Keywords Studios — Red Hot art acquisition

Keywords Studios (LN: KWS)

Last close As at 18/03/2024

2,920.00

50.00 (1.74%)

Market capitalisation

2,207m

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Research: TMT

Keywords Studios — Red Hot art acquisition

Keywords Studios’ $6m acquisition of Red Hot CG further strengthens the company’s position in the art service line, in China and with electronic arts. Management estimates that the deal will make Keywords the number one supplier of art production services to the games industry globally and increase art production capacity by 25%. The deal further enhances our estimated FY18 earnings by 6%, with the three acquisitions made so far in May enhancing earnings by 11% versus our April forecasts.

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TMT

Keywords Studios

Red Hot art acquisition

Acquisition

Software & comp services

22 May 2017

Price

800p

Market cap

£446m

€1.17/£, $1.12/€

Net cash (€m) at 31 December 2016

8.7

Shares in issue

55.8m

Free float

69%

Code

KWS

Primary exchange

AIM

Secondary exchange

N/A

Share price performance

%

1m

3m

12m

Abs

2.4

29.0

189.9

Rel (local)

(2.0)

25.3

136.5

52-week high/low

830p

260p

Business description

Keywords Studios provides localisation, testing, artwork, community support and engineering services exclusively to the video games industry. It provides services to 20 of the top 25 games developers and is leading consolidation of this fragmented industry.

Next events

H1 trading update

July 2017

Analysts

Dan Ridsdale

+44 (0)20 3077 5729

Victoria Pease

+44 (0)20 3077 5700

Keywords Studios is a research client of Edison Investment Research Limited

Keywords Studios’ $6m acquisition of Red Hot CG further strengthens the company’s position in the art service line, in China and with Activision. Management estimates that the deal will make Keywords the number one supplier of art production services to the games industry globally and increase art production capacity by 25%. The deal further enhances our estimated FY18 earnings by 6%, with the three acquisitions made so far in May enhancing earnings by 11% versus our April forecasts.

Year
end

Revenue (€m)

PBT*
(€m)

EPS*
(c)

DPS
(p)

P/E
(x)

Yield
(%)

12/15

58.0

8.0

12.6

1.2

74.0

0.1

12/16

96.6

14.9

20.3

1.3

46.0

0.1

12/17e

123.1

18.6

26.0

1.5

35.9

0.2

12/18e

136.5

21.0

29.1

1.6

32.1

0.2

Note: *PBT and EPS (fully diluted) are normalised, excluding intangible amortisation, exceptional items and share-based payments.

Bolstering position in art services and China

Red Hot CG is a China-based but UK-managed provider of a range of art services to the games industry. The company’s operating hub is in Shanghai but it has subsidiaries in lower-cost locations elsewhere in China and in Yogyakarta in Indonesia. The addition of Red Hot CG’s 220 artists should increase the group’s art capacity by circa 25%. Management estimates this will make Keywords the largest provider of art production to the global games industry, ahead of Shanghai-based Virtuos, although there remains plenty of scope for further consolidation. From a customer perspective, Red Hot provides services to broad range of developers but has a particularly strong relationship with Activision and will support Keywords’ drive to develop larger-scale, more strategic relationships with major games developers.

EPS upgraded by 7%

Red Hot generated revenues of $5.4m in FY16 and PBT of $0.9m with further growth expected in FY17. (Our estimates assume 10% growth for Red Hot in FY17.) Keywords is paying a total consideration of $6m for the business, equating to multiple of 1.1x sales and 6.7x PBT. Of the consideration, $4.35m will be paid immediately of which, $1m is deferred for three years, with the remainder satisfied by the issue of 160.8k shares on the second anniversary of the acquisition. We upgrade our FY17 and FY18 EPS estimates by 3.1% and 5.8%, respectively.

