Keywords Studios initiated at ‘buy’ by Shore Cap as games industry increases outsourcing

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Keywords Studios PLC (LON:KWS) was started at a ‘buy’ recommendation by broker Shore Capital as it initiated coverage of the technical services provider to the video games development industry.


Analysts Katie Cousins and Roddy Davidson noted that Keywords is building the world’s leading tech and creative services platform focused on video games, “the most complex of interactive content”.


READ: Keywords Studios CEO predicts ‘supercharged years’ as new console cycle begins


Because of this complexity, the games industry is increasingly outsourcing work, the analysts noted, with Keywords starting as a business service provider in Ireland in the late 1990s and since scaling into “a dominant player” with over 50 studios around the world providing services to 23 of the top 25 video game companies and all 10 of the top ten mobile game publishers.


“It is well known for its high-quality work and global reach, and by having a highly diversified model it can offer an end-to-end service across all platforms and even in adjacent industries. It can also leverage its locations to access key talent pools and speed up growth.”


The 2020 financial year is likely to take a small impact from coronavirus but the analysts expecting a return to historical norms, which include an above-industry revenue growth rate, a gross profit margin of 38% and an adjusted profit margin building to 17% by 2023.


Supported by an extra GBP100m from a recent placing, the analysts expect cash generation to continue and for the dividend to return to a progressive strategy after 2021 with around a 10% increase year-on-year.


Keywords shares currently trade on P/E multiples of 46x and 34x for this year and next year’s earnings per share, versus a historical five-year average of 34x.


Based on cash flow analysis that assumes a 7.9% discount rate and a 3.5% terminal growth rate, with a ten-year compound annual revenue growth of 8% in line with the wider market, the analysts said this points to a fair value for the shares of 2,100p, 23% upside to the last close price.


The shares were up 3% to 1,767p on Wednesday morning.

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