After a Great Quarter, Is Ubisoft Entertainment a Strong Play for Investors?

With Ubisoft's (NASDAQOTH: UBSFF  ) Watch Dogs landing as a certified hit, the company has cleared one of the most important generational hurdles it faced. The importance of introducing a successful new IP for the company was compounded by the fact that the last entry in its Assassin's Creed showed evidence of franchise decline. As per the company's recent report, Watch Dogs has shipped 8 million copies and driven Ubi to a record quarter. The company recorded revenue of $422 million for the period, good enough for a 374% increase over the same stretch last year. Yet another positive indicator was that Watch Dogs performed very well on the new-generation consoles.

Despite all of this good news, there are still substantial threats to Ubisoft's business. Is the company an advisable investment in light of the risks that it's up against? How does its structure hold up when compared against other industry players like Nintendo (NASDAQOTH: NTDOY  ) , Electronic Arts (NASDAQ: EA  ) , and Take-Two Interactive (NASDAQ: TTWO  ) ?

Why does Ubisoft have so many employees?
One of the most perplexing things about Ubisoft is its business structure. Despite being a relatively small gaming publisher, the company has one of the most bloated workforces in the industry. Much of this is a result of Ubisoft's reliance on inexpensive labor.

The French publisher has a market cap of approximately $1.9 billion, yet it currently employs 9,200 people. For comparison, Nintendo's market cap currently sits at approximately $17.1 billion and its last fiscal report listed 5,213 internal employees and 1,977 external employees. This is particularly notable because hardware is also a significant component of Nintendo's business, while Ubisoft is concentrated almost wholly on software development.

Comparing Ubisoft's employment structure with a large third-party publisher, Electronic Arts currently has about 9,000 people on its payroll. The American publisher has a market cap of approximately $11.28 billion, and it has much greater involvement in mobile development than its French rival.

How does Ubisoft look in relation to Take Two?
Given its heavy focus on console game development and relatively small size, Take-Two Interactive may be the best point of comparison when looking at Ubi's employment numbers. The company has a market cap of approximately $1.7 billion and currently employs approximately 2,530 people globally.

While the last fiscal year was a banner period for Take-Two thanks to the success of Grand Theft Auto 5, the company brought in approximately $2.35 billion in revenue compared to Ubisoft's revenue of approximately $1.37 billion across the same period. The similarities in size and core business between Take-Two and Ubisoft make the latter's structure appear highly questionable.

Ubisoft may be overly reliant on government support and tax breaks
Compared to its chief gaming competitors, Ubi is much more reliant on tax breaks and governmental support. The company has a close relationship with the French government, which once indicated it might step in to save the publisher from a hostile takeover attempt by EA, but the company's dependence on this structure also opens the door for potential problems. Recent cuts to tax incentives offered in Canada look to have a notable effect on Ubisoft and its Quebec development studio, which will be mostly responsible for the development of the next "Assassin's Creed" game after this year's Assassin's Creed Unity.

Is Ubisoft's development style sustainable?
Ubisoft makes use of a highly compartmentalized style of software development that sees large numbers of, often geographically disjointed, teams working on individual parts of games. This strategy has obvious benefits, but it can also lead to difficult development cycles, the need to cancel or rework projects, and end-products that feel disjointed.

Perhaps because of the development strategies employed by the company, Ubisoft has come to be associated with a certain style of gameplay. That's not to say the publisher doesn't have diversity across genres, but there are a number of significant similarities between Watch Dogs and games in the "Assassin's Creed" series.

While these games are currently very popular, there also appears to be a growing sentiment that the publisher releases uninspired and derivative products. Strong sales suggest that this isn't currently a major issue, but the extent to which the company is dependent on these two properties means that substantially waning interest in either series might effect the other and do substantial damage to Ubi. The publisher no longer draws massive revenue from the "Just Dance" series that was so popular on Nintendo's Wii, and it is increasingly dependent on appealing to a more discerning and critical segment of the market.

Foolish final thoughts
All of the major console game publishers have seen significant growth over the last year. Ubi's share price trades approximately 21% higher than it did twelve months ago, tracking very closely in line with the S&P 500. While the introduction of Watch Dogs as a viable property and the remaining strength in "Assassin's Creed" give Ubisoft some appeal, there are still suspect aspects in the company's business model. The company has a fair shot of outperforming the market in the next couple years, but those looking to make investments in the gaming industry might be better served by a position in Take-Two Interactive.

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