Games companies seem to dissolve or get acquired, and so Embracer’s announced breakup is a unique case for a company people already have strong opinions about. Embracer made a name for itself with a remarkable string of acquisitions, then had an equally remarkable fall once a $2 billion deal failed to materialize. This, along with rising interest rates and weaker than expected sales, led to an extended series of layoffs, closures, and divestitures to align the company with its new reality. The restructuring was recently completed, which is another reason the breakup is so surprising. Unfortunately, the temporary names for the new companies have gotten far more attention than the more important question of whether or not this breakup makes any sense. This article is an effort to examine the substance of the decision.
One reason for a lack of substantive analysis is Embracer’s notoriety. The company is not unique for its closures and layoffs, but the proximity to an aggressive, possibly even arrogant, streak of acquisitions makes it a target of understandable frustration. Few, if any, commentators were talking about financing risks at the time, but hindsight does make it seem like those firms were acquired without any plan to support them if things went wrong. The problem with the anger directed towards Embracer is that it can interfere with judgements regarding their latest actions. It is difficult to justify the company’s past actions, and there is little point in trying, but this does not mean that its plans for the futures are automatically disqualified. Lars Wingefors may not be popular, but he is much more capable of running a business than his critics. We are justified in having some skepticism based on past performance, but the breakup should be understood and judged on its own merits.
Understanding the breakup requires understanding what went wrong for Embracer in the first place, as well as the problem the proposed split is trying to solve. Theoretically it shouldn’t matter whether Embracer is one company or three, since any action the three can take independently is one the current company can take. The difference matters quite a bit in practice.
The most helpful way to think about Embracer as it is today is to recognize that it looks and acts more and more like a conglomerate. Conglomerates are a somewhat old fashioned business structure in North America (though still popular in other regions), in which a head office is basically a holding company for a large number of independent companies operating in different industries. Conglomerates are why it was possible to say that Yamaha was your favourite bike and piano manufacturer at one point in history, and some famous conglomerates like Berkshire Hathaway (Warren Buffett’s company which owns businesses as diverse as GEICO, Dairy Queen, and the Burlington Santa Fe Railway Company) still operate today. We may talk about Embracer as a gaming company, but its business activities extend to PR, comics, film and television, IP licensing, and board games, which is why it is helpful to think of it as a conglomerate.
Being involved in multiple business lines can allow a company to be more resilient to business cycles, with segments that are doing well supporting the ones that are experiencing a downturn. It is like the company version of why investment advisors recommend diversified assets. The money that comes in from a broad set of activities are also where the practicalities become important. Some conglomerates treat the cash generated from its operations like an internal capital market, redirecting money from one area into expansion in a completely unrelated sector. Normally business that want to expand this way will issue shares or borrow from investors who can express their lack of enthusiasm for a project by not handing over the money.
To understand why this would be a problem is to consider the difference between how Meta earns its money and what it spends its money on. Meta earns its money serving up ads on platforms like Facebook and Instagram, but it is called Meta because of its very costly push into virtual reality and the metaverse that has so far not generated any significant return. Shareholders might tolerate these kinds of drags on earnings when things are going well because they’re earning more than they could from alternative investments. The good times don’t last forever though, and a large portion of recent tech layoffs can be seen as the patience for big tech hobby projects running out.
Asking “who will think about the shareholders?” is a fast way to generate an unlimited supply of eye rolls, but this question does matter when a company is seeking financing. Shareholders have a claim on the earnings of a company, and if those earnings are perceived as being squandered on low value projects, investors will be more reluctant to invest. This is why conglomerates often trade at a value lower than the value of their constituent parts.
Another relevant factor is size. A conglomerate’s size can allow it to take advantage of economies of scale. Economies of scale mean that a company will face lower costs by virtue of its size. To illustrate, consider that assembling a pencil would be frustrating and time consuming on our own, but we can buy one at a price that is about equal to 90 seconds of labour at minimum wage. This is because a small number of large manufacturers make enough pencils to make it worth buying machines that make the process more efficient and bring down the cost. Economies of scale do not manifest spontaneously, and it does not appear that Embracer is realizing any of the benefits of its scale. In some ways it is admirable because Embracer’s constituent parts seem to have a degree of autonomy, but it comes at the cost of forgone savings.
Aside from Embracer’s business structure, it is worth considering Wingefors’ own thoughts on how to run a business. Whatever his popularity, he remains in charge of the company and his preferences will be reflected in the way it is run. Lars Wingefors does not like debt. He has been unambiguous on this point and it is reflected in the fact that most of Embracer’s debt is going to Asmodee (the board game part of Embracer). This preference runs counter to conventional thoughts on business, which sees the optimal capital structure as a mix of debt and equity. The average person will likely be more sympathetic to Wingefors’ thinking, since most people think of debt as a purely negative thing, but debt has an important role to play in financing most companies’ operations.
An optimal capital structure usually involves a mix of debt and equity is because it minimizes the weighted cost of capital. The cost of capital matters because it is the minimum amount the investment that is being made with the money needs to return (if you borrow money at 5% to invest in something, you want that something to return at least 5% or face an unnecessary loss). Ultimately it is the measure by which Embracer decided what projects were viable and which ones needed to be cut. Viewed in this light, the distance from the optimal capital structure can be measured in the number of cuts that didn’t need to happen save for the preference to minimize debt.
In summary, it is debatable that Embracer is benefitting from the kind of economies of scale it might enjoy, and the restructuring does not appear to have brought it any closer to this goal. It is also very likely that the unified company’s share price is lower than the value of its constituent parts, a fact reflected by the substantial increase in the share price following the announcement of the split. Finally, we know the owner intends to pursue an equity focused capital structure. In short, Embracer realizes none of the benefits of being a conglomerate and all of the penalties.
From this perspective, the split is an obvious choice. In fact, Embracer is following larger and more famous conglomerates by breaking up. GE completed its split into three companies last month and IBM had its own big split in 2020. This business structure can work, but it is relatively rare for a reason, and there is nothing about Embracer’s approach to suggest that it is better off as a conglomerate.
Business structures are not exciting to talk about, but they are much more closely tied to future successes or failures, and the resulting human interest stories, than the company’s name. The advantages of this analysis are also not limited to Embracer.
Microsoft is sometimes referred to as a conglomerate. They have also recently been in the news for closing four studios. It is common to point to the amount of money a parent company is making and wonder why a popular division is being closed. Microsoft has many things it can spend its money on, and the expectations for the company are higher than they have ever been. It is trying to avoid the problem described above of allocating the money it makes inefficiently and the resulting consequences.
Describing a problem or a decision is not the same as agreeing with the company’s choice. Less emotive analysis can seem indifferent to the people affected, but it is founded on the idea that we have a better chance of getting better outcomes if we understand what is going on. If it is too much to hope that future coverage will forego the easy joke or the populist cry, we should at least hope that they can coexist with one or two articles on substance.
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