of qualitative datapoint that suggest growing adoption by the mainstream as well. We have seen many non-eSports and non-racing celebrities embrace the surging popularity of iRacing, both before and (especially) during the COVID period. Here’s Sergio Aguero (one of the top soccer players in the world for those that don’t know) jumping into the iRacing pool, again with Fanatec gear on full display, in early May:

Aguero recently took part in an F1 virtual race; meanwhile the French sports celebrity world appears to have gone ‘all-in’ on iRacing, judging by the lineups for some of these races:

So, interest at the moment appears intense, and from many non-traditional motorsports/iRacing consumers. And while of course some of this demand is COVID-related (in the absence of many competing offerings), and of course popularity cannot remain at current peaks forever, it’s important to remember this was a market already growing at 20-30% CAGR last year and one that Fanatec was likewise massively outgrowing. That is, COVID has simply accelerated what was already happening – the rapid adoption of iRacing by mainstream consumers.

Piecing together Endor’s 2019 financials

With this as the context, we can now return to considering what this all means for Endor’s financial performance. As mentioned earlier, Endor’s disclosures are poor, and in German – not a great combination for an analyst 😛 Thus, I have had to be a little more creative, and have relied on more assumptions than usual in modeling the business, adding to the degree of risk here (although I still try to be conservative on all fronts and am comforted by the insanely low starting valuation). Still, it’s worth keeping that in mind as we go along.

To recapitulate the business model, Endor manufactures a high-end/premium consumer product, selling it to a rapidly-growing niche of hardcore fans who are somewhat price-insensitive. They outsource all manufacturing (mostly to China), though with all design, engineering, and much assembly conducted in Germany. They also self-distribute the product, relying overwhelmingly on their own website (no physical stores) to drive sales (often in limited batches or releases).

Looking at a business in isolation with these factors, you would expect to see high gross margins, driven by high ASPs, pricing power, and the self-distribution model; coupled with considerable opex in marketing and licensing but high operating leverage (marketing dollars spent is relatively fixed to maintain brand positioning, etc, as are license agreements beyond the royalty component). Operating profits, then, should be a function of the interplay between how fast the business can grow on top of a (largely) fixed cost base. In this set-up, returns on capital should be very high: little to no PP&E is required as manufacturing is outsourced; whilst inventories are quite lean, driven by batch manufacturing; and there is low net working capital.

This is basically what we see with Endor – with the caveat that there aren’t many details available yet on the 2019 year, so we have had to build up the income statement from just a couple of details. Still, it’s very clear the business inflected massively in 2019, with revenues growing 80%+ to 39mm EUR and net income coming in ‘at least at 4mm EUR’ according the January press release. Net income was 0.9mm in 2018…so net income margins have expanded aggressively as you would expect on the inflection in sales:

Let’s try to work our way up the income statement using the 2019 revenue and net income numbers as a guide. Using the ‘at least 4mm of net income’ disclosure, and fairly innocuous assumptions for tax and interest expense, we can determine that operating margins were at least in the mid-teens, a huge expansion from 5% in 2018 (note that my net income number is slightly higher at 4.5mm EUR as I believe the company was sandbagging guidance a little):

In terms of other line items further up the P&L, I have made various assumptions based upon my understanding of the business and looking at 2018 as a guide. You will notice I have kept gross margins essentially flat – fairly punitive given the 80% rise in sales – and honestly probably too low. I have done this however as I am unsure how much R&D expense will get accelerated in 2019 given the big jump in sales on new product launches; and also if any additional COGS were incurred in logistics as product delivery needs increased.

Otherwise, you will notice that personnel expenses and D&A don’t really move the needle as sales grow – that is, these line items are almost all fixed cost – but the ‘other operating expenses’ line item is the key cost variable. The company discloses that this line includes marketing and licensing – the two key variables that will ultimately dictate the shape of Endor’s profits, but unfortunately variables about which we know very little.

What we can say is that there were lumpy one-time licensing fees in 2018 (when some of the larger relationships were signed), which depressed earnings at the time; obviously going forward, there should be a fixed component to the licenses (1mm EUR/yr?) as well as royalties based on sales (10% of relevant product revenues?). I have made a few assumptions here that we will discuss shortly with regard to 2020/21 numbers, but the key point for now is that even using plugs/uncertain assumptions for these line-items, looking backwards, Endor is already a mid-teens margins business with gross revenues at 39mm EUR. As the business continues to grow, it’s hard to see how margins won’t continue to ramp, given the margin and cost structure as already demonstrated in 2019. And with the business already scaling off a VERY low base, combined with the extended growth runway for the industry, the future looks exceedingly bright.

Modeling 2020/21 and thinking about future earnings potential

Let’s look forward now to where we are and where Endor is shortly going to be. Endor disclosed recently that revenue growth accelerated again in 1Q, with quarterly revenues printing +91% at 11.6mm EUR – and recall this was mostly based on pre-COVID interest levels. With the level of engagement we have seen in recent months, and the baseline strong growth evidenced by 2019, I think it’s fair to model a continuation of aggressive revenue growth through 2020 and into 2021, at least.

