The video game industry is seeing a very predictable boom in recent times. The pandemic-fuelled boom has pushed gaming stock to new heights. A recent report by Accenture valued the gaming sector in excess of $300bn. In the wake of this surge, some UK gaming companies are shining through.
Frontier Developments (LSE: FDEV) is one UK gaming stock I am looking to add to my long-term portfolio to capitalise on the industry boom. Here is why I’m expecting huge returns from the game developer over the next decade.
Frontier Developments shares have risen 18.7% in the last month and 29.3% in the last 12 months. Despite some turbulence in the last year, I expect steady growth for the foreseeable future.
Total revenue in 2020 was £76.1m (2019: £89.7m). This is because the company has been gearing up for big-name releases in 2022. Most 2020-21 releases have been updates for existing games.
The company has maintained an operating profit margin of 22% despite the lower revenue. Also, cash balances have increased to £45.8m in 2020 (2019: £35.3m). To me, this shows how the company is well placed to undertake R&D tasks and work on conceptualisation and development of new releases.
This brings me to the host of big-name releases Frontier has planned for 2022. The developer has secured the license to release Formula 1 management games from 2022 onwards. This is a huge gaming genre and could prove very profitable. Real-time strategy game Warhammer: Age of Sigmar also looks very promising as it allows for in-game purchases and paid future content.
The company is targeting five to six releases per year from 2023 onwards, propelled by the success of third-party publishing label, Frontier Foundry. The company expects revenue in 2023 to be £160m to £180m which is twice the current revenue figures. This leads me to believe that the UK gaming stock is set for a surge in the next five years.
Attractive business model
One important factor I look for in the financial data of gaming companies is how they generate their revenue. The gaming industry is built on recurring, in-game transactions and paid downloadable content (PDLCs). This strategy helps games remain popular and profitable for several years after the initial release.
Older releases like Elite Dangerous, Planet Coaster, and Jurassic World Evolution generated 60% of the revenue in 2020 which is evidence that the Frontier’s launch and nurture strategy is the right way forward for the company.
Though I am very optimistic about the growth of the gaming industry, picking a winner among the many studios is no easy task. Frontier’s financials and business model look strong but success depends on the trajectory of the gaming industry as a whole, which is ever-changing.
Morphing audience opinions determine demand and success in the industry. Gaming enthusiasts have seen several promising releases buried because of one bad review or the launch of other popular titles.
In my opinion, Frontier Developments is a defensive game developer. They opt to generate revenue through intelligent licensing and PDLCs. Revenue from this could drive experimentation in the future too. The company is on my list of shares I would hold for a decade and I remain confident that this UK gaming stock could generate incredible shareholder returns.
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Suraj Radhakrishnan has no position in any of the shares mentioned. The Motley Fool UK has recommended Frontier Developments. 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.