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#1: Keywords Delivers Solid Results in a Challenging Year

Irish game development studio Keywords Studios reported fourth quarter and full year results for 2022 on March 15th. Despite the solid results, shares retreated due to the company’s valuation, which sits modestly higher than its peer group. 

Keywords was founded in 1998 as a localization service provider to the business software market, but it began to focus on the games market starting in 2004. This transition was completed in 2009, when Andrew Day came in as CEO and cemented Keywords’ current business strategy. While gaming underwent a multi-year decline following the Global Financial Crisis of 2008 due also in part to winding down of the seventh console generation, this transition proved worthwhile in the long run, as the industry’s annual revenue has eclipsed the size of the global music business and movies business combined. Day stepped away in 2021 due to health complications, handing the reins to Bertrand Bodson. 

Today, Keywords is the leading provider of technical services to the game industry, catering particularly to blue-chip clients developing premium titles on console and PC. These services include game localization, playtesting, audio engineering, art creation, and marketing, among others. 

The company has 12,000 employees spread among 70-plus studios in 26 countries. Even though Keywords ranks among the largest gaming companies by headcount, the studio is not well known among the general public or even within the games industry. This is deliberate, as the company does not want to shun its clients by taking the limelight itself. Ex-CEO Day said that Keywords has no plans on releasing its own games, as it doesn’t want to “bite the hands that feed it.”

Revenue for the year arrived at €690.7 million, up 34.8% from 2021’s total of €512.2 million. This marginally exceeded analyst consensus of €690.3 million. On an organic basis, which excludes acquired studios, revenue growth was 21.8%. Adjusted EBITDA of €146.9 million grew by 33.4% year-over-year, close to the inorganic revenue growth rate as EBITDA margins remained stable, dipping only 20 basis points. Note that the reporting currency Keywords uses is the Euro, despite being listed on the London Stock Exchange, which is denominated in GBP. Excluding the FX conversion, organic revenue growth would have been approximately 3% lower.

The company is divided into three reporting segments. Create combines Game Development and Art Services, Globalize combines Audio, Testing, and Localization, and Engage combines Marketing and Player Experience. 2022 saw the acquisition of five studios in the U.S., Australia, Canada and Italy, bringing Keywords’ transaction volume to over 60 studios with €600 million deployed over the last 10 years. As of the end of 2022, these three segments comprised 39.9%, 43.6%, and 16.6% of full-year, top-line revenue respectively. The breakdown below covers revenue including the impact of acquisitions. 

While Engage grew by 24.1% year over year inorganically, on an organic basis it delivered the most muted growth of the three at 9.7%. The Player Support side of the business did well, as the company reported that Social Media and Trust and Safety Services attracted new clients. However, the Marketing segment was impacted by the cost-cutting efforts of its clients, who curbed their marketing spending in favor of shoring up profitability. Keywords also notes that Marketing grew organically by 34% in 2021, making the year-over-year comparison challenging. Given these sorts of services are the first to be scaled back in a recession, Engage may continue to show lower growth. Though at less than 20% of the overall top-line, Engage’s success is not a make-or-break factor for the overall portfolio. 

Create grew 46.4% inorganically as three new game development studios were acquired: Forgotten Empires, Mighty Games, and Smoking Gun Interactive. Excluding these acquisitions, growth was 25.9%, still a strong showing given the relative lack of new game releases in 2022. This was also after Sperasoft, the company’s Russian-based business with over 400 employees, relocated to alternative locations in Europe due to the ongoing war. 

In terms of the outlook, Keywords says “clients are increasingly seeking external support” for their projects. This could be due to the slower hiring environment, in which gaming companies are more willing to outsource development to third parties on a contract basis rather than increase full-time headcount. It’s due to this factor that Keywords’ business is more “recession-proof” than traditional gaming companies, so we can expect a more defensive posture here as well as a lower beta compared to the broader industry. 

