An attractive proposition for uncertain times

Keywords Studios 26 March 2021 Update
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Keywords Studios

An attractive proposition for uncertain times

FY20 results

Software & comp services

26 March 2021

Price

2,428p

Market cap

£1.81bn

€1.16/£

Net cash (€m) at 31 December 2020 (excluding lease liabilities)

102.9

Shares in issue

74.4m

Free float

90%

Code

KWS

Primary exchange

AIM

Secondary exchange

N/A

Share price performance

%

1m

3m

12m

Abs

(4.9)

(15.5)

79.9

Rel (local)

(5.3)

(18.0)

46.7

52-week high/low

2,942p

1,330p

Business description

Keywords Studios is the largest and most diverse supplier of outsourced technical and creative services to the games industry. Through regular acquisitions, the company is building its scale, geographic footprint and delivery capability to become the ‘go-to’ supplier across the industry.

Next event

AGM

May 2021

Analysts

Richard Williamson

+44 (0)20 3077 5700

Dan Ridsdale

+44 (0)20 3077 5700

Keywords Studios is a research client of Edison Investment Research Limited

Keywords’ FY20 results were in line with its trading update (FY20 revenues €373.5m, adjusted PBT €55.0m), with 12% organic growth in FY20 despite COVID-19. Adjusted EBITDA rose 29% to €74.2m, with PBT up 35% to €55.0m and adjusted PBT margins climbing to 14.7%, close to management’s 15% long-term target. We believe the outlook for FY21 looks benign, with demand for Keywords’ services continuing to build in the short to medium term. Sonia Sedler joined in January as COO to strengthen the management team and has been appointed interim joint CEO, alongside Jon Hauck (CFO), pending Andrew Day’s return as CEO. We have updated our estimates for the €46.8m acquisition of Tantalus Media and introduced FY23 estimates. With net cash and facilities totalling €202.9m at year end, Keywords remains well placed for further M&A.

Year end

Revenue

(€m)

PBT*
(€m)

EPS*
(c)

DPS
(p)

P/E
(x)

Yield
(%)

12/19

326.5

40.9

48.8

0.58

57.7

0.02

12/20

373.5

55.0

60.9

0.00

46.2

0.00

12/21e

475.1

71.0

76.3

1.91

36.9

0.08

12/22e

536.9

79.9

85.4

2.11

33.0

0.09

Note: *PBT and EPS are normalised, excluding amortisation of acquired intangibles, exceptional items and share-based payments.

Well positioned for a strong FY21

FY20 was a year of two halves, with organic revenue growth of 8% in H120, climbing to 15% in H220 as the business adapted to new COVID-19 work patterns. FY20 adjusted PBT margins rose to 14.7% (H120 12.5%, H220 16.7%), with that momentum providing a strong start to H121. However, management remains cautious on margins rising further, with capex set to increase in FY21 and costs also likely to start to normalise in H221. Keywords reported adjusted cash conversion of 97% in FY20 (FY19 80%), with strong operating cashflow and the €110m placing contributing to FY20 year-end net cash of €102.9m (FY19 net debt €17.9m), despite the seven acquisitions announced in FY20. Post year-end, Keywords also announced the acquisition of Tantalus Media, the group’s first Australian deal.

Model updated, FY23 estimates introduced

We have updated our FY21 and FY22 estimates to incorporate the acquisition of Tantalus Media and latest management guidance. We have otherwise left our assumptions for FY21 and FY22 broadly unchanged at this early stage of the year, despite positive expectations. We have also introduced FY23 estimates.

Valuation: Multiples to fall with continuing M&A

Keywords’ shares trade on an FY21e P/E of 36.9x, falling to 33.0x in FY22e, in line with its UK and European games industry peers. Although this is a demanding valuation, management has offered a confident outlook for FY21, based on strong client demand and a period of heightened game releases, benefiting underlying growth in the period from FY21–23. With strong organic growth, supplemented by an active buy-and-build strategy, we expect earnings to rise as the year progresses, lowering valuation multiples.

