Keywords Studios (LSE: KWS) floated on London’s junior AIM market in summer 2013 at 123p a share. Its market capitalisation was less than £50m. Today, the share price is 1,232p (up over 900% since the IPO), and the market cap is £804m.
The company describes itself as the leading international technical services provider to the global video games industry. It’s been universally loved-up by those among my Motley Fool colleagues who’ve written about it previously. Most recently, Edward Sheldon has laid out the bull case with admirable clarity.
Today, I’m going to discuss three arguably negative features about Keywords. And I’ll conclude this article by giving you my opinion on whether they make it a stock to avoid.
Roll-up, roll-up
Keywords is pursuing what’s called a ‘roll-up’ strategy. This involves acquiring and merging multiple smaller companies in the same industry. The aim is to gain scale in, or dominate, a fragmented market far more rapidly than would be possible by organic expansion alone. To this end, Keywords has made dozens of acquisitions since its listing on AIM.
The City loves roll-ups, because of the juicy fees from all that M&A activity. Investors love them for the hyper-growth they promise. Roll-ups always look compelling on paper, but I’ve seen loads of them blow up over the years.
The Harvard Business Review once observed: “Research shows that more than two-thirds of roll-ups have failed to create any value for investors.” It also noted that many were “afflicted by fraud”. Often though, in my experience, there’s simply a failure to manage the sheer complexity of what they’ve created.
I’m not sure the relatively poor record of roll-ups generally is sufficient reason in itself to avoid Keywords. Equally, I know some investors who think it’s safer just to steer clear of them full stop.
Underlying performance
Multiple acquisitions year after year make it very difficult for investors to track the progress of the underlying business of a roll-up. Analysts at Peel Hunt, who currently have a ‘sell’ rating on the stock, have a number of concerns on this front. They’ve questioned whether the company has been acquiring businesses that are dilutive for the financials. And also whether it may start to overpay for those that aren’t.
I haven’t got the time — and probably not the necessary level of accounting skill either — to go through all the acquisition accounting, and reach my own conclusions about Keywords’ underlying performance. That’s unfortunate, as I’m generally loath to take any company’s word as gospel. Doubly so if it’s an AIM-listed one.
Coming up short
I always keep an eye on the level of short interest in stocks. Holders of short positions — typically shrewd hedge funds — are betting on the company’s share price falling. Such funds are adept at pulling apart company accounts. And at digging into all sorts of other nooks and crannies.
Short positions in Keywords have been rising more or less relentlessly since last summer. They’re currently at a new high of 7.04%. This means Keywords now ranks behind only IQE at the top of the list of most heavily shorted stocks on AIM.
Alongside the poor record of roll-ups generally and my uncertainty about Keywords’ underlying financial performance, the ‘red flag’ of heavy short interest tips me decidedly in favour of avoiding the stock.