But how aggressive should we be in modeling this growth? Should we think continued triple-digits, or a more ‘normalized’ return to the longer-term 30-40% CAGR trajectory? A little detective work can help at least tease out perhaps the current order demand.

This pop-up appeared on the Fanatec website as I was browsing the other day:

Since Fanatec appears to be donating a mask for every order, and the current order count is ~529k, if we can determine how quickly the order count is changing, we can determine a rough ‘orders/day’ metric. We can then make some assumptions around average revenue per order (‘ARPO’) to determine rough revenue per day run-rates, and, thus, build out a near-term forecast with more reliability.

Using the Wayback Machine, it looks like the counter started on May 5th at 514,000, and progressed accordingly over the next weeks:

• May 6th: 518,831
• May 10th: 520,724
• May 15th: 524,144
• May 18th: 526,448
• May 21st: 528,616

That is, the company appears to be running at ~780 orders per day over this period. Note that Fanatec launched their new F1 wheel for sales in this time so clearly these numbers are above a normal run-rate, but even so it appears reasonable that April would have been 500 orders/day as well (since the company was stating on the Fan Forum that demand has been ‘incredibly strong’).

But what is the average revenue per order (ARPO)? If we return to the disclosed 1Q figures of 11.6mm EUR sales, we can assume an even lower cadence of orders (totally pre-COVID) – let’s say 250 orders per day. At that level, the implied ARPO would be ~515 EUR (11.6mm EUR divided by 90 days divided by 250). This seems reasonable, or perhaps low, given the average product price point is 700+ EUR (including VAT) and many orders would likely be larger bundles.

In any case, such an assumption and even just a quarterly run rate of 500 orders per day in 2Q – that is, much lower than the apparent observed order cadence for most of May – would suggest 2Q revenues of ~22.5mm EUR, or 108% YoY growth versus 2Q’19 revenues (10.6mm EUR). Despite the inexact nature of this approach, then, there is a very real chance that Fanatec’s business is still accelerating, even from the 91% growth rate seen in 1Q!

As a result, it seems quite reasonable that 1H’20 growth will print close to 100% for the half, meaning even a much ‘slower’ back half of 2020 will still see an incredible rate of growth. This thinking guide my 2020/21 modeling: I am building in simply the observed explosive growth in 1Q/2Q’20, before assuming a large moderation in growth in 2H’20 and 2021 (back to the normalized trend around 30-40%). This hardly strikes me as aggressive – but even so, suggests incredible torque for Endor’s valuation.

A few other notes on my 2020/21 modeling assumptions:

• gross margins: I am still assuming essentially zero margin expansion at the gross profit level. For a luxury/premium product, this seems very conservative as the business scales this rapidly, but we shall see;
• licensing costs: clearly a key variable and one with minimal disclosure. I essentially assumed a fixed royalty rate of 10% on all licensed products (BMW, Porsche, F1, etc); and that licenced products comprise 70% of all product revenues in 2020E and 75% in 2021E. In other words, this cost line item expands aggressively but still scales as topline growth continues unabated;
• Personnel expenses: I model continued growth at 30% per annum. Perhaps this is a little low, but it doesn’t really move the needle as topline grows so rapidly;
• Marketing: I model 2mm EUR/year in incremental marketing spend in both 2020 and 2021 (that is, a faster pace than in 2019). Considerable uncertainty around this line item, honestly.

But in all this, the main point is simply that with revenues scaling so rapidly and the business – in 2019 – already at ~15% OPM, my model only really assumes a modest margin ramp to the ~20% or so OPM level this year and next, despite 60% revenue growth this year and 30% next year:

That is to say, the incremental operating margin being earned by Endor in 2020 and 2021 – incremental operating profits divided by incremental revenues – is only 25-30%. For a largely fixed-cost business, this seems completely reasonable to me; I think the only way this could be far off-base is if either revenue growth collapses (the least likely part of the thesis); or if expenses expand completely out of control. But even then – it is hard to see how profitability deteriorates below 2019 levels (again, already 15% OPM).

Valuation is beyond compelling

Finally we arrive at the main course: what we are actually paying for the business. As you can imagine, even in what I consider my above, relatively modest near-term growth scenario, the below valuation metrics look eye-poppingly low on basically any metric (P/E, EV/EBIT, P/FCF, P/S):

Paying 10x/7x current year/year one earnings for a net cash business growing at 100%, with a dominant position in an industry that is barely scratching the surface of its potential, is obviously hugely attractive. The fact that it has remained at these prices for so long is simply a function of its poor disclosures, specific German listing, and complete lack of interest in investor relations/marketing. Whilst I expect these to change some day, even in the absence of any better market engagement (or, heaven forbid, an uplisting to a proper exchange in the US), I can’t see how this name doesn’t rerate aggressively through the sheet weight of near-term financial performance.

