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In the seventh grade, I played video games all night long and never suspected that later I would be assembling an investment portfolio of stocks from the publishers of those games.
Video games attract both gamers and financiers. Some, naturally, pursue new sensations, while others pursue profit. Some manage to combine these roles. But even today, a number of investors are only beginning to discover this rapidly growing world.
In the article, I will show what this world is made of and present a few investment ideas.
The emergence of industry
The first interactive entertainment appeared in the 1950s, but games started to make money in the 1970s when Atari released the first commercially successful video game called Pong, an electronic ping-pong on arcade machines. Soon after, Tomohiro Nishikado developed Space Invaders, a familiar arcade game where you need to shoot aliens that are coming down from the top of the screen. Finally, the well-known Pac-Man was released.
At some point, the share of games in the entertainment industry equaled that of cinema. For a long time, arcades were the main driver of industry growth, and over time, games began to appear at home – with the release of the first consoles. But, like any young market, the gaming industry had to go through a powerful crisis in 1983.
The turnover was increasing at a dragon’s pace — and everyone around was paying attention to it. This led to the fact that everyone wanted to make money on games – even producers of dog food “Purina”. The quality of the product didn’t matter to anyone- publishers were releasing low-quality cartridges one after another. It was difficult to find anything decent on store shelves.
By 1983, the American market was flooded with low-quality games, and at some point, the bubble burst – a year before, American developers’ income plummeted by 97%.
A huge niche was freed up, which was captured by the Japanese Nintendo – there was no crisis in the industry in Japan. The company has established a strict policy: all games developed by third-party studios had to undergo quality control. This helped Nintendo capture 70% of the market, which under its patronage by the beginning of the 90s had grown 20 times.
The rapid development of computer technologies in the 90s affected the gaming industry, which led to the emergence of new companies on the market. At first, Sega competed with Nintendo, and later Sony with its PlayStation consoles and Microsoft with the Xbox series joined the competition.
At that time, many iconic franchises were born: Super Mario Bros., Crash Bandicoot, Halo, Grand Theft Auto, Mortal Kombat. The computer game market was not lagging behind: strategies were developed there – Warcraft, “Heroes of Might and Magic”, role-playing games – Fallout, console games were adapted for computers. Then, many of the largest modern game studios and companies were also born: Electronic Arts, Ubisoft, Activision Blizzard, and others.
Since then, a lot has happened in the industry, but it’s not so important for understanding the structure of the current market – it’s enough to know how the industry is structured now. Therefore, in the following, we will focus on how gaming companies operate and what they earn from.
About the industry
Currently, the video game industry is typically divided into four main segments by platforms.
Console gaming is the creation of video games for stationary and portable consoles: PlayStation, Xbox, Nintendo. The main sources of revenue are physical and digital copies of games, add-ons, seasonal subscriptions, and microtransactions. To attract users, console manufacturers often sell consoles at a loss at the beginning of their life cycle, but this is compensated by royalties: companies retain a percentage – usually the standard 30% – of digital game sales on their platforms.
PC gaming involves the release of games on computers. Consoles have a larger audience, but many still prefer to use computers, especially in countries where consoles haven’t gained popularity due to low income populations in the past, like Eastern Europe, Russia, China, and South America. Moreover, a number of exclusive games are released on PC that cannot be found on consoles.
Mobile gaming is the development of video games for smartphones and tablets. Most games on phones are free, so developers earn money from advertising and aggressive monetization of content – through subscriptions and donations. Currently, mobile gaming brings in the most money in the industry, because development costs are relatively small, and the audience sizes are colossal – up to half of the world’s population, including people who would never call themselves gamers, play them.
Cloud gaming is the ability to play video games on any computer or phone thanks to the transfer of computational loads from your device to a remote device. It is a promising industry that is developing stronger each year thanks to the acceleration of the internet.
The gaming industry is based on three main monetization models: free-to-play, pay-to-play, and services.
