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Pass the controller. London-listed video game services company Keywords Studios is weighing a £2.2bn offer that more than doubles its undisturbed share price. On Scotland’s east coast, Dundee, once famed for its production of jute, is styling itself as the gaming capital of Europe, replete with cluster effect and specialised university courses. Shares in Cambridge-based Frontier Developments, home of big budget games, such as Rollercoaster Tycoon, have more than doubled in the past two months.
Britain’s $5.5bn gaming industry, which took off after the introduction of tax breaks in 2014, could use a change in fortunes. The boom sparked by Covid-19, which saw more players spend more time gaming and prompted a record re-rating in valuations, unwound sharply last year.
Companies were left with bloated cost bases, designed to keep abreast of the 10-20 per cent annual growth rates of 2020 and 2021. They had other battles on their hands. Big shot titles, such as Gran Turismo 7, postponed by Covid, entered the market, pulling eyeballs away from less glitzy indie games. Microsoft and Sony cut contributions to developers from subscription deals.
Result: investors took a bath as the flurry of turn-of-the-decade listings, and concomitant lofty growth expectations, started to look as fantasy-like as some of the games. Cash ran dry — witness tinyBuild’s $12.3m fund raising in January — and rich multiples shrank faster than Super Mario encountering an enemy.
Hence, while that offer for Keywords looks rich at a prospective price/earnings ratio of 24 times, it basically unwinds the losses of the past 13 months or so.
Still, as putative buyer EQT’s interest suggests, the plot lines are changing. First up, swingeing cost cuts. MIcrosoft’s gaming division is cutting 1,900 of its 22,000 staff; Riot Games and Twitch are all pruning headcount. Industrywide, maybe a tenth of workers will be shed this year.
Other steps are under way to shore up balance sheets. Frontier Developments this year sold the rights to hit game Roller Coaster Tycoon 3 to Atari for $7mn, lifting its cash position to £23.4mn at the end of March.
Next, companies are reining in their ambitions and shrinking games pipelines. This is not as detrimental to earnings as it sounds: as in the music industry, back catalogues have a long shelf life. Patrick O’Donnell, analyst at Goodbody, reckons some 60 per cent of player engagement is in titles more than six years old.
Besides, it still leaves ample footprints. Indie developer Team17, for example, bought Ireland-based StoryToys in 2021, bringing in the pre-schooler market. Others have diversified into educational games and simulated experiences, like train driving.
Keywords itself occupies a more peripheral space; it provides services to gaming companies, making it a useful proxy for the sector. Investors, fearing AI would eat its lunch, have been selling down the stock. That looks overdone, at least in the short term.
The group’s long acquisition streak — more than 65 since floating in 2013; of which 22 were bought for a total €572m since the beginning of 2020 — means it has legions of engineers and facilities in 26 countries. That leaves it ready to take on the work that pruned-down studios will now be more minded to outsource, such as translation, quality control and ensuring seamless play when users switch to a different device.
Clearly, private equity sees value. EQT’s bid for Keywords is its fifth. Just a few months earlier Europe’s CVC Capital bought UK video games maker Jagex, home of the long-running RuneScape franchise, for about £910mn in a private equity flip. Game on.
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