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Down over 40% since June, is this former market darling now a bargain?

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In its five years as a listed company, video games developer Frontier Development’s (LSE: FDEV) stock has moved from 161p to trade as high as 1825p. Assuming they were sufficiently invested and didn’t sell until roughly three months ago, some of the company’s early owners must surely be well on their way to achieving financial independence.

More recently, however, this momentum has completely reversed, leaving Frontier’s stock trading 42% lower by the close of play yesterday. Based on today’s full-year figures, this drop isn’t entirely unexpected. 

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Despite the “ongoing success” of its first two franchises (Elite Dangerous and Planet Coaster), total revenue dipped almost 9% to £34.2m in the year to the end of May. A combination of investment and a lack of a new franchise launch in the year meant that earnings before interest, tax, depreciation and amortisation (EBITDA) also fell — by 26% to £9.4m. 

Nevertheless, an eventual return to form for the share price looks likely.

The launch of its Jurassic World Evolution franchise in June appears to have gone extremely well. Cumulative sales passed the one million mark only five weeks after the digital launch, allowing Frontier to register “a record trading performance during the period from the year end.” As such, it’s perhaps no surprise that management is “comfortable” with analyst revenue forecasts of between £75m and £88m for the 2018/19 financial year.   

Longer-term, CEO David Braben remains bullish. He believes Frontier’s three franchises leave it “very well positioned” in the industry. A fourth is expected to be released in FY20 and, in keeping with Frontier’s ambition to “create a multi-franchise success story“, two additional titles are also in “earlier stages of development.”  This, coupled with its growing relationship with Chinese entertainment giant Tencent following the latter’s strategic investment in 2017, should ultimately help the stock recapture its former spark.

Assuming all goes to plan, a forward P/E of ‘just’ 24 for 2019/20 could make the shares something of a bargain today.

Reassuringly expensive

Thanks to its lack of dependence on the success of just a few titles, however, my preference in this industry remains diversified gaming services provider Keywords Studios (LSE: KWS) — a stock I’ve owned for two years now. Over this time period, the company has more than quadrupled in value as the market has seriously warmed to its growth strategy.

Normally a seemingly never-ending acquisition spree would put fear into the hearts of investors. Taking into account the fragmented industry in which it operates, however, it continues to make a lot of sense for a business like Keywords. 

The latest addition to its estate is Gobo (composed of Studio Gobo and Electric Square). Purchased for a total consideration of up to £26m, it provides services to video game publishers and developers around the globe. Revenue grew from £6.2m in FY17 to £11.6m in the 12 months to the end of July.

According to Keywords, this acquisition — expected to be earnings-enhancing in the first year — “adds considerable expertise and scale” to its game development business. 

A current valuation of 45 times expected earnings will still be too high for many investors. But this isn’t to say that Keyword’s stock is necessarily overpriced. Indeed, some companies continue to motor ahead despite having a perpetually high price tag. In my mind, Keywords will continue to occupy this group. 

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Paul Summers owns shares in Keywords Studios. The Motley Fool UK has recommended Keywords Studios. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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