eSports are sexy, but expensive

The digital games and interactive media sector is probably much larger than you think and still growing. To put it into perspective, one of the highest rating movies ever, Avengers: Endgame, grossed US$858m during its opening weekend. Grand Theft Auto V’s release, earned US$1b in just over three days.

 Originally just a PC/console experience, ubiquitous smartphones are now raking in cash as well. And, it is important to clarify, the phone market appears to be a complement to the PC/console experience rather than a competitor.

Gaming Revenue

Source: Superdata

What is driving the growth of gaming?

  • The emergence of eSports. The global eSports audience grew to 450m worldwide in 2019, up 15% year on year. And this was before coronavirus forced half the world indoors. Kids under 20 are more likely to be watching esports than live sports. League of Legends tournaments routinely beat most traditional sports in viewership numbers.
  • The move to mobile. Historically Digital games were the preserve of PCs and then Consoles. Today mobile games generate almost twice the revenue of PC and Consoles combined.
  • Broadening of the Demographics. There’s a stereotype that the only people who play videogames are adolescent boys. The move to Smartphone gaming has seen games like CandyCrush, and Words with Friends effectively raise the average age of users to around 35. Additionally, women now make up almost 50% of overall gamers.
  • Evolution of the business model. Initially, game designers pursued a traditional software purchase model with dollars paid upfront. More recently, free-to-play games which have no upfront costs but use in-game purchases (for decorative items like skins), known as “microtransactions”, to generate revenue. Microtransactions accounted for four out of every five dollars spent on digital games in 2019 thanks to strong performances from mobile games like Candy Crush Saga, Honour of Kings and Fortnite. 
  • Geographic trends. More than two-thirds of digital gaming revenue is generated in Asia. The increase in affluence in China and Emerging markets is another key driver of continued growth.

Australia’s largest gamer

There is a dearth of investment options for Australian investors in this space. If we exclude microcaps (under $50M capitalisation), the only real candidate is Aristocrat (ASX:ALL). 

Aristocrat provides entertainment from casino-themed games such as Vegas Penny Slots or adventure games such as RAID: Shadow Legends. These are free to play but make money through in-app purchases. This shift to digital games now generates around 40% of its revenue. Recent comments from Aristocrat indicate revenues are up 20% due to COVID restrictions.

What is a gambling company doing developing games? Interesting that you should ask. 

As I mentioned, a key driver behind the explosion in gaming revenue has been through freemium games, those that are free to play. Some examples of how these work:

  • Fortnite is the world’s most popular game. Ask any 11-year-old boy (and increasingly girl) if you haven’t heard of it. Fortnite makes money from selling skins (different looks for characters) that have no impact on the gameplay. In other words, you pay to dress-up your avatar. In 2019 Epic games made USD 1.8b in revenue from Fortnite. Before the COVID lockdown.
  • Counterstrike is similar. Knives that look different, but make no difference to gameplay sell for hundreds and sometimes thousands of dollars.
  • Candy Crush is one of the most popular games for phones, with a higher number of women players. It is free to play, and you can share your progress with friends. And then you can pay to advance levels more quickly than you might be able to do through skill alone. 
  • Clash of Clans is another popular phone strategy game where you design a base which other players will attack, and you in turn attack theirs. Again, you can pay to advance levels more quickly than you might be able to do through skill alone.  

The mechanics of getting paid as a game developer in this area is not dissimilar to the mechanics of getting paid as a poker machine developer. The longer you can get each player to play, the more money you are likely to get. Additionally, the majority of your customers earn you almost nothing, and a much smaller number deliver you most of your revenues. And just as importantly, the basis of gameplay is psychology. How to keep the player in the goldilocks zone: not so easy that they get bored, not so hard that they get frustrated. And how to space out the dopamine shots through rewards to keep the gamers gaming.  

There is (disturbingly?) a lot closer links than you might think between gambling and gaming.

