Video Game Candidates #1: Keywords Studios

21st Apr '20 by Jack Brumby

19 comments 5669 reads

There are opportunities to make - and lose - a lot of money in this market. Last week I considered some higher risk share prices that have been heavily hit by this lockdown. There are some interesting trades to contemplate but the risks and unknowns are considerable.

For example: what will post-lockdown social distancing policies look like and how prohibitive might they be to visiting shops and bars?

It will surely be a bumpy ride, whichever way the government decides. I continue to monitor these areas of the market, but it must be stressed that not getting involved is always an option - there are plenty of other opportunities to consider where a company’s trading prospects need not depend upon shifting government pandemic policy.

For many, a more appropriate risk/reward balance can be found in looking for growing, high-quality companies with strong trading prospects not adequately reflected in their share prices. This is what I spend the bulk of my time looking for.

This search for high quality companies with strong underlying trading momentum that have compounding potential has led me to a different sector - one that, if anything, stands to benefit from present conditions...

Video games: the perfect lockdown activity?

Video games have eclipsed films and books as the predominant mode of entertainment and this market continues to be driven by attractive long term growth trends. Fortunately the UK punches above its weight in this area.

Investors have a raft of publicly traded companies - all of whom have IPOd in the past ten years or so - from which to look at.

The ones I want to look at are, in order of market cap:

Keywords Studios (LON:KWS)
Frontier Developments (LON:FDEV)
Team17 (LON:TM17)
Codemasters Group (LON:CDM), and
Sumo (LON:SUMO)

If I’ve missed any obvious candidates out, let me know in a comment. There are probably good overseas companies to look at as well. The stocks listed above have all been tremendous successes for investors so far.

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Most of them are high momentum and high quality. In the year-to-date, these stocks continue to show positive relative strength.

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TM17 clearly has the strongest share price momentum of the lot right now, up nearly 50% so far in 2020 against an All-Share that is still down…

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Simon Rowan

21st Apr '20

It is an interesting area of investment. I bought CDM last year and sold out roughly where it is now. The sp has been quite erratic. One of its first investors pulled out its entire holding at about £2.00 in the autumn which seemed a bit odd. Same thing happened with AVST (£3.60) the cyber security firm around the same time. Was a bit unsettling at the time but the shares (about 10% holdings) were found a new homes and not dumped straight onto the market which helped. Cdm seem to concentrate on formula one and have a new game for release which was delayed rather dramatically because the real formula 1 season's delayed start. A lot of games are being given away free now and pay is collected by add ons or access to other areas, which seems immensely smart. I have absolutely no experience of playing these things, but I do know plenty that do! The other big draw is if there is consolidation in this sector. I'm glad you mentioned KWS , has been on my watch list for a while(was trading over £15)because I see it'd dropped back a little. Graph looks quite good too.

Carey Blunt

I owned Keywords Studios (LON:KWS) all the way from just after the IPO but sold it in the middle of last year for the reasons you mention in the article about potential for it to disappoint on growth. I own all the others except SUMO and also Activision Blizzard (ATVI) . I have previously owned Electronic Arts but don't currently hold that one.

In my view, one of the easiest and best ways to get exposure to the Video Games and eSports industry is the Vaneck Vectors Video Games and eSports ETF. I think the codes are ESGB (Sterling) and ESPO (US Dollars). Not every broker offers it but its done really well for me and enables exposure to the larger Game producers and eSports Franchises in Asia and other locations where its difficult to buy individual shares directly.

timarr

Yep, bought the UK version Vaneck Vectors Video Games and eSports ETF and also hold Codemasters Group (LON:CDM). Although gaming is a fairly obvious place to look for growth and reliance I also feel it's a sector likely to see increased earnings for years.

One effect of the lockdown will be to move more people to homeworking and as the home becomes a hub we'll see greater use of home based online services such as gaming and streaming. Bars, restaurants and cinemas will be less popular than before - even when they open - for some time to come.

