Keywords Studios: game theory

Selling picks and shovels is always the best way to profit from a gold rush. The hit-or-miss video game business is a case in point. Providing technical services to hundreds of developers and publishers is a steady way to tap the sector’s rapid growth. That is one reason shares in the Dublin-based outsourcer Keywords Studios are up 20-fold since it joined London’s Aim in 2013. 

Most of the work in games production is still done in-house. But testing, artwork, audio, marketing, translation, cultural adaptation and even some development work is increasingly outsourced. For example, Chicago-based High Voltage, which Keywords has just acquired for up to $50m, worked under instruction from Epic Games on developing aspects of Fortnite.

High Voltage is Keywords’ second-largest deal and brings its tally of acquisitions close to 50. The £1.8bn market capitalisation company has taken advantage of its highly rated paper — trading on a lofty EV-to-ebitda multiple of 27 times — to expand geographically and into new services.

Such a “roll-up” strategy rings alarm bells for some investors. Multiple acquisitions make it harder to track a company’s underlying progress. Research suggests that on average, roll-ups destroy shareholder value. As much as 7 per cent of Keywords’ shares were on loan to short-sellers in February. Now it is just over 2 per cent.

There are reasons beyond financial engineering for the flurry of deals. Keywords should be able to sell customers more services by expanding its capabilities and geographical reach. Bigger projects should be easier to handle.

The post-acquisition departure of founders is often a reason why roll-up plays disappoint. But three-quarters of those who sold their businesses to Keywords have so far stayed. 

Keywords’ valuation is off-puttingly high. But it is the leader in a niche market growing faster than the games industry itself. To justify its valuation, it needs to go on acquiring small businesses cheaply. With just 5 per cent of a highly fragmented sector, that does not look in doubt yet.