How else can you access gaming stocks in Australia?

esports growth  

Source: Newzoo

 At the microcap end of the ASX market, several companies offer exposure to the gaming landscape. However, most of these are at a very early stage and are capital hungry. They should be regarded as options/ venture capital stage opportunities, not dissimilar to listed biotechs, where the risk to capital is high. i.e. you are more exposed to the success or failure of an individual game than you are to the growth of the entire industry. We only invest in large caps, so I haven’t looked at these companies in any detail:

    • iCandy Interactive (ASX: ICI) Mkt Cap $9M: Development and publishing of mobile games and digital entertainment for a global audience. iCandy Interactive runs a portfolio of mobile games that are being played by over 350 million mobile gamers.
    • eSports Mogul Asia Pacific (ASX: ESH) Mkt Cap $29M: An esports media & software business with an initial focus on Australia, Asia and Latin America. At the core is an esports tournament and matchmaking platform, Mogul. 
    • Emerge Gaming (ASX: EM1) Mkt Cap $23M: an eSports tournament platform and lifestyle hub Arcade X.
    • SportsHero (ASX: SHO) Mkt Cap $6.6M: a social media company engaged in the development of real-time fantasy sports app and social prediction platform ‘SportsHero’. 

What about international gaming companies?

For a more pure-play exposure to this growth, investors need to invest in US-listed video game companies like Activision Blizzard, Take-Two Interactive, and EA.

For a more diversified exposure, you can get access through Sony, Google, Apple and Microsoft. All four of these companies have significant exposure to the growth of gaming. 

For a more targeted Asian focus investors could target some of the big Chinese stocks like Tencent Holdings. But buyer beware. There is political risk in these stocks, as the situation currently unfolding with TikTok highlights.

With global COVID restrictions, all of these companies have seen significant share price appreciation since the March lows. 

The pure-play stocks generally rate well on our quality or growth criteria but look expensive to us on our value criteria. So it becomes a question of how much do you pay for growth?

What does Nucleus own?

Our philosophy is to purchase quality companies at the right price. I.e. we will pay a little extra for high-quality companies, but average quality companies need to be cheap. 

Quality Value Tradeoff

We do own the diversified names such as Sony, Google, Apple and Microsoft – although we have been lightening our exposure recently.

In Australia, we have exposure to Aristocrat, but internationally the pure-play gaming stocks look too expensive for my tastes. We want to buy them but can’t justify the current prices. In a market pullback, these stocks are high on our shopping list.  

Make no mistake, there is a generational shift underway. The average age of an eSports viewer is 23, the average soccer fan is 42. eSports viewers tend to be richer and better educated than non-viewers. It is an interesting market segment.

 

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Damien Klassen is Head of Investments at the Macrobusiness Fund, which is powered by Nucleus Wealth.

Follow @DamienKlassen on Twitter or Linked In

The information on this blog contains general information and does not take into account your personal objectives, financial situation or needs. Past performance is not an indication of future performance. Damien Klassen is an authorised representative of Nucleus Wealth Management, a Corporate Authorised Representative of Nucleus Advice Pty Ltd – AFSL 515796.

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Comments

  1. darklydrawlMEMBER

    Great article. Thanks for the investment overview in this space. A ETF covering some of these platforms would be ace.

    Whilst on games. Roblox would be another massive money maker – although it is a platform that you makes games on, rather than a specific game itself. A huge number of kids use it for gaming, social interaction, entertainment and making money and just haning out with each other – (talking 7-17 year olds mainly, so younger kids and early teens) – it has it’s own currency (Robux) that you can buy with real money. There is a whole market place where you can buy digital tools/outfits/weapons et al to use/trade on the platform.

    • I wonder whether all these competing games are going to dilute the market or whether the youngsters will just continue to channel ever more money into these games rather than say getting drunk at the pub or buying and maintaining an old car or any other such distraction.

      Heard more depressing stories on the weekend of teens and twenty somethings hooking up on Tinder rather than establishing meaningful relationships. Perhaps that generation will End up having a fairly solitary existence in front of a screen with the odd break for a Tinder bonk.

      • I think there is going to be a massive pullback from parents and kids about mobile phones and their social media apps and games. The social cracks are starting to show and its causing a lot of pain in many families.