Valuation: Continued execution key to further upside

At 32x FY18e earnings, Keywords’ rating is a substantial premium to peers (average 19x for FY18) and, in our view, further strong progress is now priced in for this year. Nevertheless, the company has a compelling platform and strategy for growth in a games industry growing at a healthy 6.6% pa. Consequently, we believe continued execution should deliver share price value in the longer term.

Estimate changes

Our estimate changes are shown below in Exhibit 1.

The Red Hot acquisition prompts a 3% upgrade to FY17 PBT and adj EPS, with FY18 figures moving up by 6%. Factoring in all three acquisitions made in May (XLOC, GameSim and Red Hot), FY17 PBT and EPS has been upgraded by 6%, with the FY18 figures upgraded by 11%.

The company is paying a gross consideration (including deferred payments and shares issued) of €10m for these three acquisitions, resulting in a $2m enhancement to our FY18 PBT, which equates to an attractive 5x forward PBT multiple.

Following the deals, the company’s mid-year net cash is likely to be at the low- to mid-single-digit level. It has a €35m revolving credit facility with Barclays and generates robust free cash flows, giving it plenty of firepower to make more earnings-enhancing acquisitions.

If the company were to invest a further €35m on acquisitions this year at the same 5x PBT forward multiple as the May acquisitions, we estimate that FY18 EPS would be upgraded by c 27%.

Exhibit 1: Estimate changes

€000s

2015

2016

2017e

2017e

Change

2018e

2018e

Change

Year end 31 December

Actual

Actual

Old

New

Old

New

Revenue

57,951

96,585

119,551

123,115

3%

130,605

136,485

5%

Cost of sales

(36,172)

(59,907)

(74,833)

(76,793)

3%

(81,843)

(85,078)

4%

Gross profit

21,779

36,678

44,718

46,322

4%

48,761

51,408

5%

EBITDA

9,459

16,893

20,414

21,152

4%

22,438

23,735

6%

Operating profit (before amort. and except.)

8,162

15,090

18,339

19,077

4%

20,156

21,453

6%

Profit before tax (norm)

8,007

14,864

18,029

18,617

3%

19,846

20,993

6%

Profit after tax (norm)

6,175

11,641

14,243

14,708

3%

15,877

16,795

6%

EPS - normalised fully diluted (c)

12.6

20.3

25.2

26.0

3%

27.5

29.1

6%

EPS – (IFRS) (c)

7.0

11.2

21.6

22.4

4%

24.0

25.7

7%

Dividend per share (pence)

1.2

1.3

1.5

1.5

0%

1.6

1.6

0%

Closing net debt/(cash)

(17,284)

(8,650)

(15,720)

(13,244)

-16%

(25,731)

(23,943)

-7%

Source: Keywords Studios data, Edison Investment Research

Exhibit 2: Financial summary

€000s

2014

2015

2016

2017e

2018e

Year end 31 December

IFRS

IFRS

IFRS

IFRS

IFRS

PROFIT & LOSS

Revenue

 

 

37,293

57,951

96,585

123,115

136,485

Cost of Sales

(24,566)

(36,172)

(59,907)

(76,793)

(85,078)

Gross Profit (inc multimedia tax credits)

12,727

21,779

36,678

46,322

51,408

EBITDA

 

 

6,027

9,459

16,893

21,152

23,735

Operating Profit (before amort. and except.)

 

 

5,159

8,162

15,090

19,077

21,453

Intangible Amortisation

(468)

(857)

(1,629)

(1,629)

(1,629)

Exceptionals

(1,461)

(1,089)

(1,316)

0

0

Other

(156)

(392)

(686)

(686)

(686)

Operating Profit

3,074

5,824

11,459

16,762

19,138

Net Interest

(106)

(264)

(287)

(460)

(460)

FOREX

467

(474)

(1,737)

0

0

Profit Before Tax (norm)

 

 

5,053

8,007

14,864

18,617

20,993

Profit Before Tax (FRS 3)

 

 

3,435

5,086

9,435

16,302

18,678

Tax

(1,215)

(1,832)

(3,223)