The idea of free-to-play is that there is zero cost to acquiring a video game: developers earn money through advertising and microtransactions. Often, microtransactions, or donations, are aggressively implemented – for example, a player cannot pass a level until they buy powerful armor for real money. However, lately donations are limited to just cosmetic items, such as nice clothing or a skin for a weapon.
Most often, free-to-play is applied in mobile gaming and on computers, but there is usually no advertising on PCs. This model is the main driver of the growth of such gaming companies’ shares as Tencent, Roblox, NetEase, and MTG.
Pay-to-play is a model currently used by developers of computer and console games. The user purchases the final product, in which there is no need to buy anything additionally. However, in recent years, companies have been adding microtransactions to paid games, as they account for up to 70% of the total revenue – much more than the sales of the game copies themselves.
Services are games that are distributed through a monthly subscription rather than a one-time purchase. To motivate players to renew their subscription, developers update and supplement the product with new content for several years. In recent years, developers have increasingly moved away from the subscription system.
But the service model came in handy when creating subscriptions similar to Spotify and Netflix, but with games – such as Xbox Game Pass and EA Play. Instead of a one-time product purchase, users get access to huge libraries of various projects for a small monthly fee.
And here again games-services came in handy: now they help motivate extending “big” subscriptions. Companies believe in this model, and for good reason: forecasts promise annual growth of the subscription market.
Market size and main trends
According to the consulting company Newzoo, the gaming industry has been steadily growing over the past six years: in 2014, the market volume reached about 84 billion dollars, and by 2020, it had already reached 179.4 billion dollars. Analysts believe that by 2023, the volumes should exceed 215 billion dollars.
The size of the video game market.
| Year | Video game market volume, billion dollars |
|---|---|
| 2018 | 138,8 |
| 2019 | 146,2 |
| 2020 | 174,9 |
| 2021 | 189,4 |
| 2022 | 203,3 |
| 2023 | 217,9 |
In 2020, the mobile and console segments showed significant growth: the first grew from $77.2 billion in 2019 to $86.3 billion by the end of 2020, and the second – from $45.2 billion to $51.2 billion. Computer and browser games showed not the strongest growth: the segment’s volume grew only from $36.9 billion to $37.4 billion.
The most gaming countries remain China and the US. They account for 49% of the gaming industry revenue – 85.3 billion dollars.
Distribution of monetary volume by regions, billion dollars
| Region | Monetary Volume (in billion dollars) |
|---|---|
| China and South Asia | 84.3 |
| North America | 44.7 |
| Europe | 32.9 |
| South America | 6.8 |
| Africa and Middle East | 6.2 |
The main growth drivers in 2020 were mobile games, the pandemic, and the new generation of consoles: PS5 and Xbox Series X/S. The pandemic did not turn the industry upside down, but only accelerated it. People around the world saw video games as an opportunity to escape from the COVID-19 reality, spend time with friends online, and immerse themselves in the world of narrative games.
In 2021 and 2022, mobile games will not be the only key driver in the industry. The pandemic has led to certain difficulties in the production of gaming consoles and the development of video games: there is a shortage of necessary components for production. In addition, gaming studios have had to slow down the development of new games and switch employees to remote work. Gradual solutions to these problems will increase console sales and accelerate the development of video games, which in turn will boost the growth of gaming companies, according to analysts from Bloomberg and Newzoo.
Analysts believe that the number of gamers will increase from 2.69 billion to 2.8 billion in 2021 – this includes anyone who plays games in any way, including mobile gamers. The video game market will reach revenue of $189.4 billion by the end of 2021. The majority of growth will come from developing markets, where more and more people are purchasing smartphones and gaming consoles due to rising incomes and lower prices for old-generation consoles. By 2023, the number of gamers in the world will reach 3 billion. The average growth rate of gamers will be +5.6% from 2015 to 2023.
| Year | Number of Gamers (billion) |
|---|---|
| 2019 | 2.55 |
| 2020 | 2.69 |
| 2021 | 2.81 |
| 2022 | 2.95 |
| 2023 | 3.07 |
The margin of profit for developers and publishers will increase. In 2020, publishers raised the base price of high-budget games from $60 to $70 – for the first time in 15 years. Companies attribute this to the rising cost of development when transitioning to a new generation of game consoles, although there were no direct indications of this: the cost of creating games is growing more slowly than the revenue of publishers. Mostly, the changes affected AAA games targeting million-dollar sales and the mass audience. Grand Theft Auto V, the FIFA game series, and Battlefield are examples of such games. Higher game prices, along with the transition from physical copies to digital content, will increase the margin of profit for both game developers and console manufacturers.
