Keywords Studios — A diversified, resilient business in troubled times

Keywords Studios (LN: KWS)

Last close As at 22/05/2024

2,920.00

50.00 (1.74%)

Market capitalisation

2,207m

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Research: TMT

Keywords Studios — A diversified, resilient business in troubled times

Keywords delivered a strong performance in FY19 (revenue growth of 30.2% overall, 15.5% organic, 21.2% like-for-like), very much in line with its January trading statement. In the face of the uncertain impact of COVID-19, we are revising our FY20 revenue estimate down, assuming nominal l-f-l 1% revenue growth, with operating profit falling to €38.1m (11.2% margin). We introduce FY21 forecasts, with games industry growth in FY21 helping the business bounce back with 15% revenue growth. The company’s FY21e P/E multiple of 31.1x reflects continuing industry growth, a strong track record and leading market position. The group prudently cancelled its final dividend for FY19, but has a strong balance sheet with €112m of cash and undrawn facilities as at YE19, leaving it well positioned for M&A.

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Written by

TMT

Keywords Studios

A diversified, resilient business in troubled times

FY19 results

Software & comp services

17 April 2020

Price

1,530p

Market cap

£1,005m

€1.15/£

Net debt (€m) at 31 December 2019

17.9

Shares in issue

65.67m

Free float

89%

Code

KWS

Primary exchange

AIM

Secondary exchange

N/A

Share price performance

%

1m

3m

12m

Abs

14.2

0.9

4.4

Rel (local)

4.9

37.3

37.7

52-week high/low

1838p

1073p

Business description

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

Next event

AGM

May 2020

Half-year results

September 2020

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 delivered a strong performance in FY19 (revenue growth of 30.2% overall, 15.5% organic, 21.2% like-for-like), very much in line with its January trading statement. In the face of the uncertain impact of COVID-19, we are revising our FY20 revenue estimate down, assuming nominal l-f-l 1% revenue growth, with operating profit falling to €38.1m (11.2% margin). We introduce FY21 forecasts, with games industry growth in FY21 helping the business bounce back with 15% revenue growth. The company’s FY21e P/E multiple of 31.1x reflects continuing industry growth, a strong track record and leading market position. The group prudently cancelled its final dividend for FY19, but has a strong balance sheet with €112m of cash and undrawn facilities as at YE19, leaving it well positioned for M&A.

Year end

Revenue (€m)

PBT*
(€m)

EPS*
(c)

DPS
(p)

P/E
(x)

Yield
(%)

12/18

250.8

37.9

43.7

1.61

40.3

0.11

12/19

326.5

40.9

47.2

0.58

37.3

0.04

12/20e

339.5

35.5

41.0

1.77

43.0

0.12

12/21e

390.4

49.5

56.6

1.95

31.1

0.13

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

FY19: Strong growth and balance sheet

In FY19, Keywords delivered 30.2% revenue growth and 15.5% underlying organic growth. The company operates in the games sector, a growing industry (Newzoo: 8.4% CAGR 2019–22e) and net beneficiary of lockdown. The group has adequate liquidity, but nevertheless management has prudently sought to preserve cash, including cancellation of the FY19 final dividend. It is cash-generative, has a strong balance sheet with net debt of €17.9m at 31 December 2019 (0.4x net debt/ adjusted EBITDA) and total cash and undrawn facilities of €112m as at YE19.

Revised FY20 and introduction of FY21 estimates

As a result of COVID-19, we revise our FY20 revenue estimate down to reflect the disruption as staff move to remote working (across the business) or are temporarily furloughed (principally audio and testing) during the lockdown. For FY20, we assume nominal 1% like-for-like revenue growth to €339.5m, with operating profit falling by c 29% to €38.1m. We also introduce FY21 forecasts, with the business bouncing back strongly once lockdown measures ease. We forecast FY21 revenues of €390.4m (+15% y-o-y). Adjusted operating margins are set to improve in FY21 – we forecast margins of 13.4% (FY20: 11.2%), operating income of €52.1m (FY20: €38.1m) and normalised EPS of 56.6c, a 38% uplift on FY20 (41.0c).