(3,910)

(4,199)

Profit After Tax (norm)

3,838

6,175

11,641

14,708

16,795

Profit After Tax (FRS 3)

2,220

3,254

6,212

12,393

14,480

Average Number of Shares Outstanding (m)

45.0

48.2

55.9

55.3

56.5

EPS – normalised (c)

 

 

8.5

12.8

20.9

26.6

29.8

EPS – normalised fully diluted (c)

 

 

8.5

12.6

20.3

26.0

29.1

EPS – (IFRS) (c)

 

 

4.9

7.0

11.2

22.4

25.7

Dividend per share (p)

1.10

1.21

1.33

1.46

1.61

Gross Margin (%)

34.1%

37.6%

38.0%

37.6%

37.7%

EBITDA Margin (%)

16.2%

16.3%

17.5%

17.2%

17.4%

Operating Margin (before GW and except.) (%)

13.8%

14.1%

15.6%

15.5%

15.7%

BALANCE SHEET

Fixed Assets

 

 

20,874

32,132

61,873

54,577

57,571

Intangible Assets

17,677

27,675

55,495

48,971

47,342

Tangible Assets

2,761

3,486

5,498

4,726

9,349

Investments

436

971

880

880

880

Current Assets

 

 

23,120

34,884

38,677

47,269

60,777

Stocks

0

0

0

0

0

Debtors

6,203

7,519

13,879

16,655

18,464

Cash

11,014

19,018

17,020

21,614

32,313

Other

5,903

8,347

7,778

9,000

10,000

Current Liabilities

 

 

(9,746)

(13,128)

(27,830)

(31,461)

(32,847)

Creditors

(9,746)

(11,965)

(19,805)

(23,436)

(24,822)

Short term borrowings

0

(1,163)

(8,025)

(8,025)

(8,025)

Long Term Liabilities

 

 

(2,607)

(3,294)

(6,016)

(6,190)

(6,190)

Long term borrowings

0

(571)

(345)

(345)

(345)

Other long term liabilities

(2,607)

(2,723)

(5,671)

(5,845)

(5,845)

Net Assets

 

 

31,642

50,594

66,704

64,196

79,311

CASH FLOW

Operating Cash Flow

 

 

2,412

4,768

17,168

21,677

23,372

Net Interest

11

(58)

(58)

(460)

(460)

Tax

(522)

(1,362)

(2,129)

(3,910)

(4,199)

Capex

(1,252)

(1,635)

(2,306)

(4,308)

(5,600)

Acquisitions/disposals

(8,889)

(7,409)

(21,104)

(7,580)

(1,500)

Financing

7,342

14,199

643

0

0

Dividends

(609)

(737)

(825)

(814)

(915)

Net Cash Flow

(4,256)

7,194

(8,611)

4,605

10,699

Opening net debt/(cash)

 

 

(15,271)

(11,014)

(17,284)

(8,650)

(13,244)

Forex gain on cash

0

0

1

0

0

Other

(1)

(924)

(24)

(11)

0

Closing net debt/(cash)

 

 

(11,014)

(17,284)

(8,650)

(13,244)

(23,943)

Source: Keywords Studios accounts, Edison Investment Research

Edison is an investment research and advisory company, with offices in North America, Europe, the Middle East and AsiaPac. The heart of Edison is our world-renowned equity research platform and deep multi-sector expertise. At Edison Investment Research, our research is widely read by international investors, advisers and stakeholders. Edison Advisors leverages our core research platform to provide differentiated services including investor relations and strategic consulting. Edison is authorised and regulated by the Financial Conduct Authority. Edison Investment Research (NZ) Limited (Edison NZ) is the New Zealand subsidiary of Edison. Edison NZ is registered on the New Zealand Financial Service Providers Register (FSP number 247505) and is registered to provide wholesale and/or generic financial adviser services only. Edison Investment Research Inc (Edison US) is the US subsidiary of Edison and is regulated by the Securities and Exchange Commission. Edison Investment Research Limited (Edison Aus) [46085869] is the Australian subsidiary of Edison and is not regulated by the Australian Securities and Investment Commission. Edison Germany is a branch entity of Edison Investment Research Limited [4794244]. www.edisongroup.com

