The Growth of Video Gaming Could Be a Win for Investors

by | Mar 15, 2021

Few industries have benefited more from the COVID-19 pandemic than the videogame industry, or “gaming.” The pandemic has made gaming more profitable than the film industry and U.S. sports combined.  The question remains: can this trend continue?

In 2020, the global gaming industry reached a revenue milestone of over $180 million, up a whopping 20 percent from 2019. This exceeded the 2019 revenues of the global film industry by over $80 million. It wasn’t a fluke caused by the pandemic; gaming has been growing steadily for the past five years. Both new and existing companies are making investments in developing new hardware, gaming platforms, and new ways to play videogames.

The growth of gaming is a trend that we at FourThought Private Wealth believe can continue for 10 years or more. Why?

Gaming Appeals to Several Generations

The fact of the matter is that many people continue to consume the types of entertainment they enjoyed when they were 17 years old. Think about Baby Boomers buying classic cars, or Generation X attending rock concerts. It makes us feel good to relive our glory days through entertainment.

Therefore, we can’t assume that all gamers are teenagers or young adults. Today, the average gamer is around 38 years old. What’s more, in 2020 we saw adults aged 45-54 years old increase their time spent gaming by 54 percent. In addition, gamers over 60 years old are spending almost five hours per week playing videogames.

This suggests that as time goes on, the cohort of older gamers that began with the introduction of Nintendo in the 1980s (or even PONG!) will continue to grow. Not only will older gamers stick with it, but younger people are still being introduced to the new, constantly improving world of gaming.

The wide appeal of gaming has made it the dominant disruptor of the entertainment industry. It has changed the way we consume media and interact with others on a day-to-day basis.

Gaming Allows People to Connect and Socialize

More than just entertainment, gaming has also developed into a way to connect socially and spend time with friends—especially for the younger generations of gamers. Just 10 years ago, a young gamer didn’t have the option of “getting online” and playing a new game with five of his or her closest friends. But in today’s world, gaming has allowed friends to stay connected even if they are hundreds or thousands of miles away.

This new way of connecting is one of the major growth drivers for gaming. It makes gamers very “sticky,” meaning that even if we get through COVID and completely back to “normal,” as we were in 2019, there will still be an immense demand for videogames.

The Scale of Gaming is Enormous

Professional videogames (known as eSports) are becoming more and more popular around the globe, with high-level videogame tournaments seeing unprecedented viewership. Just last year, the League of Legends world championship had more viewers than the NBA Finals and Major League Baseball championship series. These games are commanding huge audiences and, as a result, major cash flow from advertisement deals and sponsorships.

Gaming Allows Viewers to Feel Connected to Their Favorite Players

Professional gamers also generate large audiences even when they are not playing for a major tournament thanks to YouTube and Twitch – platforms where gamers can stream to a live audience and interact with their followers. Having this connection between a famous gamer and his or her followers is extremely important for growth in gaming as a whole and is what sets gaming apart from traditional sports.

Playing with gaming professionals or interacting with them on a streaming platform is like being able to play football with Tom Brady, then asking him personal questions about his life. Many pro gamers interact directly with their fans using online chat functions or video blogs (vlogs). This, in the long run, is very important to game platforms and developers because it inspires regular gamers to play the games of their favorite celebrity gamers, and maybe even copy some of their patented moves.

Major Investors are Putting Big Money into Gaming

As another indicator of the gaming industry’s sheer scale, look again at the League of Legends’ North American Division.  Major corporations, deep-pocketed individual investors, and even professional basketball teams invested in 12 available franchise spots to participate in the league. The Golden State Warriors, Houston Rockets, even Drake were some of the more notable, each of whom wanted a share of their own team and were willing to pay millions for it.

Where are the Best Investment Opportunities in Gaming?

Gaming is a vast industry, with multiple suppliers and a complex infrastructure. Many of the players are poised to grow along with the industry itself. Where can investors find opportunity?  At FourThought Private Wealth, our investment committee uses a multi-step process to screen for companies that we believe are worthy of inclusion in our portfolios. Here are some of the ones we have identified.

Game Console Companies

Microsoft (XBOX), Sony (PS5), and Nintendo (Switch)

Last year was an innovative year for console producers as Sony and Microsoft released the latest generation of video game consoles in the PlayStation 5 and the Xbox Series X, both released near the end of the year. Demand for these consoles was so high that retail stores were and still are having trouble keeping any inventory. Online retailers are also finding it difficult to keep up with the demand.

The demand is so high that some individuals are writing programs to automatically buy as many units as possible, then reselling them through Facebook Marketplace with a huge markup. However, Sony and Microsoft are happy as long as their products continue flying off the shelves, and this pent-up demand does not look to subside anytime soon.

