Keywords reported revenue growth of 30.2% in 2019 to €326.5m, with acquisitions boosting underlying organic growth of 15.5% during the year. However profit before tax fell 21.4% to just €17.4m, reflecting lower margin acquisitions, increased investment in operational capabilities and a significant increase in share option related expenses.
Almost 75% of employees are now working from home as the group looks to minimise coronavirus related disruption. Demand has increased for many services but, given the circumstances, the board has decided not to pay a dividend this year.
The shares rose 1.5% in early trading.
The global lockdown seems to be driving a significant increase in video gaming as an ever growing proportion of the population is confined to the couch. That makes gaming one of the few sectors that might actually see sales grow in the near term.
As market leader in outsourced design, audio and translation services for game developers Keywords would likely benefit from a surge in activity. Customers include lots of the world's biggest gaming groups, who can "pick & mix" services which range from graphics to voice actors to testing.
A decentralised model, with dozens of studios scattered around the globe, is naturally resilient to the current disruption. Teams are used to working with each other remotely and the company has quickly moved most of the workforce to working from home.
Transitioning more commercially sensitive units is less straight forward though. The Localisation and Functional Testing units account for 28% of total revenue and typically operate out of secure sites - at the moment that's not possible. We also have questions about how the switch to home working will impact efficiency - and that could be crucial if the group is to capitalise on increased demand from customers.
The coronavirus outbreak is also likely to disrupt the group's acquisition plans. Keywords has been a serial acquirer, buying smaller businesses as it looks to build the scale and expertise to serve more of its clients' needs. This makes sense to us, as Keywords looks to become the go-to provider of video game services, but acquisitions always bring risks. Inefficient integration can harm profitability and it makes it more difficult to spot lacklustre performance in the core business.
So far Keywords' strategy has been impressive. Earnings per share rose an average of 44.9% a year between 2013 and 2019, and analysts are forecasting further growth out to 2021.
However, the cost of integrating all those businesses, together with some early stage acquisitions, look set to hit margins this year and that's far from ideal. Given the services Keywords provides are inherently labour intensive, which is why developers choose to outsource them in the first place, margins are a key concern.
Net debt has risen this year and weaker cash flows have reduced the group's ability to self-fund new acquisitions. The good news is that the balance sheet isn't overstretched, but a reduced capacity for acquisitions makes organic growth even more crucial.
Looking at the longer term we continue to see Keywords as an attractive way to play the general increase in gaming spend without taking on the franchise specific risks that go with individual publishers like EA, Activision Blizzard and Ubisoft. However, it's worth bearing in mind that the shares have, so far, held up well through the market sell off and trade on a relatively high, in relation to average, price to earnings ratio of 29.8 times. If performance slips then the shares could potentially fall dramatically.
Full Year Results
Keywords completed 8 acquisitions during the year, across Game Development, Marketing and Audio Services. The total cost of acquisitions during the year was €19.6m, with a cash cost of €13.1m.
All but one (Player Support) of the group's seven service lines reported organic growth during the year. However, growth was concentrated in the Game Development and Functional Testing divisions, which both saw revenues grow by more than 30%.
Overall operating costs increased faster than revenues, with margins shrinking as a result. That largely reflects increased investment in operational capacity to support the enlarged group, with margins expected to improve going forwards.
Below the operating level Keywords incurred costs of €4.3m integrating past acquisitions, while share option related costs more than doubled to €9.8m with most (€9m) relating to employees below director level.
Keywords generated free cash flow, after integration costs, of a little under €10m. However, acquisition costs meant net debt rose €17.5m to €17.9m. That equates to 0.4 times 2019 cash profits.
Given the coronavirus disruption the board is not providing financial guidance for the current year.
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