FY20 results: A resilient performance

Keywords’ FY20 results were in line with its January trading update (FY20 revenues €373.5m and adjusted PBT €55.0m), with 12% organic growth in FY20 (despite the effect of COVID-19) leading to adjusted EBITDA rising 29% to €74.2m (FY19 €57.6m). Adjusted EBITDA margins rose to 19.9% (FY19: 17.6%), reflecting operating leverage coupled with effective cost control. Adjusted PBT rose 35% to €55.0m with adjusted PBT margins climbing to 14.7% (from 12.5% in FY19), close to management’s 15% long-term target. Notably, H220 (15% l-f-l organic revenue growth, 15.7% adjusted PBT margin) was markedly stronger than H120 (8.0% l-f-l organic revenue growth, 12.5% adjusted PBT margin) with that momentum carrying through to H121. FY20 adjusted EPS rose 25% to 60.93c (FY19 48.78c).

It was reassuring to see high adjusted cash conversion of 97% (FY19 80%), with strong operating cashflow (together with the €110m placing in May) contributing to the company reporting FY20 year-end net cash of €102.9m (FY19 net debt of €17.9m), despite having spent €39.9m of net cash on acquisitions in FY20. Together with an additional €100m of uncommitted facilities, Keywords has ample firepower to commit to future M&A.

As we mentioned in our note published on 1 March (Looking like a winner as the dust settles), the outlook for Keywords in FY21 looks strong. Publishers are developing and launching increasing numbers of new titles to serve a growing next-generation console base in FY21–23, meaning that demand for Keywords’ services should continue to build in the short to medium term.

Strengthened management team and management changes

Sonia Sedler was appointed as COO on 18 January 2021, to lead Keywords’ operational growth strategy. She brings experience in scaling businesses internationally through senior roles at Diebold Nixdorf, Sutherland Global Services, HCL and Accenture.

On 15 March 2021 the board announced that Andrew Day, CEO, would take a temporary leave of absence from the business for health reasons. Andrew Day remains a member of the board of directors pending his return, with Sonia Sedler (COO) and Jon Hauck (CFO) stepping up to become interim joint CEOs and providing the cover the group needs while Andrew Day recuperates.

M&A: Six acquisitions completed in FY20, two more in Q121

Keywords announced seven acquisitions in FY20, focused on the higher-margin business lines of Game Development (Coconut Lizard, High Voltage and Heavy Iron) and Marketing Services (Maverick Media, g-Net and Indigo Pearl), with an opportunistic acquisition of Jinglebell strengthening the Audio service line. The company committed net cash of €39.9m to the six acquisitions completed in FY20 (Heavy Iron and Tantalus Media completed in FY21), with a total maximum consideration of up to €97.2m in cash and shares, dependent on performance based earn-outs. As a result of these acquisitions, Keywords ended the year with a pro forma revenue run-rate of €409.2m (2019 €333.6m).

Post year-end, as well as completing the Heavy Iron transaction (January 2021), Keywords also announced the acquisition of Tantalus Media (March 2021).

Tantalus Media – a first foothold in Australia. Keywords acquired an 85% stake in the Australian games developer, Tantalus Media, for total consideration of US$46.8m (US$30.6m up-front, US$16.2m subject to a two year earn-out). Up-front consideration was payable 60% in cash, 40% in shares with the earn-out also a mix of cash and shares. Initial consideration equated to a multiple of c 6x FY20 Adj. EBITDA (adjusted for the 85% shareholding) and we understand the earn-out is structured to deliver a 6x overall adjusted EBITDA multiple. Tantalus Media is Keywords’ first acquisition in Australia, so we expect Keywords to follow its ‘land and expand’ strategy, expanding the suite of services available from its new base in Melbourne. Tom Crago (who retains a 15% shareholding), the founder of Tantalus Media, will work with Keywords to drive this regional expansion, both organically and through acquisition.

