With a share of 26.6% of industrial production in total GDP, Germany is the most industrialized EU country. The German chemical, machine-building and automotive sectors are world leading and many family-owned companies are dependent on them. Especially, the chemical sector is regarded as the most energy-intensive one, together with the metal processing industry. According to Statista, in 2022 309,030 of Germans worked in the chemical, 1m in the machine-building, c. 786,000 in the automotive and c. 500,000 in the metal processing industry. The respective companies usually pay above-average salaries. In terms of energy sources, Germany has diversified away from (cheap) Russian oil & gas deliveries since February 2022 and nowadays Norway is its most important supplier of gas and oil. Last year, energy from gas still accounted for 11.4% of the country’s total energy consumption. When it comes to trade, the German economy heavily depends on China, which in 2022 was its No 1 partner and generated a trading volume (imports + exports) of EUR 298.2bn.

Given the above, the German economy faces two main risks: 1. High energy prices in the long run, especially as Germany is the only country worldwide, which plans to completely withdraw from fossil energy and nuclear power so fast, and 2. A China-Taiwan war. The first scenario would likely result in the movement of production capacity – and loss of high-paying jobs – from Germany to other parts of the world. Especially, North America seems to be an attractive destination as it has access to cheap energy and is a net exporter of it. The second would significantly negatively affect the German economy as a conflict in Taiwan would likely result in sanctions by the US and the EU like those imposed on Russia after its invasion in Ukraine in February 2022.

While we believe that especially the 2^nd scenario seems unlikely for now as China needs the Western world as a trading partner – USA and Germany were its No 1 and 7 trade partners respectively in 2022 and the EU as a whole No 2 after ASEAN – and supplier of advanced technology, the above-mentioned factors also bear significant risks for Eastern European countries. For most of them, Germany is the largest trading partner by far (see table below) and a significant share of employees has jobs in German companies or their suppliers. For example, automobile producers such as VW Group (9 in Poland, 4 in the Czech Republic, 2 in Slovakia, 1 in Bosnia, 1 in Hungary), Mercedes-Benz (1 in Poland, 1 in Romania, 1 in Hungary) and BMW (1 in Hungary) have many production facilities in the CEE/SEE region. The same holds for chemical companies – which are particularly energy-intensive – such as BASF (19 production facilities in CEE) and Lanxess (3).

Source: World Bank, stat.ee (most recent data)

In this blog post, we analyze the public finances of the EU member states that before 1990 were part of the Soviet bloc. Slovenia, Slovakia, Croatia, Estonia, Latvia, and Lithuania are already members of the Euro zone and thus do not have control over their currency. When it comes to the budget and current account deficits, we have compared the most recent data from 2021, which was affected by the pandemic, with the pre-COVID year 2019. While our analysis concludes that Poland, Czechia, Estonia and Slovenia are relatively reliable debtors, the condition of public finances in Hungary, Romania and Bulgaria looks much riskier.

Sources: Eurostat, central banks, tradingeconomics.com, Worldbank, S&P, CIA World Factbook

Especially after the PiS (Law and Justice party)-led government came to power in 2015, the Polish economy has been supported a lot through various social programs e.g. the “500+” child benefit, “Dobry Start” PLN 300 one-off support for pupils and the one-off retirement payment of PLN 1,100 “Emerytura+”. While these programs are considered negative by many economists as they stimulate consumption instead of investments, apparently they have not increased the debt level as well as budget and current account deficits in Poland as much as similar measures in Hungary. Especially a high current account deficit, which reflects imports and exports of goods and services, payments to foreign holders of a country’s investments, payments received from investments abroad, and transfers such as foreign aid and remittances, can negatively affect the foreign exchange rate of a country’s currency. On the one hand, a weak currency makes exports more profitable, however on the other makes the import of important components, the servicing of foreign debt or popular consumption goods more expensive.

Apart from Poland, Czechia is another non-Euro country, whose public finances look solid. What is particularly impressive, are its significant foreign exchange reserves, which are 3.5 times higher than in Hungary that however has a similar population. The larger the foreign exchange reserves, the better a country can fight pressure on its own currency.

In Romania and Bulgaria, especially the relatively high share of foreign currency denominated debt is worrying, which can lead to issues with repayment of debt in case the local currency significantly weakens versus EUR or USD. 

