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Keywords Studios’ $6m acquisition of Red Hot CG further strengthens the company’s position in the art service line, in China and with electronic arts. Management estimates that the deal will make Keywords the number one supplier of art production services to the games industry globally and increase art production capacity by 25%. The deal further enhances our estimated FY18 earnings by 6%, with the three acquisitions made so far in May enhancing earnings by 11% versus our April forecasts.
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Keywords Studios |
Red Hot art acquisition |
Acquisition |
Software & comp services |
22 May 2017 |
Share price performance
Business description
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Keywords Studios is a research client of Edison Investment Research Limited |
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Keywords Studios’ $6m acquisition of Red Hot CG further strengthens the company’s position in the art service line, in China and with Activision. Management estimates that the deal will make Keywords the number one supplier of art production services to the games industry globally and increase art production capacity by 25%. The deal further enhances our estimated FY18 earnings by 6%, with the three acquisitions made so far in May enhancing earnings by 11% versus our April forecasts.
Year |
Revenue (€m) |
PBT* |
EPS* |
DPS |
P/E |
Yield |
12/15 |
58.0 |
8.0 |
12.6 |
1.2 |
74.0 |
0.1 |
12/16 |
96.6 |
14.9 |
20.3 |
1.3 |
46.0 |
0.1 |
12/17e |
123.1 |
18.6 |
26.0 |
1.5 |
35.9 |
0.2 |
12/18e |
136.5 |
21.0 |
29.1 |
1.6 |
32.1 |
0.2 |
Note: *PBT and EPS (fully diluted) are normalised, excluding intangible amortisation, exceptional items and share-based payments.
Bolstering position in art services and China
Red Hot CG is a China-based but UK-managed provider of a range of art services to the games industry. The company’s operating hub is in Shanghai but it has subsidiaries in lower-cost locations elsewhere in China and in Yogyakarta in Indonesia. The addition of Red Hot CG’s 220 artists should increase the group’s art capacity by circa 25%. Management estimates this will make Keywords the largest provider of art production to the global games industry, ahead of Shanghai-based Virtuos, although there remains plenty of scope for further consolidation. From a customer perspective, Red Hot provides services to broad range of developers but has a particularly strong relationship with Activision and will support Keywords’ drive to develop larger-scale, more strategic relationships with major games developers.
EPS upgraded by 7%
Red Hot generated revenues of $5.4m in FY16 and PBT of $0.9m with further growth expected in FY17. (Our estimates assume 10% growth for Red Hot in FY17.) Keywords is paying a total consideration of $6m for the business, equating to multiple of 1.1x sales and 6.7x PBT. Of the consideration, $4.35m will be paid immediately of which, $1m is deferred for three years, with the remainder satisfied by the issue of 160.8k shares on the second anniversary of the acquisition. We upgrade our FY17 and FY18 EPS estimates by 3.1% and 5.8%, respectively.
Valuation: Continued execution key to further upside
At 32x FY18e earnings, Keywords’ rating is a substantial premium to peers (average 19x for FY18) and, in our view, further strong progress is now priced in for this year. Nevertheless, the company has a compelling platform and strategy for growth in a games industry growing at a healthy 6.6% pa. Consequently, we believe continued execution should deliver share price value in the longer term.
Estimate changes
Our estimate changes are shown below in Exhibit 1.
The Red Hot acquisition prompts a 3% upgrade to FY17 PBT and adj EPS, with FY18 figures moving up by 6%. Factoring in all three acquisitions made in May (XLOC, GameSim and Red Hot), FY17 PBT and EPS has been upgraded by 6%, with the FY18 figures upgraded by 11%.
The company is paying a gross consideration (including deferred payments and shares issued) of €10m for these three acquisitions, resulting in a $2m enhancement to our FY18 PBT, which equates to an attractive 5x forward PBT multiple.
Following the deals, the company’s mid-year net cash is likely to be at the low- to mid-single-digit level. It has a €35m revolving credit facility with Barclays and generates robust free cash flows, giving it plenty of firepower to make more earnings-enhancing acquisitions.
