Consolidation has become a familiar playbook within the booming video game industry, but it’s easy to see why Dublin-based constituent Keywords Studios might end up being the last member standing on the UK exchange.
Acquisition activity by global entertainment giants and larger US players has centred around titles and intellectual property gathering, including former UK-listed players Sumo and Codemasters. Identifying an obvious suitor for video game services provider Keywords, which provides the picks and shovels for the industry, is less easy.
It is not as if performance or price would be deterrents for a buyer. Keywords might look pricey on the surface but based upon its own history, less so. An enterprise value of 20 times forecast earnings before interest, taxes, depreciation and amortisation is towards the lower end of the range recorded since the 2013 flotation, as rising rates and a natural shift away from high growth stocks since the end of last year have taken some heat out of the shares.
There are good reasons for that multiple to rise again, namely high organic growth rates, a history of rarely disappointing the market and, as brokerage Shore Capital points out, a lower risk profile attached to its business model than those of developers more exposed to the reputational risk of single title flops.
Keywords says adjusted pre-tax profit this year will be at the top end of the €90 million to €95 million range forecast by analysts. Shore Capital, which reckons €91 million, sees potential to upgrade to the outer limit of that range, which would represent 10 per cent annual growth.
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That’s hardly from a low base either, given profits were 48 per cent ahead last year, driven by a recovery in new game development. This year, that should feed through to more demand for post-production services such as localisation and testing.
While takeover activity has left the UK market sparser, Keywords is deal-hungry. The plan is to not only expand its geographic coverage, but the range of services it can offer developers, such as assisting content creation and testing. Last year it completed six deals, but a highly cash-generative business model and a net cash balance of €100 million means that hasn’t been at the expense of balance sheet security.
The Aim-listed company is eyeing cross-selling opportunities. About 130 of its 950-strong client base buy three or more services from Keywords, but it wants to increase that proportion. There are signs that the breadth of its services is paying off. Since the 2013 IPO, the group has averaged annual organic growth of 15 per cent, versus 8 to 9 per cent clocked up by the broader market.
Plans to beef up its game development business, which accounted for just over a quarter of revenue last year, might help hook more clients in. Content creation accounts for about half of the overall spending by video game publishers and yet there is still a shortage of developers, which means there is ample opportunity to grab clients. But the business also puts Keywords at the table with creators when decisions around game development are being made, which provides the opportunity to win more work further down the line.
There are risks to hitting high expectations. Wage inflation is one, particularly in an industry with a talent shortage. The return of travel and development costs means the margin is expected to move back to a more typical 13 to 14 per cent this year, from 16.8 per cent last year. What’s more, about 5.7 per cent of revenue is derived from Russia, even if it is on behalf of non-Russian clients. It is working to relocate that work. But management has a record of beating bullish guidance and this year could well be no different.
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Advice Buy
Why An expanding market should feed through to strong organic revenue growth
Ergomed
Twin engines have propelled shares in pharmaceuticals services provider Ergomed during the past three years, a period in which its market value has risen more than sevenfold and resulted in a pricier enterprise value of almost 23 times forecast ebitda.
The first was an exit from higher risk drug development and the second, the pandemic-era flight towards defensive healthcare stocks. The latter has receded but the merits resulting from the second remain.
The group specialises in providing clinical trials and monitoring trial standards within the fast-growth rare disease and oncology markets to clients spanning pharmaceutical giants to smaller biotech companies. That’s resulted in a compound annual revenue growth rate of 30 per cent since 2018.
Acquisitions have played a part, but since the healthcare group’s 2014 float, organic revenue growth has averaged 18 per cent each year, against a total revenue growth rate of 22 per cent. After stripping out the acquisition of US clinical research specialist MedSource in 2020, revenue for its clinical trials business was still up by just over a quarter.
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That deal was part of plans to expand its presence in the US market, the largest for clinical research and one where it has been under-represented. Working under contracts that span an average of three years, plus the regulatory requirement to maintain drug safety monitoring, meant Covid-related disruption was kept to a minimum.
Unlike jam tomorrow drug development companies, the revenue stream is smooth. For providing clinical trials, the group receives a single, up-front sum and monthly payments throughout the life of the contract. Those payments are not dependent on the outcome of the trial, either. Meanwhile its drug safety business has a 90 per cent revenue renewal rate.
An order book of £240 million makes up 87 per cent of this year’s expected revenue. Analysts at brokerage Numis forecast that figure at £143 million, which would be annual growth of 20 per cent, and a 12 per cent increase in adjusted ebitda to £28.5 million. But the shares have moved well ahead of that growth coming through.
Advice Hold
Buy High earnings expectations already priced in