          • Some won’t be cured. It’s going to be really hard for a lot of families.
            The best way is always prevention but if you already hooked then it’s cold turkey.
            If a major reset happens, i.e. the tech bubble bursts and craters like in dot com, then I think some of it will naturally subside a bit. We are peak fake, peak narcissist, peak obnoxious at a time where fame and fortune is deemed easy to get and if you haven’t got it you are a looser. Those things tend to get exposed when the veil is lifted.
            I just can’t believe the amount of stories I here from family and friends that have very serious issues with their teenagers on social media and access to material that we once though was unthinkable.
            FYI, watch the documentary “The Century of the Self” by filmmaker Adam Curtis. It was done in 2002 and pretty much outlines how we got to where we are today with astonishing predictions about today, 18 years after the film was made.

          • FYI, watch the documentary “The Century of the Self” by filmmaker Adam Curtis. It was done in 2002 and pretty much outlines how we got to where we are today with astonishing predictions about today, 18 years after the film was made.

            One of the great series…..
            Also note ‘Hypernormalisation’

            It isnt just about kids spending time on computers. It is about whole societies being gamed via their politics being turned inward and against government enacting policy to shape economies – all the while the 1% get richer

        • The UsurperMEMBER

          I imagine my generation (mid 20’s) may end up being quite strict with phone/computer/gaming usage since we have first hand experience with the effects. Whereas older parents don’t quite understand the technology.

          Well, I’ll be strict anyway haha

  2. I don’t really look into the gaming sector but just check out activision, ea and take two.
    Pretty nasty charts. 2 of them have a nasty 2-year double top pattern.
    What type of pullback are you guys thinking before you jump in?

  3. darklydrawlMEMBER

    Turns out that an ETF for Video Games we released just days ago on the ASX (10-Sept-2020).
    https://www.vaneck.com.au/etf/equity/espo/holdings/

    “ESPO gives investors exposure to a diversified portfolio of the largest and most liquid companies involved in video game development, eSports and related hardware and software globally. ESPO aims to provide investment returns before fees and other costs which track the performance of the Index.”

    • Damien KlassenMEMBER

      The VanEck Vectors does give you convenient access to global stocks, with some exposure to the gaming sector. But also check what you want it for as it has a relatively high weight to chip manufacturers which may or may not be what you are looking for.

      • darklydrawlMEMBER

        Thanks Damien – appreciate your insight here. I did look at the company breakdown in their PDF earlier this morning and noticed exactly that – You are correct in that it is not exactly the sectors I was originally thinking. Even so I might throw some coin at it as I feel has potential for decent growth.

  4. Well I just started playing Fortnite last week, just to see what it is all about as my 11 and 12 year olds play it all the time. I am still pretty ordinary but recorded my first k*lls the other day – high score is 2 and coming 2nd in a battle royale. A long way to go to replicate my career best form (on a Coleco Vision – NSW State Finals in the early 80s).

    On an investing note I’d agree bigger is less volatile. For folks exposed to a single game where has angry birds gone? It was everywhere a few years ago and the kids were massively into it – maybe they have just got older but I don’t think it has gone that well. Would be interesting to see what Rovio (the developer) has done since then …

    • … and I just checked. Rovio looks to have had an Euro 11.50 IPO in 2017. Traded up to 12 for a little while but is now trading at Euro 6.24 – although got down as low as Euro 3.12 in March this year. So it has doubled this year but had you bought in any time before that you are probably sitting on a book loss.

  5. What about VR gaming? Headsets now are only in a relatively small percentage of overall gamers, but the rise is exponential, the experience is so much better, the tech is advancing rapidly and the use cases go far beyond just gaming (for example fitness).

    • Yep. We are getting an Oculus for Xmas in our household. Our cousins have one (they are always tech early adopters) and we played it last time we went over. It was absolutely amazing.

    • VR and Augmented reality are the future. Half Life: Alyx is a watershed title and it’s only up from here particulalry in the FPS genre.

      The godfather of Tekken (one of the big 3 fighting game franchises with street fight and mortal kombat being the others) Katsuhiro Harada was interviewed recently that they are already in development to integrate VR into the fighting genre.