At Nintendo, their new console named the Nintendo Switch—a portable gaming console that can either be taken on the go or docked and connected to a TV—had a record year in 2020. Although the console itself was released back in 2017, Nintendo experienced the same supply and demand issues that Sony and Microsoft face today and could not produce enough games to meet the demand needs. However, in 2020 much of the supply issues were fixed as Nintendo was able to provide and distribute enough product for retailers and their online stores to allow customers to purchase the Switch on the spot. As a result, the Switch was the best-selling hardware gaming platform in both units sold and total dollars in 2020. In dollars, the Switch sales were the second highest for any gaming platform in U.S. history, eclipsed only by the Nintendo Wii in 2008.

The key takeaway is that there is an extreme misalignment in supply and demand for next generation of gaming consoles. As time goes on and supply chains improve, we should see big boosts in revenue for companies like Sony and Microsoft, much like we saw in 2020 with Nintendo.

Sony and Microsoft also own their own gaming studios, with licenses to specific games that will only be available on their respective consoles. Therefore, they can generate additional sales of software and subscriptions from customers already on their platforms—generating increased revenue with minimal to no extra cost. Over the long term this will allow the platform to experience economies of scale and expand profit margins and free cash flow.

All in all, while console sales are extremely promising for Sony, Microsoft and Nintendo, the greatest value comes from the networking effects these companies can demonstrate once they bring consumers onto their platform. This will not only drive revenue but will also be a major attribution to expanding margins for the gaming business sector.

Personal Computer (PC) Components

AMD (producer of CPU and GPU)

NVIDIA, Intel, and Corsair (keyboards and mice specifically made for gaming)

While console gaming dominated the headlines in 2020, the PC gaming market is still very big and growing at a similar rate. The main difference between PC and console gaming is that with a gaming console, you are ultimately bound to the components that Microsoft or Sony include when you make a purchase—you can’t upgrade them in the future. Most people know that videogames have improved tremendously over time in terms of graphics and quality. With console gaming, it is difficult to keep up with these changes without purchasing an entirely new console. With PC gaming, however, it is possible to build and upgrade the components at any time.

This constant need for upgrading components helps companies like AMD, NVIDIA, Intel, and Corsair continue to grow their revenue each year.

Game Developers

Take-Two Software (TTWO), Activision (ATVI), EA Sports (EA), and Tencent (TCEHY)

Game developers are the ones who build the software for videogames. Just a few years ago, these companies were tasked with harsh deadlines to put out new games regularly and sell them from $30-60 per game. Today, they have several other revenue models and streams. They can make money from in-game purchases, add-on downloadable content for their existing games, advertisements from tournaments, and—to a lesser extent—merchandise from characters in their games.

In-game purchases happen when a gamer buys content in the game itself to further customize a character. As an example, Fortnite (the popular first-person shooter owned by Epic Games & Tencent) gamers can purchase different character or weapon “skins” that allow customization of the way characters look and even dance. In-game purchases are a major revenue driver for many games.

Game Platform Companies

Sea ltd (SE), Microsoft (MSFT), Unity (U), Google (GOOGL)

Gaming platform companies can generate revenue from game developers to allow people to play on the platform, they can charge monthly fees for subscription services, or in the case of Unity – they can be the platform that the majority of game developers use to create their games.

What is a gaming platform? Think of them as the “Netflix” equivalent for video games. Both Sony and Microsoft have gaming platforms or apps where the customer can pay a monthly subscription fee and access a whole library of games. This is a win-win as Sony and Microsoft are now able to generate consistent, recurring revenue from subscribers and consumers can easily gain access to hundreds of games without having to buy each game separately.

Google is also working on a gaming platform through their “Google Stadia” which is essentially cloud gaming. The overall goal of Stadia is to be exactly like the Netflix app, making a console unnecessary and allowing consumers to game right from their smart TVs. This technology is far from perfect as latency and other major issues still need to be solved.

Deep Research is the Key

Even though we are bullish on the gaming industry as a whole our team at FourThought employs a strict fundamental research process whereby we typically only invest in a company if it meets the criteria set forth by a given strategy. We vet each prospect using a series of tests and analyses to ensure the company has strong growth prospects, maintains stable fundamentals, and has good management.

Key Sources:

https://www.barrons.com/articles/videogame-stocks-are-multiplying-how-to-play-the-boom-51611353045

https://www.marketwatch.com/story/videogames-are-a-bigger-industry-than-sports-and-movies-combined-thanks-to-the-pandemic-11608654990

https://www.inc.com/darren-heitner/watching-video-games-is-now-bigger-traditional-spectator-sporting-events.html

This blog is for general information and educational purposes only and must not be considered investment or planning advice. Such advice is tailored to your individual situation and objectives. All investments involve risk. 

Jake MacFarlane is an Associate Analyst at FourThought Private Wealth.

 

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