Shares in Frontier Developments (FDEV:AIM) have fallen from June 2018’s £18.25 peak to 849.4p amid a broader de-rating of the global gaming sector and as the hype dies down over its Jurassic World: Evolution game despite it being a monster hit.

Perhaps investors want to see a broader roster of games from Frontier, and some may not like the lumpiness of its earnings. 

A ban on new video games in China has started to be lifted, but this excludes its biggest player, Tencent.

In 2017, Tencent made a £17.7m strategic investment in Frontier for a 9% stake to help scale up the business and accelerate growth in the key Chinese market.

Video game publisher Take-Two Interactive Software recently joined rival Electronic Arts in forecasting sales below Wall Street estimates, only adding to fears competition from free-to-play ‘battle royale’ games such as Fortnite and PUBG is eating into sales from traditional players.

Activision Blizzard’s weak outlook statement also soured sentiment towards the sector. Yet the global games industry backdrop is only strengthening and readers might be wondering whether Frontier’s share price correction is a waving red flag or an attractive new entry point?

WHAT DOES FRONTIER DO?

Founded in 1994 by CEO David Braben, co-author of the seminal Elite game, Cambridge-based Frontier Developments makes and publishes video games for PCs and consoles.

It has successfully shifted from a ‘work-for-hire’ developer to a higher margin self-publisher and launched three successful games franchises, Elite Dangerous, Planet Coaster and Jurassic World Evolution. All three are performing well in an increasingly competitive market.

Frontier’s fourth game franchise, based on the company’s own unannounced intellectual property, should be released later this year. It also has many other projects in various stages of development; franchises will be a mix of licensed and original intellectual property.

THE BULL AND BEAR CASE

Bull points include a management team with a gaming sector track record and there is exciting growth potential as the game industry moves to cloud delivery.

Liberum Capital says the games release cycle could accelerate and also believes streaming could provide new monetisation possibilities.

It says: ‘There have been a number of public comments from the major platform providers (Sony, Microsoft, etc.) and possible new entrants to the gaming sector about the potential to launch new delivery and monetisation models, which could accelerate growth for the whole computer gaming sector including Frontier.

‘Google is already testing a streaming service (Google Project Stream), which is expected to be launched later this year and there has been speculation that tech and telecom giants such as Amazon and Verizon could also be preparing to announce new platforms,’ says the broker.

Bear points include a competitive market, limited earnings visibility, the risk new games are duds as well as staffing recruitment challenges.

CONTENT OPPORTUNITIES

Frontier’s strategy of providing updates alongside the creation of a paid downloadable content business is proving successful and extending the longevity of   its titles.

It is releasing new content for its games, meaning there is a tail of content and revenue to come from each franchise which investors shouldn’t underestimate. It will build on this base with further games releases, smoothing out what is currently a lumpy portfolio.

Rather than the traditional model of hit-driven disc sales, Braben informs Shares that digital has become the dominant force. ‘That is great for a company like us because we can go directly to customers now, whether it is through our own store, through STEAM, through Microsoft or the PlayStation store.’

POSITIVE OUTLOOK

Stockbroker Peel Hunt says Frontier is well positioned with a strong franchise portfolio, plenty of cash and upcoming franchises in the works. Investment bank Jefferies argues that the prospect of the next franchise being unveiled and released during the current calendar year should generate ‘renewed excitement if not the over-exuberance of Jurassic World Evolution’.

Half year results published on 6 February showed operating profit shooting up from £3m to £17.2m, year-on-year. ‘We made more profit in that six month period than in the whole of the previous six years,’ says chief financial officer Alex Bevis.

Armed with £39.5m net cash, Frontier has the firepower for potential acquisitions to supplement what thus far been an organic growth story.

We see merit in owning the shares at the current price given how a lot of fears about the industry have already been priced in. However, this is a high-risk investment so only put up money you can afford to lose. You will also need to be patient as there may not be a re-rating catalyst for the share price until the next franchise is launched.

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