Mighty Kingdom and the subsidy tsunami

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Price at posting: $0.095

Rather than head out on Saturday evening and risk being forced into isolation, I opted to stay in and play video games instead. Mighty Kingdom Limited (ASX:MKL) had just released their first console game, ‘Conan Chop Chop’ so I paid the $21.99 retail price in the hope that in addition to being fun, it might also help me put together my next blog post. 

MKL is a video game developer based in Adelaide, South Australia and its share price has been in decline since it listed on the ASX 12 months ago. The IPO price was $0.30.

Waiting for the tide to come in

Video game development has a very low capital intensity. Wages are the dominant cost for game developers and so more employees helps to drive more revenue. The problem with this is that there is a lag between hiring new employees and receiving revenue for their work – games take time to develop. 

MKL have increased their head count from 70 to 140 employees since listing on the ASX and this lag has caused their losses to balloon. As shown in Figure 1, while employee benefits expense had more than doubled at the half year, revenue had only increased by 42%. 

While MKL waits for the revenue tide to roll in, it must also concern itself with the question of how to remain solvent. The company undertook a capital raising in December 2021 raising $5 million but they also employ a non-dilutive method of financing, in the form of government subsidies. They may be able increase this source of financing going forward.

Subsidy Tsunami

The global video game market is estimated to be worth more than AUD$250 billion. At present, Australia generates a very small percentage of that revenue, but the Australian Government has plans to increase this share through the Digital Games Tax Offset (DGTO). The draft legislation was released on 21 March 2022.

The DGTO is a 30 per cent refundable tax offset for eligible business that spend a minimum of $500,000 on qualifying Australian development expenditure related to the development of eligible games from 1 July 2022. 

MKL also claims the Research and Development Tax Incentive (RDTI) which offsets the cost of eligible research and development at a rate of up to 43.5 per cent. MKL currently have a RDTI receivable of $2,224,976 on the balance sheet which is likely to be received in the March quarter.

Finally, MKL receive the SA Video Game Development Rebate (SAVGDR) which is a discretionary rebate equal to 10 per cent of eligible expenditure on video game development work undertaken in South Australia.

Importantly, although the RDTI and DGTO are structured as tax offsets, they are refundable if a company is in a tax loss position and so make an important contribution to cash flow. The SAVGDR sits outside the tax system and is also paid as cash.

The combined effect of these three incentives would be to subsidise game development wages – the dominant cost for game developers – by an enormous 30-43.5% for financial years commencing 1 July 2022. 

Of course, even with these subsidies, MKL may never reach profitability.

A rising tide lifts all boats

Other ASX listed video game developer, Playside Studios Ltd (ASX:PLY) and Icandy Interactive Limited (ASX:ICI) are already claiming the RDTI and also appear to be likely beneficiaries of the DGTO, if passed.

It is also possible that other video game developers may establish a presence in Australia to take advantage of the DGTO.

According to Ron Curry, chief executive of the Interactive Games & Entertainment Association, “There’s a number of significant global businesses looking at coming here, and they’ve just been waiting for the details of the [policy].”

In terms of deal size, 2022 has already been the largest year ever for M&A activity in the digital games industry. The DGTO could drive further M&A activity in Australia if new entrants decide to acquire rather than set up their own game development studios. MKL could be a compelling target based on a comparison of the price to sales ratios of the three ASX listed game developers discussed. 

The Federal election will take place in May and the introduction of any DGTO legislation will be dependent on the make-up of the next incoming elected government. Should the DGTO be passed, better days may be ahead for MKL and its share price.

Was the game fun though?

The game was fun and taking a leaf out of MKL’s book, I will be subsidising my $21.99 purchase by claiming a tax deduction because it helped me write this post.

Shorting Hat