Keywords Studios plc (KWS) Earnings Call Transcript & Summary

Hello, and welcome to this Annual General Meeting's presentation of Keywords Studios for 2020. I'd like to cover 4 themes, if I might, on this very short presentation. The first one being about the business itself, the resilience that we feel that we have within our business and why that is the case. I then want to talk about COVID-19, the impact that it has had and is continuing to have on our business; look at COVID-19 again, but this time, from an industry perspective, so the video games industry and how that is impacting our end use market. And then finally, I want to get on to the fundraise that we've just successfully completed in raising GBP 100 million in new capital to be used for acquisitions. So with that in mind, if we can just get to the next slide which is, of course, the obligatory disclaimer. Read that at your leisure. And then on to the picture here, which is a business of some resilience. So for those of you that know the business well, we have, over the last 10 years or so, gone from being a single-location business to one with 59 studios around the world. The key to this is, of course, that we're in the right locations. So we're in the right locations in order to be close to our clients, which is something that matters a lot still in this day and age. But we're also in the right locations in order to get access to the world's best talent for the services that we provide, both very, very key factors and both of which provide us with opportunities for growth. Second factor to consider with our business is the range of services that we offer. So back in 2009, we were essentially a 2 services company. Today, we have 7, arguably 8, when you break down our marketing services from -- out from under our art service where they're currently housed and where they will be separated later as we bring those services to scale. Now as you can see from the doughnut, those services make up a very nice sort of balanced picture in terms of the percentage of revenue that they account for within the total Keywords business, bearing in mind, of course, that some of those sectors are substantially larger than others. So game development, for instance, is a much larger sector than any of the others, and something like functional testing is close to $1 billion in size. The other aspect of our business, which again, I think, points to one of resilience is the penetration that we have amongst the sort of who's who of the video games industry. So we really do deal with pretty much all of the leading game developers and publishers around the world, whether they'd be in China, Japan, Europe, U.S., Canada. And that means that we have less dependency on any one customer, but it also means that we're dealing with the blue chip of the video games industry. So when it comes to things like having concerns about being paid on time and so on, this is less of an issue for us, I believe, than it would be if we were focused more on the smaller companies, of which there are thousands around the world. The other thing -- so that's the resilience of the business. Now as you know, we are very fast growing, tend to grow around about 15% on an organic basis. That's been the average of the last 5 years or so. But we supplement that with a very successful M&A program. So we have acquired something like 44 businesses since we came to market in 2013. And those businesses have all been integrated and have gone on to grow faster under Keywords than they were growing before. And that has something that has delivered incredible value accretion to our shareholders. And when we get on to the capital raise, you'll see the point here, which is that we very much want acquisitions to continue to be a core sort of pillar for Keywords. Not only are they highly accretive in their own right, but what they do is they help us to flesh out this global platform of services that we're building for the video games industry. It's through those acquisitions that we're able to accelerate the development of some of the services, all of which are essential for our clients, that bring in more talent and generally help us to fill in any holes that we've got, either with our geographic reach or with the services offering, so very fundamental in terms of continuing to make this platform and in driving us to become the go-to provider for the services -- each of the services that we provide, which rely on scale, expertise, reputation credentials of having worked on all the top video games and so on and so forth. So highly complementary to the fundamental sort of strategy of Keywords. So that's the picture of resilience and growth. I think the other thing that sometimes people get a little bit stuck on is the difference between organic growth and acquired or acquisition-led growth, the point being that we do make a lot of acquisitions. And if we were to try to separate out the original Keywords business at the time of flotation, it was only a EUR 16 million business in revenue terms. And then just look at the organic growth from thereon, it wouldn't make any sense at all. So what we've done in this chart on the bottom right is to show the original Keywords business, the amount of revenue that we have effectively acquired at the date that we acquired it, and then what that combined business has gone on to do in the period from 2013 to 2019. So as you can see, we've actually generated EUR 102 million of pure organic revenue growth over that period, which, of course, comes from the combination of the original business and the acquisitions. So I think that's the easiest way to sort of sense-check the fact that Keywords remains a very strong organic growth-driving business. On to COVID-19 and the effect that's having on us as a business. We've reported fairly extensively on this over the last month or so. But just to remind you as to exactly where we're sitting right now. Having completed January, February, March and April, that really painted a picture of 2 halves. So there was January and February, which was the first 2 months of our reporting year, which was largely unaffected by COVID. I say largely because we do have 5 studios in China, employing about 800 people. And that business, as you know, was affected by COVID in February of this year, starting the beginning of February. But even including that effect, January and February showed 21% growth year-on-year. And that, in fairness, does include the effect of acquisitions. The effect of acquisitions has not been that great during the period. So to sort