Seven service lines to become eight for H121 results

Over FY20, Keywords has strengthened its position in Marketing Services and Game Development, announcing acquisitions of three further companies in each service line. As a result of the acquisition-driven growth in Marketing Services, management has confirmed that from H121, it will break Marketing Services out separately from Art Services, creating an eighth service line.

Exhibit 1: FY20 service line performance

Exhibit 2: FY21 service line outlook

Source: Keywords

Source: Keywords

Exhibit 1: FY20 service line performance

Source: Keywords

Exhibit 2: FY21 service line outlook

Source: Keywords

In terms of FY20 performance, the service lines can be broken into two groups. The first group includes Art Services (including Marketing Services), Game Development, Functionality QA and Player Support. These were all able to translate their working patterns to accommodate remote working in H220, delivering strong organic growth in FY20 and seeing a markedly stronger H220 than H120, save for Games Development, where recruitment, training, on-boarding and business development issues restricted growth in H220. These issues are also likely to constrain growth in Game Development in H121.

The other group includes Audio Services, Localisation and Localisation QA, which struggled with the transition to remote working. Audio Services was heavily reliant on voice actors visiting physical recording studios. An online recording solution has now been developed as projects pick up again in FY21. Localisation experienced delays in the receipt of content in H120, as some clients experienced disruption to production schedules. Localisation returned to modest growth in H220, which Keywords expects to build on in FY21, with a strengthened sales effort. Localisation QA also suffered from disruption in H120, largely addressed in H220 through flexible working arrangements, using studios for priority activities. However, challenges remain around the recruitment of native language testers in lockdown.

Environmental, social and governance strategy

Keywords is committed to conducting its business responsibly, while operating to the highest standards of honesty, integrity and ethical conduct. Six priority areas have been identified, with the group due to report regularly on progress in each of these areas. The six areas are: People; Diversity; Customer Centricity & Innovation; Communities; Governance; and the Environment. Further details of Keywords’ strategy in each of these areas is expected to be provided in the FY20 annual report.

Other ESG progress made in FY20 included:

The publication of Keywords’ Code of Conduct, available in 12 languages on its website.

The establishment of a Global Diversity & Inclusivity Counsel, with unconscious bias training introduced for individuals involved in recruitment.

The group launched a Keywords Cares matched fund raising programme, in which the group will match funds raised for good causes by its teams around the world.

The establishment a US$0.5m hardship fund to support Keywordians experiencing financial hardship as a result of COVID-19.

Keywords has quantified its scope 1 and 2 greenhouse gas emissions, establishing an FY20 baseline for future reporting.

Updated estimates, introduction of FY23 estimates

As stated in our Outlook note in March 2021 (Looking like a winner as the dust settles), the key growth drivers for Keywords remain intact: in the short term, growth should be supported by continued development spending and the increasing trend towards outsourcing; medium-term growth will be boosted by a strong pipeline of launches for next-generation consoles in FY21–23; and long-term demand is underpinned by strong secular and technology trends.

We have revised our estimates for FY21, principally to reflect the acquisition of Tantalus Media, the impact of which then flows through into FY22, but also to pick up on the revised management guidance included with the FY20 results on PBT margins and effective tax rate. We have also introduced our estimates for FY23.

Exhibit 3: Revised estimates

2020

YoY

2021e

2021e

YoY

2022e

2022e

YoY

2023e

YoY

31-December

Actual

Chge

Old

New

Chge

Chge

Old

New

Chge

Change

New

Chge

Revenue

373,538

14%

464,520

475,118

2.3%

27%

520,263

536,858

3.2%

13%

590,544

10%

Gross Profit (inc multimedia tax credits)

141,772

18%

176,214

181,068

2.8%

28%

197,941

204,084

3.1%

13%

224,492

10%

Gross Margin (%)

38.0%

37.9%

38.1%

38.0%

38.0%

38.0%

EBITDA (Adjusted)

74,177

29%

89,703

92,729

3.4%

25%

100,821

102,896

2.1%

11%

112,393

9%

Operating Profit (before amort. and except.)