DISCLAIMER
Copyright 2017 Edison Investment Research Limited. All rights reserved. This report has been commissioned by Keywords Studios and prepared and issued by Edison for publication globally. All information used in the publication of this report has been compiled from publicly available sources that are believed to be reliable, however we do not guarantee the accuracy or completeness of this report. Opinions contained in this report represent those of the research department of Edison at the time of publication. The securities described in the Investment Research may not be eligible for sale in all jurisdictions or to certain categories of investors. This research is issued in Australia by Edison Aus and any access to it, is intended only for "wholesale clients" within the meaning of the Australian Corporations Act. The Investment Research is distributed in the United States by Edison US to major US institutional investors only. Edison US is registered as an investment adviser with the Securities and Exchange Commission. Edison US relies upon the "publishers' exclusion" from the definition of investment adviser under Section 202(a)(11) of the Investment Advisers Act of 1940 and corresponding state securities laws. As such, Edison does not offer or provide personalised advice. We publish information about companies in which we believe our readers may be interested and this information reflects our sincere opinions. The information that we provide or that is derived from our website is not intended to be, and should not be construed in any manner whatsoever as, personalised advice. Also, our website and the information provided by us should not be construed by any subscriber or prospective subscriber as Edison’s solicitation to effect, or attempt to effect, any transaction in a security. The research in this document is intended for New Zealand resident professional financial advisers or brokers (for use in their roles as financial advisers or brokers) and habitual investors who are “wholesale clients” for the purpose of the Financial Advisers Act 2008 (FAA) (as described in sections 5(c) (1)(a), (b) and (c) of the FAA). This is not a solicitation or inducement to buy, sell, subscribe, or underwrite any securities mentioned or in the topic of this document. This document is provided for information purposes only and should not be construed as an offer or solicitation for investment in any securities mentioned or in the topic of this document. A marketing communication under FCA Rules, this document has not been prepared in accordance with the legal requirements designed to promote the independence of investment research and is not subject to any prohibition on dealing ahead of the dissemination of investment research.
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Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

245 Park Avenue, 39th Floor

10167, New York

US

Sydney +61 (0)2 9258 1161

Level 25, Aurora Place

88 Phillip St, Sydney

NSW 2000, Australia

Edison is an investment research and advisory company, with offices in North America, Europe, the Middle East and AsiaPac. The heart of Edison is our world-renowned equity research platform and deep multi-sector expertise. At Edison Investment Research, our research is widely read by international investors, advisers and stakeholders. Edison Advisors leverages our core research platform to provide differentiated services including investor relations and strategic consulting. Edison is authorised and regulated by the Financial Conduct Authority. Edison Investment Research (NZ) Limited (Edison NZ) is the New Zealand subsidiary of Edison. Edison NZ is registered on the New Zealand Financial Service Providers Register (FSP number 247505) and is registered to provide wholesale and/or generic financial adviser services only. Edison Investment Research Inc (Edison US) is the US subsidiary of Edison and is regulated by the Securities and Exchange Commission. Edison Investment Research Limited (Edison Aus) [46085869] is the Australian subsidiary of Edison and is not regulated by the Australian Securities and Investment Commission. Edison Germany is a branch entity of Edison Investment Research Limited [4794244]. www.edisongroup.com