As an aside on the homeworking theme, this will see a permanent shift in working patterns partly because of government policy to reduce carbon emissions and partly through companies realising that it's possible to deliver without paying for large, expensive buildings. I understand that the managed service property vendors are seeing high levels of enquiries from companies looking at using their offices for occasional meetings rather than continuing to pay for central offices. Commercial property is another sector to avoid or, at least, only invest in selectively.

And a note in the Codemasters Group (LON:CDM) update last week pointed out that they were seeing a drop in retail sales which was more than compensated for by higher margin online revenues. Another grim portent for the High Street. So in the context of prospects for retail, leisure and commercial property looking poor gaming is a sector likely to at least hold its own.

I also used to hold Keywords Studios (LON:KWS) but I'm not convinced it offers the same scaling properties as the actual gaming companies. I can sell the same game lots of times but I can only develop it once. Gaming companies with multiple franchises are relatively resilient. And Keyword are insanely acquisitive, it's like having an investment with ADHD, unable to stand still for even a moment.

Rusty2

VANECK VECTORS ETF (LON:ESGB) though is international, it does not seem to have any UK shares, about 50% is US, 22% Japan, 8% Hong Kong and 8% S. Korea.

I have held all mentioned in the article apart Sumo (LON:SUMO), the only one I hold now is £TM17, but I have been looking to buy back into Codemasters Group (LON:CDM).

HumourMe

I've not been buying https://www.stockopedia.com/share-prices/cd-projekt-sa-WAR:CDR/ (CD Projekt) for about a year. As it has gone from ~200PLN to 350PLN this might appear to be an error. They are the company behind The Witcher game (licenced from the author who didn't initially think it would be successful). Cyberpunk is their new game released later this year.

Long term I've been trying to get my head around the extensibility of their franchise. They also own GOG an online PC games store and rival to steam, so that should smooth earnings. The prior lumpy earning spikes mainly put me off.

djack

Jack I would be interested in your take on Bidstack (LON:BIDS) and £GFIN. They're both loss making but both are trying to become leaders in their respective spaces. I think both companies have benefited from the lockdown. Whether that remains once is eased is something I'm watching.

VANECK VECTORS ETF (LON:ESGB) though is international, it does not seem to have any UK shares, about 50% is US, 22% Japan, 8% Hong Kong and 8% S. Korea.

Yep, I think that's a good thing (well, if we try and ignore the exchange rate).

The "UK version" just means it's quoted in sterling rather than dollars. The underlying holdings are the same.

Jack Brumby

Interesting re. scalability of £KWS. Clearly valuation and the size of the video games market it services are key considerations. My initial feel is that big game developments will continue, they are only going to get more complex, and KWS is exposed to some strong market growth - but I need to look at this more if I am to have a firm belief one way or the other. The valuation demands a lot, as with most of these companies... I'll be looking at other listed gaming stocks with different models soon.

Really enjoyed your thread by the way, very thought-provoking (Themes for a Long-Term Lockdowned Investor)

MrGeorgeJones

Great post Jack. I'd be interested to know if Keywords or any of the other gaming companies you will be featuring have mentioned how they are coping with Covid-19?

Presumably, its employees need specialist software and hardware to provide their services, especially those in the art department. Are their employees able to work from home with their current equipment or perhaps they have taken it home with them?

I followed Gfinity (LON:GFIN) a while ago. It has been a serial cash raiser with several pivots in its business strategy, so that has made me cautious. I haven't looked at it for a while though, so the situation might have changed.

I'm not familiar with Bidstack (LON:BIDS) , but again the lack of cash generation concerns me. It seems like quite a high burn rate right now so hopefully it does begin to benefit.

One of the big attractions of the gaming stocks I've listed here is that they have established, profitable, cash generative business models, with net cash on the balance sheets (barring Keywords Studios (LON:KWS)).

There could be an opportunity, but BIDS and GFIN look a bit too high up the risk curve for me right now. Both have high levels of equity dilution over time, which is a characteristic I'm keen to avoid in this market. Perhaps they will prove their models and become leaders in time, but they might have to burn through a lot of shareholders' cash to get to that point.

