Keywords Studios — £100m placing, trading resilient

Keywords Studios (LN: KWS)

Last close As at 01/11/2024

2,920.00

50.00 (1.74%)

Market capitalisation

2,207m

More on this equity

Research: TMT

Keywords Studios — £100m placing, trading resilient

Keywords announced a £100m equity placing on 14 May 2020. The funds are to increase flexibility for the group’s buy-and-build M&A strategy and reinforce its financial position. Management also updated on trading over March and April (7% y-o-y growth), with January and February showing 21% y-o-y growth. Recognising this resilience during lockdown, we have raised our revenue growth forecast for FY20 to 8% y-o-y (4% previously), with a consequential impact on FY21e (€405.8m, 15% growth). We maintain our view that Keywords is well placed as the only games service provider on a global scale. The P/E rating (45.8x FY20e, 34.9x FY21e) reflects the company’s leading market position, track record and potential, but should fall further as Keywords executes its buy-and-build strategy.

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Written by

TMT

Keywords Studios

£100m placing, trading resilient

Equity placing

Software & comp services

19 May 2020

Price

1,714p

Market cap

£1.25bn

€1.12/£

Net debt (€m) at 31 December 2019

17.9

Shares in issue (post May 2020 placing)

72.66m

Free float

90%

Code

KWS

Primary exchange

AIM

Secondary exchange

N/A

Share price performance

%

1m

3m

12m

Abs

15.9

10.4

1.6

Rel (local)

11.4

37.0

23.2

52-week high/low

1,838p

1,073p

Business description

Keywords Studios is the largest and most diverse supplier of outsourced services to the games industry. Through regular acquisitions, the company is building its scale, geographic footprint and delivery capability. Its ambition is to become the ‘go-to’ supplier across the industry.

Next event

AGM

27 May 2020

H120 results

September 2020

Analysts

Richard Williamson

+44 (0)20 3077 5700

Dan Ridsdale

+44 (0)20 3077 5700

Keywords Studios is a research client of Edison Investment Research Limited

Keywords announced a £100m equity placing on 14 May 2020. The funds are to increase flexibility for the group’s buy-and-build M&A strategy and reinforce its financial position. Management also updated on trading over March and April (7% y-o-y growth), with January and February showing 21% y-o-y growth. Recognising this resilience during lockdown, we have raised our revenue growth forecast for FY20 to 8% y-o-y (4% previously), with a consequential impact on FY21e (€405.8m, 15% growth). We maintain our view that Keywords is well placed as the only games service provider on a global scale. The P/E rating (45.8x FY20e, 34.9x FY21e) reflects the company’s leading market position, track record and potential, but should fall further as Keywords executes its buy-and-build strategy.

Year end

Revenue (€m)

PBT*
(€m)

EPS*
(c)

DPS
(p)

P/E
(x)

Yield
(%)

12/18

250.8

37.9

43.7

1.61

43.9

0.09

12/19

326.5

40.9

47.2

0.58

40.7

0.03

12/20e

352.9

37.3

41.9

1.77

45.8

0.10

12/21e

405.8

51.6

55.1

1.95

34.9

0.11

Note: *PBT and EPS are normalised, excluding amortisation of acquired intangibles, exceptional items and share-based payments.

Equity placing: £100m raised for M&A/balance sheet

The equity placing was announced after close of business on 14 May 2020 and carried out through an accelerated bookbuild on a non-pre-emptive basis (although in consultation with its major shareholders) to minimise cost, risk and management distraction. 6.9m shares, representing a c 10.5% increase in the issued share capital on a pre-placement basis, were issued at a price of 1,450p, a 5.8% discount to the closing price on 14 May 2020 (1,540p). £100m (gross) has been raised through the placing and will be used to provide management with increased flexibility around its buy-and-build M&A strategy, as well as to reinforce the group’s financial position.

Forecasts: FY20/21 revised upwards

Keywords’ trading update confirms that short-term trading has been more resilient than we had assumed (7% y-o-y growth reported in March and April) and with hindsight, we may have been overly aggressive in our estimate cuts in April. Accordingly, we have increased our estimates to reflect 5% annual growth on the FY19 year-end revenue run rate (8.1% y-o-y), where previously we had assumed revenue growth of 1%. We have not changed our key assumptions for FY21, with forecast revenue growth of 15% over FY20 (€405.8m), operating margins normalising to 13.4% (FY20e: 11.3%) and the tax rate held at 18.2%.

Valuation: M&A firepower of €220m

Keywords’ shares trade on a P/E of 45.8x our updated FY20e estimates, falling to 34.9x in FY21e. We see little prospect for material M&A in H120, although accretive acquisitions in H220/FY21 would bring these multiples down. Despite current uncertainties, Keywords’ buy and build strategy, which has delivered a five-year EPS CAGR of 42% to FY19, supported by the industry’s strong underlying growth, appears sustainable in the medium to long term.

