Estimated to already be worth $152bn last year, I remain very bullish on the future of video gaming as an investment theme. As such, I’m drawn to today’s full-year results from Cambridge-based developer and UK growth stock Frontier Developments (LSE: FDEV).
How’s it been doing?
It’s doing very well. Revenue moved 19% higher over the 12 months to the end of May, supported by many/most of us being confined to our homes. The £90.7m logged was a record for the company. A maiden contribution from Frontier Foundry — its label for third-party publishing — was another positive.
All told, earnings before interest, tax, depreciation and amortisation (EBITDA) jumped 21% to £38.1m, lending great support for Frontier’s ‘launch and nurture’ strategy. This is where it releases a game and then updates it over time; the idea being that a player will become increasingly invested in a game and continue playing the title for years to come. To date, FDEV has four such franchises: Elite Dangerous, Planet Coaster, Jurassic World Evolution and Planet Zoo.
Can all this continue?
This growth stock’s next game — Jurassic World Evolution 2 — is due for release in early November in time for Christmas. Frontier Foundry will also release three titles in the current financial year (Lemnis Gate, FAR: Changing Tides and Warhammer 40,000: Chaos Gate — Daemonhunters). As a result, the mid-cap thinks revenue will come in somewhere between £130m to £150m. That’s a huge jump on today’s already great numbers.
It potentially gets even better the following year. In FY23, between £160m and £180m is expected thanks to contributions from its hotly-anticipated first Formula 1 management game and its Warhammer Age of Sigmar IP real-time strategy title. The latter is licenced from market darling and FTSE 250 constituent Games Workshop.
So, what are the risks?
One potential issue is that more casual gamers will want to do other things with their time post-pandemic. In this way, Frontier is no different from other lockdown winners such as Bloomsbury Publishing and musical instrument seller Gear4music. This is inevitable to some degree but its impact should not be discounted.
Another potential drawback is that earnings at any developer can fluctuate from year to year. This is usually due to the irregular release of games. Even if release dates were consistent, there’s a chance that a particular game won’t be popular. Moreover, a competitor could release something that generates higher interest. In this way, gaming is no different from the music or movie industries.
Even nailed-on winners can suffer teething issues. Frontier experienced this itself in the last year following the release of a bug-laden Elite Dangerous: Odyssey. Although things now seem to be fixed, the episode certainly did its reputation with gamers no favours. It might also explain why this growth stock has been quite volatile in recent months.
Considering these potential headwinds, Frontier’s forward P/E of 38 feels punchy, to say the least. Then again, I wouldn’t be surprised if a deep-pocketed suitor submitted a generous bid for the whole company at some point anyway. That’s exactly what happened to one of FDEV’s highly-rated peers earlier this year.
Potential obstacles aside, I remain positive about this UK growth stock. Backed with over £42m in net cash on the balance sheet, I reckon this is a cautious buy for my own portfolio.
Paul Summers 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.