57,259

33%

70,303

72,979

3.8%

27%

79,321

81,948

3.3%

12%

90,143

10%

Operating Margin

15.3%

15.1%

15.4%

15.2%

15.3%

15.3%

Profit Before Tax (norm)

54,954

34%

67,803

70,979

4.7%

29%

76,821

79,948

4.1%

13%

88,143

10%

PBT (norm) Margin

14.7%

14.6%

14.9%

14.8%

14.9%

14.9%

Profit After Tax (norm)

43,927

31%

55,437

56,783

2.4%

29%

62,810

63,959

1.8%

13%

70,515

10%

EPS - normalised (c)

60.9

25%

74.3

76.3

2.6%

25%

83.8

85.4

1.8%

12%

93.8

10%

Dividend per share (p)

0.00

-

1.91

1.91

-

-

2.11

2.11

-

-

2.32

-

Closing net debt/(cash)

(102,875)

(139,530)

(110,475)

(154,611)

(201,898)

Source: Company accounts, Edison Investment Research

Assumptions underpinning our estimates

Revenues: for FY23, we have assumed 10% revenue growth from FY22, in line with management’s 10–15% long-term guidance, indicating FY23 revenues of €591m.

Margins: although there is potential for Keywords to achieve higher margins, for the moment we assume management will continue to target revenue growth over margin enhancement and, as such, we assume gross margins remain stable at c 38% for FY21-23, with an adjusted PBT margin conservatively slightly below management’s long-term target of 15%.

Tax rate: Keywords’ tax rate rose to c 20% in FY20, up from 18.2% in FY19. Management has guided towards the effective tax rate rising further in FY21 to 21%. We expect this level to be sustainable and maintain this assumption for FY22 and FY23.

Capex: with the impact of COVID-19, management put a temporary hold on discretionary capex in FY20. We have assumed this will rise again in FY21, with an element of catch up, with lower utilisation of assets in a work-from-home environment or a potential more flexible future working environment. On this basis, we have assumed a c 40% y-o-y rise in capex in FY21 to €19.1m, rising steadily to €23.8m in FY23.

Deferred consideration: contingent consideration on the balance sheet rose to €18.8m at year-end 2020 from €6.0m at year-end 2019, with c 80% payable in 2021. We estimate liabilities of c €14m for FY22 and FY23, assuming 75% of maximum potential consideration is paid.

We have also assumed that tax credits – the Multimedia Tax Credit (Canada) and the Video Games Tax Relief (UK) – grow at 10% in each of FY21, FY22 and FY23. We note that €2.5m of FY21 tax credits were brought forward and recognised in FY20.

Finally, we expect a resumption of Keywords’ progressive dividend policy in FY21, starting with the FY21 interim dividend. We assume a one-third/two-thirds split between interim and final dividend, with a total dividend of €1.91 per share in FY21. We assume 10% y-o-y dividend growth for FY22 and FY23.

Exhibit 4: Financial summary

€'000s

2019

2020

2021e

2022e

2023e

31-December

IFRS

IFRS

IFRS

IFRS

IFRS

PROFIT & LOSS

Revenue

 

 

326,463

373,538

475,118

536,858

590,544

Cost of Sales

(206,234)

(231,766)

(294,050)

(332,774)

(366,052)

Gross Profit (inc multimedia tax credits)

120,229

141,772

181,068

204,084

224,492

Investment income

-

1,437

-

-

-

EBITDA (adjusted)

 

 

57,611

74,177

92,729

102,896

112,393

EBITDA (reported)

 

 

43,375

66,760

92,729

102,896

112,393

Operating Profit (before amort. and except.)

