Join our community of smart investors

Profit from Frontier Developments' burgeoning releases

Growth forecasts look justified with a roster of big-name releases announced
November 18, 2021
  • Strong games pipeline for the next two fiscal years
  • 'Launch and nurture' business model supports long-term sales
Tip style
Growth
Risk rating
Medium
Timescale
Long Term
Bull points
  • Sequel to biggest-selling game just released
  • Robust games pipeline
  • Game add-on purchases model performing well
Bear points
  • Delays and launch issues for key title
  • Restrictions in Chinese market 
  • Semiconductor shortages could hit the top line

Like a tyrannosaurus rex crushing an opponent in one of its Jurassic World video games, Cambridge-based video game developer and publisher Frontier Developments (FDEV) stomped on opposition to deliver record revenue and operating profit in its 2021 fiscal year. This was achieved despite the company not releasing a major new title in the period.

Frontier has benefited from the video game industry’s pandemic boom as digital-heavy companies smash earnings records. Lockdowns have drawn increased attention to video games as both a form of entertainment and a means to interact with friends and family when physical interaction is hindered.

But what happens when these pandemic-driven tailwinds recede? As economies and societies reopen more fully, there is a risk that Frontier’s growth rates will falter against robust comparatives. According to video game market analyst Newzoo, global industry revenue growth will slow to 1.4 per cent for 2021 after 2020’s incredible 23 per cent.

Stymied growth is not the only concern. Covid-19, as well as helping to drive increased revenues, has contributed to launch issues and delays in game production. There are fears around the situation in China, too, with state restrictions on the video game market, and the global shortage in semiconductors which has hit console production.  

Frontier looks well placed to manage these risks. Its business model, games pipeline, and underlying fundamentals make it attractive as a long-term growth stock.  While new buzzwords are floating around the market – non-fungible tokens (NFTs) comes to mind – Frontier does the video game basics well and it is on this that its fortunes depend.

 

A nurturing business model

Frontier produces its own titles, such as hit series Elite Dangerous, and has a separate label for publishing third-party games called Foundry. Foundry posted its first revenues in FY2021 with the release of two titles. All games are developed using the in-house ‘Cobra’ technology system which boosts efficiency by making titles suitable for publication across major gaming platforms. Cobra has recently been infused with “cloud-based analytic capability”.  

The company's latest annual results to the end of May 2021 illustrates the sector’s pandemic boost as more people got into gaming while stuck at home. Revenue was up 19 per cent to £91m and operating profit spiked by 20 per cent to £20m. Operating margins have held fairly steady at 22 per cent for the past three years.

But the results also demonstrate the success of the company’s ‘launch and nurture’ business model. Rather than a new game producing a strong income stream initially and this flow quickly diminishing, the model expands existing franchises through the regular release of paid downloadable content (PDLC) packs. Such packs include, for example, new characters and scenarios for gamers to enjoy. This means titles produce more cash flow over a longer period.

Frontier makes almost all sales through digital channels – 96 per cent came from digital sources in the 2021 fiscal year. PC sales are made through third-party channels such as Steam, while console sales are managed through relationships with Microsoft (US:MSFT), Sony (JP:6768) and Nintendo (JP:7974).

Most sales – around 60 per cent – are through Steam. The platform, which is run by Valve, takes a significant 30 per cent cut from each sale which is standard across digital industry platforms. In a survey of over 3,000 industry professionals by the Game Developers Conference earlier this year, only 3 per cent of respondents thought this level of cut to be "fair".

Wolfire Games, a games developer based in California, is currently pursuing antitrust claims against Valve in the US. Depending on the outcome, this may potentially lead to a change in industry pricing structures to the benefit of Frontier. The company, and the wider market, will be watching events closely.

 

 

Dinosaurs and the pipeline

Frontier’s big-beast, blockbuster franchise is based upon the $5bn Jurassic World film series. The group’s biggest selling game to date is 2018's Jurassic World Evolution. The game franchise has a close relationship with the films – the actors provide voiceovers and narrative for example – which helps attract attention.

Evolution provides an exemplar for the use of add-ons and downloadable content to maintain sales after a title’s original release. Numerous PDLC packs were released over 2018 and 2019, which allow gamers to play with new dinosaurs and locations within the virtual world.