According to Newzoo’s forecast, the cloud gaming market will reach a volume of $1 billion by the end of 2021. The market growth is explained by the spread of 5G, increased computing power, and Microsoft’s xCloud service for cloud gaming. By the way, starting from September 15, 2021, thanks to xCloud, Android users will be able to play cloud games included in their Xbox Game Pass subscription. There are also competitors to this service: GeForce Now, Google Stadia, PlayStation Now, and others.
Investors want cloud gaming to be built on ecosystems that bring together different game publishers. In this way, ecosystems will be able to offer subscriptions in the future, providing access to a wide range of games. Microsoft plans to collaborate with key cloud companies and major game developers. Currently, analysts from Newzoo believe that the market volume will reach $4.8 billion by 2023, which prompts attention to be paid to this development vector.
Gaming subscriptions are another driver of the video game market. In Western countries, gaming subscriptions are in high demand due to the consistently growing library of games and low prices. Investors also like gaming subscriptions because they increase the predictability of cash flows for gaming companies, whose financial results depend more on the release and success of a new game than on the macroeconomic situation. In addition, gaming subscriptions contribute not only to long-term revenue growth, but also to the development of independent game studios.
The esports industry is one of the fastest growing and high-margin industries in the world. It generates significant revenues and attracts the attention of tech giants. Hundreds of millions of people follow the action and tactical geeks in virtual battles. Esports matches already gather more viewers than baseball, hockey championships, basketball, and some elite European football leagues.
Esports is promising thanks to the intersection of three highly profitable industries: sports, entertainment, and technology. All of this allows for the transformation of the industry into a powerful and highly profitable ecosystem with a multitude of players. The industry itself is growing rapidly mainly due to the increase in the number of gamers and high audience engagement. Popular online games have relatively low system requirements and can be installed on almost any modern computer.
Unlike football, esports has not yet fallen under the influence of bureaucrats and government institutions, allowing major game and gaming accessory manufacturers to turn this sport into a powerful business. Most esports events are funded by gaming companies, hardware manufacturers, and even bookmakers. Sponsorship contracts and broadcasting rights are the main source of income for independent organizers and high prize winners. For example, the prize pool of the Fortnite World Cup is $30 million. /invest-in-future/ Experiment: investing in future technologies.
According to Newzoo’s estimates, the revenue of the esports industry will grow from $947.1 million to $1,084 million from 2019 to 2021. 75% of the annual revenue in 2021 will come from sponsorship and broadcasting of esports competitions. Newzoo analysts predict that the revenue of the esports industry will reach around $1.617 billion by 2024, and the audience will increase by 10.1% to around 728.8 million. The most important market for esports is China, which accounts for approximately 25% of the entire industry’s revenue. Following China is the United States, together they generate about 50% of the industry’s revenue.
It is difficult for private investors to invest directly in esports: the industry is very young and the entry threshold into an esports company is quite high. One can invest in a local esports team and hope for a certain portion of the profits, but such a bet is extremely risky. A more reliable way is to invest in a gaming-themed ETF, mainly specializing in esports, and stocks of companies working in this industry, which we will discuss below.
WHAT YOU NEED TO KNOW
Sector volatility
The video game industry is one of the most rapidly growing and promising markets in the world. Although it may seem that gaming company stocks are constantly showing strong growth, this is not always the case. The dynamics of a gaming company’s stocks are more closely tied to new products and the number of users than to macroeconomic situations. A failed release of a new game can easily plummet a company’s stock prices.