Valuation: Positive returns from continued execution

Keywords’ shares trade on a P/E of 43.0x our updated FY20e estimates, falling to 31.1x in FY21e. We see no prospect for M&A in H120, although potential accretive acquisition activity in H220/FY21 would bring these multiples down. Despite the current challenges, Keywords’ strategy, which has delivered a five-year EPS CAGR of 42% to FY19, supported by the industry’s strong underlying growth, appears sustainable in the medium to long term.

COVID-19 impact

In its COVID-19 update on 25 March 2020 (see our flash note), Keywords’ management stated that the business impact had been minimal in the first two months of the year, with some short-term disruption in China affecting the company’s five studios there. These have now returned to near full production. Since then, Keywords has seen disruption across all service lines and locations, mitigated by actions from its early experience applied across the group.

Functional Testing (21% of FY19 revenue), Localisation Testing (7%) and Audio Services (12%) (together representing c 40% of FY19 revenues and 38% of staff) have been most disrupted as these businesses have been harder to transition to remote-working – the testing businesses because of client concerns over the security of pre-release games and audio services as the high quality of sound studios is hard to replicate remotely. However, with revenues likely deferred rather than lost, some of the staffing costs have been offset through furloughing and the flexible cost base of freelance staff. Across the firm, 5,500 staff have now been moved to remote working, c 75% of total staffing.

Management also stated that it does not believe that COVID-19 will affect the business materially in the medium term, and indeed, it has already seen an increase in demand for services as existing and new clients re-appraise production arrangements and make contingency plans. Management hopes that Keywords will be able to benefit from this pent-up demand once the operating environment normalises, underpinning stronger expectations for FY21e.

The group has adequate liquidity, but nevertheless management has prudently sought to preserve cash, including cancellation of the FY19 final dividend payment. It is cash-generative, with FY19 cash conversion of c 79%, and has a strong balance sheet with net debt of €17.9m at 31 December 2019 (0.4x net debt/adjusted EBITDA). Keywords has total cash and undrawn facilities of €112m at 31 December 2019, including €30m of the RCF accordion facility currently being executed.

Please see our sector report, European video games: A safe haven in troubled times, published on 8 April for more information on the impact of COVID-19 on the gaming sector.

Certain sectors provide some respite for those in lockdown. The games sector is one, and as such is a beneficiary of the global lockdown. The transition from office work to remote working has caused significant business disruption, but for most games companies the disruption has been effectively managed, with business continuity plans now largely implemented. Its youthful workforce and agile development allow it to adjust to staff working from home, as well as to capitalise on back catalogues of existing games and mature digital delivery channels. Looking ahead, we see a period of three to six months with consumers isolated from normal activities and other forms of entertainment; while it lasts, this period will provide a substantial benefit for games companies. This is an acceleration of the digitalisation of the games industry. Thereafter, we expect the industry to return to its long-term growth trends (Newzoo: 8.4% CAGR 2019–22e).

Revised FY20 and introduction of FY21 estimates

We have revised down our estimates for FY20 to reflect the near-term challenges that we anticipate, particularly in H120, before Keywords can hopefully start to get back on track in H220. We have also introduced estimates for FY21 (Exhibit 1).

FY20 – our base case scenario

Trading in FY20 started in line with market expectations in the first two months of the year, with COVID-19’s impact limited to Keywords’ business in China. However, with the spread of COVID-19, we anticipate an impact on Keywords’ business in Q2 (particularly in Audio, Localisation Testing and Functional Testing), reducing in Q3 and thereafter. Although there is a significant chance of a global recession, we believe the games industry will prove relatively resilient, continuing to benefit from strong consumer demand. As such, we very much expect Keywords to get back on track quickly in H220, seeing a degree of catch-up from pent-up demand in FY21.

With current headwinds, we have pulled back our FY20 forecasts and assumed nominal revenue growth of 1% on the FY19 year-end revenue run rate. With the group’s investment in remote working (c 5,500 staff transitioned to date), furloughing of staff, lower productivity and investment in hardware and systems, we expect H120 margins to have been adversely affected and assume a 3% reduction in FY20 adjusted operating margins (14% to 11%), with PBT margins compressed to 10.5% from 12.5% in FY19.

