It is hard to pinpoint an exact reason for the 17 per cent share price fall Frontier Developments (FDEV) suffered on its results day, or indeed the cause of a sharp reversal in investor sentiment since May’s highs of 1,880p. We can speculate. Perhaps investor overexcitement ahead of June's launch of a Jurassic World game meant some froth needed to come off the shares, but even so the decline seems extreme. Blame could also be put on recent regulatory changes in China, which have made it hard to launch new video games in Frontier’s third-largest market. But considering the wealth of opportunities in other geographies and the fact that a fickle Chinese government is nothing new, we think that share price move looks like an overreaction on these grounds, too. Moreover, in the last few months news from Frontier has been nothing but positive: the launch of its most successful franchise to date; assurance that its fourth game will be on the shelves in the 2020 financial year; and profit numbers ahead of expectations.
Track record for highly successful games
Impressive long-term growth forecasts
Net cash
Experienced management
Hard to predict revenues from new franchises
Challenges in China
Frontier now trades on a price/earnings growth (PEG) ratio of just 1.5 times. Given biannual game launches mean biannual spikes in sales and earnings (see table), our PEG uses a price/earnings (PE) ratio based on average EPS over the last two financial years and a 38 per cent forecast compound annual growth rate (CAGR) to 2022, by which time game launches are expected to be more frequent and broker Liberum predicts EPS will be 65.2p.
The key to Frontier’s long-term growth forecasts is its multi-franchise model. Historically an outsourcer to the video game industry, Frontier has built a reputation for high-quality games that operate on many platforms. Its first self-published game, Elite Dangerous, reported £18.6m of sales in its first year, Planet Coaster was similarly successful, while Jurassic World – which was launched in June alongside the film release – surpassed 1m downloads in its first six weeks. The game is expected to add £59.4m to 2019 revenues.
What’s special about the group’s games is their ability to generate substantial revenue for many years after the initial spike at launch. Indeed, broker Liberum is forecasting a 41 per cent increase in revenues from Elite Dangerous in the year to May 2020 thanks to new add-ons, while Planet Coaster revenues are expected to be maintained at £8.4m from the current financial year onwards.
This ongoing revenue is bolstered by new game launches that are becoming increasingly frequent. The group plans to deploy some of its substantial cash resources into outsourcing, which will increase the capacity for new games. The cash position was boosted by the purchase of a 9 per cent stake for £17.7m by Chinese games giant Tencent last year. Frontier itself generated £10.2m of cash in 2018 from operations from £9.4m of profits before depreciation and amortisation, although there was an outflow of £2.8m after accounting for game development costs. Management is confident that Frontier will be releasing two games per year by 2021 and, although it is hard to predict revenues, broker expectations range between £20m and £35m in the game’s first year, based on the company’s track record.
| FRONTIER DEVELOPMENTS (FDEV) | ||||
| ORD PRICE: | 1,010p | MARKET VALUE: | £391m | |
| TOUCH: | 1,010-1,015p | 12-MONTH HIGH: | 1,880p | 816p |
| DIVIDEND YIELD: | nil | PE RATIO: | 39 | |
| NET ASSET VALUE: | 143p* | NET CASH: | £24.1m | |
| Year to 31 May | Turnover (£m) | Pre-tax profit (£m) | Earnings per share (p) | Dividend per share (p) |
| 2016 | 21.4 | 2.6 | 8.0 | nil |
| 2017 | 37.4 | 8.5 | 24.4 | nil |
| 2018 | 34.2 | 3.9 | 11.6 | nil |
| 2019** | 80.3 | 19.2 | 42.8 | nil |
| 2020** | 70.9 | 11.1 | 25.8 | nil |
| % change | -12 | -42 | -40 | - |
| Normal market size: | 750 | |||
| Matched bargain trading | ||||
| Beta: | 1.52 | |||
| *Includes intangible assets of £29.2m, or 75.4p a share | ||||
| **Broker Liberum forecasts | ||||