 

 

42,983

57,259

72,979

81,948

90,143

Amortisation of acquired intangibles

(7,318)

(8,808)

(11,317)

(13,376)

(14,714)

Exceptionals

(4,348)

(2,650)

-

-

-

Other (incl share based payments)

(9,775)

(15,350)

-

-

-

Operating Profit

21,542

41,119

61,662

68,572

75,429

Net Interest

(2,513)

(2,522)

(2,000)

(2,000)

(2,000)

FOREX

(1,658)

(6,103)

-

-

-

Profit Before Tax (norm)

 

 

40,913

54,954

70,979

79,948

88,143

Profit Before Tax (FRS 3)

 

 

17,371

32,494

59,662

66,572

73,429

Tax

(7,462)

(11,027)

(14,196)

(15,990)

(17,629)

Profit After Tax (norm)

33,451

43,927

56,783

63,959

70,515

Profit After Tax (FRS 3)

9,909

21,467

45,466

50,582

55,801

Average Number of Shares Outstanding (m)

65.1

70.8

74.5

74.9

75.1

EPS - normalised (c)

 

 

48.8

60.9

76.3

85.4

93.8

EPS - normalised fully diluted (c)

 

 

47.2

57.7

73.1

82.1

90.5

EPS - (IFRS) (c)

 

 

15.2

30.3

61.1

67.5

74.3

Dividend per share (p)

0.58

0.00

1.91

2.11

2.32

Gross Margin (%)

36.8%

38.0%

38.1%

38.0%

38.0%

EBITDA Margin (%)

13.3%

17.9%

19.5%

19.2%

19.0%

Operating Margin (before GW and except.) (%)

13.2%

15.3%

15.4%

15.3%

15.3%

PBT Margin (%)

12.5%

14.7%

14.9%

14.9%

14.9%

BALANCE SHEET

Fixed Assets

 

 

245,461

309,685

338,541

352,731

370,225

Intangible Assets

196,769

240,810

264,522

269,495

276,111

Tangible Assets

22,163

26,419

31,563

40,780

51,658

Right of use assets

21,469

27,807

27,807

27,807

27,807

Investments

5,060

14,649

14,649

14,649

14,649

Current Assets

 

 

120,483

189,567

211,101

267,289

325,824

Stocks

-

-

-

-

-

Debtors

43,243

47,832

55,537

62,202

68,422

Cash

41,827

103,070

110,670

154,807

202,093

Other

35,413

38,665

44,894

50,281

55,309

Current Liabilities

 

 

(57,292)

(91,130)

(95,588)

(98,382)

(101,021)

Creditors

(49,471)

(83,696)

(88,154)

(90,948)

(93,587)

Short term borrowings

(80)

(73)

(73)

(73)

(73)

Lease liabilities

(7,741)

(7,361)

(7,361)

(7,361)

(7,361)

Long Term Liabilities

 

 

(85,694)

(36,887)

(36,887)

(36,887)

(36,887)

Long term borrowings

(59,671)

(122)

(122)

(122)

(122)

Lease liabilities

(14,166)

(21,503)

(21,503)

(21,503)

(21,503)

Other long term liabilities

(11,857)

(15,262)

(15,262)

(15,262)

(15,262)

Net Assets

 

 

222,958

371,235

417,167

484,752

558,141

CASH FLOW

Operating Cash Flow

 

 

46,069

80,879

85,509

98,843

108,035

Net Interest

(9,411)

(9,816)

(9,047)

(9,047)

(9,047)

Tax

(13,288)

(4,459)

(14,196)

(15,990)

(17,629)

Capex

(13,145)

(13,908)

(19,131)

(21,617)

(23,778)

Acquisitions/disposals

(27,762)

(39,936)

(33,874)

(6,217)

(8,269)

Financing

-

111,698

-

-

-

Dividends

(1,197)

-

(1,662)

(1,836)

(2,026)

Net Cash Flow

(18,734)

124,458

7,600

44,137

47,287

Opening net debt/(cash)

 

 

430

17,924

(102,875)

(110,475)

(154,611)

Forex gain on cash

1,293

(3,426)

-

-

-

Other

(53)

(233)

-

-

-

Closing net debt/(cash) (excluding lease liabilities)

 

 

17,924

(102,875)

(110,475)

(154,611)

(201,898)

Source: Company accounts, Edison Investment Research

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Copyright: Copyright 2021 Edison Investment Research Limited (Edison).

