Interview - Keywords Studios eyes brighter future after Xbox warning

26th Sep 2013 13:58

A recent profit warning for video games support services company Keywords Studios (KWS) could provide a good buying window for smallcap investors. The company was poised to release its first set of results since its July flotation when news from Microsoft cast a dark shadow over its short-term business prospects.Back in the summer the company had excited potential shareholders with the prospect of a bumper year of growth as the two biggest consoles in the $80bn video games market were due to simultaneously launch their new iterations, Microsoft's Xbox One and Sony's new Playstation 4, in November. This unprecedented event in the industry, with the associated boost in number of games for the new consoles, requires much use of the sort of games translation and testing services in which KWS specialises. Dropping the X-bombHowever, a week before KWS released its first-half results, Microsoft revealed it would not launch the Xbox One in the 21 countries initially promised but 13, with the remaining eight countries receiving their console in 2014.Moreover, many games publishers have decided to delay product launches for the existing-generation consoles as they focus on the new machines, hitting the industry's historically strong second half of the year.The wind has been taken out of KWS's sails, with the year of growth downgraded to a flat one. "We have seen a much softer market than we were expecting," Chief Executive Andy Day admits to DigitalLook/Sharecast. "The knock-on effect is our results for the full year are going to be below IPO expectations even though we've gained market share."Naturally, the shares were hit hard by the news, having risen from their 123p float price to almost 180p the profit warning sent them shooting down to below 114p. Buy on bad newsBut this is where the opportunity lies, as the underlying growth opportunity remains intact.KWS expects the bumper year to roll over to 2014 when the industry should see significant activity as it returns to more normal launch activity, combined with more territory launches and games releases for the next generation consoles.Day and Finance Director David O'Connor have already made much of the investment needed to cater for that increased demand. This is shown in the results, for the 27 weeks to July 8th, with significant investment in the launch of operations in Seattle and additional headcount across the group dragging profits before tax and IPO costs to just €0.4m, from €1.4m in the same period last year despite revenues growing 12% to €7.2m. Showing their confidence, the board proposed a maiden interim dividend payment of 0.33p per share.Growth remainsThe revenue growth is an indication that of the company's claims to be growing its share of what is itself a growing market for translation and testing services across consoles, mobile phones and social media games. This market is worth around $600m a year, with games companies internal operations controlling a third and the remainder up for grabs for outsourcing companies.While clients in the console gaming side are large - Sony, Microsoft, Electronic Arts, Activision, Namco Bandai - the market for testing and localisation is as fragmented as a shotgun-blasted zombie or CandyCrushed sweet. With a head office in Dublin and outposts in Montreal, Rome, Seattle, and Tokyo, Keywords offers translation into 40 different languages. It has just a 5% share yet is one of the larger players and one of the few global operators, with most competition specialising in their home language. Acquisitions anticipated?Day says the long-term focus is on organic growth but acknowledges acquisitions were certainly one of the reasons for floating on the public markets. "Our market share continues to expand from our ability to deliver a high quality and flexible service to clients," he says. "We add a few every year - there are new clients in social and mobile popping up all the time. "We plan to broaden the range of services and leverage our international footprint both organically and by acquisition."The management pair say they are "actively exploring" acquisition opportunities but only elaborate with "watch this space".Forecasts from analyst Will Wallis at house broker Numis, based on existing contractual relationships point to profits falling 11% to €2.4m in the current full year before a 50% increase for 2014 to €3.6m with predicted earnings of 7.3 euro cents.