Keywords proves its strength in a gaming recession

In 2022, the gaming industry – like many sectors boosted by the pandemic – went through its own recession. Industry analysts New Zoo estimated that the size of the total market contracted for the first time in its history last year, falling 4.3 per cent to $184bn (£152bn). This drop should be set against the 34 per cent growth between 2019 and 2021, but has still been a shock for an industry that grew consistently over the past decade. 

However, despite the wider videogames industry shrinking, Keywords managed to grow organic revenue by 21.8 per cent, an acceleration from 19 per cent in 2021. As a provider of services to the industry, the popularity of any one game doesn’t affect Keywords’ performance directly because revenue isn’t dependent on the final release. All that matters is that a lot of games are produced, which is why we have previously described Keywords as a picks-and-shovels play, in the tradition of those businesses that made their money selling tools to miners during California’s gold rush, rather than doing the speculative digging.

Last year’s growth was also well ahead of what the company initially expected. As late as November, management had been guiding for full-year organic revenue growth of over 10 per cent in November, but by January it was confirmed it would climb a fifth. Foreign exchange swings may have helped, but a management team that underpromises and overdelivers is much better than the other way around. Neither is it only management that underestimates its prospects: for much of the past decade, full-year reported earnings per share have consistently beaten analyst guidance. When 2022 figures were released this week, they exceeded consensus forecasts by 3.2 per cent, despite a steady stream of upgrades over the past year.

Size is a plus

Both a strength and weakness of Keywords is its scale. It has made more than 60 acquisitions and spent almost €600mn (£527mn) since 2014. These companies have also been acquired across the world, making Keywords a global business, and enabling it to service the largest games studios on every continent. It works with 23 of the top 25 largest game developers, including well-established names including Electronic Arts (US:EA), Google, Netflix (US:NFLX), Apple (US:AAPL), Microsoft (US:MSFT) and Tencent (HK:700). None of its competitors can do this in the same way.

However, acquisitions always bring risks and merging all these businesses together efficiently is easier said than done. Over the past two years, bolt-on deals and transaction-related foreign exchange movements have contributed to an 87 per cent rise in goodwill assets, to €397mn. A drop in the pre-tax discount rate used to assess goodwill value – from 12.5 to 10 per cent and reflecting the group’s lower weighted average cost of capital – also helped. This creates plenty of opportunity for impairments if the consolidation is executed poorly, or acquired businesses fall short of management’s central medium-term growth rate assumption of 10 per cent.

It’s a risk that has been noted by Matt Tonge, a fund manager at small-cap asset manager Liontrust’s Economic Advantage Team. However, he has seen an improvement in the past few years. “On a capital markets day a few years ago some of the acquired businesses referred to themselves as ‘I’, but there seems to have been a shift recently towards a more streamlined business.”

The shift Tonge refers to relates to the ‘One Keywords’ initiative, launched last year, which seeks to preserve the group’s geographically diverse and entrepreneurial culture while consolidating all services into three divisions: create, globalize and engage.

Developers know Keywords can deal with every aspect of a game’s international launch. The create division, which combines art services and game development, helps with the design of the game. The globalize arm, which brings together audio, testing and localisation, makes sure there are no bugs in a game and translates it for international release. Finally, the engage team deals with all the marketing and PR around a launch.

Having employees across the world also allows Keywords to offer 24-hour service and to arbitrage cheaper sources of labour on behalf of developers, such as finding game designers in India to carry out design work for a US customer.

Technology boosts productivity 

Numis believes Keywords’ recent spate of technology company acquisitions will boost productivity once they are bedded in.

Helpshift, which was acquired for $75mn in December, develops software that Keywords hopes will improve customer support, including an AI chatbot. Dublin-based KantanAI, formerly known as KantanMT and bought in 2019, is a machine-learning translation platform that enables Keywords to quickly translate games into multiple languages. The platform has allowed Keywords to develop a workflow system with Microsoft that brought the localisation processing time down from 13 hours to 43 minutes. Mobile development group Mighty Games, also acquired last year, uses AI to test the games, which would be an improvement on the hundreds of gamers it employs to do this currently.

"You can see the logic of these acquisitions and as the company scales we could see margin expansion as these technologies can be applied to more pieces of work," says Tonge. What is clear, from the group’s cash flow statement, is that it remains highly cash generative even after capital expenditure and M&A is accounted for.

The breathless hype around AI, especially since OpenAI’s release of ChatGPT in December, means investors should be wary of any company’s claims for the technology. However, the Helpshift deal shows Keywords has been ahead of the curve when it comes to identifying AI’s practical use cases. Whether the company has overpaid for this exposure remains to be seen, although KantanAI’s ability to streamline translation services looks set to drive growth and could prove invaluable. Asia is the fastest-growing market for Netflix, and US content producers are targeting it as a future growth driver. 

This year will be slower

Although Keywords’ revenue isn’t as volatile as that of the gaming developers it services, it is not completely disconnected from the fate of the wider market. After a down year for the industry, developers are expecting to cut back on spending next year and Keywords is forecasting 10 per cent organic growth. It is also expecting adjusted profit to drop from 17 per cent towards the historical average of around 15 per cent, which the company has pinned on rising labour costs and travel expenses.

Numis has assumed these growth rates and margins will persist into 2024, resulting in adjusted earnings of €1.22 per share this year and €1.35 in 2024. That pitches the shares onto an expensive-looking price/earnings multiple of just under 25 for the next 12 months. However, this is below the five-year average of around 33, per FactSet, and we believe the growth last year in the face of economic headwinds is evidence of its robustness.

The gaming industry may be slowing from the pandemic peak. But that was an exceptional year and the industry is almost guaranteed to carry on growing given its popularity among the younger generations. Demographics are inevitable and Keywords’ growth-oriented strategy means it can profit without the scary bumps in the road.