Globalize, the company’s largest segment by revenue, grew 29.8% on an inorganic basis and 23.4% organically. This part of the business is primarily comprised of Functional Testing, which provides games testing solutions to developers, and Localization, encompassing localization and internationalization services to clients in the industry. In August, Keywords acquired Mighty Games for $6.9 million, to boost its AI-based testing platform. Localization is also poised to benefit from AI, and performance was strong owing to “the deployment of a specific AI driven text localization workflow” for a key client. 

AI can boost margins in the long-run for Globalize, which contributes a lower proportion of Group EBITDA than Create despite its larger size and much higher headcount. Deployment of AI could reduce the need for human translation for audio and text localization, especially as the technology grows more “humanlike” in the coming years.

Growth for the entire business is expected to moderate to just over 10% organically in 2023. While this was in line with expectations, shares fell by 8.8% after earnings. Keywords had a 16x EV/EBITDA multiple (unadjusted EBITDA) for FY 2022, low for historical standards but higher than other similarly sized mid-cap gaming companies. However, Keywords should not be evaluated versus gaming studios, but more uniquely as a picks-and-shovels technology provider, providing underlying technology and services for the industry. The company has a consistent track record of growing FCF as well, though looks less cheap based on this metric. Costs have remained moderate and EBITDA margins stable despite headcount growth from 9,493 in 2021 to over 12,000 to close out 2022. 

This is reflected in the company’s share price, which increased 2.89% in 2021 and fell 7.32% in 2022. Compared to the median gaming company we track, where share prices fell 4.99% in 2021 and fell 29.4% in 2022, the stock performance of the company has been exceptional. But at its current multiple, returns may be more muted than a game development studio trading at <10x earnings due to steep losses when compared to 2021. Regardless, it’s hard to imagine an actual down year for Keywords, given it posted mid-double digit growth in 2022, the worst year for the games market since the GFC. 

#2: What Meta’s “Year of Efficiency” Means for Gaming

Source: Lifewire

The first quarter hasn’t even ended yet, but Meta’s “Year of Efficiency” is in full swing. Last November, the company cut more than 11,000 jobs, or 13% of the workforce, in its most significant job cuts in its history. This was in response to Meta’s dismal Q3 2022 earnings report, which saw the company report a revenue decline for a second straight quarter and profits plunged by 52%.

In the subsequent quarter ending in February, CEO Mark Zuckerberg declared that 2023 would be focused on efficiency, and Meta would become “a stronger and more nimble organization.” Shares surged nearly 20%, helping to reverse some of the losses of last year, in which Meta plunged 64%. 

Now in March, the technology conglomerate is laying off another 10,000 employees and closing an additional 5,000 open roles. These reductions will affect technology groups in late April and business groups in late May. In addition, lower-priority projects will be canceled and the organization will be made less hierarchical. This is an about face for Zuckerberg and Meta, as just last year the company declared it saw no end in sight to increasing spending to enable its metaverse vision. Meta no longer appears to be as “all-in” on the metaverse as it was this time last year, as the term was only mentioned twice in Zuckerberg’s 2,200-word statement. 

Meta now expects total expenses for 2022-2023 to come in between $86 billion to $92 billion, down $3 billion from the prior forecast. Zuckerberg told analysts last month that Meta would be “cutting projects that aren’t performing or may no longer be crucial.” Given the Reality Labs segment lost $13.7 billion in 2022 developing VR and AR technologies, major cost cuts may be coming to increase its focus on the core mission and reduce the cash burn. It’s unlikely all of this work will be reversed, but it’s difficult to imagine this cash burn continuing given that VR sales declined last year. Revenue in the fourth quarter, which coincides with the holidays, was only slightly higher than even Q4 2020.

Road to VR
Source: Road to VR

Google is also looking to cut costs by reducing AR spending. Sales ceased for Glass Enterprise Edition on March 15th, and support for the product will end just six months from now. This is the second major product discontinuation for Alphabet thus far in 2023, after the cloud gaming service Stadia went offline permanently in January. Gaming and VR/AR/XR go hand in hand, as the most immediate applications for headsets remain games and other interactive content. With the discontinuation of Glass, the only games-related property Alphabet retains is in streaming with YouTube Gaming. 

