Keywords Studios PLC (LON: KWS) – Eyeing more acquisitions with continuing revenue growth

Keywords Studios PLC is a FTSE AIM UK 50 Index listed Company which is involved in the creative and technical services platform for the video games industry. It was established in 1998 and now operates in 21 countries. It has 61 facilities, which are strategically located in the Americas, Asia, and Europe. It offers integrated art creation, software engineering, marketing services, localisation, testing, customer care, and audio services across 16 games platforms and more than 50 languages. It has built a client base of over 950 blue-chip clients. In January 2021, the Company will release the FY20 trading update.

Growth Prospects and Risk Assessment

KWS has a strong market position, and it caters to 23 of the top 25 most prominent games companies, including Bandai Namco, Microsoft, Activision Blizzard, Electronic Arts, Konami, Ubisoft, Square Enix, among others. In the past six months, the Company has undertaken the acquisitions of Coconut Lizard, Maverick Media, and Heavy Iron, which will further bolster the Company’s financial performance.

(Source: Kalkine Research, Refinitiv)

It has a strong balance sheet and stable cash generation, which provides financial flexibility to pursue strategic acquisitions. During the pandemic, it successfully raised £100 million in a placing, and it expects to complete further acquisitions over the months ahead from the strong and attractive pipeline of opportunities.

 (Source: Kalkine Research, Refinitiv)

However, there are certain risk and uncertainties to business growth. There is a significant operational risk through Covid-19 pandemic and technology changes. It is also exposed to financial risk associated with the availability of substantial funding, credit and liquidity risk, and fluctuation in foreign exchange and interest rates. Further, macroeconomic uncertainties can impact consumer confidence and reduce non-discretionary expenditures. Also, increasing competition and new entrants can put pressure over profitability margins.

Industry Outlook Dynamics

The technology sector is highly dominated by the Company based in the United States and China. However, the United Kingdom has been gaining a foothold at a global level, as the investment has increased since 2014. The chart below depicts that over the past one year, the Technology sector has outperformed all the other major sectors with sparkling 45.52% of return, while Oil & Gas has proven to be the most battered sector. Invariably, social distancing measures amid Covid-19 pandemic has benefitted the Technology, Consumer Goods and Healthcare sector the most globally.

(Source: Kalkine Research, Refinitiv)

Meanwhile, according to a report from Grand View Research, the global video game market size was valued around US$151.06 billion in 2019, and it is projected to reach US$291.16 billion by 2027, representing a CAGR of 8.2%. The technological innovation and proliferation in both software and hardware shall drive the growth further in the future.

Key Fundamental Statistics

Key Shareholders Statistics

Key Recent Developments

17 September 2020: KWS announced the acquisition of entire issued share capital of Heavy Iron Studios, Inc. for total consideration of up to US$13.3 million.

27 August 2020: Announced the acquisition of Maverick Media Limited for a consideration up to £3.6 million.

26 June 2020: Announced the acquisition of Coconut Lizard Limited for a consideration of up to £2 million.

15 May 2020: The Company completed the equity placing to raise nearly £100 million in gross proceeds by issuing 6,900,000 new ordinary shares.

Business Segments

(Source: Company Website) 

Financial and Operational Highlights (for the six months to 30 June 2020 (H1 FY20), as on 17 September 2020)

(Source: Company Website)

• The Company has shown a robust growth in revenue of 13.3% year-on-year, with an increase in all service lines, particularly in the Group’s largest service line (Game Development).
• Demand for most of the services has remained strong, despite the operational disruption. PBT (profit before tax) increased by 66% year-on-year.
• Total net cash stood at €101.0 million and €100 million of further funds available from undrawn committed facilities under the KWS’s Revolving Credit Facility (RCF), reflecting robust balance sheet position.
• Net proceeds of €110.7 million from equity placing used to pay down drawings on RCF and available to deploy on the value-creating M&A programme.
• Improvement in the adjusted cash flow conversion rate to 50.2% (H1 2019: 30.0%).
• Since June 2020, some selected studios have been re-opened (mostly audio studios and some testing locations).
• The trading performance in July 2020 and August 2020 has been decent with continued growth seen across all the service lines.
• The Company announced the acquisition of Heavy Iron (consideration of up to US$13.3 million) and Coconut Lizard (consideration of up to £2 million) in the Game Development service line. Also, the Company has acquired Maverick Media in August 2020.

Financial Ratios – Strong Profitability Margins versus the Industry Median

Reported profitability metrics for the first half of 2020 were higher against the corresponding period of the last year, reflecting higher revenue generated and better control over expenses as compared to the previous year. On the liquidity front, the current ratio was higher than the industry median of 1.32x, reflecting sufficient current assets to pay short-term obligations and robust liquidity profile to tackle the challenging market dynamics. On leverage front, the debt-equity ratio was 0.09x, which was lower as compared to the industry median of 0.34x, reflecting that the Company is less leveraged as compared to the industry. 

Share Price Performance Analysis

 (Source: Kalkine Research, Refinitiv)

On 22 September 2020, at the time of writing (before the market close, at 10:22 AM GMT+1), Keywords Studios Plc shares were trading at GBX 2,161.04, down by 2.30% against the previous day closing price. Stock 52-week High was GBX 2,314.00 and Low of GBX 1,069.00, respectively.

Bullish Technical Indicators

 (Source: Kalkine Research, Refinitiv)

From the technical standpoint, shares were trading well above the support level of 50-day (GBX 2,101), 100-day (GBX 1,9323), and 200-day (GBX 1,693) simple moving average prices, which reflects an uptrend in the stock and carrying the potential to move up further. Also, 14-day RSI is currently supporting an upside move (around 42.10 level), which means the stock price could increase in the short term.

In the last one year, Keywords Studios Plc share price has delivered ~74.12% return as compared to ~7.36% return of FTSE AIM UK 50 index, which shows that the stock has outperformed the index during the last one year.

The Company’s stock has delivered a positive return of around 18.36% in the last three months. Also, it had delivered a positive return in the last six and nine months of around 61.28% and 46.25%, respectively.

Valuation Methodology: EV/Sales Approach (NTM) (Illustrative)

Business Outlook Scenario

During H2 FY20, the Company anticipates robust demand for their services, supported by the upcoming new console launches, development of new streaming platforms, and increased game play. Therefore, it expects good revenue growth in the H2 FY20 despite the Covid-19 related challenges on their testing business. Moreover, it is likely to continue to drive incremental margin increases until the end of FY21. Subsequently, the Board remains committed to resuming its progressive dividend policy in 2021.

Moreover, the growth drivers in the video games market remain intact, and thus, KWS is expecting to have continued strong demand across all service lines. The demand for video games has considerably accelerated during the pandemic, which would enlarge the video games content going forward.

Regarding the Art Creation and Marketing services business, the Company operates in a large addressable market which remains highly fragmented. It expects to report this business separately once it achieves a sizeable scale. Even in the audio localization services market, there is an opportunity to grow the market share organically as well as with acquisitions over time.

Considering the signs of recovery, decent operating & financial performance, high level of cash generation capabilities, and support from the valuation as done using the above method, we have given a “Speculative Buy” recommendation on Keywords Studios at the current price of GBX 2,161.04 (as on 22 September 2020, before the market close at 10:22 AM GMT+1), with lower-double digit upside potential based on 5.51x EV/NTM Sales (approx.) on FY20E Sales (approx.). 

*All forecasted figures and Peer information have been taken from Refinitiv, Thomson Reuters.

*Dividend Yield may vary as per the stock price movement.

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