of step it back and to look a little bit more at the underlying growth, which is still pretty strong, you'll need to reduce that by a few percentage points, probably something like about 3 percentage points, I would think. And then if we look at March and April, March and April was when COVID affected most of Europe and the U.S. and Canada. So our business then, we started entering lockdowns, we started losing access to our studios around the world city by city. And so March was a kind of a month where we were scrabbling to move everything to work from home, so our revenues were trending down fairly fast in some of our service lines. April, that trend continued a little bit towards the sort of trough, and then we started to climb back up the other side of April. You can see that a little bit in our people numbers that we've been reporting. So we have been reporting on the number of people that we've moved to work-from-home arrangements. And you can see that we started March with pretty much everybody working in our facilities. By the end of March, I think it was, we had 4,500 people moved to work-from-home arrangements. And that has since increased primarily because we've been getting more and more projects set up for work-from-home in our testing businesses where we've been doing that in conjunction with the consent of our clients and so on. That's now increased to 6,300 people, more or less, as at today. And we have a further 800 people also working from our facilities, the majority of which are, as I said earlier, in China. We do obviously expect those revenue numbers to improve incrementally as we move more people to work from home and also as we start to gain access to our studios around the world. Our audio business, which, like our testing business, was actually the most affected by COVID, where obviously not having access to our recording studios meant that we couldn't perform that activity apart from a degree of work that we were able to do in a remote fashion recording actors from home. But most of it was effectively stopped or paused. We now have access to those studios. We're now doing the production in our studio locations, and we expect that business to increase over the coming months and for us to be able to catch up on most of the revenue that was effectively paused during March and April and into May. So the interesting picture I paint is one of actually very good customer demand. That's really important to understand, that it's not a question of demand here at all. In fact, probably, demand is, if anything, increased during these COVID times. It's really been one of production capacity and being able to reposition our business to work-from-home, particularly our testing business, and then being able to sort of catch up and to grow into the demand that's out there. It is, however, likely that in the short term, demand will continue to outstrip our ability to supply. Now one thing I'd just like to go back and talk about is the -- yes, the effect on our revenues and particularly the fact that it's affected these 2 service lines, the audio business and the testing businesses. Now what is important to understand is that both those businesses have a very high degree of flexible cost base. So even in normal times, if our revenue is down, for instance, in our audio business, that means we're not paying actors, we're not paying third-party studios, we're not paying freelance audio directors or freelance audio engineers, for instance. So it's a very flexible cost base. And the same is largely true for our testing business, where we've set it up in such a way that we have a very flexible level of labor where, effectively, we're able to call our -- many of our testers in on a project-by-project basis. So when there's work to be done, they get the call, they come in, they test. When there's no work to be done, they go home, they do their second job, their third job, whatever. And then hopefully, they come back to us when the call comes for further testing. So that's kind of fortunate in terms of -- when looking at the impact on our business as a whole, not only is the revenue side to take into account but there's also the cost base to consider as well. So moving on now to the industry itself and -- oops, gone one too far. Here, I want to show you a picture of what's happening in the video games market as a whole and, in particular, the impact of COVID-19. So pre COVID-19, we were dealing with a fast-growing video games industry, had a nice ongoing continuing trend towards outsourcing, both of which are fundamental drivers for Keywords. And the industry as well is constantly innovating, constantly coming up with new ways of distributing games and also new platforms in which games are played. And 2020 is no exception, so we have the streaming platforms and the subscription platforms, the likes of Apple Arcade and Google Stadia. And then next year, I believe, there are more streaming platforms launching. We also have the launch of a kind of streaming platform from Facebook this year. And later on in 2020, we have the new consoles, the Xbox X Series (sic) [ Xbox Series X ] and the PlayStation 5 launching as well, which would be a welcome refresh for a console -- for the console market, where we have effectively now run into our seventh year of the current generation of that hardware. So good drivers for the industry itself. And then when we overlay the effect of COVID on that, it's kind of an interesting story because what COVID has done and the lockdowns and so on that's accompanied COVID and the threat from the coronavirus is that it's led more people to be at home with more time than ever before, and what they're doing with their time is turning to video games. So we have, obviously, experienced gamers are playing more games than ever before, and they're consuming content faster than ever before, but we also have people that have not really played games before discovering them for the first time. And we have lapsed gamers who are going back to video gaming and rediscovering video gaming in this particular time. And most of these people are actually using games as a way of getting some social interaction. It's very, very sort of a healthy way in the kind of lockdown situation of getting that social interaction that's so hard to achieve any other way. So I think it's been a bit of a lifesaver for a lot of people. And of course, I think what that does is it paints a picture of an industry that's likely to exit COVID bigger and stronger than before. Certainly, many of the publishers and developers out