Walt Disney's Marvel Entertainment unit and Japanese listed video game powerhouse Square Enix recently inked a multi-year, multi-game licensing agreement. This will see the two companies collaborate to develop and publish games based on Marvel Super Heroes, beginning with The Avengers.

The deal is a further endorsement of Square Enix which has a proven track record of video game excellence and has sufficient scale to develop new games and expansion packs across existing and emerging platforms. The company is arguably one of the leaders in adapting blockbuster titles for mobile, with the likes of Lara Croft GO highly-regarded in the west and numerous titles having proved themselves commercially in Asian markets.

This is the first major video game licensing deal following the shake-up of Disney's internal video game team last year. It is an exciting agreement for both Disney and Square Enix in our view. While the Marvel IP is being monetised extraordinary well at the box office, it has been woefully under-exploited on the video game side.

Financially, Square Enix has been performing well, with net sales in the nine months to end-December 2016 of ¥190.08 billion, up 24.4 per cent from the same period the prior year. The increase was driven by the digital entertainment (video games) segment, with several big releases in 2016. The company also cited "strong download sales of catalogue titles released previously".

Operating income, though, declined 9.7 per cent to ¥21.28 billion due to a hefty rise in cost of sales. The latter can be a lumpy item for game developers such as Square Enix. However, development costs for blockbuster titles such as Final Fantasy XV will continue paying off for the company in the future.

Attributable net profit was up 26 per cent from the prior corresponding period to ¥17.06 billion on the back of a lower effective tax rate.

The digital entertainment segment is the core driver for the company. The segment plans, develops, distributes and operates digital entertainment content, primarily in the form of video games for console, PC and mobile (iOS, Android).

Sales in this area surged 32.8 per cent year-on-year to ¥146.2 billion. Square Enix released several blockbuster titles for console and PC. These included Final Fantasy XV and the PlayStation 4 version of Rise of the Tomb Raider.

Although the company didn't single out any specific sales figures for the games, an earlier news release reported that Final Fantasy XV had already sold 6 million copies, shortly after release in late November.

In multiplayer online role-playing games, sales fell as there were no major expansions released during the nine-month period. For mobile, net sales "increased significantly" due to strong sales of major titles such as Hoshi No Dragon Quest and Final Fantasy: Brave Exvius (which features Ariana Grande as a character).

Although segment sales surged, operating income of ¥21.79 billion was down 5.8 per cent from the previous year. Higher development costs compressed margins from 21.0 per cent to 14.9 per cent.

The Disney deal, though, could well signal a new frontier for earnings. In this context we view the company's valuation as undemanding compared to peers. The stock is trading on a price to earnings multiple of 18 times for the year to March 2017, falling to 14 times the following year. Further, Square Enix enjoys a strong balance sheet with a large net cash position.

Greg Smith is head of research at investment research and funds management house Fat Prophets. Interests associated with Fat Prophets declare a holding in Square Enix. For a free trial to Fat Prophets' daily market commentary please click here.