In November 2017, Electronic Arts shares fell by 8.5% due to the scandal with in-game transactions in the paid game Star Wars Battlefront II. More financially capable players easily leveled up key characters in the game, giving them an advantage over regular players, and it was practically impossible to strengthen their characters without donating. In short, people bought the game and then had to invest money in the game to access cool heroes and weapons. As a result, EA had to completely change the character leveling system, and donations can now only be used to purchase cosmetic accessories. /guide/volatility/ What is volatility on the stock market?
It is impossible not to mention the unsuccessful launch of the game Battlefield V, which caused the company’s shares to drop for three months. It’s simple: the storyline campaign of the game partly did not correspond to historical reality, and many players saw more propaganda of new ethics in the new part of Battlefield than a revolutionary shooter. The company’s sales expectations were not met, and the shares went down.
It is also important to remember that large investors and funds consider digital entertainment industry securities to be extremely risky. Therefore, there is a high probability that investors will primarily dump stocks of gaming companies during a downturn or prolonged economic crisis.
In addition, investors find it difficult to translate the gaming success of a studio into financial language. A truly high-quality game doesn’t always make investors increase their investments in the company. The product must justify the developers’ high costs and bring them substantial income. Here, investors encounter a serious problem: neither gaming studios nor major investment banks are able to accurately and timely forecast the cash flows of gaming companies, which increases the volatility of the sector as a whole. The reason for this is the opaque process of game development and unrealistic forecasts by gaming companies.
Due to this, Polish gaming studio CD Project’s stocks partially dropped at the end of 2020. Investors had high hopes for their game Cyberpunk 2077. Although the game broke several records, the studio’s stocks continue to fall to this day.
The reasons for the fall are predictable. Firstly, gamers’ expectations of the game were too high: there wasn’t as much cyberpunk in the game as they wanted, and the release itself came with a series of agonizing bugs and crashes. Secondly, the game’s graphics looked terrible on old generation consoles – we’re talking about the PS4, Xbox One and a potential hundred million players who ultimately didn’t want to spend €60 on a game with terrible graphics and lots of bugs. The shortage of new generation consoles also played a role. All this led to a drop in game sales, which turned out to be significantly lower than investors expected.
In April 2021, the company decided to adopt a new development strategy and release a patch to fix bugs in the game, but ambitious plans did not have the expected effect: stocks fell by 15% and are traded at the 2019 price level.
All of the above allows us to make an important and eternal conclusion.
Remember about diversification. Don’t invest all your capital in one industry – not even half of it. The video game industry is incredibly volatile and carries great risks. No game developer can survive the failure of a released game without serious financial losses. It’s always important to remember about diversification and rational allocation of investments in various assets.
Small and medium-cap companies are growth leaders.
More often, small and medium-sized gaming companies are European and Asian underestimated and fast-growing producers of mobile and indie games, oriented towards the international market.
Papers of such companies are attractive for several reasons:
- They have a powerful potential due to the distribution through app stores, increasing audience and revenue growth in the near future.
- Mobile gaming is a fundamental driver of the industry. More and more people worldwide are purchasing smartphones, and the number of gamers is steadily increasing. Mobile game publishers and app stores are the main beneficiaries in this case.
- It is difficult for major players such as Electronic Arts, Ubisoft and Activision Blizzard to redirect resources and developers from console and computer games to mobile development. Most of their mobile releases have failed or do not generate the expected revenue. This is why investors are eagerly investing in small and medium-sized companies, as they dominate a large part of the market.
As an example, I will cite the Singaporean mobile game producer Sea Ltd. The company went public in late 2017, and since then its stocks have grown by about 1400% due to its successful business model and partnerships with tech giants. Although such stock dynamics may seem speculative, the revenue growth of the Singaporean company amounted to almost 200% in 2019 and about 178% in 2020. /index-weights/ How to weigh a stock portfolio by market capitalization and sectors.
Most of the revenue came from the high-margin gaming direction. In addition, the company has healthy finances: there are free cash flows, and capital is growing. Investors have great confidence in Sea Ltd, knowing that there is no business in the world with identical revenue growth rates. Right now they are developing mass-selling mobile games and servicing FIFA Online and League of Legends.