COVID-19: Trading resilient in spite of COVID-19

In Keywords’ trading update with its FY19 results in April 2020, management reported that there had been some short-term disruption to all service lines, particularly Functional Testing, Localisation Testing and Audio Services (together representing c 40% of FY19 revenues and 38% of staff) as these businesses have been harder to transition to remote-working.

Alongside its placing announcement, on 14 May 2020, management provided a short business update. This highlighted that trading was up 21% in January and February over the same period in 2019, while March and April were up 7% against the same two months in 2019. Over 6,000 staff (>80%) are now remote-working (up from 5,500 in April) with a further 800 working from facilities (mostly in China) (>90% are now operational out of a total employee base of c 7,300). Management expects revenue to continue to improve as testing staff are enabled to work from home (as client confidentiality concerns are addressed) and the audio business gains access to its studios.

Management has stated that it does not believe that COVID-19 will affect the business materially in the medium term, and indeed, it has already seen an increase in demand for services (although the business is capacity-constrained) as existing and new clients re-appraise production arrangements and make contingency plans.

As lockdowns ease, management continues to see an increase in client demand as the industry builds towards the next-generation console launches in Q420. Management expects to benefit from this pent-up demand once the operating environment normalises and management can start to increase capacity, underpinning stronger expectations for FY21.

The placing: £100m gross proceeds for M&A

The placing was announced after close of business on 14 May 2020 and carried out through an accelerated bookbuild on a non-pre-emptive basis (although in consultation with its major shareholders) to minimise cost, risk and management distraction. The gross proceeds were £100m, with 6.9m shares being issued at a price of 1,450p, a 5.8% discount to the closing price on 14 May 2020. The new shares list on 20 May.

The primary purpose of the placing is to provide Keywords with flexibility to continue to execute its buy-and-build M&A strategy, as well as to reinforce the company’s financial position to ensure it will continue be viewed as a strong partner by its clients through FY20 and beyond.

Exhibit 1: Details of the placing

Shares in issue (pre-placing)

65.76m

Closing share price on 14 May 2020

1,540p

Gross proceeds from placing

£100m

Issue price

1,450p

Discount to closing share price

5.8%

Number of new shares to be issued

6.90m

Total number of shares in issue (post-placing)

72.66m

Dilution (before considering the benefit of any funds used for M&A)

9.5%

Source: Company, Edison Investment Research

Forecasts: Upward revisions to FY20 and FY21

We take this latest update as confirmation that trading has been more resilient than we had assumed in the short term (7% y-o-y growth reported in March and April) and with hindsight, we may have been overly aggressive in our estimate cuts in April 2020.

FY20 – 5% growth on YE19 revenue run-rate

Accordingly, we are raising our estimates to reflect annual growth of 5% on the FY19 year-end revenue run rate of c €336m (8.1% y-o-y growth), where previously we had assumed revenue growth of 1%. We believe this is still conservative, but with ongoing uncertainties about the economic situation, new work patterns and the pace of recruitment, we believe prudence is still the right call.

With the group’s additional investment in remote working, furloughing of staff, investment in hardware and systems, and factoring in lower productivity, as we had forecast previously, we continue to expect margins (particularly in H120) to be adversely affected and assume FY20 adjusted operating margins fall to c 11.3% (FY19: 13.2%), with PBT margins compressed to 10.6% from 12.5% in FY19.

We have not changed our key assumptions for FY21, with forecast revenue growth of 15% over FY20 (€405.8m), operating margins normalising to 13.4% (FY20: 11.3%) and the tax rate held at 18.2%.

Exhibit 2: Revised estimates

€'000s

2019

2020e

2021e

Y-o-y

Actual

Old

New

Change

Old

New

Change

Change

Revenue

 

 

326,463

339,451

352,895

4.0%

390,369

405,829

4.0%

15%

Cost of Sales

(206,234)

(213,067)

(221,259)

3.8%

(244,547)

(254,236)

4.0%

15%

Gross Profit (inc multimedia tax credits)

120,229

126,385

131,636

4.2%

145,822

151,593

4.0%

15%

Gross Margin (%)

36.8%

37.2%

37.3%

0.2%

37.4%

37.4%

0.0%

0%

Operating Profit (before amort. and except.)

