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Research: TMT
In its trading update, management confirmed that adjusted FY20e PBT is expected to be c €52m, a 27% increase y-o-y and 12.7% ahead of our prior estimate, with revenues of €367m, 0.5% ahead of our prior estimate. FY20e margins of 14.2% vs 12.5% in FY19 are driven by improved operational leverage and tight cost control, together with COVID-19 related cost reduction (eg marketing, travel). Having pared back our forecasts at the start of the COVID-19 pandemic, we now upgrade our FY20 estimates for a second time to reflect the significantly stronger margins in H220e, raising our FY21 estimates and introducing our FY22 estimates. We have also incorporated the US$32m acquisition of the LA-based marketing services business, gnet. With substantial financial resources following its £100m placing in May, management remains focused on its M&A agenda.
Written by
Keywords Studios |
Strong trading update and acquisition of gnet |
Trading update |
Software & comp services |
26 November 2020 |
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Business description
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Keywords Studios is a research client of Edison Investment Research Limited |
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In its trading update, management confirmed that adjusted FY20e PBT is expected to be c €52m, a 27% increase y-o-y and 12.7% ahead of our prior estimate, with revenues of €367m, 0.5% ahead of our prior estimate. FY20e margins of 14.2% vs 12.5% in FY19 are driven by improved operational leverage and tight cost control, together with COVID-19 related cost reduction (eg marketing, travel). Having pared back our forecasts at the start of the COVID-19 pandemic, we now upgrade our FY20 estimates for a second time to reflect the significantly stronger margins in H220e, raising our FY21 estimates and introducing our FY22 estimates. We have also incorporated the US$32m acquisition of the LA-based marketing services business, gnet. With substantial financial resources following its £100m placing in May, management remains focused on its M&A agenda.
Year end |
Revenue (€m) |
PBT* |
EPS* |
DPS |
P/E |
Yield |
12/18 |
250.8 |
37.9 |
45.5 |
1.61 |
54.7 |
0.07 |
12/19 |
326.5 |
40.9 |
48.8 |
0.58 |
51.1 |
0.03 |
12/20e |
367.0 |
52.0 |
58.0 |
0.00 |
42.9 |
N/A |
12/21e |
433.6 |
61.6 |
65.3 |
1.91 |
38.2 |
0.09 |
Note: *PBT and EPS are normalised, excluding amortisation of acquired intangibles, exceptional items and share-based payments.
FY20e: Operational leverage drives margin growth
Based on the provisional figures, H220e has been considerably stronger than H120, with 12% y-o-y revenue growth delivering FY20e revenues of €367m. H220e adjusted PBT of €30.3m, vs €21.7m in H120, suggests 35% y-o-y adjusted PBT growth vs H219 and an adjusted PBT margin of 15.7% versus 12.5% in H120. The adjusted PBT margin for FY20e as a whole is expected to be 14.2%. The anticipated improvement in margins in H220e vs H120 is due to improved operational leverage on the back of higher revenues (€193.5m implied in H220e vs €173.5m in H120) and tight cost control.
Revised FY21 and introduction of FY22 estimates
Our revenue estimates for FY21 rise by 5.1% to €433.6m, incorporating the revenue from the acquisition of gnet and a 12% increase on FY20e, and we have introduced an FY22 revenue forecast of €485.7m, a further 12% increase as industry growth is set to continue. Reflecting the stronger than expected adjusted PBT in FY20e, we raise our FY21e forecast margin to 14.2% (FY20e: 14.2%), rising further to 14.6% in FY22e. We leave our gross margins at 37.6% in FY21e, rising slightly to 37.9% in FY22e and expect a resumption of Keywords’ progressive dividend policy in FY21.
Valuation: US$32m gnet deal, further M&A expected
Keywords’ shares trade on a P/E of 42.9x our updated FY20e estimates, falling to 38.2x in FY21e, having incorporated gnet into our model. With substantial net cash as well as €100m of undrawn facilities, management’s growth strategy, supplemented by M&A (which has delivered a five-year EPS CAGR of 42% to FY19), appears sustainable and should continue to support the shares.
Revised FY20–21 and introduction of FY22 estimates
We had expected Keywords’ business to bounce back relatively quickly once global lockdowns eased (as was seen by its Chinese studios), supported by pent-up demand from its core client base wishing to keep major projects on track and underpinned by strong consumer demand for games across all platforms and geographies. However, we have been positively surprised by the speed of the recovery and, with strengthening margins, the growing potential for cross-selling across service lines and sector growth driven by demand from an increasing consumer base of next-generation consoles, we expect to see a return to trend growth in FY21–22.