If the company were to invest a further €35m on acquisitions this year at the same 5x PBT forward multiple as the May acquisitions, we estimate that FY18 EPS would be upgraded by c 27%.
Exhibit 1: Estimate changes
€000s |
2015 |
2016 |
2017e |
2017e |
Change |
2018e |
2018e |
Change |
Year end 31 December |
Actual |
Actual |
Old |
New |
Old |
New |
||
Revenue |
57,951 |
96,585 |
119,551 |
123,115 |
3% |
130,605 |
136,485 |
5% |
Cost of sales |
(36,172) |
(59,907) |
(74,833) |
(76,793) |
3% |
(81,843) |
(85,078) |
4% |
Gross profit |
21,779 |
36,678 |
44,718 |
46,322 |
4% |
48,761 |
51,408 |
5% |
EBITDA |
9,459 |
16,893 |
20,414 |
21,152 |
4% |
22,438 |
23,735 |
6% |
Operating profit (before amort. and except.) |
8,162 |
15,090 |
18,339 |
19,077 |
4% |
20,156 |
21,453 |
6% |
Profit before tax (norm) |
8,007 |
14,864 |
18,029 |
18,617 |
3% |
19,846 |
20,993 |
6% |
Profit after tax (norm) |
6,175 |
11,641 |
14,243 |
14,708 |
3% |
15,877 |
16,795 |
6% |
EPS - normalised fully diluted (c) |
12.6 |
20.3 |
25.2 |
26.0 |
3% |
27.5 |
29.1 |
6% |
EPS – (IFRS) (c) |
7.0 |
11.2 |
21.6 |
22.4 |
4% |
24.0 |
25.7 |
7% |
Dividend per share (pence) |
1.2 |
1.3 |
1.5 |
1.5 |
0% |
1.6 |
1.6 |
0% |
Closing net debt/(cash) |
(17,284) |
(8,650) |
(15,720) |
(13,244) |
-16% |
(25,731) |
(23,943) |
-7% |
Source: Keywords Studios data, Edison Investment Research
Exhibit 2: Financial summary
€000s |
2014 |
2015 |
2016 |
2017e |
2018e |
||
Year end 31 December |
IFRS |
IFRS |
IFRS |
IFRS |
IFRS |
||
PROFIT & LOSS |
|||||||
Revenue |
|
|
37,293 |
57,951 |
96,585 |
123,115 |
136,485 |
Cost of Sales |
(24,566) |
(36,172) |
(59,907) |
(76,793) |
(85,078) |
||
Gross Profit (inc multimedia tax credits) |
12,727 |
21,779 |
36,678 |
46,322 |
51,408 |
||
EBITDA |
|
|
6,027 |
9,459 |
16,893 |
21,152 |
23,735 |
Operating Profit (before amort. and except.) |
|
|
5,159 |
8,162 |
15,090 |
19,077 |
21,453 |
Intangible Amortisation |
(468) |
(857) |
(1,629) |
(1,629) |
(1,629) |
||
Exceptionals |
(1,461) |
(1,089) |
(1,316) |
0 |
0 |
||
Other |
(156) |
(392) |
(686) |
(686) |
(686) |
||
Operating Profit |
3,074 |
5,824 |
11,459 |
16,762 |
19,138 |
||
Net Interest |
(106) |
(264) |
(287) |
(460) |
(460) |
||
FOREX |
467 |
(474) |
(1,737) |
0 |
0 |
||
Profit Before Tax (norm) |
|
|
5,053 |
8,007 |
14,864 |
18,617 |
20,993 |
Profit Before Tax (FRS 3) |
|
|
3,435 |
5,086 |
9,435 |
16,302 |
18,678 |
Tax |
(1,215) |
(1,832) |
(3,223) |
(3,910) |
(4,199) |
||
Profit After Tax (norm) |
3,838 |
6,175 |
11,641 |
14,708 |
16,795 |
||