While the Quest has sold poorly in the most recent quarter, it actually reached its highest market share since at least Q1 2021, according to research from Counterpoint. But for Meta, this is a drop in the bucket; the $727 million generated from Reality Labs in Q4 2022 was just 2.3% of the quarter’s overall revenue. And this proportion actually shrunk YoY from 2.6%, as advertising performed less poorly comparatively. 

The “Year of Efficiency” is an exercise in cost prudence due to the violent shareholder reaction last year within the tech investment community. While Meta may be unique in the scale of its restructuring, having rid itself of a quarter of its workforce, it is not alone in trading off growth prospects for profitability. In the gaming world, so far this year we have seen layoffs at Microsoft affecting Xbox Games Studios and reductions affecting EA’s Apex Legends, its most popular in-house IP. Take-Two has reduced headcount at various publishing subsidiaries, with a primary emphasis on Private Division, while layoffs have also affected smaller gaming firms ranging from small to mid-sized studios, gaming-focused media publications, and esports organizations. 

At Microsoft, 10,000 employees were laid off that comprised 5% of its total workforce in January. These cuts were aimed at gaming studios including 343 Industries, Bethesda, and Bethesda parent ZeniMax. This resulted in the third delay to Bethesda’s highly anticipated RPG Starfield, the studio’s first original IP in over two decades. Microsoft will incur a restructuring charge on its next earnings, a one-time cost that will positively affect adjusted EBITDA in all future quarters. In the long run however, this trade-off may result in lower potential revenues due to the deteriorating game pipeline, which outweighs the effects of reduced OpEx. Titles like Elder Scrolls VI, Fallout 5, and Wolfenstein III may see their release dates pushed out even further as a result. 

In EA’s case, the entire Baton Rouge studio was let go in February, consisting of over 200 quality assurance testers for Apex Legends. These duties will reportedly be spread out to other EA offices. However, this comes just a month after Respawn Entertainment announced that Apex Legends Mobile would be shutting down on May 1st, 2023. Concurrent with the announcement on Apex Mobile, EA announced it would be buying back $320 million in stock this quarter. Despite the popularity of Apex, which has over 15 million weekly active players and a thriving esports scene, immediate profitability has proven more important. 

While none of these are as eye-popping as Meta, these exercises show how sensitive the gaming world is to rising interest rates, which result in a higher cost of debt and reduced equity valuations. Zuckerberg said in his statement that “profitability enables innovation,” but perhaps a more accurate assessment is that “profitability enables survival,” especially for public organizations. 

There are also a number of large gaming companies that have not yet been affected, but have even more extreme profitability challenges. Ubisoft for example has seen its stock price plunge by nearly 50% since the start of 2022, with only a marginal uptick since a seven-year low in February this year. Shareholders who have held Ubisoft shares since its IPO in 1996 have realized a CAGR of 8.8%, and its stock price is in line with its highs during the internet bubble’s peak in 2000.

Source: Koyfin

After reaching a peak of $900.9 million EBITDA during FY 2021, Ubisoft saw the metric plunge by 53.3% to $420.3 million in FY 2022, or the lowest since 2014. Now on a LTM basis, EBITDA is $100.5 million, the lowest in at least a decade. 

Ubisoft has faced numerous challenges in keeping up with the rapidly changing games market. One of the main issues has been the rise of free-to-play games, which offer gamers a lower barrier to entry and monetize better over longer periods of time. While free-to-play dominates mobile, it’s also become one of the most lucrative business models for console gaming over the last decade. Meanwhile, Ubisoft’s traditional business model of selling premium games at a $70 price point has only grown more stale in the age of F2P and, increasingly, subscription gaming. 

Another challenge is the increasing importance of live services and ongoing content updates. Players have become accustomed to games-as-a-service, and expect constant updates which can be costly and time-consuming for developers. Lastly, the company has been plagued with diversity and inclusivity issues, which have led to employee protests against management. 