Based on the provisional figures released in Keywords’ trading update, H220e has been considerably stronger than H120, with 12% y-o-y revenue growth delivering FY20e revenues of €367m. However, importantly, with implied H220e adjusted PBT of €30.3m vs €21.7m reported in H120, this translates into 35% y-o-y (H220e vs H219) adjusted PBT growth and an adjusted PBT margin of 15.7% in H220e versus 12.5% in H120. The adjusted PBT margin for FY20e is therefore expected to be 14.2%.
The improvement in margins in H220e vs H120 firstly reflects margin compression due to COVID-19 related disruption and a resulting revenue shortfall in H120, with far less disruption experienced in H220. Together with improved operational leverage, on the back of higher revenues (€193.5m in H220e vs €173.5m in H120) and tight cost control, this has meant that the H220e results have also benefited from COVID-19 related reductions in operating expenditure, including direct costs such as travel, conferences and marketing. We understand that there has been no material change in business mix in FY20.
Despite a trend of strengthening margins, for the reasons set out above, we see the elevated 15.7% adjusted PBT margin in H220e as unlikely to be sustained in FY21. With more normal levels of capex, marketing spend and travel expected in FY21, we currently anticipate profitability to build from the blended 14.2% margin forecast for FY20e; as such, we estimate 14.2% adjusted PBT margins for FY21e.
Exhibit 1: Revised estimates
€'000s |
2019 |
2020e |
2021e |
Y-o-y change |
2022e |
Y-o-y change |
||||
Year end 31 December |
Actual |
Old |
New |
Change |
Old |
New |
Change |
new |
||
Revenue |
326,463 |
365,056 |
367,011 |
0.5% |
412,461 |
433,643 |
5.1% |
18% |
485,680 |
12% |
Gross profit (inc multimedia tax credits) |
120,229 |
138,021 |
138,649 |
0.5% |
153,868 |
162,989 |
5.9% |
18% |
184,031 |
13% |
Gross margin (%) |
36.8% |
37.8% |
37.8% |
37.3% |
37.6% |
37.9% |
||||
EBITDA (adjusted) |
57,611 |
64,066 |
69,910 |
9.1% |
77,560 |
83,518 |
7.7% |
19% |
94,796 |
14% |
Operating profit (pre amort. and except.) |
42,983 |
49,677 |
55,521 |
11.8% |
56,939 |
64,118 |
12.6% |
15% |
73,296 |
14% |
Operating margin |
13.2% |
13.6% |
15.1% |
13.8% |
14.8% |
15.1% |
||||
Profit before tax (norm) |
40,913 |
46,177 |
52,021 |
12.7% |
53,439 |
61,618 |
15.3% |
18% |
70,796 |
15% |
PBT (norm) margin |
12.5% |
12.6% |
14.2% |
13.0% |
14.2% |
14.6% |
||||
Profit after tax (norm) |
33,451 |
37,755 |
42,533 |
12.7% |
43,693 |
50,380 |
15.3% |
18% |
57,884 |
15% |
EPS – normalised (c) |
48.8 |
51.5 |
58.0 |
12.6% |
56.4 |
65.3 |
15.7% |
13% |
75.3 |
15% |
Dividend per share (p) |
0.58 |
0.00 |
0.00 |
1.95 |
1.91 |
(1.8)% |
- |
2.11 |
- |
|
Source: Keywords Studios accounts, Edison Investment Research
Introduction of FY22 forecasts
Although Keywords is a service provider to the games industry and has not benefited directly from lockdown, unlike the digital games publishers, its future growth is still supported by strong and continuing games industry growth. Newzoo’s latest forecasts (November 2020) imply 10.5% games industry growth globally between 2019 and 2023, with the games industry forecast to deliver global revenues of US$175bn in 2020, continuing to grow to US$218bn in revenues by 2023.
Revenues: our revenue estimate for FY21e has risen by 5.1%, incorporating the revenue from the acquisition of gnet and a 12% increase on FY20e. Supported by continuing industry growth, we have assumed 12% revenue growth in FY22. These levels of growth represent a degree of catch-up from FY20e, leading to FY21e revenues of €433.6m and FY22e of €485.7m.
Margins: management has guided towards adjusted PBT margins normalising towards the end of FY21e, versus 14.2% for FY20e. Therefore, we are using what we believe to be relatively conservative 14.2% margins for FY21e, rising to 14.6% in FY22e. We assume gross margins of 37.6% in FY21e (broadly flat vs FY20e), rising marginally to 37.9% in FY22e.
Tax rate: through effective planning, Keywords’ tax rate has reduced steadily from 22% in FY16 to 18.2% in FY19. We assume this level is sustained and forecast a tax rate of 18.2% in FY21 and 22.
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 FY22.