Based on the methodology of S&P, Hungary’s and Romania’s current BBB- rating is the weakest investment grade rating. The rating agency’s definition is as follows: “An obligation rated ‘BBB’ exhibits adequate protection parameters, however adverse economic conditions or changing circumstances are more likely to lead to a weakened capacity of the obligor to meet its financial commitment on the obligation.” Estonia, whose debt only equals 18.1% of its GDP, and Czechia both have an AA- rating. According to S&P, it “differs from the highest-rated obligations only to a small degree”. Of all ex-communist EU member states, Slovenia has the best S&P credit rating (AA).

Business description

The LSI Software Group, which has c. 300 employees (full-time and freelancers), was founded in 1998 and is based in Lodz. It is a provider of Enterprise Resource Planning (ERP) software for hotels, restaurants (products: Gastro, tAPP Gastro, POSitive Restaurant), cinemas (POSitive Cinema) – in these three areas, it is Polish market leader with a share of between 43% and 75% – sports facilities and retailers. In addition, it is the exclusive distributor of POS management systems and peripheral devices of the company Posiflex and, since year-end 2021, the robots of the Chinese company PUDU, which operates in 60 countries worldwide. Due to the structure of the company’s sales – the sector HoReCa accounts for c. 70% of its annual sales – LSI Software was hit hard by the COVID-19 pandemic, with a revenue and EBITDA decline of 17% and 43% respectively y-o-y. 

LSI Software, where in 2021 international revenues made up 24% of the total, generates sales from software integration, consulting, services, and hardware delivery. Last year, revenues from own software and maintenance/servicing accounted for 53.7% of the total, however the distribution activities (mainly sales of Posiflex products and PUDU robots) were most profitable with a gross margin of 30%. Recently, the company started offering its software products in the SaaS model, which is particularly attractive for smaller clients due to the low monthly fee of c. PLN 250. In our view, this should increase the share of recurring revenues from currently c. 50% and improve profitability in the coming years. 

According to management, LSI’s clients include >5,000 restaurants, c. 1,500 cinemas and several dozen cinema chains. The 3-4 largest customers account for only 15-20% of the company’s yearly sales and the customer churn only equals <5%. Examples of clients include the cinema chains Helios S.A. (Poland), Muvi Cinemas (Saudi-Arabia), KITAG Cinemas (Switzerland) and the leading Polish retail and restaurant chains CCC and Amrest.

Currently, LSI Software has c. 300 employees, of which 75% work as software developers and testers and 25% in other functions such as sales & marketing, HR and administration. Although there is no employee incentive scheme, the employee fluctuation is below peers, according to management.

LSI Software’s largest shareholder is its CEO Grzegorz Siewiera, who owns 30.8% of its shares, but 53.6% of the votes. The Spanish family office Inmuebles Polo SL owns a stake of 13.2%.

Recent results

Between 2013 and 2019, LSI Software grew at a CAGR of 14.8% on top line. After the pandemic year 2020, in which the company was hit hard due to its dependance on the HoReCa sector, in 2021 LSI Software’s revenues went up by 25.5% to PLN 54m. While the gross margin jumped to 30.7% (2020: 21.3%), EBIT and net income improved by 256% to PLN 5.9m (11% margin) and by 169.1% to PLN 6.5m respectively. However, due to higher investments in working capital and CAPEX operating and free cash flow deteriorated to PLN 4.5m (2020: PLN 9.9m) and PLN -3m (PLN 6.1m) respectively. In 2021, LSI generated a ROCE of 10% compared to an estimated WACC of 18% at present. 

Due to the recovery in most of its markets after COVID-19-related lockdowns for 9M/22 LSI Software reported revenues of PLN 40m, which corresponds to a y-o-y increase of 19.9%. 18% (9M/21: 11%) of total sales were generated abroad, of which 6% (4%) in the US. The share of revenues from own products and services declined to 52.8% (54.7%), which mainly stemmed from 24.9% higher sales of hardware such as PUDU robots. In 9M/22, the Group’s gross margin improved from 22% last year to 23.4%. However, following 85.7% lower other operating income due to a one-off effect – in 9M/21, LSI reported PLN 3.4m of COVID 19-related government grants vs. PLN 245k in 9M/22 – as well as 21.6% higher sales costs y-o-y (e.g. trade fairs, sales staff), which should have already positively impacted results in Q4/22, EBIT declined from PLN 1.6m to PLN -1m and net income from PLN 1.4m to PLN -1.3m. Between January and September 2022, free cash flow equalled PLN -10.9m (9M/21: PLN -698k), which was related to significant investments in inventories of PLN 5.7m due to longer delivery times of suppliers, among others. At the end of September 2022, the company had net debt of PLN 2.9m, which corresponds to 6.5% of its equity. Its interest-bearing debt mainly reflects the valuation of its office leasing contract in Warsaw according to IFRS 16.