 

 

42,983

38,127

39,883

4.6%

52,133

54,194

4.0%

36%

Operating Margin

13.2%

11.2%

11.3%

0.6%

13.4%

13.4%

0.0%

18%

Profit Before Tax (norm)

 

 

40,913

35,527

37,283

4.9%

49,533

51,594

4.2%

38%

Profit After Tax (norm)

33,451

29,048

30,483

4.9%

40,500

42,184

4.2%

38%

EPS - normalised (c)

 

 

47.2

41.0

41.9

2.3%

56.6

55.1

(2.7%)

31%

Dividend per share (p)

0.58

1.77

1.77

-

1.95

1.95

-

10%

Closing net debt/(cash)

 

 

17,924

(11,228)

(106,837)

(39,367)

(135,676)

Source: Company accounts, Edison Investment Research

Acquisition pipeline – super-charged by placing

Keywords’ strategy of using earnings-enhancing acquisitions whilst consolidating a fragmented games outsourcing market is intrinsic to the investment case. Given the current environment, we do not anticipate material M&A in H120 (although we wait to be proven wrong). However, we strongly believe that deals will resume in H220, with distressed/ready sellers looking to exit towards the end of what will have been a difficult year for many.

Even before the placing, the group had net debt of €17.9m, modest gearing of 0.4x net debt/adjusted EBITDA and total cash and undrawn facilities of €112m as at 31 December 2019. After the placing, the company now has an additional c £97m of net cash post raise – and total M&A firepower of c €220m. The company has previously guided towards €30–80m of M&A in a ‘typical’ year.

Valuation – multiples expected to fall as deals executed

Keywords has delivered an adjusted EPS FY13–19 CAGR of 42% and we believe should revert to double-digit revenue growth in the medium term (FY21 onwards). We retain our view that Keywords is strongly placed as the only games service provider on a global scale. The company’s P/E rating (45.8x FY20e, 34.9x FY21e) reflects its leading market position, track record and potential, but should fall further as Keywords continues to execute its buy-and-build strategy.

Exhibit 3: Financial summary

€'000s

2017

2018

2019

2020e

2021e

31-December

IFRS

IFRS

IFRS

IFRS

IFRS

PROFIT & LOSS

Revenue

 

 

151,430

250,805

326,463

352,895

405,829

Cost of Sales

(96,345)

(154,997)

(206,234)

(221,259)

(254,236)

Gross Profit (inc multimedia tax credits)

55,085

95,808

120,229

131,636

151,593

EBITDA (adjusted)

 

 

26,645

43,729

57,611

55,037

70,531

EBITDA (reported)

 

 

22,203

34,304

43,375

44,285

58,703

Operating Profit (before amort. and except.)

 

 

23,915

38,916

42,983

39,883

54,194

`

(3,038)

(6,872)

(7,318)

(8,325)

(9,574)

Exceptionals

(3,016)

(5,296)

(4,348)

0

0

Other

(1,426)

(4,129)

(9,775)

(10,753)

(11,828)

Operating Profit

16,435

22,619

21,542

20,806

32,793

Net Interest

(818)

(1,316)

(2,513)

(2,600)

(2,600)

FOREX

(3,623)

791

(1,658)

0

0

Profit Before Tax (norm)

 

 

23,097

37,911

40,913

37,283

51,594

Profit Before Tax (FRS 3)

 

 

11,994

22,094

17,371

18,206

30,193

Tax

(4,731)

(7,191)

(7,462)

(6,800)

(9,410)

Profit After Tax (norm)

18,366

30,720

33,451

30,483

42,184

Profit After Tax (FRS 3)

7,263

14,903

9,909

11,406

20,782

Average Number of Shares Outstanding (m)

58.7

64.3

65.1

69.0

72.3

EPS – normalised (c)

 

 

31.3

45.5

48.8

41.9

55.1

EPS – normalised and fully diluted (c)

 

 

30.0

43.7

47.2

41.9

55.1

EPS - (IFRS) (c)

 

 

12.4

23.2

15.2

16.5

28.7

Dividend per share (p)

1.46

1.61

0.58

1.77

1.95

Gross Margin (%)

36.4%

38.2%

36.8%

37.3%

37.4%

EBITDA Margin (%)

14.7%

13.7%

13.3%

12.5%

14.5%

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

15.8%

15.5%

13.2%

11.3%

13.4%

PBT Margin (%)

15.3%

15.1%

12.5%

10.6%

12.7%

BALANCE SHEET

Fixed Assets

 

 

142,927

198,215

223,992

218,512

216,210

Intangible Assets

131,610

180,086

196,769

188,728

179,154

Tangible Assets

10,111

15,002

22,163

24,724

31,996

Investments

1,206

3,127

5,060

5,060

5,060

Current Assets

 

 

80,182

100,348

120,483

249,176

290,404

Stocks

0

0

0

0

1

Debtors

27,473

37,019

43,243

45,405

52,216

Cash

30,374

39,870

41,827

166,587

195,426

Other

22,335

23,459

35,413

37,184

42,761

Current Liabilities

 

 

(51,677)

(95,031)

(49,551)

(49,846)

(50,846)

Creditors

(32,734)

(54,960)

(49,471)

(49,766)

(50,766)