Capex: Keywords put a temporary hold on discretionary capex spending during the COVID-19 pandemic, and we expect capex to normalise in FY21 and FY22. On this basis, we forecast capex to return to 4.0% of revenue in FY21 and FY22, €17.5m and €19.6m respectively.
Dividend: the final dividend for FY19 was cancelled with the onset of COVID-19, meaning that the total dividend payable for FY19 was 0.58p. We do not expect Keywords to pay an FY20 dividend but rather, given the company’s statement in September that the board remains committed to resuming its progressive dividend policy in 2021, we expect a resumption of its progressive dividend policy with the FY21 interim dividend, assuming 10% growth over our estimate for the FY19 full-year dividend prior to the spring 2020 lockdown. This implies a total FY21 dividend of 1.91p per share (FY18: 1.61p, FY19: 0.58p, FY20: 0.0p). We assume continuing 10% y-o-y dividend growth for FY22.
M&A: US$32m acquisition of gnet, more to come in FY21
By its nature, the timing of acquisitions can be hard to predict, but hot on the heels of Keywords’ trading update came the announcement of the acquisition of g-Net Media (gnet), a Los Angeles-based creative and strategic marketing services business for up to US$32m in cash and shares.
Management expects gnet to deliver revenues of US$20m and EBITDA of about US$3m in FY21, implying a 15% margin (broadly in line with Keywords). With US$18m payable upfront (56% of total potential consideration), of which US$14.4m is payable in cash, the initial consideration represents 0.9x expected FY21e revenues (year to 31 December 2021) and 6x FY21e EBITDA. The remaining consideration of US$14m (44% of the maximum) is performance related and payable on the first and second anniversary of the deal in a mix of cash and shares. The acquisition has been factored into our model, but given its timing shortly before Thanksgiving and the seasonally light month of December, we do not envisage any material contribution to Keywords’ FY20 revenues or PBT.
The gnet deal is one of Keywords’ larger and more expensive (as would be expected for a US West Coast-based deal) recent acquisitions but is in line with management’s stated M&A strategy and consistent with other recent acquisitions in supplementing Keywords’ marketing and development capabilities (similar to the other three deals completed in FY20). The acquisition of gnet looks like a sensible deal that will strengthen Keywords’ marketing capabilities and deepen its relationships with games publishers including Activision, Microsoft, Bethesda and Bungie, as well for media companies such as Netflix, Amazon Prime and NBC Universal.
Keywords’ strategy of using earnings-enhancing acquisitions while consolidating a fragmented market is intrinsic to the investment case. Management has stated that the acquisition pipeline remains strong and that it continues to receive healthy inbound interest from around the world. With substantial financial resources following its £100m placing in May, as well as undrawn committed facilities of up to €100m, the company retains considerable firepower for further M&A. As we do not incorporate future acquisitions into our forecasts, M&A activity represents a source of potential upside to our earnings estimates.
Exhibit 2: Financial summary
€'000s |
2018 |
2019 |
2020e |
2021e |
2022e |
||
Year end 31 December |
IFRS |
IFRS |
IFRS |
IFRS |
IFRS |
||
PROFIT & LOSS |
|||||||
Revenue |
|
|
250,805 |
326,463 |
367,011 |
433,643 |
485,680 |
Cost of Sales |
(154,997) |
(206,234) |
(228,363) |
(270,655) |
(301,649) |
||
Gross Profit (inc multimedia tax credits) |
95,808 |
120,229 |
138,649 |
162,989 |
184,031 |
||
EBITDA (adjusted) |
|
|
43,729 |
57,611 |
69,910 |
83,518 |
94,796 |
EBITDA (reported) |
|
|
34,304 |
43,375 |
60,198 |
71,690 |
81,786 |
Operating Profit (before amort. and except.) |