Exhibit 1: Revised estimates

€000s

2019

2020e

2021e

Old

New

Change

New

y-o-y growth

Revenue

326,463

374,913

339,451

(9.5)%

390,369

15.0%

Cost of Sales

(206,234)

(234,889)

(213,067)

(9.3)%

(244,547)

14.8%

Gross Profit (inc multimedia tax credits)

120,229

140,024

126,385

(9.7)%

145,822

15.4%

Gross Margin (%)

36.8%

37.3%

37.2%

(0.3)%

37.4%

0.3%

EBITDA

50,278

61,192

45,165

(26.2)%

60,227

33.3%

Operating Profit (before amort. & exceptionals)

42,983

53,419

38,127

(28.6)%

52,133

36.7%

Operating Margin

13.2%

14.2%

11.2%

(21.2)%

13.4%

18.9%

Profit Before Tax (norm)

40,913

52,419

35,527

(32.2)%

49,533

39.4%

Profit After Tax (norm)

33,451

42,983

29,048

(32.4)%

40,500

39.4%

EPS - normalised (c)

47.2

64.8

41.0

(36.8)%

56.6

38.2%

Dividend per share (p)

0.58

1.95

1.77

(9.2)%

1.95

10.2%

Closing net debt/(cash)

17,924

(7,647)

(11,228)

(39,367)

Source: Company accounts, Edison Investment Research

Introduction of FY21 forecasts

As stated above, we expect Keywords to bounce back relatively quickly once global lockdowns ease (as has already been seen in its Chinese studios), supported by pent-up demand from its core client base wishing to keep major projects on track (particularly ahead of Thanksgiving and the Q4 console launches) and underpinned by strong consumer demand for games across all platforms and geographies.

Revenues: we have assumed 15% revenue growth with FY21 revenue of €390.4m, at the top end of management’s 10–15% guidance. This assumes a contained impact from COVID-19, with the company benefiting from a degree of catch-up from FY20, supported by the return of underlying growth in the games sector.

Margins: our 13.4% operating margin forecast builds on the 11.2% we now forecast for FY20. We believe the company could achieve a higher margin, but at this stage we would prefer to be conservative. We assume gross margins remain at c 37% for both FY20 and FY21.

Tax rate: through effective planning, Keywords’ tax rate has reduced steadily from 22% in FY16 to 18.2% in FY19. We expect this level is sustainable and forecast a tax rate of 18.2% in both FY20 and FY21.

Capex: as COVID-19 has bitten, management has put a temporary hold on discretionary capex spend. We expect capital spend to resume later in the year, with an element of catch-up in FY21. On this basis, we have assumed a c 25% fall in capex to €10.3m in FY20 (FY19: €13.1m), rising to €15.7m in FY21.

Deferred consideration: after a relatively quiet year for M&A in FY19 (eight acquisitions), the contingent consideration on the balance sheet fell from €19.3m at year-end 2018 to €6.0m at year-end 2019. We forecast that up to €5m will be payable in FY20 if performance conditions are met.

We have also assumed that tax credits – the Multimedia Tax Credit (MMTC – Canada) and the Video Games Tax Relief (VGTR – UK) – grow at 10% in FY21.

The final dividend for FY19 has been cancelled, meaning the total dividend payable for FY19 was 0.58p. We expect a resumption of dividend payments with the FY20 interim dividend, assuming 10% growth for the FY20 dividend over FY18. This implies a total FY20 dividend of 1.77p per share (FY18: 1.61p, FY19: 0.58p). We assume continuing 10% y-o-y dividend growth for FY21.

Acquisition pipeline – H220 weighted

Keywords’ strategy of using earnings-enhancing acquisitions whilst consolidating a fragmented games outsourcing market is intrinsic to the investment case. Given the current environment and the steps management has taken to preserve cash, we do not anticipate M&A in H120. However, we may well see deals resume in H220 with distressed/ready sellers looking to exit towards the end of what will have been a difficult year for many.

The group retains good firepower for M&A with net debt of €17.9m, gearing of 0.4x net debt/adjusted EBITDA and total cash and undrawn facilities of €112m as at 31 December 2019. Although acquisitions are necessarily opportunistic, management’s focus is likely to be around building the group’s higher-margin marketing and development capacity.