      Other trend is now games are being updated constantly and add on packs etc have to be continually purchased. That’s where the growth is.

    • As VR becomes better, that is what I predict will break any tenuous hold on reality our addicts will have. And why not? It is a seductive vision, your tasks are all within reach, success can be yours for the taking, your body can be amazing, and you can make a fortune (with in-game currency). A whole transformative immersive experience can be created with VR soon. For many it will be irresistible, consuming time and effort that can never be replaced.

      It was 10 or 15 years ago a friend almost got me hooked on Eve Online. He had built a huge capability in game. I pottered around for a few weeks and realised just what a huge time commitment it took. It has its own vocabulary and deep technical knowledge to fit out various ships. If he had spent half that energy being better at his profession, he would have reaped huge real-life rewards. I now potter with the occasional game that won’t be addictive and time-consuming. The same cannot be said of my audio book collection, however.

  6. Dunno if the gambling analogy holds universally across the industry. You’ve also got very successful developers like CD Projekt who primarily focus on quality products and experiences with deep narratives, not cheap sugar hits.

    • Agreed, their Witcher 3 is one of the best “grown up” games of all time. I’d put the Red Dead Redemption series and Skyrim in a similar pool of deep, complex, long lived games that have made a fortune for their respective companies. There are definitely many different styles of gaming out there. The eSports world is aimed at specific types of games that suit their format.

      Fortnite’s creator Epic is probably not a good one to invest in right now as they have decided that taking on Apple & Google at the same time in a fight over revenue split is a good idea. That will be an interesting legal fight to watch for investing implications for the industry.

      • darklydrawlMEMBER

        Keep in mind that “Fortnite” is a nice side hustle for Epic Games who make (by far) most of their money from the “Unreal Engine” which is the “go to” cutting edge graphic engine for many different commercial and industrial domains of which gaming is merely one of them. The unreal engine is deeply embedded and respected in many industries outside of the gaming space.

        https://www.unrealengine.com/en-US/

        On a side note, Epic also own “house party” – the phone app that had a surge in popularity during lockdown – again, petty cash to them.

        Even if Fortnite was closed down tomorrow, Epic would be fine. The Fortnite income is nice play money for them and Fortnite is a great advert for the Unreal Engine, but they don’t need Fortnite to survive at all.

  7. I’m still enjoying playing Star Raiders on my Atari 800XL. This game was published in 1979 and is still challenging and enjoyable today. Atari had the home console market (well 70%) of it in 1981 and over $1B of revenue. Within a few years, the whole games market had collapsed, too much US made crap (Pre Nintendo/Sega) I wonder if we will ever have a repeat of that these days?

  8. Games like Grand Theft Auto and Fornite represents a totally different market. The former is akin to a very long movie, the later is akin to gambling : that’s what loot boxes are. Some of the players will spend $$$$$ to get the item they want.

    Aristocrat and eGambling should be a natural fit, but the competition is immense. It cost 700 million and 5 years to developer a game like Red Dead Redemption 2, and made over 1 billion dollars in revenue. A game like Fate Grand/Order took less than 2 year to make, cost a few million dollars to make, and revenue just past 4 billion dollars. If you’re investing in the market : you can’t go by the usual investment metrics : you must play the game in alpha/beta.

  9. You have to know your stuff when it comes to games, sure the bigger the publisher/developer the safer it could be but generally the bigger they are the more they start to lose their drive for making games outside of profits and can make incredibly poor decisions as per the blizzard fiasco which tanked their stock. Mobile casino games attract a lot of older business types and require them to produce actual games to tap into younger markets, raid also got their name out there by becoming a meme through sponsoring every YouTuber under the platform which was only amplified when it hit meme status and people would pretend to be sponsored by them when they werent.

  10. IMO google will be the winner here. streaming (nearly) eliminates hacking (cannot deploy hacks from the client). Hacking is actually still the biggest issue holding back e-sports. It breaks belief in all current esports; compound the fact everyone is cheating – with the fact it’s a digital (not real) sport. it can’t move forward. this is why streaming gaming is the true future of eports – Google currently in the lead there.

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