|
|
38,916 |
42,983 |
55,521 |
64,118 |
73,296 |
Amortisation of acquired intangibles |
(6,872) |
(7,318) |
(11,324) |
(13,505) |
(15,125) |
||
Exceptionals |
(5,296) |
(4,348) |
(2,370) |
0 |
0 |
||
Other (incl share based payments) |
(4,129) |
(9,775) |
(10,753) |
(11,828) |
(13,011) |
||
Operating Profit |
22,619 |
21,542 |
31,074 |
38,785 |
45,160 |
||
Net Interest |
(1,316) |
(2,513) |
(3,500) |
(2,500) |
(2,500) |
||
Forex |
791 |
(1,658) |
0 |
0 |
0 |
||
Profit Before Tax (norm) |
|
|
37,911 |
40,913 |
52,021 |
61,618 |
70,796 |
Profit Before Tax (FRS 3) |
|
|
22,094 |
17,371 |
27,574 |
36,285 |
42,660 |
Tax |
(7,191) |
(7,462) |
(9,488) |
(11,238) |
(12,912) |
||
Profit After Tax (norm) |
30,720 |
33,451 |
42,533 |
50,380 |
57,884 |
||
Profit After Tax (FRS 3) |
14,903 |
9,909 |
18,086 |
25,047 |
29,748 |
||
Average Number of Shares Outstanding (m) |
64.3 |
65.1 |
69.6 |
74.1 |
74.3 |
||
EPS - normalised (c) |
|
|
45.5 |
48.8 |
58.0 |
65.3 |
75.3 |
EPS - normalised fully diluted (c) |
|
|
43.7 |
47.2 |
55.8 |
63.1 |
73.0 |
EPS - (IFRS) (c) |
|
|
23.2 |
15.2 |
26.0 |
33.8 |
40.0 |
Dividend per share (p) |
1.61 |
0.58 |
0.00 |
1.91 |
2.11 |
||
Gross Margin (%) |
38.2% |
36.8% |
37.8% |
37.6% |
37.9% |
||
EBITDA Margin (%) |
13.7% |
13.3% |
16.4% |
16.5% |
16.8% |
||
Operating Margin (before GW and except.) (%) |
15.5% |
13.2% |
15.1% |
14.8% |
15.1% |
||
PBT Margin (%) |
15.1% |
12.5% |
14.2% |
14.2% |
14.6% |
||
BALANCE SHEET |
|||||||
Fixed Assets |
|
|
198,215 |
223,992 |
231,673 |
232,769 |
234,260 |
Intangible Assets |
180,086 |
196,769 |
202,978 |
196,513 |
188,848 |
||
Tangible Assets |
15,002 |
22,163 |
23,636 |
31,196 |
40,352 |
||
Investments |
3,127 |
5,060 |
5,060 |
5,060 |
5,060 |
||
Current Assets |
|
|
100,348 |
120,483 |
243,790 |
287,324 |
339,801 |
Stocks |
0 |
0 |
0 |
0 |
0 |
||
Debtors |
37,019 |
43,243 |
46,785 |
52,399 |
58,687 |
||
Cash |
39,870 |
41,827 |
158,692 |
192,015 |
233,055 |
||
Other |
23,459 |
35,413 |
38,313 |
42,911 |
48,060 |
||
Current Liabilities |
|
|
(95,031) |
(49,551) |
(49,948) |
(43,125) |
(35,916) |
Creditors |
(54,960) |
(49,471) |
(49,868) |
(43,045) |
(35,836) |
||
Short term borrowings |
(40,071) |
(80) |
(80) |
(80) |
(80) |
||
Long Term Liabilities |
|
|
(11,158) |
(71,528) |
(71,194) |
(73,194) |
(75,194) |
Long term borrowings |
(230) |
(59,671) |
(59,671) |
(59,671) |
(59,671) |
||
Other long-term liabilities |
(10,928) |
(11,857) |
(11,523) |
(13,523) |
(15,523) |
||
Net Assets |
|
|
192,374 |
223,396 |
354,321 |
403,774 |
462,951 |
CASH FLOW |
|||||||
Operating Cash Flow |
|
|
33,954 |
46,069 |
66,181 |
74,690 |
83,643 |
Net Interest |
(502) |
(9,411) |
(6,263) |
(3,425) |
(2,276) |
||
Tax |
(6,304) |
(13,288) |
(9,488) |
(11,238) |
(12,912) |
||
Capex |
(9,440) |
(13,145) |
(11,083) |
(17,461) |
(19,556) |
||
Acquisitions/disposals |
(25,766) |
(27,762) |
(19,481) |
(7,823) |
(8,289) |
||
Financing |
0 |
0 |
97,000 |
0 |
0 |
||
Dividends |
(1,080) |
(1,197) |
0 |
(1,421) |
(1,570) |
||
Net Cash Flow |
(10,090) |
(18,734) |
116,866 |
33,323 |
40,040 |
||
Opening net debt/(cash) |
|
|
(11,094) |
431 |
17,924 |
(98,942) |
(132,264) |
Forex gain on cash |
(3) |
1,293 |
0 |
0 |
0 |
||
Other |
(1,432) |
(52) |
0 |
0 |
0 |
||
Closing net debt/(cash) |
|
|
431 |
17,924 |
(98,942) |
(132,264) |
(172,305) |
Source: Company accounts, Edison Investment Research
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Research: TMT
Nanoco has secured just under £1m grant funding for a life sciences project to develop a heavy metal-free quantum dot testing kit to detect COVID-19. The project will last 18 months and represents a potential third segment for generating future revenues in addition to established activities in sensing and display applications. We make minor adjustments to our estimates, although there is no impact on EBITDA or cash flow.