So, where could it realistically go? Even with the idiosyncratic listing and German-only financials, why couldn’t this name trade at 20x forward earnings? That implies a triple based on my 2021E numbers, or around 165 EUR/share, and that’s very much a starting point. Absolute revenues next year will still be <100mm EUR, and the iRacing vertical is still clearly in just its infancy. There is no reason to expect Fanatec can’t remain a dominant player in the premium end of the market for many, many years of secular growth. Frankly I would be surprised if this company were still independent in a few years, if the valuation of the group didn’t expand hugely to match the opportunity before it.

The competitive landscape and other risks

Endor is a great little company with a compelling offering and a strong position – but of course it is not with competitors. However, there are really only two key competitors, one large (Logitech) and one small (Thrustmaster).

Logitech is a diversifed provider of computer and gaming peripherals, like keyboards, mice, headsets, etc; specific iRacing accessories are a very small (but fast growing) part of what is a >$2bn revenue pool today. As you can probably tell from the below screenshot, the product is very much entry-level and ‘casual’ (it looks much more like a game controller/toy), and Logitech has no specific legacy in steering wheels for gaming. The price point (300-400 EUR) is also considerably lower than the median Fanatec product, and they only have a couple of different items to choose from:

Thrustmaster, on the other hand, is a more serious player despite being also a much smaller company. Their core edge appears to be in pedals – indeed, some fan forums suggest they have the best pedals even though Fanatec’s wheels are superior – and they also have a more up-market image given a licensing agreement with Ferrari. You can see they also trade on a more premium brand image and go for extreme realism in their designs:

Whilst the Ferrari relationship is impressive and a great win, there are also limitations to Thrustmaster’s offering. A quick tour around their online site demonstrates both a limited product set (there aren’t nearly as many customized options available as at Fanatec, simply because Fanatec has most of the exclusive licenses); and the site itself is a little clunky and ‘home-made’ (as opposed to Fanatec, which feels slick all the way around.

Furthermore, they have also a strong emphasis on headsets and audio – a lower priced (and margin) product category that Fanatec eschews. Also, as already mentioned, last year Thrustmaster thought the market only grew in the low-20s% (and indeed its own sales trajectory has been up and down) whilst Fanatec grew topline 80% (and has compounded sales growth at 40% for over 10 years). So whilst not doing badly, it appears they are ceding share to Fanatec, and this likely continues. This appeared to be the case once again in 1Q, with Thrustmaster revenues barely growing year over year (even as Fanatec saw the explosive growth we discussed).

In other words, I am not terribly worried about the competitive landscape near-term. I feel it is far more likely Logitech is an acquirer of Endor, sooner or later, in an attempt to buy growth and beef up its own offering. Of course this is contingent upon Fanatec’s founder, Herr Jackermeier, consenting to sell, since he still owns 40% of the business (another great sign for the long-term). Otherwise, Thrustmaster makes a decent product in some areas but financially doesn’t have the wherewithal to invest to challenge Fanatec, and already appears to be falling further behind.

There are clearly other risks to the investment, some of which I have touched upon already. Principally, though, this is a small-cap, illiquid, opaque company, with significant unknowns beyond the usual – a function of the specific listing on a minor Munich exchange; and the fact that the company hasn’t required much or any external capital raising in a long time and so has not yet been forced to improve disclosures. This necessarily increases the riskiness of the investment, and must be taken into account. Of course I am confident the valuation more than makes up for this, but we have to recognize there may be no near-term solution to some of these issues. We are truly beholden to the owner-operator here, for now. Of course the flipside of this reality is that any change in the status quo – any English disclosures; more KPIs given; broker coverage, etc – will be additive to the company’s valuation.

Otherwise the main thing I worry about is opex growth. Jackermeier is clearly a visionary and obsessed with the quality of the product; this has served Fanatec well so far and helped build its strong market position. But it could also hamper the ability of Endor to see operating earnings explode as they should – if he decides to plough all these soon-to-be-excess earnings back into R&D vanity projects; expensive celebrity sponsorships, and the like. This is not the ‘typical’ German mindset – but then again, Jackermeier does not appear to be a typical German CEO. At some point I do expect to see chunky dividends paid out to holders (including Jackermeier, of course, who is as incentivized as anyone to do the right thing given his huge ownership stake), but it is for now one of the factors keeping me up at night.

Still, I am sleeping pretty well at the moment principally because the entry price for the investment is so many multiples below where it should be, today. Even if many of these risks proliferate and/or there are bumps along the road, the margin of safety to a reasonable fair value remains gargantuan, and the story appears to keep getting better. So, for now, and at these prices (mid-50s EUR), I couldn’t be more excited about Endor.

Disclosure: long Endor AG