DISCLAIMER
Copyright 2017 Edison Investment Research Limited. All rights reserved. This report has been commissioned by Keywords Studios and prepared and issued by Edison for publication globally. All information used in the publication of this report has been compiled from publicly available sources that are believed to be reliable, however we do not guarantee the accuracy or completeness of this report. Opinions contained in this report represent those of the research department of Edison at the time of publication. The securities described in the Investment Research may not be eligible for sale in all jurisdictions or to certain categories of investors. This research is issued in Australia by Edison Aus and any access to it, is intended only for "wholesale clients" within the meaning of the Australian Corporations Act. The Investment Research is distributed in the United States by Edison US to major US institutional investors only. Edison US is registered as an investment adviser with the Securities and Exchange Commission. Edison US relies upon the "publishers' exclusion" from the definition of investment adviser under Section 202(a)(11) of the Investment Advisers Act of 1940 and corresponding state securities laws. As such, Edison does not offer or provide personalised advice. We publish information about companies in which we believe our readers may be interested and this information reflects our sincere opinions. The information that we provide or that is derived from our website is not intended to be, and should not be construed in any manner whatsoever as, personalised advice. Also, our website and the information provided by us should not be construed by any subscriber or prospective subscriber as Edison’s solicitation to effect, or attempt to effect, any transaction in a security. The research in this document is intended for New Zealand resident professional financial advisers or brokers (for use in their roles as financial advisers or brokers) and habitual investors who are “wholesale clients” for the purpose of the Financial Advisers Act 2008 (FAA) (as described in sections 5(c) (1)(a), (b) and (c) of the FAA). This is not a solicitation or inducement to buy, sell, subscribe, or underwrite any securities mentioned or in the topic of this document. This document is provided for information purposes only and should not be construed as an offer or solicitation for investment in any securities mentioned or in the topic of this document. A marketing communication under FCA Rules, this document has not been prepared in accordance with the legal requirements designed to promote the independence of investment research and is not subject to any prohibition on dealing ahead of the dissemination of investment research.
Edison has a restrictive policy relating to personal dealing. Edison Group does not conduct any investment business and, accordingly, does not itself hold any positions in the securities mentioned in this report. However, the respective directors, officers, employees and contractors of Edison may have a position in any or related securities mentioned in this report. Edison or its affiliates may perform services or solicit business from any of the companies mentioned in this report. The value of securities mentioned in this report can fall as well as rise and are subject to large and sudden swings. In addition it may be difficult or not possible to buy, sell or obtain accurate information about the value of securities mentioned in this report. Past performance is not necessarily a guide to future performance. Forward-looking information or statements in this report contain information that is based on assumptions, forecasts of future results, estimates of amounts not yet determinable, and therefore involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements of their subject matter to be materially different from current expectations. For the purpose of the FAA, the content of this report is of a general nature, is intended as a source of general information only and is not intended to constitute a recommendation or opinion in relation to acquiring or disposing (including refraining from acquiring or disposing) of securities. The distribution of this document is not a “personalised service” and, to the extent that it contains any financial advice, is intended only as a “class service” provided by Edison within the meaning of the FAA (ie without taking into account the particular financial situation or goals of any person). As such, it should not be relied upon in making an investment decision. To the maximum extent permitted by law, Edison, its affiliates and contractors, and their respective directors, officers and employees will not be liable for any loss or damage arising as a result of reliance being placed on any of the information contained in this report and do not guarantee the returns on investments in the products discussed in this publication. FTSE International Limited (“FTSE”) © FTSE 2017. “FTSE®” is a trade mark of the London Stock Exchange Group companies and is used by FTSE International Limited under license. All rights in the FTSE indices and/or FTSE ratings vest in FTSE and/or its licensors. Neither FTSE nor its licensors accept any liability for any errors or omissions in the FTSE indices and/or FTSE ratings or underlying data. No further distribution of FTSE Data is permitted without FTSE’s express written consent.

Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

245 Park Avenue, 39th Floor

10167, New York

US

Sydney +61 (0)2 9258 1161

Level 25, Aurora Place

88 Phillip St, Sydney

NSW 2000, Australia

Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

245 Park Avenue, 39th Floor

10167, New York

US

Sydney +61 (0)2 9258 1161

Level 25, Aurora Place

88 Phillip St, Sydney

NSW 2000, Australia

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