Short term borrowings

(18,943)

(40,071)

(80)

(80)

(80)

Long Term Liabilities

 

 

(10,420)

(11,158)

(71,528)

(71,194)

(73,194)

Long term borrowings

(337)

(230)

(59,671)

(59,671)

(59,671)

Other long term liabilities

(10,083)

(10,928)

(11,857)

(11,523)

(13,523)

Net Assets

 

 

161,012

192,374

223,396

346,648

382,574

CASH FLOW

Operating Cash Flow

 

 

21,389

33,954

46,069

53,076

59,426

Net Interest

(253)

(502)

(9,411)

(6,263)

(3,425)

Tax

(4,731)

(6,304)

(13,288)

(6,800)

(9,410)

Capex

(3,803)

(9,440)

(13,145)

(10,657)

(16,341)

Acquisitions/disposals

(90,090)

(25,766)

(27,762)

(316)

0

Financing

82,936

0

0

97,000

0

Dividends

(867)

(1,080)

(1,197)

(1,279)

(1,412)

Net Cash Flow

4,581

(10,090)

(18,734)

124,761

28,839

Opening net debt/(cash)

 

 

(8,650)

(11,094)

431

17,924

(106,837)

Forex gain on cash

(891)

(3)

1,293

0

0

Other

(1,246)

(1,432)

(52)

0

0

Closing net debt/(cash)

 

 

(11,094)

431

17,924

(106,837)

(135,676)

Source: Company accounts, Edison Investment Research

General disclaimer and copyright

This report has been commissioned by Keywords Studios and prepared and issued by Edison, in consideration of a fee payable by Keywords Studios. Edison Investment Research standard fees are £49,500 pa for the production and broad dissemination of a detailed note (Outlook) following by regular (typically quarterly) update notes. Fees are paid upfront in cash without recourse. Edison may seek additional fees for the provision of roadshows and related IR services for the client but does not get remunerated for any investment banking services. We never take payment in stock, options or warrants for any of our services.

Accuracy of content: 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 and have not sought for this information to be independently verified. Opinions contained in this report represent those of the research department of Edison at the time of publication. 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.

Exclusion of Liability: To the fullest extent allowed by law, Edison shall not be liable for any direct, indirect or consequential losses, loss of profits, damages, costs or expenses incurred or suffered by you arising out or in connection with the access to, use of or reliance on any information contained on this note.

No personalised advice: The information that we provide should not be construed in any manner whatsoever as, personalised advice. Also, 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 securities described in the report may not be eligible for sale in all jurisdictions or to certain categories of investors.

Investment in securities mentioned: Edison has a restrictive policy relating to personal dealing and conflicts of interest. 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, subject to Edison's policies on personal dealing and conflicts of interest.

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This report has been commissioned by Keywords Studios and prepared and issued by Edison, in consideration of a fee payable by Keywords Studios. Edison Investment Research standard fees are £49,500 pa for the production and broad dissemination of a detailed note (Outlook) following by regular (typically quarterly) update notes. Fees are paid upfront in cash without recourse. Edison may seek additional fees for the provision of roadshows and related IR services for the client but does not get remunerated for any investment banking services. We never take payment in stock, options or warrants for any of our services.

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Investment in securities mentioned: Edison has a restrictive policy relating to personal dealing and conflicts of interest. 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, subject to Edison's policies on personal dealing and conflicts of interest.

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Edison Investment Research Pty Ltd (Edison AU) is the Australian subsidiary of Edison. Edison AU is a Corporate Authorised Representative (1252501) of Crown Wealth Group Pty Ltd who holds an Australian Financial Services Licence (Number: 494274). This research is issued in Australia by Edison AU and any access to it, is intended only for "wholesale clients" within the meaning of the Corporations Act 2001 of Australia. Any advice given by Edison AU is general advice only and does not take into account your personal circumstances, needs or objectives. You should, before acting on this advice, consider the appropriateness of the advice, having regard to your objectives, financial situation and needs. If our advice relates to the acquisition, or possible acquisition, of a particular financial product you should read any relevant Product Disclosure Statement or like instrument.

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Research: Investment Companies

Fidelity European Values — Following the same tried-and-tested strategy

Fidelity European Values (FEV) plans to change its name to Fidelity European Trust later this year to better reflect its objectives; however, there will be no change to the disciplined investment process. Manager Sam Morse continues to focus on cash-generative companies with strong balance sheets and significant dividend growth potential. He has increased the trust’s level of gearing to benefit from an anticipated recovery in the European stock market, as equity prices typically discount an economic improvement by around six months. However, the manager is continuing to run the portfolio in a measured way, acknowledging that ‘there is no big rush to change the portfolio, as costly mistakes can be made’. FEV has outperformed the continental European market over the last one, three, five and 10 years in both NAV and share price terms.

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