Video games remain one of the best long-term structural growth sectors, according to analysts at Berenberg, with many high-growth companies’ shares trading on valuations below pre-pandemic levels.
“While we are in no way calling the bottom in share prices – an impossible task given the current macro and geopolitical uncertainty – we do think that medium- and long-term investors should start building their wish list,” wrote analyst Edward James in a note that also examined the impact of Russia’s invasion of Ukraine, the M&A outlook and who will benefit from the metaverse.
With the sector broken into four investment themes, the analyst started with a group containing Keywords Studios PLC (AIM:KWS, OTC:KYYWF), Team17 Group PLC (AIM:TM17) and tinyBuild Inc (LSE:TBLD), which have de-rated by more than 50% in the last three months to around 20 times one-year-forward earnings.
“In our view, this offers a rare opportunity to buy diversified growth which has historically traded at a significant premium to the market,” James said.
He said Devolver Digital Inc (AIM:DEVO) was a ‘hold’, as though he likes the business and it has a strong growth outlook, “its circa 35% valuation premium to peers makes it less attractive”.
Next are a pair of “fallen angels”, Frontier Developments PLC (AIM:FDEV) and Sweden-based Stillfront, which both have had challenges and seen their shares tumble.
“However, there is a pathway to a recovery in growth which could result in a strong recovery.”
Least preferred in the sector are Poland’s CD Projekt, maker of the Cyberpunk 2077 and a rated ‘sell’, and Assassin’s Creed maker Ubisoft, which is rated ‘hold’.
“We believe the outlook for CD Projekt and Ubisoft to be challenged with downside risk to consensus estimates.”
Despite some many M&A deals in the sector in recent years, James said the video game industry remains highly fragmented and with significant scope for further consolidation.
He noted that Berenberg video game coverage only accounts for 16% of market share.
“We believe Electronic Arts Inc. (NASDAQ:EA), Focus Home, Rovio, Stillfront Group and Ubisoft are the most likely to attract take-out interest among our coverage.”
On the metaverse, James said: “whichever form it takes, [it] is positive for IP owners, particularly those with large franchises, like EA.”
However, he expected Keywords Studios as likely to be the "greatest beneficiary in the short to medium term" as tech titans such as Facebook and Google plough significant investment in interactive entertainment and the metaverse.