Keywords Studios — An attractive proposition for uncertain times

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.

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.

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).

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.

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.

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:

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.

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.