Enthusiast Gaming Holdings Inc. (TSX: EGLX) has just released its third-quarter results. With significant revenue growth being reported no matter how the figures are sliced and diced, this is looking like a hot company to invest in right now.
In the markets, investors reacted favorably to the news, too. Enthusiast Gaming shares jumped up significantly, closing Tuesday’s trading day 10.26% up on Monday’s close, with further gains being seen so far today. However, while the report was generally positive on the surface, it’s important that investors note that all may not be what it seems.
While reported revenue was up significantly, reported gross margin was not
Enthusiast’s recent acquisition of Omnia Media skews the figures somewhat. With the acquisition completing on August 30, investors reacting to the news need to keep in mind that the reported revenue growth of 133% should be tempered with respect to the additional revenue brought in by the Omnia arm of the business during the month of September.
Taking Omnia’s results from the previous two fiscal years (ending Aug. 31) of US$46.5 and US$59.9 and projecting them forward, a rough ballpark estimate we can arrive at is that the Omnia contribution to the reported figure would be anywhere from US$6-8 million. The upper end of this estimate effectively explains the entire reported revenue growth of CA$9.3 million (Q3 CA$16.3 million, Q2 CA$7 million) as being entirely attributable to the additional contributions from the Omnia business.
With that being said, Enthusiast is reporting pro-forma growth of 17% percent for the quarter. And while this is still a respectable figure, this should, again, be regarded with an eye to the additional overheads that come with onboarding a new business. Whether Enthusiast will manage to eke out significant cost reductions through streamlining the two businesses is yet to be seen. In any case, Q3 reported gross margin was $4.1 million, just 28% up when compared with Q2 gross margin of $3.2 million. Again, this is not an insignificant figure, but it is certainly a little more tame than the 133% growth in reported revenue.
Markets are still responding positively to Enthusiast Gaming
At the time of writing, Enthusiast gaming is trading at approximately $2.30 per share. After opening the week at $1.84, this represents a +25% jump in price over the past day and a bit. And while it’s difficult to say exactly how much of this growth is attributable to otherwise positive market sentiment flowing through from COVID-19 vaccine optimism, it should be fair to say that most of it is on the back of the results announcement.
With the S&P/TSX Composite Index up by approximately half a percent over the same period, Enthusiast Gaming’s share price growth far outpaces the broader market. This raises the question—do the fundamentals underlying the glossing over in the highlights report warrant such a leap?
Additional mergers and acquisitions only muddying the waters
Further complicating the matter for investors in this company is a large number of mergers and acquisitions that took place throughout 2019. This, in the words of the company’s own release, “reduce[s] the comparability of year-over-year figures.” To state this in a slightly more direct way: “we can’t guarantee these figures are accurate.”
And language like this should always act as a warning sign. Whilst companies are theoretically compelled by regulatory requirements to report conservative pro-forma estimates, without full access to their books and accounting methods (guaranteed not to be GAAP), it’s difficult to tell how “conservative” is defined here. Arguably, a defensible position could involve the bump in gaming over the height of COVID-19 lockdowns being used as a justification for choosing the most “conservative” of what may be overly-optimistic methods.
Enthusiast Gaming: Buy or sell?
Given the difficulty of defining exactly what’s happening under the hood of Enthusiasts results, investors should approach with caution. It is also likely that the momentum provided by this week’s glossed-up results is in need of a correction before buying considerations should be treated with any seriousness.
On the other hand, digital media and esports are a massive growth industry right now. With a predicted CAGR of 9% in the esports market over the coming two years, there is certainly a lot of growth to be had here. Thus, even if Enthusiast’s results should be viewed with some skepticism, continued growth is not out of the question.
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