Profit After Tax (FRS 3) |
2,220 |
3,254 |
6,212 |
12,393 |
14,480 |
||
Average Number of Shares Outstanding (m) |
45.0 |
48.2 |
55.9 |
55.3 |
56.5 |
||
EPS – normalised (c) |
|
|
8.5 |
12.8 |
20.9 |
26.6 |
29.8 |
EPS – normalised fully diluted (c) |
|
|
8.5 |
12.6 |
20.3 |
26.0 |
29.1 |
EPS – (IFRS) (c) |
|
|
4.9 |
7.0 |
11.2 |
22.4 |
25.7 |
Dividend per share (p) |
1.10 |
1.21 |
1.33 |
1.46 |
1.61 |
||
Gross Margin (%) |
34.1% |
37.6% |
38.0% |
37.6% |
37.7% |
||
EBITDA Margin (%) |
16.2% |
16.3% |
17.5% |
17.2% |
17.4% |
||
Operating Margin (before GW and except.) (%) |
13.8% |
14.1% |
15.6% |
15.5% |
15.7% |
||
BALANCE SHEET |
|||||||
Fixed Assets |
|
|
20,874 |
32,132 |
61,873 |
54,577 |
57,571 |
Intangible Assets |
17,677 |
27,675 |
55,495 |
48,971 |
47,342 |
||
Tangible Assets |
2,761 |
3,486 |
5,498 |
4,726 |
9,349 |
||
Investments |
436 |
971 |
880 |
880 |
880 |
||
Current Assets |
|
|
23,120 |
34,884 |
38,677 |
47,269 |
60,777 |
Stocks |
0 |
0 |
0 |
0 |
0 |
||
Debtors |
6,203 |
7,519 |
13,879 |
16,655 |
18,464 |
||
Cash |
11,014 |
19,018 |
17,020 |
21,614 |
32,313 |
||
Other |
5,903 |
8,347 |
7,778 |
9,000 |
10,000 |
||
Current Liabilities |
|
|
(9,746) |
(13,128) |
(27,830) |
(31,461) |
(32,847) |
Creditors |
(9,746) |
(11,965) |
(19,805) |
(23,436) |
(24,822) |
||
Short term borrowings |
0 |
(1,163) |
(8,025) |
(8,025) |
(8,025) |
||
Long Term Liabilities |
|
|
(2,607) |
(3,294) |
(6,016) |
(6,190) |
(6,190) |
Long term borrowings |
0 |
(571) |
(345) |
(345) |
(345) |
||
Other long term liabilities |
(2,607) |
(2,723) |
(5,671) |
(5,845) |
(5,845) |
||
Net Assets |
|
|
31,642 |
50,594 |
66,704 |
64,196 |
79,311 |
CASH FLOW |
|||||||
Operating Cash Flow |
|
|
2,412 |
4,768 |
17,168 |
21,677 |
23,372 |
Net Interest |
11 |
(58) |
(58) |
(460) |
(460) |
||
Tax |
(522) |
(1,362) |
(2,129) |
(3,910) |
(4,199) |
||
Capex |
(1,252) |
(1,635) |
(2,306) |
(4,308) |
(5,600) |
||
Acquisitions/disposals |
(8,889) |
(7,409) |
(21,104) |
(7,580) |
(1,500) |
||
Financing |
7,342 |
14,199 |
643 |
0 |
0 |
||
Dividends |
(609) |
(737) |
(825) |
(814) |
(915) |
||
Net Cash Flow |
(4,256) |
7,194 |
(8,611) |
4,605 |
10,699 |
||
Opening net debt/(cash) |
|
|
(15,271) |
(11,014) |
(17,284) |
(8,650) |
(13,244) |
Forex gain on cash |
0 |
0 |
1 |
0 |
0 |
||
Other |
(1) |
(924) |
(24) |
(11) |
0 |
||
Closing net debt/(cash) |
|
|
(11,014) |
(17,284) |
(8,650) |
(13,244) |
(23,943) |
Source: Keywords Studios accounts, Edison Investment Research
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