Leading outsourced service provider to the global gaming industry, Keywords Studios (KWS:AIM) is one of the most successful companies to float on AIM, growing from a £50 million market valuation to its current size of £1 billion.

Growth stocks went out of favour when interest rates shot up, hence why its shares have struggled recently. Over the last two years the share price has more than halved from a high of £32 while the PE (price to earnings) ratio has fallen by 77% to the current rating of 10.9 times expected 2023 earnings per share and 9.8 times next year’s EPS, according to Stockopedia and Refinitiv data.

We believe the PE now undervalues Keywords’ growth opportunity and dominant market position, presenting savvy investors the opportunity to invest in a great business at a great price.

Despite having a market share of just under 6% Keywords is more than three times the size of its nearest competitor according to Numis.

Although it is harder to pin down competitive advantages for service providers compared with companies that own intellectual property or strong brands, Numis believes Keywords’ scale and breadth convey certain advantages.

As the largest provider in a relatively immature market, reputation is an important differentiator. Over many years Keywords has regularly made acquisitions, spending around €600 million to gain access to a wide range of niche skills as well as broaden its geographical spread. This has brought the company significant cross-selling opportunities and insight into client needs.

A good example of one of Keywords’ differentiated services is its beta game testing. It comprises a community of 20,000 gamers who have signed a non-disclosure agreement to test games just before they go live and give valuable insight to video game creators.

The company’s services include localisation of content which helps game makers launch into multiple markets and languages simultaneously.

Over the medium-term management believes it can grow annual sales by 10% organically augmented by acquisitions while achieving an adjusted pre-tax margin of around 15%.

First-half results published on 12 September saw a 19% increase in revenue (10% organic) and adjusted operating profit was 5% ahead. However, the shares fell after the company flagged that US entertainment strikes could impact organic growth in the second half of 2023 by 2% to 2.5%.

Excluding the impact which largely depends on how long the strikes persist the company said second half organic growth is expected to be in line with the first. The strikes are a risk to consider, yet the current depressed price presents a great opportunity for someone with a long-term view to invest in a quality compounder.

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