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Invest in post-lockdown gaming with Team17

Video games have been the ideal lockdown distraction but this boom is sustainable long term
March 4, 2021
  • Team17 can capture long-term growth in video games, beyond lockdown booms 
  • Its strong IP portfolio acts as a distinctive economic moat   
Tip style
Growth
Risk rating
High
Timescale
Long Term
Bull points
  • Long-term growth in video game market 
  • Formidable IP portfolio
  • Highly cash generative 
Bear points
  • Lockdown surges will make 2020 a tough comparator 
  • New video game habits might not stick post-Covid

“There’s not a lot of people with purple hair in the City,” confesses the chief executive of Team17 (TM17), to an audience of female entrepreneurs at a fireside chat series in 2019. Debbie Bestwick, who has led the video-game developer since 2009 (first as co-CEO before quickly becoming its sole head) and owns a 22 per cent stake in the group, does not match the profile of traditional top executive at a £1bn listed bussiness. But her leadership has propelled the stock to more than triple in value since it listed in 2018, while continuing to attract industry-wide recognition for its video games, including most recently the MCV Indie Publisher of the Year award in 2020.   

The group, which Bestwick co-foundedin 1990, has a well-respected reputation in the UK video games industry. It is little wonder why: its formidable portfolio ofintellectual property (IP) includes brands such as the massively popular Worms franchise, as well as Overcooked and The Escapists titles. All three have won a number of awards, including Baftas. But the bulk of the group’s revenues comes from its work with third-party developers. Here, Team17 assists smaller studios with development and production, as well as bringing the product to market, in exchange for a fixed percentage of the royalties. 

 

2020’s double dose 

The video game industry has been an immediate beneficiary of the various coronavirus restrictions across the world – and Team17 was no exception. Its results for the full year should be officially released in the coming weeks, although a trading update in January has already revealed that management expects adjusted cash profits to have grown by more than a third overall last year. 

Sage investors will be wary of the temporary nature of a lockdown boom – the group acknowledged a one-off benefit during the first spring lockdown, but said that it had quickly normalised in the second half. But that period was no doubt helped by the launch of the new PlayStation and X-box consoles from Sony (JP:X) and Microsoft (US:MSFT) respectively. 

The combined impact of a lockdown surge and a new generation of consoles will make 2020 a tough comparator: consensus forecasts suggest that sales will grow 8 per cent in the 2021 financial year (the broker forecasts used in our table are conservative against consensus), compared with an expected34 per cent in 2020. 

But the market should be prepared for slowdowns in tech and media spaces that have benefited from the pandemic. Take streaming giant Netflix (US:NFLX) – its shares have recovered since it said that new sign-ups were slowing late last year, because management flagged early on that it would not be able to sustain the level of growth it saw in the spring. Team17 has similarly avoided creating the impression of being able to keep up with the dizzying pace of sales that it achieved in 2020. 

 

Holding onto growth

Even so, the pandemic sales gains are not expected to reverse. Team17’s focus on life cycle management means that it can tempt its customers to stick with games for longer. That involves adding more downloadable content (DLC) and enables the company to squeeze more revenue out of games that have already been released. While the proportion of sales coming from new products will depend on the number, timing and scale of releases that year, a steady stream of back catalogue revenue proves that Team17 is adept at ensuring its games have a long, engaging shelf life. 

 

The group's ability to keep players coming back for more is also a credit to the quality of its IP – and that base is getting stronger. This year it announced the £12m acquisition of one of its third-party titles Golf With Your Friends, the biggest deal of its kind for the group since it bought The Escapists in 2016 before its IPO. The acquisition means that it can extend the life cycle of this brand, too, as well as introduce sequel games – and, importantly, without having to compensate an independent developer. More acquisitions like this could eventually help fatten up the group’s gross margin.    

This already sit at a chunky 48 per cent, and the mostly digital nature of the group’s products means that operating cash conversion has averaged 105 per cent since it listed. But the business of developing video games is not a cheap one: £3.2m worth of capitalised development costs in 2019 stood at 17 per cent of the group's pre-tax profits that year. And  employees have to work to the industry’s notoriously difficult deadlines – although so far the pressures of the pandemic have not caused launch or service delays, unlike at some peers. That, as well as an attractive return on capital employed rate of 23.5 per cent, should signal to investors that Team17 is smart at allocating its resources. 

 

HOW TEAM17 COMPARES WITH LONDON-LISTED PEERS

NameTIDMMkt CapNet CashPriceFwd PE (+12mths)FCF yld (+12mths)EBIT MarginROCEFwd EPS grth FY+1Fwd EPS grth FY+23-mth Mom3-mth Fwd EPS change%12-mth Fwd EPS change%
Team17 TM17£957m£49m728p373.0%31.3%26.3%30%9%-9.9%3.4%43.5%
Sumo SUMO£512m£6m300p312.0%16.5%15.1%9%33%4.9%13.4%7.5%
Keywords StudiosKWS£1,882m£63m2,530p401.5%7.7%9.7%17%23%6.3%5.7%18.5%

Source: FactSet

The long-term view

With such a juicy business model, strong IP and loyal customers, we would not be surprised if Team17 ended up with a similar fate to Codemasters, the racing game developer that was acquired by Electronic Arts (US:EA) last year. Large insider stakes mean it would need to be a sweet deal. Indeed, as there is still room for further growth in the video games sector: in 2019, the company recognised smartphone gaming as its largest addressable market, which according to research by consultancy newzoo grew by 16 per cent last year to $64bn. 

As a number of developers push back against app store rules (look no further than Fortnite maker Epic Games suing Apple (US:AAPL) in the European Union for enforcing its 30 per cent fee), Team17’s focus may well turn to its mobile games as its next stimulant for growth. 

Lockdown easing might spook the market, and it is not guaranteed that casual gamers will want to look at their screens as much once pubs, restaurants and clubs have opened back up again. But there will always be a large core market that supports the gaming industry – and that specific customer base is growing. Amazon’s (US:AMZN) streaming service Twitch, where people tune in to watch others play video games, logged an incredible 5.4bn hours of viewed content in the final quarter of 2020 alone, according to a report from Streamlabs and Stream Hatchet. 

Shares in Team17 have dropped by around a tenth since the start of the year, although not for any immediately obvious reason – perhaps as part of a market-wide movement away from growth stocks, or names that were labelled as lockdown beneficiaries. But we do not think investors should be too worried: the company is armed with at least nine titles in the pipeline for this year, including a new highly-anticipated Hell Let Loose game, which has received wide praise during the alpha-testing ‘early access’ stage. The shares are not cheap, but a forecast next-12-month free cash flow yield of 3 per cent looks reasonable to us based on the quality of the company's IP and the growth potential. 

 

Team17  (TM17)    
ORD PRICE:730pMARKET VALUE:£960m  
TOUCH:725-735p12-MONTH HIGH:900pLOW:424p
FORWARD DIVIDEND YIELD:NILFORWARD PE RATIO:42  
NET ASSET VALUE:71.1p*NET CASH:£48.8m**  
Year to 31 DecTurnover (£m)Pre-tax profit (£m)***Earnings per share (p)***Dividend per share (p) 
201729.67.34.9nil 
201843.211.98.1nil 
201961.820.113.6nil 
2020***82.726.717.1nil 
2021***83.026.917.2nil 
 +0.4+1+1- 
NMS:     
Beta:0.5    
*Includes intangible assets of £43m, or 33.6p a share
**Includes lease liabilities of £1.5m
***Berenberg forecasts, adjusted PTP, EPS figures