Exhibit 2: Financial summary

€'000s

2017

2018

2019

2020e

2021e

31-December

IFRS

IFRS

IFRS

IFRS

IFRS

PROFIT & LOSS

Revenue

 

 

151,430

250,805

326,463

339,451

390,369

Cost of Sales

(96,345)

(154,997)

(206,234)

(213,067)

(244,547)

Gross Profit (inc multimedia tax credits)

55,085

95,808

120,229

126,385

145,822

EBITDA

 

 

26,645

44,232

50,278

45,165

60,227

Operating Profit (before amort. and except.)

 

 

23,915

38,916

42,983

38,127

52,133

Intangible Amortisation

(3,038)

(6,872)

(7,318)

(8,050)

(8,855)

Exceptionals

(3,016)

(5,607)

(4,348)

0

0

Other

(1,426)

(4,129)

(9,775)

(10,753)

(11,828)

Operating Profit

16,435

22,308

21,542

19,325

31,451

Net Interest

(818)

(1,316)

(2,513)

(2,600)

(2,600)

FOREX

(3,623)

791

(1,658)

0

0

Profit Before Tax (norm)

 

 

23,097

37,911

40,913

35,527

49,533

Profit Before Tax (FRS 3)

 

 

11,994

21,783

17,371

16,725

28,852

Tax

(4,731)

(7,191)

(7,462)

(6,480)

(9,034)

Profit After Tax (norm)

18,366

30,720

33,451

29,048

40,500

Profit After Tax (FRS 3)

7,263

14,592

9,909

10,245

19,817

Average Number of Shares Outstanding (m)

58.7

64.3

65.1

65.3

65.4

EPS

 

 

31.3

45.5

48.8

42.2

58.3

EPS - normalised (c)

 

 

30.0

43.7

47.2

41.0

56.6

EPS - (IFRS) (c)

 

 

12.4

22.7

15.2

15.7

30.3

Dividend per share (p)

1.46

1.61

0.58

1.77

1.95

Gross Margin (%)

36.4%

38.2%

36.8%

37.2%

37.4%

EBITDA Margin (%)

17.6%

17.6%

15.4%

13.3%

15.4%

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

15.8%

15.5%

13.2%

11.2%

13.4%

PBT Margin (%)

15.3%

15.1%

12.5%

10.5%

12.7%

BALANCE SHEET

Fixed Assets

 

 

142,927

198,215

223,992

219,755

218,525

Intangible Assets

131,610

180,086

196,769

189,004

180,149

Tangible Assets

10,111

15,002

22,163

25,692

33,316

Investments

1,206

3,127

5,060

5,060

5,060

Current Assets

 

 

80,182

100,348

120,483

150,420

191,478

Stocks

0

0

0

0

1

Debtors

27,473

37,019

43,243

43,675

50,227

Cash

30,374

39,870

41,827

70,978

100,118

Other

22,335

23,459

35,413

35,767

41,132

Current Liabilities

 

 

(51,677)

(95,031)

(49,551)

(49,846)

(50,846)

Creditors

(32,734)

(54,960)

(49,471)

(49,766)

(50,766)

Short term borrowings

(18,943)

(40,071)

(80)

(80)

(80)

Long Term Liabilities

 

 

(10,420)

(11,158)

(71,528)

(71,194)

(73,194)

Long term borrowings

(337)

(230)

(59,671)

(59,671)

(59,671)

Other long term liabilities

(10,083)

(10,928)

(11,857)

(11,523)

(13,523)

Net Assets

 

 

161,012

192,374

223,396

249,136

285,963

CASH FLOW

Operating Cash Flow

 

 

21,389

33,954

46,069

53,619

52,594

Net Interest

(253)

(502)

(9,411)

(6,263)

(1,425)

Tax

(4,731)

(6,304)

(13,288)

(6,480)

(9,034)

Capex

(3,803)

(9,440)

(13,145)

(10,251)

(15,718)

Acquisitions/disposals

(90,090)

(25,766)

(27,762)

(316)