Summary & Conclusion

In our view, LSI Software is a solid, owner-managed software company with a leading position in its domestic market and strong growth potential related to the roll-out of SaaS-based products and further international expansion. Based on most recent broker estimates, it is currently trading at an EV/EBITDA 2022E of 4.5x, EV/EBITDA 2023E of 3.7x, P/E 2023E of 7.5x and PEG of 0.23. For the coming years, we expect an acceleration of growth and regular dividend payouts. We also believe that due to its strong product portfolio and attractive valuation LSI Software could be taken over by a larger player soon. 

Business description

Kino Polska TV S.A. (KPL PW), which is based in Warsaw, is a leading producer and broadcaster of thematic TV channels with operations in 68 countries worldwide and a 36% share of international sales in total revenues. The company owns one of the largest catalogues with Polish content (movies, series, documentaries etc.) and through its owner SPI International, which since March 2022 has been part of the leading European media company Canal+ Group, has access to high-quality international movie content on an exclusive basis in Poland. Of the sales related to TV channels, which last year accounted for 88.1% of the total, 56.9% stem from recurring transmission/subscription fees, which makes KPL less dependent on very profitable but cyclical advertising sales.

KPL broadcasts channels under the six main brands Telewizja Kino Polska, Kino Polska Muzyka, Kino TV, FilmBox, Zoom TV and Stopklatka TV. All are wholly-owned and, except Zoom TV, profitable. Telewizja Kino Polska and Kino Polska Muzyka are focused on high-quality Polish movies and related music videos and FilmBox, Kino TV and Stopklatka on international movies. Zoom TV, which is supposed to become profitable in 2023E according to management, broadcasts series, documentaries and shows. All KPL’s channels can be watched on multiple platforms including digital terrestrial TV (DVB-T), satellite & cable, online and on mobile devices. The FilmBox channel family, which KPL produces, is already available in 68 countries in the CEE & SEE region, North- and South America and Asia. 

According to wirtualnemedia.pl, there is a trend towards consolidation of thematic channels because many broadcast the same content that is often repeated. In the future the remaining TV channels will be well-profiled to certain operators and advertisers and available not just on digital terrestrial TV, satellite and cable platforms but also via streaming services such as Netflix or HBO. Moreover, with improving internet speed video content will increasingly be consumed on mobile devices. According to We Are Social, movies and videos are by far the most popular type of paid content worldwide. 

Recent results

KPL is a fast-growing and highly profitable company with a revenue CAGR in 2015-2021 of 15.7% and double-digit EBIT margins in each of the last seven years. In 2021, revenues came in PLN 257.2m (+21.4% y-o-y), EBITDA at PLN 117.3m (+32.5%; 45.6% margin) and net income at PLN 48.6m (+78.6%). Operating and free cash flow amounted to PLN 57.3m (2020: PLN 28.4m) and PLN 50.9m (PLN 24.6m) respectively. At 24.9%, ROCE was very strong. Despite the Ukraine conflict, in H1/22 the company’s sales advanced by 17.1% y-o-y to PLN 139.3m, EBITDA by 4.9% to PLN 57.3m (41.1% margin vs. 45.9% in H1/21) and net income by 5.8% to PLN 21.2m (15.2% margin). At the end of June 2022, Kino Polska TV had a net gearing of -12.5% and thus was net cash. 

On November 9^th, KPL issued preliminary results for Q3 and 9M/22. Between June and September, consolidated revenues equalled PLN 65m (+2.3% y-o-y), while in Jan-Sep they amounted to PLN 204.3m (+12%). However, in Q3/22 net income declined by 39% y-o-y to PLN 6.7m due to exchange rate differences and higher expenses related to ZOOM TV. This year, the PLN reached the weakest level ever compared to the USD and EUR. 