The sequel, Jurassic World Evolution 2, was released earlier this month to much excitement. While the related film release – Dominion –  has been pushed back to June 2022 due to the impact of the pandemic on production, the game will benefit from interest from current Evolution gamers and from increased attention once the film appears. Peel Hunt notes that the first Evolution has more than 3m players, a solid foundation for the sequel.

Looking ahead, Frontier has a robust release pipeline for at least the next two fiscal years. New games will include the first of a new annual Formula 1 series, combat strategy game Lemnis Gate, and “atmospheric vehicle adventure” title FAR: Changing Tides. Six new titles have been confirmed for the Foundry label.

Particularly noticeable releases are the two upcoming games set in the universe of stock market darling Games Workshop (GAW). Warhammer 40,000: Chaos Gate – Daemonhunters will be released the current financial year through the Foundry label and Warhammer Age of Sigmar will reach shelves next financial year. With the growth of interest in the Warhammer world in recent years, analysts expect strong sales from these titles.

 

Struggles and risks

The pandemic has led to production issues for Frontier. The company's “most ambitious development project to date”, the Elite Dangerous: Odyssey expansion, was delayed several times due to Covid-19 and when finally released in May was beset with glitches and performance issues. The release was panned in online reviews. CEO David Braben made a public apology. The latest results perhaps understate the issue, noting: “The overall reception to this major content update has been disappointing”.

Further bad news for Frontier comes from China. The government earlier this year limited the number of hours that children under the age of 18 can spend playing video games to three per week. State media in the People’s Republic said the move was part of a drive to combat mental and physical health issues among the young.

Epic Games has just "shut down" its Fortnite game in China – the state hasn't given approval for it and hasn't approved any title in over three months. Fortunately for Frontier, it only garners around 5 per cent of its revenues from China, but in such a significant developing economy the restrictions and market environment are far from ideal.

Another risk for Frontier’s top line is the ongoing shortage in semiconductors. These are used, for example, in the production of video game consoles and PC components. Nintendo recently announced that it expects to sell 1.5m fewer Switch consoles this fiscal year due to the shortages. Whether this problem will be a short-term blip or a long-term issue, and how serious the impact on Frontier will be, is not yet apparent. But, ultimately, fewer consoles will mean fewer games sold.   

 

Future growth

Frontier’s management is bullish about growth prospects, though. For the year to the end of May 2022 it forecasts £130m-£150m of revenue, “implying an annual growth rate of 43 per cent to 65 per cent” against 2021. 2023 forecasts are up at £160m-£180m, which on the high-end would double revenue from the latest full-year results. Consensus forecasts fall about midway in the guidance range. Encouragingly, forecasts continue to be subject to modest upgrades despite the challenges set by comparisons with 2020's bumper year.

The shares are valued at 32 times forecast earnings for the next 12 months. With significant growth expected over the next few years, backed up by an impressive games pipeline, this valuation doesn’t look too demanding. Indeed, a price/earnings growth (PEG) ratio of 1.8 does not look too much of a challenge. The shares are also currently trading below their peak in the spring, which cold prove a good buying opportunity given the launches on the horizon.  

Company DetailsNameMkt CapPrice52-Wk Hi/Lo
 Frontier Developments  (FDEV)£967m2,455p3,470p / 2,085p
Size/DebtNAV per share*Net Cash / Debt(-)Net Debt / EbitdaOp Cash/ Ebitda
 289p£20.3mna94%
ValuationFwd PE (+12mths)Fwd DY (+12mths)FCF yld (+12mths)PEG
 32N/A4.3%1.8
Quality/ GrowthEBIT MarginROCE5yr Sales CAGR5yr EPS CAGR
 21.2%15.0%33.5%67.5%
Forecasts/ MomentumFwd EPS grth NTMFwd EPS grth STM3-mth Mom3-mth Fwd EPS change%
 N/A14%-5.6%5.7%
Year End 31 MaySales (£m)Profit before tax (£m)EPS (p)DPS (p)
20199020.343.2nil
20207616.839.4nil
20219119.753.3nil
f'cst 202214031.370.4nil
f'cst 202317038.786.1nil
chg (%)+21+24+22
Source: FactSet, adjusted PTP and EPS figures 
NTM = Next 12 months   
STM = Second 12 months (ie, one year from now) 
*Includes intangible assets of £39m, or 182p a share