Investors’ guide to the world of online gaming

Following on from the success of the film streaming business model, the meteoric rise of cloud-based video game streaming has breathed new life into the gaming industry, uncovering a wealth of opportunities for investors with a taste for tech.

Increasingly sophisticated product offerings have seen millennials progressively choosing gaming over mall trips and movies for entertainment. But, contrary to stereotypical perceptions of gaming as an anti-social activity carried out in dark rooms or dingy arcades, online gaming has become something of a social and cultural phenomenon.

Recent advancements in internet speed, which improved by 23% between 2017 and 2018 alone, means that gamers are now able to join global communities of like-minded individuals and friends, and engage in a vivid battle royale with players around the world from the comfort of their own home – all without experiencing any package losses or delays. As an added benefit, gamers can simultaneously chat with each other in real-time, sharing a rewarding digital experience without any of the awkward silences and pauses that characterised early Skype conversations.

And it is this very networking effect that continuously attracts new users, driving rapid uptake and market growth. According to market research company Newzoo, there were as many as 2.2 billion active gamers at the end of 2018, and this number is expected to grow to around 2.4 billion by the end of this year.

Additionally, growing emphasis on games optimised for mobile devices rather than traditional gaming consoles has attracted new audiences across multiple generations, who are drawn to the convenience of playing while completing daily activities such as traveling, waiting in reception areas or queuing.

Thus, while video game console sales have steadily dropped over the past ten years, the global market value of the cloud gaming industry soared by 46.67% between 2017 and 2018 alone, climbing from $45 million to $66 million within twelve months. And according to some market estimates, this figure could reach as much as $450 million by 2023.

Source: Statista (2019)

Source: Statista (2019)

The online gaming industry also exhibits other attractive features for investors, including:

Effective distribution models: Companies in the industry enjoy the benefits of an extremely simple, cost-effective distribution model. Where gaming companies previously had to print physical discs and distribute them to resellers, users can now stream or download products online, transforming the nature of these companies into highly scalable businesses that are able to advertise and reach markets globally, although effectively only distributing from one location.

Greater monetisation: Advancements in data analysis and processing have enabled creators to better monetise games through an enhanced understanding of in-game purchasing behaviour, enabling businesses to optimise their content and maximise profits. And any new digital items or looks need only be created once before being sold to all existing consumers – another key benefit of the digital distribution model.

High barriers to entry: Barriers to entry are quite high, as online games are becoming increasingly expensive and complex to develop, offering existing firms some protection in terms of revenue and value. Likewise, mobile gaming is following a similar trend as mobile games steadily become more advanced.

So where to start?

The biggest risk of investing in gaming companies is that revenues are often dependent on one or two popular titles, or on the release of new titles, as rapidly changing technology means that games can quickly become obsolete. Investors should therefore rather consider larger companies whose revenues are diversified across several titles.

Within this space, Activision Blizzard (ATVI) and Nintendo emerge as strong contenders for further consideration, with healthy balance sheets, well-established gaming franchises and strong prospects.

Activision Blizzard

ATVI, home of the popular Call of Duty series, sells 75% of its content digitally, and boasts nearly 500 million active monthly users across 196 countries.

The company already employs some 9,000 individuals, and in February it announced plans to grow its development team by some 20% over the course of 2019 in order to speed up the release of games and updates.

The company currently has five key divisions, namely:

Activision: Develops, distributes and publishes immersive, interactive entertainment software for gaming consoles, mobile and tablet platforms, and PCs, including blockbuster franchises such as Call of Duty® and Skylanders®.

Blizzard Entertainment: Develops, distributes and publishes some of the most iconic entertainment experiences in gaming, such as World of Warcraft®, StarCraft®, Diablo®, Hearthstone®, and Heroes of the Storm™, also for gaming consoles, mobile and tablet platforms, and PCs.

King Digital Entertainment: Creates leading interactive entertainment for the mobile world. Host to more than 200 fun titles, King's franchises include such names as Candy Crush®, Farm Heroes®, Pet Rescue®, and Bubble Witch®.

Major League Gaming: ATVI’s professional esports gaming league and platform.

Activision Blizzard Studios: Produces film and television content from ATVI’s IP.

ATVI’s stock came under some pressure earlier this year following the announcement that it would be ending its partnership with Destiny developer Bungie (which acquired full publishing rights to the hit game), as well as over fears regarding strong competition from Epic Games’ Fortnite. The company has also seen some churn in leadership, with the departure of two chief financial officers over the past year.

However, with a market cap of $36 billion, ATVI remains a formidable player and market leader in the industry, with a long track record of successful titles and IP, and capable leadership in the form of experienced chief executive officer Bobby Kotick. And while revenues are somewhat volatile owing to the release of games in certain years and updates in others, the company’s profit margins are high and stable, and are expected to remain so.

ATVI’s return on equity (ROE) stands at 16.4%, with a dividend yield of 0.8% and a price-earnings ratio (non-GAAP) of 17.4 on a trailing 12-month basis.

Nintendo

From somewhat humble origins as a playing cards manufacturer, gaming giant Nintendo is now a globally recognised household name, with an impressive history spanning some 140 years.

The company manufactures software, such as the Super Mario Bros franchise, and gaming consoles such as the Wii and Nintendo Switch devices, which have received a particularly welcome boost over the past few years owing to China’s 2015 decision to lift the ban on the sale of gaming consoles.

Much like ATVI, Nintendo also experiences cyclical earnings related to game releases. However, two major game releases set for 2019 should not only drive revenue in their own right but are also expected to grow further demand for Nintendo Switch devices. These include the launch of Super Mario Maker 2 which hit shelves just a few weeks ago, and the eagerly anticipated Pokémon: Sword and Shield game due in November.

Nintendo has a market cap of some $50.1 billion and boasts a strong track record with a diverse array of hit gaming franchises, with a ROE of 14.2%, dividend yield of 2.2% and price-earnings multiple of 18.4 adjusted for cash.