there are making more money than they were prior to COVID, thanks to all of these people playing games and playing games for longer, so consuming the content and, obviously, with that content consumption comes, at some point, through whatever mechanism, a requirement to pay for it. The other thing that's happening with COVID-19 is that we've got what I believe to be a further sort of acceleration in the trend towards outsourcing. I think companies around the world are looking far more closely at their supply chains than ever before. I think they're considering the fragility of some of their existing arrangements, whether that's because they've been using smaller vendors on a more tactical basis, whether they have been very heavily reliant on internal organizational structures that have shown a bit of the strain during this period. Whatever it is, I think there's probably a good practice emerging here to have at least a reasonable percentage of business that is with secondary source such that if your own internal organization is disrupted by an event such as this, okay, this is a particularly extreme one and it's worldwide. But country by country, territory by territory, the ability to lean on somebody like Keywords and be able to move production around the world, I think, is particularly attractive, as it is, of course, to have a company like Keywords there with the financial solidity, the professional focus on providing services. So fairly hopeful that we're going to see a further sort of acceleration in this trend towards not only outsourcing, but let's say, more strategic and perhaps outsourcing that is accompanied by some fairly sort of thorough due diligence in terms of the solidity and the resilience of the chosen partners. And then finally, of course, this industry is typified on the services side by a highly fragmented marketplace, which does provide benefits for us as an active acquirer. Of course, we are the leading consolidator. But beyond this as well, I think it makes it fairly clear in terms of keywords and how we're able to differentiate ourselves with the rest of the vendor or the rest of the supplier landscape as being the provider of scale amongst what is otherwise a very fragmented marketplace. So on to the reason for the fundraise, as I said, we raised GBP 100 million. That is against the backdrop of an industry that's doing particularly well. There is the sort of accelerating trend towards external development. We do and always do maintain a very strong pipeline of acquisitions. It's probably a little bit better than it has been for some time and it's probably being enhanced right now. There are some inbound opportunities coming to us where I think that absent COVID, some of those opportunities wouldn't be there. It's definitely the case that for smaller businesses with a higher reliance on a smaller number of clients or even just a handful of projects, an impact such as COVID can have a very unsettling effect and can lead to a bit of financial stress. So we hope to be in a very good position to welcome the right sort of companies into the Keywords family over the next year or 2 as a result of this fundraise. I do want to make the point that the funding that we have raised was not done at all for liquidity purposes. We entered the COVID situation with very low gearing. We had 0.4x net debt-to-EBITDA and our banking covenants allow us to go up to 3x. We're also in the process of extending our banking facilities through the exercise of our accordion feature, which would have added another -- or which will add another EUR 30 million or so of liquidity to the position that we already enjoyed. So this GBP 100 million raise was really designed to ensure that we can continue to make the acquisitions that we intend to make, continue to add that incredible value that we are adding to our shareholders and to our company as a whole through our M&A program in a market that might otherwise be a little bit more risk-off, that might not reward us for using our balance sheet in uncertain times. So I think it's a front-footed move. It's a prudent move as well, and it preserves the balance sheet such that we can have this incredibly strong position moving forward for the next year or 2. A lot of people have asked about how quickly we intend to deploy this money. We've been very clear to say that, look, we don't have 1 or 2 big opportunities up our sleeve that we just weren't ready to announce at the time of the fundraise. This really is something that you should expect us to deploy in the ordinary course. The ordinary course for us, and it's hard to say, I mean, M&A is always very difficult to predict, of course. But I would say that in a sort of ordinary year, we would normally be spending something like EUR 50 million to EUR 80 million on acquisitions. So GBP 100 million would take us through 1, 1.5 years or so to deploy that money through our M&A program, assuming the regular flow of deals, which is usually sort of $5 million to $30 million per acquisition and 5 to 10 companies also per year. So very pleased with the results of that fundraise, very pleased to see the share price trading the way it has been in the days and week or so following that, and definitely look forward to having an exciting year with adding some really well-thought-through highly selective acquisitions and welcoming new members of the Keywords team to the family. And then finally, in terms of closing remarks, I really just wanted to share with everybody how pleased I have personally been and how pleased we, as a Board, have been with the way in which Keywords Studios has navigated the challenges of COVID-19. I think we've really proven to ourselves and to everybody else just how resilient the business is, but also how important it is to the video game sector as a whole. I definitely feel a sense of responsibility in terms of continuing to service those games that are already in the market and continuing to help our clients bring new and fresh content to the players. Couldn't be more happy, more proud with the fantastic Keywordians around the world, the efforts that people have put in to move what is, to all intents and purposes, the entire company of 7,500 people or so to work-from-home arrangements in a very short period of time has been nothing short of remarkable. So big thank you to everybody, to my wonderful colleagues all over the world. Thank you very much, and hope to speak to you at the end of July, as usual, and to share with you our sort of first thoughts on trading for the 6 months. Thank you very much. Bye-bye.