What drives the growth of gaming companies
In search for stable and long-term growth, video game makers rely on three main drivers.
Increasing the user audience. This is a complex and capital-intensive, but effective strategy. The essence is to create a video game that will be played by both arcade shooter enthusiasts and perfectionists who only acquire storyline games. These are usually games with an open world, filled with hustle and bustle, unforgettable adventures and the ability to realize your dreams. Minecraft, the GTA series, Assassin’s Creed and Forza Horizon are examples of games that developed on this model and brought huge profits to developers. The recently released American gaming company Roblox follows this strategy, as do Take-Two and French Ubisoft.
Creating franchises and continuing development of popular games. The most popular strategy at present. The developer creates sequels to previous successful games: Assassin’s Creed, Call of Duty, Far Cry. The average player is more likely to pay attention to a game with a well-known and popular name rather than a completely new product.
Acquiring gaming companies and studios. This development model can be afforded by large investment companies and tech giants. Stillfront is an example of an investment company whose business model is based on investments in the industry and the acquisition of European game studios. In 2020, the Swedish Stillfront acquired two gaming companies. The first is American Super Free Games, which released Trivia Star, Word Nut, and Word Collect. The second is German Sandbox Interactive, with which Stillfront plans to release mobile games in 2021. In 2020, the company’s shares grew 174%.
The gaming divisions of Microsoft and Sony are developing along the same model. In 2014, the Swedish gaming studio Mojang, which gave us Minecraft, was bought by Microsoft for $2.5 billion. In 2021, Microsoft acquired Bethesda, one of the largest publishers, for $7.5 billion.
The financial capabilities of gaming companies are significantly limited. Not all studios are able to adhere to three strategies, so most companies focus on increasing the gaming audience and releasing new products for the games that have already gained popularity among the audience. It should be remembered that a billion-dollar deal can cost a gaming company its existence, while a tech giant is only threatened by temporary losses.
How to invest in video games
Most Western game publishers are publicly traded companies whose stocks are traded on stock markets. But it is not necessary to buy shares of individual companies.
You can invest in thematic ETFs focused specifically on video game developers and manufacturers of gaming hardware and consoles. There are currently five such funds in the ETF world.
The video game and esports industry is not limited to game studios and developers. It is possible to invest in technologies that make this industry possible. We are talking about software developers, hardware manufacturers, game consoles, computers, accessories, and app stores.
Companies such as Intel, Nvidia, Microsoft, Sony, Apple, Alphabet, and Asus are global blue chips and tech giants, including earning profits from the gaming industry. For example, in 2020, the App Store brought Apple a revenue of $64 billion, or about 25% of the entire corporation’s revenue. The gaming section accounts for 62% of the App Store’s revenue, or $39.68 billion. The App Store is one of the key drivers of revenue growth and a good opportunity to diversify the business away from mobile device sales.
Investments in video games and esports do not require any deep knowledge in the field of game design, programming, or software. To learn how the gaming industry works and how video games are developed, I recommend reading the book “Theory of Fun for Game Design” by Raph Koster. Don’t forget to keep up with announcements of new games, thematic forums, and industry trends. To do this, thematic forums on DTF and “Habr” are suitable.
Review of thematic ETFs
? VanEck Vectors Video Gaming and eSports ETF (ESPO)
One of the largest thematic funds under management, with about $830 million. The fund actively invests in American, Japanese, Chinese, and European companies. ESPO’s portfolio includes shares of 25 issuers. The fund has two key criteria for selecting companies:
- Game technologies and video games bring in at least 50% of the profits.
- The business model has an impressive growth potential.
Over the past year, the return on ETF has been about 76%. The commission is 0.55%.
