2023-11-07 14:43:51 ET
Summary
- Keywords Studios has experienced impressive growth, outpacing the gaming industry, through mergers and acquisitions and diversification into various gaming segments.
- The company's financial performance is strong, with consistent operating income and quarterly net profits.
- While the stock's P/E ratio is higher than the sector median, it is currently lower than its historical average, suggesting possible undervaluation.
Introduction
Keywords Studios plc (KYYWF) has been in the business of offering various technical and creative services to the video game and digital media industries for more than two decades. In this period, the gaming industry has grown by leaps and bounds. The number of game titles released annually has grown significantly with the advent of digital distribution platforms and mobile devices, increasing the quantity and diversity of game titles available to consumers.
Industry reports project the video game industry revenue to grow at a CAGR of 9.83% between 2023 and 2027. During the 2020 pandemic season, the video game industry revenue grew rapidly, spurred by the number of people who actively purchased and played video games during lockdowns. By the end of H1 FY20, the gaming industry quickly surpassed the $159.3 billion EOY revenue initially projected by market watchers and analysts, prompting a revised estimate of $174 billion by year-end - about 20% YoY growth. This growth continued in FY21 as the gaming industry crossed $192.3 billion, though at a much lower YoY growth compared to FY20's YoY growth. In FY22, the industry saw a ~4.5% decline (or a correction) in growth, recording $184.4 billion in revenue. For the current year, estimates sit at $187.7 billion, representing a tiny 2.6% YoY increase. While the industry is expected to grow at 2.6% YoY for FY23, Keywords Studios' revenue estimate for this year is $843.38 million - a 15% YoY growth.
Growth in the video game and digital media industries has recently slowed and momentum for game companies was generally weak in the first half of this year with weak game sales and a decline in mobile gaming, but a turnaround is expected in the second half. Experts see this year as a reset year for the gaming industry, following last year's correction. The industry has experienced recent waves of layoffs. Even large game devs continue to axe employees as they aim to cut OpEx and focus on being profitable. Just last week Sony-owned game developer Bungie ( SONY ) reportedly laid off about 8% of its total employees. Frontier Developments plc ( FRRDF ) announced layoffs last month, following disappointing financial performance. Keywords Studios has not announced any recent major layoffs besides the layoff of 13 quality assurance unionized developers working on BioWare games at one of its studios in Canada. The layoff was because the term contract of the devs had ended, unlike some other game developers who have cut staff mainly to cut costs. I think Keywords' new $400 million revolving credit facility ((RCF)) is coming into play here as it gives the company adequate liquidity to weather any storm companies in the industry currently face. The new credit facility, secured last month, is an upgrade of a previous €150 million ($160.4 million) RCF.
Keywords Studios has continued to expand its game development service line over the years, setting up new studios and offices in Australia and Europe , and acquiring Hardsuit Labs and social media agency Digital Media Management . In the recently released H1 FY23 result , the company acknowledged closing four high-quality acquisitions for a total maximum consideration of ~€130 million (~$139 million) since the start of this year.
KWS Growth Trajectory
Keywords Studios has grown more than the gaming industry in terms of CAGR, and I think this can be attributed to the many mergers and acquisitions (M&As) and the wide expansion the company has been experiencing over the past few years. M&As allow Keywords Studios to acquire established companies with expertise in different gaming-related services. Keywords serve several segments in the gaming industry, including art creation, localization, and audio creation segments. This diversification into multiple segments enables the company to serve a wide range of gaming developers and publishers, ensuring a steady flow of projects and revenue, and providing stability and a continuous stream of work all year round.
The state of Keywords' financials looks good. The latest financial results, for the half-year FY23, reported consolidated revenue of €383.5 million ($411.7 million), which is a 19.4% increase over last year's H1 revenue. The revenue growth is driven by "robust organic growth and supplemented by acquisitions." Keywords Studios showed the ability to increase its sales from its core business operations as it reports an organic revenue growth of 10.4% in H1, primarily driven by growth in combining the demand for its game development and art Services, which the company calls its Create service line.
Assessing the efficiency and profitability of Keywords Studios' core operations, the income statement shows that operating income has been consistent and has shown improvement over time. Though SG&A expenses and operating expenses have slightly increased this year, which are in line with revenue growth, the company's operating income has not been impacted. Keywords Studios' bottom line looks strong. The company has posted quarterly net profits for at least the past eight quarters.
The cash flow statement shows cash outflows since Q3 FY22. The company's cash acquisitions increased significantly in that period (clearly because of its M&As), resulting in a high cash burn in investing activities which in turn has led to negative net change in cash over this period. The cash burn has also resulted in a decline in the company's cash and equivalents over time, as seen on the balance sheet .
Valuation
KYYWF is down 49% YTD. The momentum for this stock is currently weaker than that of its sector. Its P/E GAAP (TTM) of 38.41x is 59.91% higher than the sector's median P/E. While the P/E multiple seems way higher than its sector median P/E, KYYWF's P/E is currently lower than its historical average P/E, as seen in the chart above.
Comparing Keywords to some peers in the Interactive Home Entertainment sector, we see that Keywords' P/E is on par with the current P/E trend among profitable game devs.
Conclusion and Takeaway
In conclusion, Keywords Studios has witnessed impressive growth, outpacing the gaming industry, primarily due to strategic mergers and acquisitions, diversification into various gaming segments, and steady financial performance. The company's core operations show efficiency and profitability, with consistent operating income and a strong bottom line, as reflected in consistent quarterly net profits. While its P/E ratio is higher than the sector median, it is currently lower than its historical average, suggesting possible undervaluation.
I believe that a hold is a prudent rating for this stock. For investors considering a gaming stock, monitoring KYYWF's performance until the end of the fiscal year is a wise approach to gauge the industry's momentum and this stock's potential. For investors who already have KYYWF in their portfolio, holding onto the stock is a reasonable strategy. The YTD price decline may present an opportunity for potential recovery, especially with the expected industry turnaround in the second half of the year.
For further details see:
Keywords Studios: A Gaming Stronghold