After paying dividends in each year after its IPO in 2011 until 2018, the company resumed its dividend payouts in 2022. For fiscal-year 2021, it paid out a DPS of PLN 0.50, which corresponds to a payout ratio of 20.5% and a dividend yield of 4% at present.

Summary & Conclusion

We like Kino Polska TV due to its competent management, the strong anchor shareholder Canal+ (is wholly owned by Vivendi Group), a cash-generating and fast-growing TV business, which is based on high-quality content, and very attractive valuation (currently, its trailing EV/EBITDA after H1/22 results equals just 4.1x and trailing P/E after prel. 9M/22 figures 8.8x). We also believe that in the next 3-4 years Canal+ will buy all outstanding shares of the company and de-list it, which will likely be conducted at a significant premium to the current share price. Regarding dividend payouts, we expect that Kino Polska TV will distribute at least 20% of its annual net income to shareholders in the coming years.

When it comes to risks, investors should be aware of the following: (1) An economic slowdown would negatively affect KPL’s advertising sales, which are highly profitable, (2) KPL’s content costs are in EUR and USD, but >60% of revenues in PLN, (3) Competition by streaming platforms such as Netflix, which nowadays invest billions of USD in own content, (4) Inability to renew co-operation agreements with cable operators and satellite platforms, and (5) Kino Polska TV’s stock can only be traded in Warsaw, which reduces the number of potential new investors

Business description

The Krakow-based gaming studio Starward Industries S.A. was founded by former employees of the most famous Polish games developer CD Projekt S.A. The CEO Marek Makuszewski is the company’s largest shareholder with a stake of 18.2%, while members of the management and supervisory board and employees own in total 31.9% of the company.

Starward Industries owns the rights to the IP of Stanislaw Lem, the author of the world-famous science fiction novel “Solaris”. According to our research, the licensing contract, which was signed with the heir of Stanislaw Lem, comprises a single-digit percentage fee on future sales of the company’s products.

Based on Mr Lem’s IP, Starward Industries is currently working on the AA+ game “The Invincible”, which it expects to release in 2023E for PC, Google Stadia, and all next-gen consoles. The game, which is currently No 79 on Steam Global Wishlist, has so far cost PLN 12m/EUR 2.7m. The marketing of the game will be financed by Starward’s new publisher 11bit Studios S.A., which has developed the successful games “Frostpunk” and “This War of Mine” and is considered one of the best-managed Polish video game companies.

According to its representatives, Starward Industries currently employs 34 people, thereof 25 developers and 9 marketing, communication, legal and administration staff. Many of them have worked at the largest Polish video game studios Techland and CD Projekt in the past. As almost all employees are or will soon be the company’s shareholders, the fluctuation is very low. When it comes to software developers, Starward has all necessary skills on board and thus does not need to outsource much work. In our view, this gives it full control over the quality. 

Recent results

In 2021, Starward Industries had a net loss of PLN 2m with zero revenues from product sales. In H1/22, the net loss equalled PLN -878k and the free cash flow PLN -867k. We estimate the company’s current net cash at PLN 6.5m, which according to its representatives will be sufficient to finance operations until the release of “The Invincible”, which we expect in September 2023 at the latest (in Q4, usually all the largest game premieres take place).  

Summary & Conclusion

In our view, Starward Industries is one of the best gaming studios on the Warsaw Stock Exchange. We like the committed management team, the fact that insiders incl. employees hold >30% of the shares, the track record of the team and the publishing agreement with 11bit Studios, which also holds a stake of 5.1% in the company. 

Based on our estimates, we forecast that with 800,000 copies sold Starward Industries will generate revenues of PLN 134m and a net profit of PLN 45m in 2023E. This would imply a highly attractive P/E 2023E multiple of 2.6x at present. We expect that Starward Industries will pay out a significant share of its net profit as dividends. In our view, the payout ratio could reach 40%, which would correspond to a dividend yield of 15.5% at present.

The main risks, which investors should be aware of, are (1) delays with the production of the game, and (2) bad quality of the end-product, which would negatively affect its sales.

Apart from the Warsaw Stock Exchange, Starward Industries’ shares can also be traded in Germany.