To most people, Britain is probably not the first country one would think of in regards to the entrepreneurial spirit. However, while browsing through the country's listed companies, we found a sizable pool of high-quality companies that can balance growth and return so well as to create tremendous wealth for shareholders.
In some of our previous articles, we covered a couple of "young" public companies from the UK, including Bioventix (LSE:BVXP, Financial), Fever-tree Drinks (LSE:FEVR, Financial) and Craneware (LSE:CRW, Financial). In our opinion, they share the common traits of strong business fundamentals, being led by founding members and possessing an entrepreneurial culture. While being relatively small-sized, they concentrate on their respective niches with market leadership positions in sheep monoclonal antibodies, premium tonic water and hospital billing software, respectively.
We regard these companies as the "startups" of the stock market, which generate a double-digit rate in terms of both returns on capital and year-over-year growth.
When it comes to investing, our first impression on the gaming business typically relates to a lack of predictability and sustainability, since the industry is hit-driven to a large extent. That is, even a new entrant with only a small technical advantage can steal significant market share with a one-off blockbuster. In contrast, market leaders still have to continually release some hits to stay successful.
Nonetheless, we believe that Team17 is a different species in this space. The secret sauce lies in the company's revenue-sharing partnership model collaborating with independent (aka indie) developers around the globe. Unlike high-cost triple-A games produced by industry giants like Electronic Arts (EA, Financial) and Take-two Interactive (TTWO, Financial), the indie projects are generally small-sized and flexible, and hence, well-known for their innovation, creativity and artistic experimentation. The niche has been seeing robust growth due to the adoption of digital distribution and reduced barriers to entry for smaller development teams through middleware gaming engines.
Team17 primarily targets the premium (instead of the "free to play") segment of indie games, with no dependency on any single franchise or title. This diversification significantly improves the visibility of the business for its owners. As of fiscal 2019, roughly three-quarters of the total sales come from the back catalog of more than 300 digital revenue lines.
On top of that, the company appears to seed additional recurring cash streams at a rapid pace, with seven new releases in 2019 and another ten planned this year. While the company develops its own games, the revenue share of its first-party content is less than 20% of the total. We would view the hit-driven risk at Team17 as being quite limited.
Team17 was founded in 1990. The venture went through ups and downs, from a golden era with multiple number-one releases (including the massive success of Worms) to a period where the business turned into a "single intellectual property company." Riding this roller coaster journey is Debbie Bestwick, one of the founding members and current CEO, who led the management buyout, restructured the organization and took the company public.
The British entrepreneur developed her significant interest in video games during childhood and managed a video game store right after high school. She is now a member of the Most Excellent Order of the British Empire. Under Bestwick's leadership, Team17 established the label and incubator model and repositioned itself as "a games label created by independent developers for independent developers." The business soon turned around to achieve sustainable profitability, leveraging its expertise in product acquisition, IP incubation, go-to-market execution and lifecycle management.
For the last three years, Team17 earned an average 12% return on assets and increased its top-line at a compound annual rate of 66%. According to the management, the global games industry is expected to expand at 9% per year through 2022, underpinned by the emergence of more revenue channels (e.g., Games-as-a-Service) and healthy growth in active users across multiple platforms. While the superior growth may moderate at some point, we feel that Team17's low-risk business model is appealing in light of its scalability, predictability, and favorable industry trends.
Disclosure: The mention of any security in this article does not constitute an investment recommendation. Investors should always conduct careful analysis themselves or consult with their investment advisors before acting in the stock market. We own shares of Craneware and Bioventix.
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