The largest positions of the ESPO fund.
| Title | Share of ETF assets |
|---|---|
| Nvidia Corp | 8.43% |
| Tencent Holdings Ltd | 7.40% |
| Advanced Micro Devices Inc | 6.97% |
| Sea Ltd | 6.57% |
| Nintendo Co Ltd | 6.14% |
| Activision Blizzard Inc | 5.51% |
| Netease Inc | 4.81% |
ESPO will suit investors who, in pursuit of high returns, do not forget about serious risks. The fund includes not only stable tech giants and major game developers, but also young companies with good potential. Managers are paying increasing attention to mobile gaming and gradually building positions in European and Asian mobile companies. This could be a key driver of profitability growth in the future.
? Roundhill BITKRAFT Esports & Digital Entertainment ETF (NERD)
An interesting thematic fund, the feature of which is investments in companies that directly finance esports competitions and teams. NERD also focuses on gaming companies with small and medium capitalization.
As of March 31, 2021, the fund’s yield for the year was 126.70%. It currently holds stocks of 35 issuers. Since 2019, NERD has held large positions in the stocks of Huya – a Chinese gaming streaming platform, Tencent Holdings Ltd and DouYu International Holdings Ltd – a Chinese video game developer, which is why it has achieved such a high yield.
Management fee – 0.55%.
The largest positions of the NERD fund
| Title | ETF Asset Allocation |
|---|---|
| Modern Times Group | 5.54% |
| Corsair Gaming Inc | 4.93% |
| Activision Blizzard Inc | 4.90% |
| Razer Inc | 4.81% |
| Sea Ltd | 3.90% |
| Afreecatv Ltd | 3.79% |
| Electronic Arts Inc | 3.53% |
The fund is efficiently diversified and invests in various gaming projects and products. It is currently the most specialized fund in the video game and esports industry. It is suitable for those who have dreamed of becoming a hardcore investor and earning money from growth stocks.
? The Global X Video Games & Esports ETF (HERO)
Invests in companies that develop and publish video games, streaming gaming and esports platforms, gaming hardware manufacturers, as well as cloud businesses.
In structure, HERO is similar to the fund of the investment company VanEck, because it mainly holds positions in the stocks of large companies. The yield for the year was approximately 88%. This is primarily due to the strong growth of stocks in Nvidia, Sea Ltd, Embracer Group, and Netease Inc. The fund uses various strategies to maximize profits and focuses on medium-cap companies.
Annual commission – 0.5%.
The largest positions in the HERO fund as of March 31, 2021.
| Title | ETF Asset Allocation |
|---|---|
| Nvidia Corp | 6.94% |
| Sea Ltd | 6.69% |
| Netease Inc | 6.27% |
| Electronic Arts | 6.02% |
| Activision Blizzard Inc | 6.00% |
| Nintendo Co Ltd | 5.34% |
| Embracer Group AB | 5.15% |
This is the largest fund among all gaming ETFs: HERO contains shares of 45 issuers. In addition, it is also the most diversified. Only 30% of all assets are accounted for by the American market, while other funds exceed 37% in their share of the American market. The standard deviation for the fund since its inception is about 19%, which is very good for such a volatile industry. HERO is suitable for those who want to invest in large and medium-sized gaming companies.
Let’s compare the results of the funds with the technology index NASDAQ 100 and the largest American index S&P 500. The FXES fund is not on the chart because it was launched on July 7, 2021. /snp-nasdaq/ Investment strategies in S&P 100 and Nasdaq.
All three funds have outperformed the NASDAQ 100 and S&P 500 in terms of returns. In addition, there is a significant correlation between the three funds and the technology-based NASDAQ 100 index.
Remember
- Stocks of gaming companies can be high-yielding, but it is important not to forget about the risks. A failed launch of a new game can greatly affect the stock prices and create serious problems for the publisher. The smaller the company, the higher the risk that a failed novelty will be the publisher’s last game.
- To cover as many stocks in the gaming industry as possible, consider gaming ETFs. They demonstrate excellent profitability and are well diversified. Another way to invest in video games and esports is through the stocks of technology giants such as Nvidia, Microsoft, Intel, Apple, and others, without which new games would simply not exist.
- The main thing is to know how to allocate funds across different gaming projects and trends. This way, you reduce risks and increase your chances of catching that explosive stock.
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