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Smartphone games hit Keywords Studios' sweet spot

Last updated: 15:49 03 Dec 2014 GMT, First published: 16:49 03 Dec 2014 GMT

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Here’s a little nugget of information film buffs already probably know.

The most expensive big screen epic of all time, weighing in at US$300mln, is the third in the Pirates of the Caribbean series.

You’d have to sell a lot of seats and popcorn to cover those costs.

Mind boggling as the figure is, it still falls US$200mln short of covering the development and marketing budget for Destiny, the latest blockbuster video game from Activsion.

Here’s the thing - and for all the oldies out there this will come as a huge shock: the games industry, worth a staggering US$65bn, is now bigger than Hollywood.

So, hitching your trailer to this juggernaut represents a great business model, particularly if you can withstand its periodic troughs.

Keywords Studios (LON:KWS), which listed on AIM last July, has done just that. But rather than developing the latest best seller, it provides services that are integral to making the likes of Assassin’s Creed, Forza, Farmville and Candy Crush international best sellers.

So, it offers a range of ‘creative translation services’ such as local language text and audio for games as well as providing functional testing of the latest release.

The acquisition of Lakshya Digital recently took Keywords into the business of art creation too. And that’s the model; widening the offering while cementing its position in the markets where it already thrives.

The group works with 18 of the top 25 names in the game business, including Microsoft, Sony and NAMCO Bandai.

It’s an industry that’s growing 8-9% annually, while the proliferation of games via smartphones hits Keywords’ sweet spot.

“Video games used to be defined as things that went out on a console, or PC. The language set was fairly limited, perhaps four or eight languages,” chief executive Andrew Day told Proactive Investors.

“But with smartphones, the language mix is 28 regularly and 40 plus sometimes. The other driver is games as a service rather than a retail product. So, they now exist in live mode, so you have packs and expansions.

“There is always some more content to buy, and we are all about content.”

The company, founded in 1998, now has 11 offices in nine countries employing 600 staff. The workforce rises to 1,500 when demand is higher and doesn’t count freelancers.

This year Keywords’ revenues are predicted to be around €35mln, while analysts expect pre-tax profits of €5mln. Those profits will rise to €6.7mln by the end of 2015 and then to €7.6mln 12 months later, according to City broker Numis.

It is a rarity for AIM in being a dividend payer, while net cash of around €9.6mln means that combined with stock and borrowing it could afford to spend €20mln on acquisitions.

Close inspection of the profit and loss account reveal gross margins are in the order of 33-35%, giving a net margin of up to 15%.

The customers, meanwhile, are fairly sticky. “Most of our revenues are recurring if not always contracted,” said Day.

“So, they come from major clients that partner with us to give us 60-80% of their requirements year on year.

“So, we are not hunting for individual orders. We are there with master agreements in place.”

Listed at 123p, the shares hit 167p in June, but have since drifted down and are now changing hands for 140p each.

At that price the stock is trading on 20 times current-year earnings, falling to a more reasonable 16 times 2015 EPS.

“We think this remains attractive for a business with robust underlying growth and profitability,” said the company’s broker Numis recently. It thinks the stock is worth 200p, representing a 43% gain if it hits this target.

Day said: “The new consoles are now going to more territories than the previously. The target audience has changed. It used to be predominantly males [playing video games]; but that isn’t the case now. Over 50% of gamers are women.

“Smartphones, meanwhile, are a very explosive multiplier for where games go to. So, the fundamentals of the industry are good.”

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