Small Cap Value Report (Wed 8 Feb 2017) - KWS, DSG, DPP, TLY, FLOW | Paul Scott

8th Feb '17 by Paul Scott

40 comments 19287 reads

Good morning!

Yesterday's report was late. Here is the link to it - covering 7 companies, to get you started today.

I'll have a quick whizz through today's results & trading updates now. Then I'm off for later today for a week abroad. So Graham will be (hopefully!) covering tomorrow's news. Then, subject to jetlag, it might be a joint effort on Friday. I'm taking my laptop with me, so it's more a question of doing the markets somewhere else, rather than a proper holiday!

Keywords Studios (LON:KWS)

Share price: 609p (up 2.9% today - so far)
No. shares: 54.4m
Market cap: £331.3m

Trading update - for the full year, calendar 2016.

This group describes itself as;

the international technical services provider to the global video games industry

This update reads very well. Figures are given too, which is always helpful. Revenues of E96.6m, and adjusted profit before tax of E14.8m are said to be;

...comfortably ahead of consensus market expectations. This performance has been driven by strong like-for-like growth, due to the continued growth of the established business as well as the contribution of the eight acquisitions completed during the year.

Eight acquisitions in a year - that is very aggressive expansion, and could possibly carry some risk of over-stretching management? Although the total cash outlay of E20.7m suggests that they are smallish bolt-on acquisitions.

Outlook comments are fairly generic, but sound alright;

Although it's early in 2017, we are therefore confident of making continued progress in the year ahead."

My opinion - the shares have done fantastically well, tripling in price in the last year, so I'm sure the company has a lot of very happy shareholders.

The shares look richly-priced, but performance to date seems to justify that. Also, note that broker forecasts have been steadily rising, so it looks like one of these growth companies which is growing into its high valuation.

I don't really understand its business model, or how to value it, so it's not something I would be interested in. Well done to holders though, so far, so good!

As with all highly rated shares though, if the company does put a foot wrong, then the price would lurch sharply lower. Big ratings don't leave room for disappointment. It's always worth keeping that in the back of one's mind, I find.

Dillistone (LON:DSG)

Share price: 93.8p (down…

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Foolish Pat

8th Feb '17

Great update as usual Paul. What are your current thoughts on G4M as it has sky rocketed recently?!

Paul Scott

Hi Patdownie,

I'm still positive on G4M, and haven't sold any.

Fast-growing eCommerce shares are not being valued on a PER basis, and haven't been for a while. The more normal valuation metric at the moment seems to be about 2-5 times sales, and anticipating anything up to 2 years growth within that.

I don't necessarily agree with that method, but that's how things are being valued right now. On that basis, G4M still looks good value.

As with all growth stocks though, if growth stalls, then it'll be a sudden, violent lurch down in price. So always worth keeping that in mind.

I've heard that a number of analyst/Institutional site visits recently to G4M's York HQ have gone well. The stock is very tightly held, and Instis want to buy. That's usually a positive thing for the share price, whilst stock market conditions remain positive anyway.

Regards, Paul.

cojode

Hi Paul
hope you enjoy the (what sounds like a "working") holiday. If you have time between packing would be interested if you have a view on Freeagent which you covered recently, rose to £1.40 2 weeks ago but is back to c.£1.07 t.his morning. I know you normally comment on news/RNS when published but in the absence of any formal communication I can find no obvious reason for the retrace.
Anyway enjoy the sunshine (unless it's Warsaw again in which case enjoy the vodka)

Hi cojode,

There's not been any news on FreeAgent Holdings (LON:FREE) so I suppose the price fall is just buyers & sellers doing what they do, in an illiquid stock.

Regards, Paul.

Carey Blunt

Hi Paul,
Liked your update on Keywords Studios (LON:KWS) which I have held from 150p. The business model is reasonably simple, they provide graphics and audio and translation services to big computer game companies including companies who make games for consoles and mobile games for iPad, iPhone, android etc.

Imagine you are a games company and you are making the latest greatest game and you want great graphics and music and for it to be translated into 13 languages. You can hire people but then when the game production cycle is finished you are left with loads of people who you may not have work for.
The trend now is to outsource the production of those assets to a company like Keywords Studios (LON:KWS) to reduce your risk.

Keywords Studios (LON:KWS) strategy is to be the big player in that market and is buying up small bolt on companies (as you mention) who have existing contracts with the big games companies and then cross sell and up sell new services from the rest of the group.

So you buy a company that provides graphics services to Sony and a company that provides audio to Zynga and then cross sell the services. It's more complex than that in that there is a geographical component so you need to provide all those services across the world, many big game producers are in Asia but Disney is obviously US based etc so some of the acquisitions are aimed at giving a geographical benefit.

The management seem shrewd and they do seem to be delivering against a good strategy. I'm very happy with my holding but I do worry that the story is so compelling that the SP may get ahead of itself at some point so I'm keeping a close eye on it.

Well worth researching for anyone not yet already a holder.
Cheers
Carey

P.s. Earnings oversea are translating back into sterling nicely so some FX win and brexit proofing have driven up the SP.

ACounsell

Hi Paul,

Any thoughts on today's announcement on CFO departure from Revolution Bars (LON:RBG) - a stock you have been positive on in the past. The market doesn't like it with shares down nearly 6% - could there be something other than 'family reasons' behind the departure?

One more thing about Keywords Studios (LON:KWS) while I remember.....