Australia

Edison Investment Research Pty Ltd (Edison AU) is the Australian subsidiary of Edison. Edison AU is a Corporate Authorised Representative (1252501) of Crown Wealth Group Pty Ltd who holds an Australian Financial Services Licence (Number: 494274). This research is issued in Australia by Edison AU and any access to it, is intended only for "wholesale clients" within the meaning of the Corporations Act 2001 of Australia. Any advice given by Edison AU is general advice only and does not take into account your personal circumstances, needs or objectives. You should, before acting on this advice, consider the appropriateness of the advice, having regard to your objectives, financial situation and needs. If our advice relates to the acquisition, or possible acquisition, of a particular financial product you should read any relevant Product Disclosure Statement or like instrument.

New Zealand

The research in this document is intended for New Zealand resident professional financial advisers or brokers (for use in their roles as financial advisers or brokers) and habitual investors who are “wholesale clients” for the purpose of the Financial Advisers Act 2008 (FAA) (as described in sections 5(c) (1)(a), (b) and (c) of the FAA). This is not a solicitation or inducement to buy, sell, subscribe, or underwrite any securities mentioned or in the topic of this document. For the purpose of the FAA, the content of this report is of a general nature, is intended as a source of general information only and is not intended to constitute a recommendation or opinion in relation to acquiring or disposing (including refraining from acquiring or disposing) of securities. The distribution of this document is not a “personalised service” and, to the extent that it contains any financial advice, is intended only as a “class service” provided by Edison within the meaning of the FAA (i.e. without taking into account the particular financial situation or goals of any person). As such, it should not be relied upon in making an investment decision.

United Kingdom

This document is prepared and provided by Edison for information purposes only and should not be construed as an offer or solicitation for investment in any securities mentioned or in the topic of this document. A marketing communication under FCA Rules, this document has not been prepared in accordance with the legal requirements designed to promote the independence of investment research and is not subject to any prohibition on dealing ahead of the dissemination of investment research.

This Communication is being distributed in the United Kingdom and is directed only at (i) persons having professional experience in matters relating to investments, i.e. investment professionals within the meaning of Article 19(5) of the Financial Services and Markets Act 2000 (Financial Promotion) Order 2005, as amended (the "FPO") (ii) high net-worth companies, unincorporated associations or other bodies within the meaning of Article 49 of the FPO and (iii) persons to whom it is otherwise lawful to distribute it. The investment or investment activity to which this document relates is available only to such persons. It is not intended that this document be distributed or passed on, directly or indirectly, to any other class of persons and in any event and under no circumstances should persons of any other description rely on or act upon the contents of this document.

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United States

Edison relies upon the "publishers' exclusion" from the definition of investment adviser under Section 202(a)(11) of the Investment Advisers Act of 1940 and corresponding state securities laws. This report is a bona fide publication of general and regular circulation offering impersonal investment-related advice, not tailored to a specific investment portfolio or the needs of current and/or prospective subscribers. As such, Edison does not offer or provide personal advice and the research provided is for informational purposes only. No mention of a particular security in this report constitutes a recommendation to buy, sell or hold that or any security, or that any particular security, portfolio of securities, transaction or investment strategy is suitable for any specific person.

Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

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Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

1185 Avenue of the Americas

3rd Floor, New York, NY 10036

United States of America

Sydney +61 (0)2 8249 8342

Level 4, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

1185 Avenue of the Americas

3rd Floor, New York, NY 10036

United States of America

Sydney +61 (0)2 8249 8342

Level 4, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

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