With an enterprise value of about $3.8 billion, Ubisoft could be sold off at a 40% premium valuing the company at around $5.3 billion. This premium would be similar to what Microsoft paid for Activision Blizzard. But any potential suitor would have to face a hostile regulatory M&A environment, and would have to totally revamp Ubisoft from within. 

Another option would be for an external CEO to come in and clean house, taking a page from Meta’s book and letting go a huge chunk of the workforce, starting with management. In terms of other options like a PE-led buyout which would increase Ubisoft’s debt load even further, this could be ruinous given the company’s ballooning Net Debt/EBITDA. Profitability has to be improved from within rather than boosting ROE by saddling more debt on. 

Source: Koyfin

The pursuit of “efficiency” is good news for shareholders in the near-term. But in the highly competitive games industry, a studio’s longer term prospects are driven by its talent and games pipeline. The live service model is here to stay but cannot be utilized without development resources experienced in its implementation. Companies like Ubisoft may be able to eliminate redundant or underperforming positions, but without a fundamental rethink of the business, innovation will continue to stagnate.

Top Movers

Weekly Top Gainers
  • For the week ending March 17th, 2023: the average return for gaming companies tracked by Naavik with a market capitalization exceeding $500 million was +2.2%. The S&P 500 returned +1.4% and the Nasdaq-100 returned +5.8%.
  • This was the best week for tech stocks since last November, when inflation data came in much cooler than expected. Headline CPI for February this week measured at 6.0% YoY, in line with analyst expectations and the eighth consecutive decline in the annual rate. Despite the collapse of regional bank stocks, markets responded positively to interest rates across the curve plummeting. A 50-basis-point hike for the FOMC meeting on March 22nd has been totally priced out, with the odds for no increase and 25 bps roughly even. 
  • Playtika and Wemade were the top gainers for the week, gaining +15.8% and +14.3% respectively. Wemade announced a strategic partnership with Web3 data provider Space and Time for future GameFi development. They also issued a press release related to their latest MMORPG MIR M, which reached 200,000 concurrent players. Playtika had no notable company specific news.
  • Keywords Studios was the top loser for the week, with shares shedding -10.4%. The company’s earnings were positive despite the street reaction, and is covered in more detail above.

Most Notable Strategic Investments

Source: Maglazana
  • Abu Dhabi-based G42 acquired a stake exceeding $100 million in privately held ByteDance, at a $220 billion valuation. G42 provides AI services to private clients and the UAE government across sectors like energy, aviation, and healthcare. ByteDance is the parent of TikTok and its Chinese counterpart Douyin. ByteDance also has a number of game holdings including Nuverse, the publisher of Marvel Snap, and Moonton, which is known for the popular mobile esport Mobile Legends: Bang Bang. The deal is the latest in Middle Eastern investment in technology and gaming companies, as the MENA region grows into a local powerhouse. (Link)
  • Bandai Namco invested in two technology and gaming startups through its new “021 Fund.” The fund’s goal is to invest in companies that can enable a Bandai Namco metaverse using its IP.  The first investment is in DeepMotion, whose main business is the development of generative AI technology to create 3D animations from video. The second is in SuperGaming, which is building a multiplayer gaming platform where developers have access to common resources. DeepMotion is based out of the Bay Area and SuperGaming is located in Pune, India. (Link
  • Plug In Digital, a French video game distributor that helps partners optimize their revenue, acquired free-to-play developer Celsius Online. (Link 1) The Celsius team is comprised of 50 individuals and has made cross-platform games for mobile, console, PC, and VR. Plug In calls this acquisition a part of a “new growth strategy” where external studios are acquired wholly. (Link 2)

