The video game industry has come a long way since Pong or even the original Super Mario Bros. What began as a fairly niche market in the late 70s and early 80s has ballooned into one of the largest entertainment sectors, pulling in more revenue than both the movie and music industries. And it doesn’t appear to be stopping any time soon. In 2017, the global video game market reached $121 billion. Analysts are expecting it to grow at c.10.3% CAGR over the next four years.

In addition, the internet has opened the door for even greater revenue as developers are able to include additional downloadable content as well as bypass physical software and the overhead costs associated with it. These advances have allowed developers to make and keep more of the revenue associated with their products. So if there’s ever been a time to look into the prospect of investing in video games, now is that time.

One of the more promising developers is a UK-based company named Codemaster Group Holdings PLC (LON: CDM) that’s earned high praise for several of their successful racing franchises: DiRT, GRID, and Formula 1. Metacritic, a well-respected review-aggregating website, has listed four Codemaster-developed games in their list of the top 10 best racing games on Sony’s Playstation 4. And what’s more, Codemaster owns the IPs of three of their franchises (DiRT, GRID, and ONRUSH).

Although the barriers to entry for video game development have shrunk over the past decade due to simplified game engines, creating a AAA title – whether a shooter or a racing game – requires a large team of experienced developers. At around 500 employees, Codemaster has the largest team of dedicated racing developers in the world. In addition, they’ve developed a proprietary development engine that has reduced both the time and money required to bring a game from concept to console. This fact has made it almost a certainty that Codemaster will retain their license to develop official Formula 1 video games for the foreseeable future.

In addition to their established franchises, Codemaster has recently released ONRUSH, an action-oriented arcade racer that has received favorable to mixed reviews on Metacritic. ONRUSH is evidence that Codemaster is willing to innovate and explore styles of play that are new and potentially untapped in the market.

One of the things that has become increasingly attractive about video game investments in general – and Codemaster more specifically – is the larger share of revenue collected through downloadable content and micro-transactions. Some of the leading developers in the industry are earning over 50% of their revenue through these longer-term streams. Codemaster has a tremendous opportunity on this front – especially with their free-to-play title and their newest franchise, ONRUSH.

Another thing that makes investment in Codemaster worth considering is the growing interest in Formula 1 racing in Asian territories. It’s no surprise that China is one of the newest and fastest-growing markets for video games of every kind. Liberty Media, the company behind Formula 1, is currently eyeing a major push into China. If this were to be successful, it would be a major boon for Codemaster’s Formula 1 racing series.

Currently, Broker Liberum expects revenues of £71.5m (+12%) in FY19, £81.0m (+13%) in FY20 and £90.2m (+11%) in FY21. With all things considered, Codemaster is expected to reach an EPS growth rate of 11% in FY20 and 12% in FY21. As a result, Broker Liberum has derived a £440 million valuation to their business which works out to c.310p per share. Analysts are largely expecting Codemaster to trade in line with the video game sector as a whole.

With all of that said, there are a number of contingencies to consider when looking at Codemaster. As we’ve already noted, their Formula 1 games are based on a license that has to be renewed every few years. Though there is no obvious competitor for that license right now, that could change. In addition, ONRUSH has not had the success of their previous franchises. And the micro-transactions that have been such a boon to many developers have also led to backlash from consumers when they weren’t handled well. The video game market is large – and competitive. Because of this, success in the market is subject to a number of factors that must be carefully navigated. Though they face challenges like any other company, Codemaster has a proven track record with a team of successful leaders at the helm. If you’re considering an investment in the video game sector, they’re at least worth considering.

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