22nd Apr '20

I will check Cd Projekt out - The Witcher might be the type of IP to have legs. I've been aware of it as a concept for a long time - from Polish fantasy book series, to successful indie game, to bona-fide AAA blockbuster, through to post-Game of Thrones Netflix flagship. It must have been growing in popularity for a decade or more by now... The danger, as ever I suppose, is that this is peak popularity and something new will come along. Cyberpunk could help shoulder the burden.

I am sure I have heard of GOG as well, so would like to take a look at how big that business is. The revenues for Steam must be huge.

Wilbraham

There was quite an impressive capital markets day presentation back in February - gives a good insight into the various business strands and nice to see how some of the recent acquisitions were welcomed to the 'KWS family' and given their own presentation slots. Also a 90 slide powerpoint for those that haven't time to sit through 2.5 hrs of presentation https://www.keywordsstudios.com/content/uploads/2020/02/Keywords-Studios-CMD-London-Presentation-Feb-2020-0.pdf

I found something interesting: https://www.gamesindustry.biz/...

I believe that the way we need to think about the potential of "video" games is the way that we think about other media today.

You (probably) don't know anyone who doesn't listen to music, you don't know anyone who doesn't watch films or TV Shows and within a very short number of years you won't know anyone who doesn't play video games in one form or another on a very regular basis.

Its really easy for our generations (i'm making assumptions here about the "our" bit but stay with me) to think of video games as something that is the domain of the male, fairly affluent, under 25 demographic but its really increasingly not the case.

Mobile games have really made a cultural change which changes the demographic year on year. Its really not in question that more people are going to play games in the future, its going to be everyone playing games for an increasing proportion of their days.

If you project ahead only a little bit and you make sure you consider the mobile games market then the potential size of the market is actually huge.

Its possible to draw some parallels to movie companies to project how Games companies might turn out. I think its true that almost no movie company does their own on set catering or set building or post processing or audio dubbing. They hire in specialist companies to do all that while they concentrate on the scripts and the actors and coordinating the whole thing together. I think that's how the games market will turn out and that's exactly what Keywords Studios (LON:KWS) are aiming for, to be the catering and set builder and audio dubbing company of choice but for games.

WelshMat

23rd Apr '20

Hi MrGeorgeJones. I actually work in this industry and used to work for one of the companies in this list. Due to the way that modern software development works development studios have sent all of their staff home and are able to work from home. I am a working remotely as a software engineer; as are my colleagues who work in art, audio, production, design. As well as more traditional business roles.

Where I live there are a large number of games studios and I have a lot of friends in the industry at a number of companies and they are all now 100% work from home studios.

Splode

24th Apr '20

herbie47, timarr - Regarding the Vaneck Vectors Video Games and eSports ETFs, yes, I believe ESGB and ESPO are basically the same entity on the LSE but denominated in GBP and USD respectively. They have similar spreads (~ 0.5%) and both have recorded a number of deals on L2 today, although the $ shares have about twice the number at the moment. Not surprisingly they both really kicked off in mid March. I bought soon after. The daily range of the ESPO ($) shares is greater that the ESGB (£) shares and the latter frequently 'gap' in these turbulent times.

Interactive Investor and Barclays offer both varieties but iDealing only seems to offer the ESPO ($) shares.

Eggy Toast

30th Apr '20

I'm a big kid when it comes to games and it has to be said Cyberpunk has people salivating.

richman01

6th Jul '20

Excellent advice on ESPO- thank you

john652

20th Jul '20

Hi Timarr,

I have just watched the Codemasters Group (LON:CDM) update on PIworld. Very positive and upbeat and worthy of increased investment however the final few minutes they went into the slide on the earnout for the SMS acquisition. As you hold I suspect you've looked into this hence the question.

Now this seems to say that over the next 3 years the management team could earn 107% of EBITDA amounting to a max of $160M dollars.What I am struggling understanding is, well , this number. They are forecasting £100m per year revenue & £24m net profit. So I cant really reconcile a net profit of of say £73 million at current forecasts with the requirement to pay out unto $160m??

Am I missing something & does this mean they'll need to take on debt for this.

Thanks
John

Video game candidates #1: Keywords Studios

Video games: the perfect lockdown activity?

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Jack Brumby

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