Most Notable Venture Financings

  • Digital payments firm Tilia raised $22 million in funding to handle payments for the metaverse and the broader digital economy. Tilia is a subsidiary of Linden Lab, the creator of Second Life, and handles payments within the game as well. The funding will be used to expand Tilia's platform and increase its support for new digital economies beyond Second Life. Brad Oberwager, who was previously executive chairman, has been appointed as CEO. He will be joined by Aston Waldman as CFO, was previously the acting CEO of Tilia. (Link)
  • Moxy secured $10 million in funding to create an esports platform using blockchain technology and a unified crypto wallet. The platform allows developers to organize events without having to implement their own solution. Entry fees are denominated in the MOXY token, and the prize pool is divided among the players (90%), developers (6%), and the Moxy Foundation (4%). (Link)
  • Brazilian Web3 game publisher Jungle raised $6 million to finance its upcoming mobile shooter. The game is slated to launch this year and will feature an open market economy based on the blockchain. Jungle’s strategy is to acquire IP from existing developers, “acquiring and optimizing existing games,” according Framework Ventures principal Brandon Potts. The company currently consists of eight employees. (Link)
  • GenPop Interactive, a new venture between American musician BloodPop and former Bandai Namco executive Aubrey Tennant, raised $6.5 million in seed funding from investors. GenPop’s first project is a competitive team-shooter whose development will be based on community feedback. The studio is headquartered in Los Angeles and the team, which currently consists of 25 employees, is entirely remote. (Link)

Other News

Source: Twitch
  • A number of new studios opened up from veteran developers across the games industry:
  • Fuse Games was founded by former Criterion Games veterans, a subsidiary of EA since 2004. Criterion is known for racing franchises like Burnout and Need for Speed. The team is based in Guildford like Criterion and currently consists of 17 people. The five founding members include Matt Webster, Steve Uphill, Pete Lake, Andrei Shires, and Alan McDairmant. The studio’s first game will be a AAA title launching on consoles and PC. (Link)
  • Yellow Brick Games is a new studio based in Quebec City and created by a group of game veterans with experience at Activision Blizzard, Bioware, EA, and Ubisoft. The team employs 15 individuals at the moment and is actively recruiting for remote roles outside of Quebec, including the rest of Canada and other countries. Founding members include Thomas Giroux, Jeff Skalski, and Frédéric St-Laurent B. Yellow Brick Games plans on adopting a “craftsman approach” for new titles, instead of focusing on AAA development. (Link)
  • Magic Soup Games was created by Blizzard Entertainment veterans Jen Oneal, J. Allen Brack, and John Donham. The studio was self-funded to free itself from external influence and currently has just five employees, all working fully remotely. The co-founders have experience leading teams in games like World of Warcraft, Star Wars, EverQuest, and Diablo. (Link)
  • Gas Giant Games was devised by two former Diablo developers, Jay Wilson and Julian Love. Wilson was the lead designer of Diablo III and Julian love was the lead technical artist. The duo plans on creating an action RPG based on original IP, with more details to be announced at the upcoming GDC. The team says they’ve assembled “a large team of gaming industry veterans,” but the operation appears to be in stealth mode given only the cofounders are listed on the website. (Link)
  • Garena’s Free Fire Max, its graphically enhanced version of Free Fire, is shutting down its servers in Brazil. Players in the game received a message stating that resources will be focused on the original Free Fire, and Garena would “stop providing maintenance and updates for the Max version” starting March 21st. It is unclear whether servers will be closing in other regions given only Brazilian players seem to have received this message. (Link)
  • Twitch CEO and co-founder Emmett Shear is stepping down from the role after more than 16 years at the company, to spend more time with his family and newborn. The streaming service’s current President Dan Clancy will be taking over as CEO immediately. Emmett was one of the four co-founders of in 2006, a website whose gaming section turned into Twitch in 2011 and was then acquired by Amazon in 2014. Twitch today is the biggest gaming streaming platform in the Western world. Just days later, however, Twitch announced layoffs of more than 400 employees as part of a larger Amazon workforce reduction. (Link 1) (Link 2

A big thanks to Mario Stefanidis, CFA for writing this update! If Naavik can be of help as you build or fund games, please reach out.

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