As the computer gaming industry takes hold internationally, it has become both technically and financially inefficient for developers to provide every service of game development.
That has thrown up a big opportunity for companies such as Keywords Studios PLC (LON:KWS) to fill in the gaps.
The firm recently published a solid set of interims, which were helped by an “exceptional second quarter” posted by Synthesis, one of the company’s latest acquisitions.
"The group has delivered a first half performance comfortably ahead of our expectations, driven by good organic growth, but also substantially complemented by acquisitions,” said chief executive Andrew Day.
Adjusted profit before tax almost tripled to €6mln in the six months to the end of June, while total revenue nearly doubled to €42.4mln.
Net cash fell to €3.5mln from €6.1mln for the same period in 2015, although this was largely because of the acquisitions made by Keywords.
On the whole, the first half performance was solid, with Keywords upping its dividend by 10% to 4.4p as a result.
The signs look good for the second half, too.
Keywords told investors at the start of November that it was outperforming current expectations, due in large part to the continued strong performance of its recent acqusition, Synthesis (more below).
It now expects revenues and adjusted profit before tax for the year to December to be "significantly ahead" of market forecasts.
Big Business
Computer games are very big business. Global sales are expected to be around US$115bn by 2018.
Keywords Studios services are used by 21 of the top 25 games developers.
Established in 1998 and headquartered in Dublin, it operates across Europe and Asia, as well as from studios in Canada, US and Brazil.
There are 120 permanent staff members flexing to over 1,000 at peak times.
Most games are developed in English, but sales are global and that has created a business in translating games into local languages and cultures.
Keywords specialises in these localisation services –the translation and cultural adaptation of video games across different platforms for international distribution.
Its regional studios provide voice over recordings, script translation and actor selection in more than 15 countries and 30 languages.
It also provides localisation testing to ensure the adapted content fits the context of the game as well as functionality testing for in-game defects and console specifications compliance.
Its current model involves native language testers playing through localised versions of the games, covering cultural, linguistic and functionality aspects simultaneously.
Following a number of strategic acquisitions, Keywords has also branched out into artwork creation for video games, such as concept art and character animation.
The group has identified an increasing trend for games developers to outsource at these stages.
Next Generation Consoles
Thus far, the market for games has been heavily reliant on the console product cycle and the release schedule of the console makers, Sony, Microsoft’s Xbox and Nintendo.
Traditionally game development has slowed in the run up to the release of the next generation consoles as software soon becomes irrelevant and outdated, but that may be changing with the advent of the cloud.
Plugging China Gap
Gaming is a fragmented market and Keywords has started to expand its range by bolt-on acquisitions.
From three service lines when it listed in 2014, it now has six.
These newer service lines (such as customer support and art creation) have made good contributions to overall revenue.
Further regional acquisition is one Keywords’ routes to future growth.
"We are not forgetting our core business of translation and localisation testing. You should expect to see from us some acquisition activity fairly widely spread across the board," said Andrew Day, chief executive.
The acquisitions of Reverb and Kite Team, for example, have given Keywords a presence in South America.
Asia-Pacific, though, accounts for three of the top four video games markets in the world.
PwC projects that it will be the fastest growing region increasing to $40bln in 2016 compared to $24bln in 2011.
The group was looking in particular to plug a geographic gap in China, with existing customers already requesting support.
And its $5.5mln deal to buy Beijing-based Mindwalk will do just that.
The acquisition will add 150 artists to the group's existing operation.
Biggest deal to date
The group's acquisition of Synthesis was its largest deal to date and also took out its main rival.
Keywords paid €18mln for Synthesis, split €10m in cash now, €1mln in cash in 2017 based on 2016 revenues, and €7mln in equity over one and two years.
The studio's primary operations are in audio and localisation, alongside modest-sized localisation testing.
It has a strong customer base and an impressive list of games to its name, including Call of Duty, Grand Theft Auto, World of Warcraft and Assassins Creed.
In 2015 it reported pro forma revenue of €16.9m and profit before tax of €2.0mln.
The acquisition was seen by analysts as a significant consolidation move, as Synthesis was the group's closest competitor.
It gives the group a 15% of the global outsourced localisation market.
Swimming upstream
In July 2016, the company broadened its reach and paid C$5.25mln (£3mln) for Canadian concept art group Volta.
The concept art stage of a game is at the beginning rather than late in the production cycle, when localisation normally is applied.
It sets the look and feel of a game, which may become increasingly important as the next evolution takes hold.
Boss Day is playing down any imminent benefit from augmented reality and virtual reality games, but most experts say they will be next big things off the gaming block.
The potential for augmented reality (images imposed on a real life background) has already been highlighted by Pokémon Go, while virtual reality headsets are improving all of the time.
What the brokers expect
A trading update in early August indicated trading at Synthesis had been very strong since its acquisition, which has obviously been verified by the release of the half year results.
Consensus revenue forecasts in 2016 are now €82mln with adjusted profit forecast of €13.1mln, according to finnCap.
Keywords has said it doesn’t expect this year to be characterised by the typical weighting towards the second half.
Assuming the second half numbers come close to those achieved in the first six months, Keywords is well on target to meet those expectations.
Broker finnCap was very impressed with the interim results for the first six months of the year.
“Results are considerably ahead of our H1 expectations, with outperformance both in terms of revenue and earnings,” said the broker’s Harold Evans.
“Given the significant investment in the senior management team made over the past 12 months, it is very positive to see such a quick recovery in margins – to a level not seen in recent years (at interims),” Evans added.
What is it worth?
Shares are currently trading at an all-time high of around 460p, which values the company at £254mln, or nearly four times expected sales.
finnCap thinks Keywords still has some headroom for price growth though, and has upped its price target for the stock to 475p.
-- Update for trading update and share price --