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Questor: Codemasters looks cheap after a keenly priced acquisition. Keep buying

F1 computer game
Codemasters makes games such as DiRT Rally 2.0 and F1

Questor share tip: readers who followed our tip last Christmas have already made 50pc but there should be more to come

The problem Father Christmas has with digital natives is that there is very little to leave under the tree for them to unwrap come Christmas morning.

Music, books and video have largely vanished on to phones and tablets; even cash gets credited to their banking app instead of being slipped into an envelope with season’s greetings. But at least the computer games industry can be relied on to keep bringing out consoles to nestle beneath the pine branches.

Not for much longer, however. The launch last month of Google’s Stadia games streaming service is a reminder that gaming is lightening Santa’s sack even further. When the Xbox and PlayStation take to the IT “cloud” next year, the edge will further be taken off the “console cycle” that used to plague games developers because fans would hold off buying new titles until the latest device had been launched.

This brave new virtual world is already with us. Codemasters, the developer best known for its racing games, reported in the first half of the year that 62pc of revenues came from digital downloads, compared with 53pc 12 months earlier and 33pc before that. The company turned into a Christmas gift for readers this time last year when we recommended the shares: they have since gained about 50pc.

Codemasters was not alone. In fact, the whole crop of British games developers – Team17 (another Questor tip), Sumo Group and Frontier Developments – have enjoyed strong share price performance in 2019.

Digital has helped by boosting demand, driving up margins, reducing the need to invest in physical stock and enabling developers to capitalise on their back catalogue, notably the off-road driving game DiRT Rally 2.0 in Codemasters’ case.

The firm has been quick to capitalise on emerging opportunities such as “e‑sports”, where fans clamour to watch gamers playing games, and is co-developing a mobile game with NetEase, one of China’s top games providers. In the last six months it swung to a £12m operating profit from a £3m operating loss.

The Aim-quoted firm has had a busy autumn. First it extended its crucial licence with Formula One motor racing for its video game franchise until 2025, with an option to push out to 2027. Codemasters is paying a higher minimum fee but gets trackside advertising slots in exchange.

Then the Indian media giant Reliance Big Entertainment sold its remaining 14.2pc stake in the business at 205p a share, a hangover from the stock market listing in June last year.

Finally, Codemasters’ boss Frank Sagnier hit the acquisition trail, paying up to $196m (£149m) for Slightly Mad Studios, another British racing game developer, which will broaden its portfolio in its chosen specialism.

SMS’s financials aren’t up to much currently but should rev up thanks to the three new titles due for release in the next financial year, one of them rumoured to be based on the Fast & Furious movie franchise, according to Goodbody, the stockbroker.

Analysts at Investec like the price, noting that it equates to 3.2 times SMS’s earnings last year, or 1.6 times sales, and the fact that the deal expands Codemasters’ crop of developers by a third to 600. The acquisition won’t hit its cash pile – £25m at the half year – because it raised £20m in a placing at 210p a share to cover the upfront acquisition cost.

The new shares began trading last week. The balance will be paid largely in cash over three years, depending on performance.

Jefferies, the house broker, calculates that the deal will knock pre-tax profits by a third in the current financial year, which ends in March, but next year should boost the bottom line by 90pc.

On a fully diluted basis, Jefferies has pencilled in 20.6p of earnings per share for the enlarged group, putting it on a forecast multiple of less than 12. That is less than half the rating that the sector enjoys on average, making Codemasters look cheap again.

Questor says: buy

Ticker: CDM

Share price at close: 239p

Read the latest Questor column on telegraph.co.uk every Sunday, Tuesday, Wednesday, Thursday and Friday from 6am.

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