The main risk to watch out for is the sales cycle of the man consoles. When a new version of the Sony PlayStation and Microsoft XBox are due out, Games producers slow their games development cycles because they don't want to develop for the old version when a new version is due out and they what to see what the sales of those platforms are like before they commit to making new games for them.

This can cause work to drop off for a while and could cause KWS revenues to become lumpy. This happened immediately after the IPO which caused their first RNS to be a profit warning which damaged their reputation and took more than a year to recover from in the eyes of the market.

I think Paul commented on this on yesterday's report if I remember right.

Carey,

Thanks - seen it now in yesterday's comments. Clearly I'm not paying enough attention! Paul's comment pretty much mirror my thoughts and the market seems to think the same today.

cholertonandrew

Hi Paul, on Revolution Bars I don't know the company very well but I remember reading a very small piece in Shares magazine in the issue with cover date of 26th January. The Chief Executive was quoted as saying that they can make 70% to 80% gross margin on their cocktails. I wonder whether that could be squeezed in time but that could already be reflected in the rating. Or it could be seen as encouraging if they can roll out new premises and take those margins. He also said that if raw material prices increase they could add a bit on to the price of cocktails and consumers wouldn't notice, at least the way they would with a pint of beer. Thought that was an interesting comment.

Just thought I'd share those comments for anyone who might not have seen them.

Appreciate all the reports.

Regards
Andrew

pwozzy

Hi Paul,

Thanks for your ongoing comments on £G4M; it is particularly interesting to hear the insight on institutional demand. Would you be happy to share how you learn about the site visits - is it twitter/contact with management or just through people you know in the industry?

As always, your work is much appreciated!

Best,

TamzinPiworld

I looked at Keywords Studios (LON:KWS) in September 15 when sp c145. I thought with all the acquisitions (then!) the integration risks were just too high; and the risk of game launches (which cased a profit warning after the IPO). However, seeing the management of some of the acquisitions: Volta, Mindwalk and Lakshya, speak at their Capital Markets Day in November video here:

http://www.piworld.co.uk/videos/2017/1/6/keywords-studios-kws-art-in-focus-capital-markets-event

I was impressed by their cohesion between the management of the acquisitions, their shared vision, and the opportunity to upsell the other's offerings to each of their existing customer base. So impressed, I bought in at 470 - way above the 145 of my original research, and well aware it had already risen c. 150% since beginning of 2016.

JohnEustace

There is a good article on KWS here. I'm also a happy holder.
http://www.proactiveinvestors.co.uk/companies/news/172838

truegent

G4M still havent made single penny though as the cash flow statement shows ! dont get me wrong youve made money here whilst i didnt, but still worth mentioning ;)

Hi truegent,

Actually G4M is on track to make c.£2-3m profit/cashflow in the current year (ending 28 Feb 2017). With spectacular top line growth, that could perhaps double next year.

The market is going wild for companies reporting extremely high organic growth rates right now. The other thing to consider, is that once they reach decent scale, then the marketing spend can be reduced as a percentage of revenues, resulting in much higher profit margins further down the line.

So once you weigh up these factors, the valuations aren't quite as bonkers as they might initially look. But it's a different mindset altogether from value investing.

Do you want to sit on the sidelines, saying that everything is too expensive, whilst watching multiple shares multibag?! I don't.

Regards, Paul.

Tortoise investor

The margins bit is the main thing I worry about. Fine for now but profits could get slashed in any recession. I am long though as it looks like a good business tapping into twentysomethings' riches and nights out.

It's frustrating the share price dropped so much this morning but ultimately I think the CFO jumped before he was pushed. He had only been there five months! What is clear is that RBG need to get a better PR team as that RNS wasn't particularly well worded and could have stressed that there is no evidence of financial impropriety (if, as I hope, that's the case). As someone working in communications and health policy it makes me pretty angry to see such badly worded statements. I can't understand for the life of me why they can't be a bit clearer; it's counterproductive. If there is a problem then I would also prefer them just to warn of it upfront as it will eventually leak out anyway.

iwright7

Carey,

I brought Keywords Studios (LON:KWS) in November. I see Finncap have increase their target price today from 500p to a whooping 692p. I don't think the £KWS narrative is any different now to my November buy in notes, which are below:

Significantly ahead of current market expectations, due to increased seasonal work at newly acquired Italian Synthesis. 52 week high and 98M. Games market growth 6-8%/annum. Each group a integrated profit centre with 85% GM. Mostly bill in € and $ (£ = only 3%). Very competent CEO. Understand that their customers need to love them. 80% repeat business with strong organic growth and acquisitions with a lot of service cross selling. Selling time and carefully monitor workload. Low Capex requirement. Flex work force by employing short term gaming graduates on low pay. Small % market share so good potential.

sparkler

Paul,

Can I ask what happened to your write-up of 32Red? Back on 2nd Feb you said "I have a half written section on 32Red to finish from yesterday". Any chance of seeing this piece?

timarr

It's still comment 26 on Monday's report.

timarr

Funderstruck

The CEO seems rather arrogant to me , not the sort of comment drinkers will welcome , make them feel rather taken for granted. Usually when a CFO resigns the notice is embellished somewhat to put investors at ease. Not in this case.

Small Cap Value Report (Wed 8 Feb 2017) - KWS, DSG, DPP, TLY, FLOW

Keywords Studios (LON:KWS)

Dillistone (LON:DSG)

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Paul Scott

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