0

Financing

82,936

0

0

0

1,000

Dividends

(867)

(1,080)

(1,197)

(1,157)

(1,277)

Net Cash Flow

4,581

(10,090)

(18,734)

29,152

27,140

Opening net debt/(cash)

 

 

(8,650)

(11,094)

431

17,924

(11,228)

Forex gain on cash

(891)

(3)

1,293

0

0

Other

(1,246)

(1,432)

(52)

0

1,000

Closing net debt/(cash)

 

 

(11,094)

431

17,924

(11,228)

(39,367)

Source: Company accounts, Edison Investment Research

General disclaimer and copyright

This report has been commissioned by Keywords Studios and prepared and issued by Edison, in consideration of a fee payable by Keywords Studios. Edison Investment Research standard fees are £49,500 pa for the production and broad dissemination of a detailed note (Outlook) following by regular (typically quarterly) update notes. Fees are paid upfront in cash without recourse. Edison may seek additional fees for the provision of roadshows and related IR services for the client but does not get remunerated for any investment banking services. We never take payment in stock, options or warrants for any of our services.

Accuracy of content: All information used in the publication of this report has been compiled from publicly available sources that are believed to be reliable, however we do not guarantee the accuracy or completeness of this report and have not sought for this information to be independently verified. Opinions contained in this report represent those of the research department of Edison at the time of publication. Forward-looking information or statements in this report contain information that is based on assumptions, forecasts of future results, estimates of amounts not yet determinable, and therefore involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements of their subject matter to be materially different from current expectations.

Exclusion of Liability: To the fullest extent allowed by law, Edison shall not be liable for any direct, indirect or consequential losses, loss of profits, damages, costs or expenses incurred or suffered by you arising out or in connection with the access to, use of or reliance on any information contained on this note.

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General disclaimer and copyright

This report has been commissioned by Keywords Studios and prepared and issued by Edison, in consideration of a fee payable by Keywords Studios. Edison Investment Research standard fees are £49,500 pa for the production and broad dissemination of a detailed note (Outlook) following by regular (typically quarterly) update notes. Fees are paid upfront in cash without recourse. Edison may seek additional fees for the provision of roadshows and related IR services for the client but does not get remunerated for any investment banking services. We never take payment in stock, options or warrants for any of our services.

Accuracy of content: All information used in the publication of this report has been compiled from publicly available sources that are believed to be reliable, however we do not guarantee the accuracy or completeness of this report and have not sought for this information to be independently verified. Opinions contained in this report represent those of the research department of Edison at the time of publication. Forward-looking information or statements in this report contain information that is based on assumptions, forecasts of future results, estimates of amounts not yet determinable, and therefore involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements of their subject matter to be materially different from current expectations.

Exclusion of Liability: To the fullest extent allowed by law, Edison shall not be liable for any direct, indirect or consequential losses, loss of profits, damages, costs or expenses incurred or suffered by you arising out or in connection with the access to, use of or reliance on any information contained on this note.

No personalised advice: The information that we provide should not be construed in any manner whatsoever as, personalised advice. Also, the information provided by us should not be construed by any subscriber or prospective subscriber as Edison’s solicitation to effect, or attempt to effect, any transaction in a security. The securities described in the report may not be eligible for sale in all jurisdictions or to certain categories of investors.

Investment in securities mentioned: Edison has a restrictive policy relating to personal dealing and conflicts of interest. Edison Group does not conduct any investment business and, accordingly, does not itself hold any positions in the securities mentioned in this report. However, the respective directors, officers, employees and contractors of Edison may have a position in any or related securities mentioned in this report, subject to Edison's policies on personal dealing and conflicts of interest.

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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

1,185 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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Research: Financials

S&U — Sound liquidity, positive near-term cash flow

The scenario of higher unemployment and pressure on average incomes that threatens S&U’s motor finance customers has become reality with remarkable speed. Nevertheless, we believe government actions should provide mitigation and even allowing for an increase in arrears the company is likely to generate cash as collections outpace much reduced lending demand, augmenting the liquidity headroom it already has. This together with maintenance of relations with customers, brokers and introducers should mean the business is positioned to progress strongly once conditions normalise.

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